Safilo Group S.p.A (OTCPK:SAFLF) Q4 2018 Results Earnings Conference Call March 13, 2019 1:30 PM ET
Company Participants
Angelo Trocchia - Chief Executive Officer
Gerd Graehsler - Chief Financial Officer
Conference Call Participants
Cedric Rossi - Bryan Garnier
Alberto Checchinato - Fidentiis Equities
Henry Hillgarth - Quaero Capital
Operator
Good evening, and welcome to the Safilo Full Year 2018 results. This call may contain forward-looking statements relating to future events and operating economic and financial results for the Safilo Group. Such forecasts, due to their nature, imply a component of risk and uncertainty due to the fact that they depend on the occurrence of certain future events and developments. The actual results may therefore vary, even significantly, to those announced in relation to the multitude of factors.
Today's participants are Angelo Trocchia, Chief Executive Officer; Gerd Graehsler, Chief Financial Officer; and Barbara Ferrante, Director of Investor Relations.
I would now pass the call over to Mr. Angelo Trocchia, Chief Executive Officer. Mr. Trocchia, you may begin.
Angelo Trocchia
Hi, good evening, and thank you for attending today's conference call on the Safilo 2018 results. As a practice initiated a couple of years ago, at the end of January, we released our full year and fourth quarter preliminary sales, and we also provided a more precise indication on where we expected to close the year in terms of adjusted EBITDA.
Now, before we get into our full set of results, let me briefly summarize the few important things that we have been focusing in the year since when I joined the group in, around end of April. We had quite an intense period in which we have been clearly focusing on few clear priorities. First of all, we have been working on a new plan to turn around the company performance after some difficult years. We have been working on quite a comprehensive refinancing plan to secure the group's financial structure and keep working and investing on our core business as one of the main player of the industry. The third, we have been focusing strongly on our core business, strengthening our foundation. And last, but not least, in delivering our 2018 results.
In August, we presented the, an update of the company business plan. First of all, resetting the target we had for 2018, which became the base period for a 2-year project to revive top-line growth, and to recover a sustainable level of profitability by 2020. Everything we initiated in the second half of 2018 was done with a clear purpose of exploiting more and better the core strengths of the group.
Our brand portfolio covering all the key segments of this large and attractive industry, our product creation and development skills, and our DNA and historical that goes back to 140 years of manufacturing of very specific and very unique product, on top of our big and important worldwide distribution network. For all these reasons, we immediately and intendedly focused on shaping a new commercial organization in all our key markets: North America, Latin America, APAC, EMEA, bringing back capabilities and leadership from the industry, with the aim of improving our go to market and brand execution. But even more important, try and force to recover a strong customer relationship and really putting, thanks to these experienced people, putting the customer at the heart of what we are doing every day. In the second half of the year, we also paid quite a close attention to all our operations. And with a, and a sharper and deep focus on our investment in need in order to accelerate the alignment of the company cost structure to its current and envisaged scale.
So big focus on any kind of cost in operation in order any kind of cost to really make our P&L as sustainable as possible. At the end of September, we announced a comprehensive refinancing plan consisting of a share of capital increase of €150 million, and the new debt refinancing for another €150 million. The latter agreement was executed at the end of October, just before the approval of the capital increase by the extraordinary shareholder meeting and it matures in June 2023, while the share capital increase was successfully completed by January 2, this year.
Overall, this was a fundamental project, which, to be honest, we conducted in one of the most difficult years in recent memory for global equity and trading market, but that we will, we have successfully concluded. And also I think, this is a sign of a renewed partnership between Safilo and key leading brand, key leading banks, and reconfirmation of all the support of the group reference shareholders and our significant number of institutional and retail investor who joined the capital increase.
So a very reassuring message that the market has believed, has trust in the capital increase. And I really like, on behalf of Safilo, I want to thank everyone for the clear demonstration of trust in the company's key objective to improve its performance. The crucial task we had to accomplish in 2018 did not distract us from the day-to-day work and focus on our core business. We remain strongly committed on the renewal of important license agreement. We extended Kate Spade until 2020, we renewed Fossil until 2023, havaianas until 2024, Banana Republic and Tommy Hilfiger until 2025. Tommy Hilfiger is quite important, we are working very well and the results are very, very positive.
So the fact that together we have been extending till 2025 is a strong message for us. And we signed new agreements in December for Missoni and, at the very beginning of this year, for Levi's. These brands fits in a different way, but it fits perfectly with our portfolio. From our previous collaboration with the brand, we share with Missoni the same value of strong design, value and tradition, quality, and the sort of nature out intensity that the Missoni brand take within itself, which I think, is perfectly fitting with what Safilo stands for, Italian company, rooted in the history, which makes the quality, the heart of what we do.
