Chocoladefabriken Lindt & Sprüngli AG

Ladies and gentlemen, welcome to the Half Year Figures 2020 conference call and live webcast. I am Sandra, the chorus call operator. I would like to remind you that all participants will be in listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. You can register for questions at any time by pressing star and one on your telephone. Webcast viewers may submit their questions in writing via the relative field. For operator assistance, please press star and zero. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Martin Hooke, Chief Financial Officer. Please go ahead, sir.

Ladies and gentlemen, it is my pleasure to welcome you to the Linden Springer Telephone Conference on the occasion of our half-year results 2020. During the presentation, I will provide some additional comments on the charts that were uploaded this morning to our website. and where a transcript of my speech will be available. I'll guide you through the slides via webcast. The presentation will take approximately 30 minutes. Following the presentation, I will hand over to the operator, who will then manage the question and answer session. The agenda points of the presentation can be seen on this chart and include our response to the COVID-19 crisis, a detailed review for the first half, our expectations for the full year for 2021 and in the medium term, and a chance for you to ask questions at the end of the presentation. I would also refer you to the disclaimer at the end of this slide deck. Before I comment the usual slides showing our financial results, I would like to take 10 minutes to share with you some additional information concerning the impact of COVID-19 on our business and our response to that challenge. Despite the extreme and exceptional nature of this epidemic, we are pleased that our existing systems with just a few additional measures have coped extremely well. Importantly, we decided not to fundamentally change our plans, though we did make a number of tactical changes to mitigate the effects of the pandemic. First and foremost, we wanted to ensure that our employees were safe and provided all the support they needed at the group level and, more importantly, at the local level. A central pandemic team in Switzerland, including the CEO and group HR, took charge of group-wide issues such as insurance and legal and monitored the latest global medical advice. Group-wide health and safety instructions were defined and the global supply chain was secured. In parallel, local pandemic teams were set up in each major location whose task it was to monitor closely the latest developments and to make recommendations to their local operations. A constant flow of information between the central and decentralized teams ensured that best practice was shared. All our factories and retail stores adapted new layouts and additional hygiene regimes that included social distancing, face masks, and hand sanitizing. Similarly, in our administrative centers, we adopted social distancing and limited the number of people in meeting rooms and other areas. In addition, we take the temperature of all visitors at reception before entry. At the peak of the outbreak, close to 100% of all administrative staff were working from home. More recently, as circumstances have allowed, this number has decreased to roughly 50%. Throughout the whole period, we remained fully in control of the day-to-day business. Working from home functioned extremely well and administrative productivity remained high throughout. Our existing logistics systems required no adaptation or additional measures, both for the inflow of raw materials and packaging to our factories and for the outflow of finished products to our customers. Everything worked well without disruption. Likewise, production ran smoothly and unhindered by the new hygiene regimes. Of course, we faced some rather unique challenges in the marketplace and had to balance shorter-term needs with longer-term priorities. We were determined not to neglect our employees, abandon our customers or sacrifice our longer-term objectives. Within that context, we were able to take a number of prudent actions to mitigate certain short-term negative effects, thereby maximizing demand, minimizing costs and optimizing our cash. To support the ongoing business, we maintained planned growth investments. We even slightly increased our promotional support to help our retail partners sell through Easter products. We maintained our usual high level of product innovation, especially for Lindor and Excellence, as well as the regular renovation of our seasonal ranges. None of our planned new product launches were postponed due to COVID-19. At the same time, we minimized costs and postponed investments if doing so did not conflict with our longer-term plans. For example, vacancies were not immediately replaced and budgeted new positions were not filled. Leases were renegotiated with landlords and expansion capex was postponed where it made sense in order to maintain our strong liquidity position. By contrast, we generally avoided layoffs and furloughed the majority of our retail staff. This was a cost that we were willing to accept. All the while and as planned, we have been implementing the restructuring measures in the US that were announced in January. We have even accelerated one of these initiatives which I will discuss later. Crisis or no crisis, we decided to continue to invest in our future sales and profitability and in our key brands. In fact, Advertising in the first half was likely higher in absolute terms than during the same period last year. We also continue to invest in projects that drive efficiency, so we are ready to leverage these assets as soon as demand returns. Last but not least, I would like to thank all our frontline employees for their incredible efforts in maintaining the availability of our products and meeting the needs of our consumers. On slide five, I would like to give you some insights as to how the pandemic has impacted the business on three levels, by sales channel, by product category, and by geography. You will see that we experienced positive as well as negative trends. An analysis of both is important to understand what can be expected once the pandemic ends. In the first box, you will see that the negative growth effects have come primarily from channels that were closed and therefore simply unavailable to our consumers. The main ones to mention here are our 500-owned stores, travel retail, food service in the US, and the traditional specialist channel in Italy. By contrast, we saw a substantial increase in our sales over the internet. Although our online sales are still small and we're unable to compensate, This increase has demonstrated the future importance of this channel. Indeed, our online business doubled in the first six months of 2020. In terms of categories, we saw considerable growth in self-consumption products as consumers treated themselves at home. For example, the Excellence brand grew double-digit. This proves that consumers have stayed loyal to our premium offering even if they have been unable to buy gifts for others. In key geographies, despite the major lockdown, we saw either modest growth, as in Germany, France, and in the US wholesale with both Lindt and Ghirardelli, or stable sales trends, such as in the UK and Spain. In Russia and other Eastern European growth markets, we achieved mid-single-digit organic sales growth while in Scandinavia we even grew double-digit. The resilience of these important geographies makes us confident for the future. The markets most affected by the COVID-19 crisis were Italy and Switzerland in Europe, and Australia, China, Japan, Brazil and South Africa in the rest of the world. The effects differed according to the timing and extent of lockdown in the various markets. In the US, all our stores were closed for an extended period and hence experienced a 100% shortfall during that time. Finally, the Russell Stogall brand in North America, with its focus on seasonal items and gifting, was heavily impacted during the Easter season. In June, at the lockdown East, group sales showed some normalization of trends, which is reassuring for the future. Let's now move to the final slide of this special introduction. As we look to the future, we continue to see a significant demand for our products, and we are more determined than ever to exploit that unchanged potential. We are confident because we have seen, even under the weight of such extreme external factors, that underlying consumer demand has remained buoyant. In short, for us, The new normal will look remarkably like the old normal. Over the medium to long term, we are maintaining the focus on our leader products, on premiumization and on our growth markets. We will continue our clear focus on the successful excellence and Lindor franchises. The premiumization of Anglo-Saxon markets, notably the USA, UK, Canada, and Australia, and our investment in new growth markets such as Japan, China, Brazil, and Russia, will continue to generate significant incremental business. In 2020, our investments in brands will be at least the same as in 2019. Our product innovation plans are unchanged and continue to represent an important part of our growth story. Even our geographic expansion plans are unchanged, as we see advantages in maintaining the pace of expansion in spite of the current external issues. We see online sales channels as an additional important growth opportunity. By developing an extensive network of of its own retail stores, Lint and Springly, has long recognized the importance of alternative channels as a means of generating additional sales and reducing dependency on traditional channels. Three years ago, we launched an e-commerce project with the aim of generating sustainable double-digit growth within this channel over the medium and long term. We are starting to see the first results of this initiative, with a doubling of this business over just the past six months, which accounts now for about 4% of our total revenue. We have just relaunched the lint.co.uk website and will relaunch the lint.com site in the second half. Our click-to-water business, for example with Tesco in the UK, and sales via third-party platforms such as Amazon and Alibaba, are now starting to drive substantial growth. We are still in the early phases of our e-commerce journey and, looking forward, we see enormous potential for the high value-gifting product range such as ours. Finally, as you know, we are implementing various initiatives in the US to streamline our operations for growth. Our plans in logistics, retail merchandising, and production are well on track and will be implemented as planned this year. In fact, we are bringing forward the closure of the redundant Russell Stover factory to August this year, seven months ahead of schedule. The retail network closures are progressing as planned and will continue into 2021 as scheduled. After this special analysis, of how we are managing the impact and implications of COVID-19, I will now provide the usual detailed review of our results. The organic topline results for the group was negative 8.1%. As discussed previously, we achieved different results depending on geography, category