With Levi's, we have instead an important opportunity to fuel growth in the contemporary segment, by the way, the largest foresight and development potential, and a very appealing further opportunity to grow in key emerging markets such as China. Our 2018 economic results were quite in line with our expectations. We closed the year with net sales of €962.9 million, down 4% at constant exchange rate, mainly driven by the weak performance of sunglasses in the fashion luxury segment, also impacted by the exit of Celine.
On the other hand, the year showed also positive results. The overall good performance of our own brand, driven by Polaroid and Safilo, whilst Muse and Carrera were pretty stable, the first against high comparator and declines in our business. While on the other side, Carrera, we saw the decline of the last few years up to low single digit and if we exclude the sport, which has been the decision to get it out, we had, this is a result which can be judged very positive and very encouraging for where we need to take Carrera. It was then also a very positive year for licensed brand in the contemporary and premium segment. I will not comment more on this, I think that Gerd will come back on this part of the, our portfolio, which is quite an important part. In 2018, we saw the first sign of improvement at operating level with the adjusted EBITDA margin improving to 4.9% of net sales from 4% in 2017, up 15.5%, mainly thanks to the progress in our cost-saving initiatives.
On the other hand, the successful completion by the end of the year of the share capital increase allowed us to close the year with a drastic reduction of our group net debt from €131.6 million at the end of 2017 to €32.9 million as of December, 2018.
I stop here, I hand over to Gerd and then I will come back at the end. Thanks.
Gerd Graehsler
Thank you, Angelo. So moving to our top-line performance. Full year net sales reached €962.9 million, down 4% at constant exchange rates and 7% at current exchange rates. In the fourth quarter, net sales increased by 1.3% at constant exchange rates and 1.8% at current exchange rates to €249.1 million. As we had already highlighted commenting the third quarter results, in 2018, the product supply business with Kering, which I remind you is entirely booked in Europe, was more heavily faced towards the second half of the year and in the fourth quarter, in particular. Clearly, this gave a positive contribution to the sales of the period, but also dilution effect of the gross margin as we will see later on.
At constant exchange rates, our wholesale business excluding the production business with Kering, was down 4.9% in the year and 3.3% in the fourth quarter. These latter results are slightly better than what we communicated in our preliminary sales as we more precisely allocated the impacts of IFRS 15 on the base periods. Adding on what Angelo has just commented and with reference to our core wholesale business, I would like to highlight the good performance recorded in the year by our prescription frames business, up mid-single digits at constant exchange rates thanks to round of broad-based brand improvement driven by some of our key licenses, namely Tommy Hilfiger, Hugo Boss, and Kate Spade, our proprietary brand Safilo, but also by the positive performance of Dior optical collections within our fashion luxury portfolio.
I'd also like to add that half of the decline we reported in the sunglass business was explained by Celine in the base period, net of the new Moschino and rag & bone business in 2018. By geographical area. In Europe, full year net sales were eventually in line with 2017 representing the biggest portion of our total business, 46.5%, and closing the GAAP accumulated in the 9 months after growing 25% in the fourth quarter at constant exchange rates. The performance of our business in Europe, excluding the production agreement, was negative by 4% in the year, while we recorded a significant improvement in the fourth quarter, up 12% at constant exchange rates.
In the year, European sales were more heavily affected by the high weight of Celine in the base period and by the weak trends recorded by sunglasses in the fashion luxury segment, in particular in the second and third quarter. On the other hand, the region had a very positive broad-based progression in prescription frames, up around plus 11% in the year. Looking at the improvement recorded in the fourth quarter, the period benefited of easy comps but also of healthy underlying trends, in particular in the Iberian markets, Germany, and Central and Eastern European countries. It's worth mentioning the very good season Polaroid enjoyed in Spain, which is a highly competitive marketplace, where Polaroid has become a business case that we want to leverage and reapply also in other markets. In North America, full year net sales declined by 8.1% at constant exchange rates and by 9.5% in the fourth quarter, with the wholesale business remaining soft, down 6.6% and 6.7% in the respective periods.
Sales at the 80 Solstice stores in the United States declined by 16.5% in the year and by 23.9% in the fourth quarter. A weak performance caused by a combination of declining traffic, for which our comp sales were negative by around 7% in the year and 12% in the fourth quarter, and of course, the closure of 22 stores as part of the restructuring plan. Q4 had a tough base of comparison in terms of the business with chains, as we have lost some listings at the end of 2017, and on this front though, we think that we have done some significant steps forward, for instance, in terms of improving trade terms so that we can regain trust and have soon again new business opportunities with these players.