and sales channel. I will give you more details in a subsequent chart. EBIT came in at 17 million, which means that the EBIT margin was slightly above 1%. This is lower than last year, driven by the declining sales and the negative impact on cost absorption. Net income was 19.7 million, with the net income margin at 1.3%. We again had some positive developments on the tax side. Thanks to good progress in our negotiations with foreign tax authorities, the uncertainties with regards to transfer pricing risks could be reduced, resulting in lower current tax liabilities. In addition, the Swiss tax reform, announced in 2019, led to an additional capitalization of deferred tax assets in the balance sheet and correspondingly positive P&L impact. We are pleased that free cash flow reached 156 million in the first six months, coming in at about 10% of total group sales. Despite the lower operating profit and net income, we saw positive impacts from our proactive management of networking capital and CapEx. Our net debt position, which includes a lease liability of $470 million, increased to $567 million. This is likely higher than in December 2019, but lower than one year ago, when net debt was at $780 million. At this point, I would also like to stress the equity ratio remains strong at 57.7%. Despite the challenges to our top-line growth, mainly coming from closed sales channels, our balance sheet remains healthy and robust, with a strong liquidity position even after paying the special dividend in May. I already mentioned in my introduction the key drivers for half-year organic sales growth shown here on slide nine. But I think that it is worth pointing out how exceptional this year is. It is indeed the first time for more than 25 years that the group has registered negative organic sales. A closer analysis of the reporting period demonstrates that negative impacts occurred in just a couple of exceptional months. In fact, we had a strong start to the year and the game is strong June, after most of the sales channels reopened. In most key markets, regardless of absolute trends, we continue to gain market share with our key franchises, Excellence and Lindor. Therefore, it is clear that underlying consumer demand remained buoyant throughout, and this persuades us that future demand for our premium chocolate remains intact. On slide 10, we present as usual the sales growth in Swiss francs over the last five years. In most prior years, Swiss franc growth has been negatively impacted by the strengthening of our reporting currency. In the first half of 2020, this has again been the case due to the weakening of most currencies compared to the Swiss franc. The overall negative impact was 4.6 percentage points. Looking on slide 11 at the sales bid by market in the first half, North America reached 35.9% of total sales. Another important piece, Germany attained a 18.2% share with the UK approaching 6.8%. The rest of the world at 12.9% was the most impacted by COVID-19, especially in markets such as China, Japan, Brazil, and South Africa. Please bear in mind that these numbers are shown in Swiss francs. Therefore, all percentages have also been impacted by currency fluctuations compared to last year. The drivers of our sales results are shown in the chart here on slide 12. Group volume, in fact, declined by just 1.4%, but combined with a negative price mix effect of 6.7%, overall organic sales fell by 8.1%. As I mentioned above, the foreign exchange impact was negative 4.6% and this resulted in the 12.7% decline in Swiss francs. The key thing to understand is the dynamic within the price mix impact. The pricing impact was in fact slightly positive so that the negative impact came entirely from the mix. The negative mix was in turn driven entirely by COVID-related effects. In particular, the channel mix due to much lower sales in our own retail stores, as well as sales returns and participation in markdowns to support the trade sell-through of unsold Easter products. We now turn to slide 13 to review the key regional segments. In our biggest region, Europe, organic sales came in at negative 4.9%, compared to positive 5% at the half-year 2019, representing a better performance than the other two regions. We delivered a solid performance in important markets like Germany, France, the UK and Spain. In Scandinavia, without a lockdown, the key market of Sweden, growth was even double-digit. In the Eastern European markets, Russia and Czech Republic, Slovakia and Hungary, we also grew mid-single-digit. By contrast, In markets with a traditionally large Easter season, especially Italy, Switzerland and Austria, we suffered significant sales shortfalls. In addition, Italy had to close all its traditional retail stores while Switzerland suffered from a complete absence of tourists. North America's overall negative 8.2% performance hides positive underlying trends. Lint USA and Ghirardelli, in fact, demonstrated good resilience in the wholesale channel with low single-digit growth. Unfortunately, the closure of our U.S. retail store network during most of the first half led to a double-digit sales decline in that channel. Also, the important Ghirardelli food service business was negatively impacted by the closure of most restaurants and cafes. The extremely positive performance in e-commerce was an important sales driver, but e-commerce is not yet large enough to offset the negative impact from the closed stores. As mentioned at the start of this presentation, the online channel is a strategic priority for our business. Russell Stover's main business is focused on gifting and sharing, mainly during the important Valentine's, Easter and Christmas seasons. The start to the year was very strong with a good performance during Valentine's, but Easter sales did suffer in wholesale, compounding the shortfall from the brand's own retail stores. By contrast, we saw good sales momentum with the Russell Stover sugar-free range using stevia extract as a sweetener. We have continued to make good progress on various projects to further leverage the Russell Stover acquisition and on our overall streamlining initiatives in the US, which are mainly in the areas of production, merchandising, logistics and procurement and IT. We expect bottom line benefits from those projects in the coming years, which will be in part reinvested in the brands. Benefits have already started to kick in this year and as mentioned in my introduction, we are accelerating the closure of the redundant Russell Stover factory by around seven months. Overall, we are convinced that we are taking the right strategic steps for future success at Russell Stover and in the US generally, and that we are on the right track. Overall, in the rest of the world, we saw a decline of 18.4% compared to plus 8.3% in the first half of 2019. This region was the one most impacted by COVID-19, not least of all because we report travel retail in this segment. Due to global and local travel restrictions, sales in this channel came to a virtual standstill in the second quarter. As the first market to enter lockdown, China was impacted very early on and most severely, but we have seen nothing to make us doubt our positive medium-term assessment of this market. Brazil and Japan, which have been a focus for Lint retest store network development, suffered due to this channel being closed during a major part of the first half. South Africa saw a significant spike in COVID-19 cases, and a curfew was implemented across the entire country with very limited commercial activity, all of which led to a decline in sales. Australia was quite resilient in the wholesale channel, representing another positive sign for the future. In the medium term, we are convinced that we will again reach double-digit growth within the rest of the world segment. Indeed, many of these countries are large chocolate markets with significant premiumization potential for Lindt. Let's move on now and go through the different cost categories, starting with material costs on slide 14. Material costs, which have been adjusted for changes to inventories, came in at 35.3%, 330 basis points higher than in the previous year and 180 basis points higher than in 2018. There are two factors behind this negative development, one sales related and one cost related. As explained earlier, our sales volume declined only slightly, meaning that we did not produce did not produce and sell much less chocolate than in 2019. It is simply that we achieved a much lower net sales per ton, net sales being the denominator in this calculation. On the cost side, we have seen increases over the past 12 months in cocoa bean, cocoa butter, and hazelnut prices, which will have an impact on our full year results. Looking forward, we estimate that our overall material cost should be at roughly the same level in 2021 as in 2020. On slide 15, I would just like to take a quick dive into our most important commodity, cocoa. Development of the cocoa market over the next 12 months remains uncertain. The outlook depends heavily on the positioning of market speculators with an over-proportionate influence on the cocoa market. That said, the market currently expects a slight surplus for the 2019-20 harvest season, but a larger surplus of around 300,000 tonnes for the 2020-2021 crop. The surplus predicted for the new crop is the reason why cocoa futures have declined over the past few months. By contrast, the living income differential of $400 per tonne implemented by Ghana and Ivory Coast has helped push pricing in the opposite direction. Overall, as can be seen from this chart, cocoa bean future prices in London are currently trading at around 1,600 pounds versus around 1,700 pounds one year ago. At the same time, cocoa butter ratio has more or less stabilized at high levels of 260 to 270. This compares to a ratio of around 270 to 280 one year ago. Based on current market expectations and including the living income differential, we assume that cocoa bean prices for 2020-2021 crop will increase only slightly. Despite an absolute decrease of 42 million, personnel expenses were unable to keep pace with the decrease in sales. As a result, personnel expenses increased by 110 basis points. A large part of our personal expenses are fixed costs, and so the decline in the overall sales inevitably led to these economies of scale. Given that we expect organic sales growth to recover and normalize in the medium to long term, the ratio of personal expenses to sales is therefore expected to come down again in the future. Although operating expenses decreased by 47 million, the ratio increased by 100 basis points driven up by two factors. Here again, we experienced these economies of scale from fixed expenses such as warehousing costs. Secondly, as explained earlier, we maintained advertising investments at a high level and continued to invest in our brands in all geographies with the objective of emerging from the COVID-19 crisis as one of the structural winners. These two negative effects were partially offset by the positive impact of lower variable percentage rent expenses in our retail stores and other smaller runoff effects. Within the depreciation and impairment category, we also experienced these economies of scale, as depreciation in absolute