Moving to our business performance in Asia-Pacific and in the rest of the world. We had a challenging second half of the year in both areas. In the full year, sales in Asia-Pacific closed positive, up 2.1% in constant exchange rates while declining 19.2% at constant exchange rates in the fourth quarter. The full year performance was supported by the positive performance, again, of our prescriptions frames business, one of the challenging comps base, Japan, Australia, and Korea were the weakest spots in the period. At the beginning of November 2018, we appointed a new Commercial Leader for Asia-Pacific in Greater China, Connie Lai, seasoned in our industry and now equipped with the aim of strengthening our business development capabilities in the region, fulfilling an opportunity that we, as a company, still have to catch, which is the diversification of our business portfolio in terms of brands and in terms of geographies.
The year was down 8.6% at constant exchange, and the rest of the world declining by 21.6% in the fourth quarter. As highlighted already in the third quarter, when the decline in the region had somehow exceeded our expectations, the negative performance here was entirely due to the business managed by Middle East and African distributors, which were exiting the second half of 2017 with elevated stock levels compared to consumption and hence, we saw this slump in the order taking this year. On the other hand, we want to highlight the positive performance of India, which represents now 14% of the region and is growing by over 20% in 2018, thanks in particular to the positive development of our proprietary brands and Carrera.
Also in EMEA, we have a new leadership, our latest appointment, Andrea Zaffin, who has become Commercial Leader of EMEA, managing India, Middle East and Africa, has more than 15 years of experience in the industry and the region. And finally in Latin America, which is one of our most promising regions within the emerging markets, we had a decent year, a more moderate decline in the fourth quarter and particularly a good performance in Mexico. And as Angelo was alluding, also here, we have appointed new leadership, David Anabitarte, was appointed beginning of October 2018 as the new Commercial Leader for Latin America. And David has also over 20 years of industry experience and an in-depth understanding and close relationships with the key customers and partners of this region.
Moving now to our economic results and starting as usual with our industrial performance, gross profit in 2018 equaled €481.5 million, down 7.3% compared to the previous year with the gross margin at 50.0% of sales compared to 50.2% last year. At constant exchange rate, the margin was instead up, by plus 20 basis points. In the fourth quarter, gross profit equaled €115 million, which is up 2.7% compared to the same quarter of 2017, while the gross margin improved by 50 basis points from 45.7% to 46.2% of sales.
Key drivers of the stability we reported in the year, at the gross margin level, were first of all, a positive planned performance, which allowed us to increase cost of goods sold, efficiencies and counterbalance negative volume mix effect, resulting from the contraction of our wholesale revenues and also the unfavorable impact from ForEx. Looking at Q4 gross profit, I would point out the 50 points margin improvement was somewhat capped by higher obsolescence cost we incurred at the end of the year, as previously mentioned, also by a greater dilution from the higher production business with Kering in the quarter, which comes at a much lower gross margin, of course.
At the operating level, adjusted EBITDA 2018 was €47.5 million, which is up plus 15.5% compared to 2017. The adjusted EBITDA margin increased to 4.9% of sales from 4%, while at constant exchange rates, the margin improved actually by 130 basis points compared to the year before. In the fourth quarter, the adjusted EBITDA equaled €10.3 million compared to the loss of €2.1 million we incurred in the same quarter of 2017, and the adjusted EBITDA margin moved from 0.8% negative to positive 4.1% this year. 2018 overhead cost savings finally totaled €26 million at the top of the expectations we had for the year. In the last 3 months of the year, as Angelo said before, we paid close attention to all operations driving a sharper investment focus and a very close eye on all the spending.
The final comment I want to make on the Q4 adjusted EBITDA is that its overall improvement, on top of what we have already commented on gross profit, was also capped by the negative retail performance, which was diluting the group operating performance by 70 bps in the quarter. We closed the year with an adjusted group net loss of €26.7 million compared to the loss of €47.1 million we recorded in 2017. Beyond what we have already described, the main additional items to explain our bottom line are on one side higher net financial charges which were €17.3 million compared to €14 million in 2017, which is reflecting an increase in net interest expenses due to the higher utilization of the revolving credit facility during the year.
On the other hand, income taxes declined from €29.4 million to €9.2 million mainly due to the reduced U.S. federal tax rate and lower write downs of deferred tax assets. Now to the free cash flow of the year, this was negative for €25.6 million compared to a negative flow of €70.1 million in 2017. And as you know, 2018 included the third and the last compensation payment of €30 million received in September from Kering. In 2018, cash flow from operating activities equaled a positive generation of €2.7 million compared to an absorption of €31.1 million in 2017. Key drivers of this result were the improvement in EBITDA, and a cash flow from the recovery of tax credits. Networking capital equaled an absorption of €17 million, and this was characterized by lower inventories and the days on hand improving by 4 days in terms of the constant currency, which is a positive driver that was more than counterbalanced by a significant reduction in trade payables.