terms was at the same level as in the first half of 2019. Key drivers for the increase of depreciation in recent years have been our CAPEX program, aimed at satisfying future volume growth, and the reporting of depreciation for right-of-use assets in line with the new IFRS 16 standard, effective from 2019. One of the biggest investments relates to our lint factory in Stratum, New Hampshire, in the U.S. which is planned to absorb the expected medium-term increase in volume from gaining U.S. market share. Due to the slowdown in 2020, we are slightly re-facing overall CapEx in that factory, leading to lower CapEx in 2020 and 2021 than originally planned. I will discuss CapEx in more detail later. The EBIT figure remained positive at 17 million or 1.1% of sales, but was significantly down compared to the first half of 2019. The decrease of nearly 110 million is due to the factors discussed at length in the previous slides and are primarily the result of the COVID-19-related diseconomies of scale and the negative mix impact on the top line. Net income also remained positive, coming in at 20 million or 1.3% of net sales. The decline in net income was less marked than for EBIT thanks to positive developments within financial items and income tax. Net financial expenses came in at 13.4 million, a decrease of 1.3 million or minus 9% versus last year. This was mainly due to the lower US dollar interest rate and the related lower hedging costs for subsidiary financing. As already mentioned, we again had some positive developments on the tax side, termed by the lower current tax liabilities related to lower transfer pricing risks and further capitalization of deferred tax assets related to the Swiss tax reform. Looking forward, and based on our current outlook, we consider a tax rate of 21 to 22%, be sustainable over the medium term, assuming no major changes in tax legislation. CAPEX from the first half came in at $117 million, at roughly the same level as last year. This is less than planned, given that we have decided to postpone certain growth-related investments. We now expect CAPEX to reach around $230 to $250 million for the full year, which is about the same level as in 2019. As communicated above, we are refacing our CapEx plans where it makes sense and now expect CapEx to be between 250 to 300 million over the medium term. As I take you through the bridge of the main cash-relevant developments of the first half, please bear in mind the impact of net debt of IR4S16 and specifically the lease liability with its negative impact of 470 million. At the end of the first half, net debt reached 567 million, much lower than the 780 million of one year ago, but higher than the 423 million at the end of 2019. Consequently, we are now more focused than ever on cash generation. Indeed, In the period under review, we managed to generate a pre-cash flow of 156 million. The increase in net debt of 144 million was mainly due to the special dividend paid out in May to our shareholders. In total, we returned 420 million to shareholders in the period. Given today's assumptions, net debt should end the year at around 350 to 400 million. Before the lease accounting change and on a pure cash basis, our expectation should be for around 100 million net cash. That concludes my review of half year results. Let us now look at future expectations. For the full year, The group expects organic sales to decline between 5 to 7%, while EBIT margin is forecasted to be around 10%. As additional guidance, as mentioned earlier in the presentation, we plan capex of around 230 to 250 million. Of course, everything depends on how COVID-19 develops, which nobody can predict with certainty. The most important assumptions for our 2020 forecast are that there are no major second COVID-19 waves that require further widespread lockdowns. The majority of our own retail stores remain open from now until the end of the year. The holiday season business comes in at around 2019 levels in most markets. Travel retail gradually starts to gain some traction though realistically sales in that segment will remain far below 2019. From now on, therefore, we expect momentum in our business to build. The group remains confident over the mid to long term of achieving its goals of an organic sales growth of 5-7%, combined with an average increase in EBIT margin of 20-40 basis points. Consequently, I can now confirm this unchanged guidance. In the medium term, and as mentioned earlier, we expect capital expenditure of 250 to 300 million and a tax rate of 21 to 22%. For the 2021 financial year, as our business bounces back, the group expects organic sales growth to be slightly above this medium to long-term bracket. We expect our EBIT margin still to be under some pressure next year, but back at around 15% within roughly two years from now. With this, I come to the end of my presentation and hand over to the operator, who will manage the question and answer session. We ask you to limit yourselves to a maximum of three questions, so everyone has the opportunity to ask questions. Thank you.

We will now begin the question and answer session. Anyone who wishes to ask a question may press star and 1 on the touch-tone telephone. You will hear a tone to confirm that you have entered a queue. If you wish to remove yourself from the question queue, you may press star and 2. Participants are requested to use only handsets while asking a question. Webcast viewers may submit their questions in writing via the relative field. Anyone who has a question may press star and 1 at this time. The first question comes from Warren Ackerman from Barclays. Please go ahead.