Net investments in the year equaled €28.3 million, which we dedicated to our product supply and logistics network as well as to the continuation of the rollout of new IP systems. Concluding our full year review with the net debt, as already said, this stood at €32.9 million compared to €131.6 million at the end of December 2017, with the leverage ratio of 0.7x on adjusted EBITDA. The significant decrease in net debt reflected the proceeds from share capital increase, which was approved by the extraordinary shareholders meeting on October 29 and successfully concluded on January 2 of this year, when Multibrands subscribed and paid all the ordinary shares which remained unsubscribed at the end of the rights auction for a total consideration of €17.7 million. This last amount, net of the capital increase costs, was therefore not booked at the end of 2018 and we will have it in Q1 of 2019.
Angelo, back to you.
Angelo Trocchia
So thanks, Gerd. So 2018 has been quite an intense year for Safilo, but a lot has been done but still a lot to be done looking forward. And this is why, especially with focus on the top line, what we aim for this 2019 is to gradually improve our top-line performance and to finish the year with our wholesale business in growth territories. The key levers to achieve this important target clearly rests on our renewed and skilled group of commercial leaders, as we have already discussed. This is in place, up and running, since a few months and we consider this new team the foundation for the company to really rebuild the needed strong relationship with our main partners.
As discussed in August last year, the work we initiated in North America and Europe, and that we are now continuing in 2019, rests on our ongoing plan to step up service and customer care. Also on the strategic front, customer service, which I remind you, is a core element, especially in the current competitive environment to grant all the opportunity to keep growing the prescription frames business. We appointed a strong and experienced leader and we are now proceeding with the implementation of the needed ICT improvement, which will allow reliable product information in terms of client visibility on the order status and future product availability.
We have also upgraded our aftersales service, enhancing spare parts availability and implementing more extensive new warranty policies. In 2019, we will keep investing in customer service as a core driver to become a much more customer-centric organization. As you may remember, we have a new Chief Commercial Officer leading North America since July last year, Steve Wright, he has been working on building a stronger internal organization and more, and rebuild and reinforce more specific competences, which are needed in a such big market. You may also recall that the focus in this region is also to improve the trust and confidence in the company from a delivering service standpoint, reducing complexity, improving speed to market, and becoming, as said, a much more customer-centric organization.
This is clearly very important in order to strengthen our business and especially our historical strong relationship with the FIOS, the independent opticians. But also reinvent our self and become better equipped to work multichannel with more tailored proposition and tailored credit terms approach to the different customers. In our emerging market, Brazil, China, Japan, EMEA, our recently appointed leaders are working to develop new alliance and partnership in order to drive distribution enlargement and brand portfolio diversification. In some specific cases like in Japan, first important goal we have achieved was to reconquer the shelf space we lost in the previous years in a very important key account. In the course of 2019, we think we can build a better, more sustainable business also in this strategic account.
In China, under the leadership of Connie, we are upgrading and reinforcing our commercial capabilities to partner with customers in a way more relevant for what the Chinese market is asking for. For the year, we expect to confirm positive performance for our Own Core Brands, with Polaroid and Smith possibly as the key drivers as well as for our contemporary and premium portfolio. We expect a better years also for our luxury brands also behind a more stable performance of Dior. As a reminder of this year, the production volume guaranteed by the agreement with Kering half in 2019 compared to last year as the regional contract. With this decline more evident in the second half of the year as order and deliveries of this business are mainly phased in H1.
So bottom line this year, we will continuing our work to rebuild a sustainable economic performance, driven by the building blocks that we have been talking in our business plan. The year should deliver a visible recovery of our gross margin, which is expected to benefit of the cost-saving projects across plans, sourcing and P&L and a positive price mix effect helped also by the expected decline of the production business with Kering. Overhead expenses, mainly at headquarter level are also expected to further decline in 2019. We are without any doubt in the mid of a transforming the company to keep pushing, to keep pursuing our present and future opportunities, as well as to be ready to face and overcome our challenges. As part of these undertaking, we are putting our core business, our core competencies and know-how at the center of our action plan, avoiding any unnecessary complexity and refocusing the available resources on real priority behind brand and country.
So finalizing it, I mean the '19 is here, we are ready to go for it and we are ready also to answer to your question.