F.I.L.A. - Fabbrica Italiana Lapis ed Affini S.p.A. (FILA) Earnings Call Transcript & Summary

Good afternoon. This is the Chorus Call conference operator. Welcome, and thank you for joining the FILA 9 Months 2023 Results Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Massimo Candela, CEO of FILA. Please go ahead, sir.

Good afternoon, and welcome to this 9 months presentation. No doubt, I am very satisfied about the results we are delivering. I'm referring to sales. I am referring to EBITDA. I am referring to cash generation and also net income. What EBITDA is concerned, the most important message is that we have regained what we consider a consistent profitability between 17% and 18%. I think multiple times I have recalled in the meetings around the world that this target was our primary target, and in these 9 months, we are happy to show this result. In terms of net profit, I think the result is important. In a year in which we have been forced to manage a very high cost of financing and the fact that the company has been able to deliver net profit growing versus last year, I think it's a very important message. Net bank debt is even more important, we have been able in 9 months to generate also EUR 50 million free cash flow in advance of a possible extraordinary project that all of you are informed in India. So I think this is very important because, in -- after COVID, and after the acquisition in North America that has put the group in a leveraged situation, we are clearly showing a very strong path towards the reduction of the debt. So these 9 months show a very strong capability of generating cash and improving the working capital. In general terms, we can say that we are having a very strong year, almost everywhere in the world, except for Europe. In Europe, due probably to the weak economy and the high interest rate, we are really seeing a very strong, I would say, beyond every logical expectation, a very strong destocking process from our customers. So this means that for the coming quarters, the end of '23 and coming quarters in '24, our expectation are for a better environment also in Europe, but clearly in 2023, we have been able to record this kind of trend. In United States, we are seeing a very healthy growth and with a very nice profitability that we have been able to generate after our -- an Italian manager to cover the responsibility in North America. In Mexico, we see double-digit growth together with a strong increase of the Mexican pesos, which will help us in the consolidated balance sheet. In India, as you all know, now it's almost 2 years that we experienced a growth between 30% and 40% a year, that we can confirm also for the coming 2023. Considering these 9 months and not seeing significant variations during October and November, we can confirm what we said during the last call in August in which we had increased the targets of EBITDA beyond EUR 120 million threshold. And we have confirmed that cash generation will be at the high end of the -- between EUR 40 million and EUR 50 million. Now I ask Cristian Nicoletti to explain in detail the results, and I will welcome your questions later.

Thank you, Massimo. Good afternoon to everyone. You should have received the presentation and please go to the first page. Revenue. Adjusted core businesses were EUR 614.2 million, plus 3.2% on 9 months 2022, plus 6.7% at comparable FX rate. As Massimo said, Asia and Central and South America saw significant organic growth, plus 32.8% and plus 21.4%, respectively, thanks to the strong performance, particularly in the school and [indiscernible] segment in India and Mexico. I'd like to highlight in particular the performance in North America, plus 3.5% on the 9 months 2022. As you already know, since the beginning of January, FILA Group management focus was moved to North America, with aim to bring back the subsidiary to the historical level and profitability to consistent growth. In Europe, the scenario is still complex and strongly influenced by the high cost of money, which was -- which had, sorry, generated important destocking aspects. Adjusted EBITDA in 9 months 2023, excluding IFRS 16 impact, was EUR 108 million, plus 13.1% on 9 months 2022, plus 13.3% at like-for-like exchange rates. Highlighting a more than proportional growth than their revenue thanks to positive performance in [ parts of ], in North America, in Asia. Adjusted EBITDA margin was 17.6%, with a significant increase of 150 basis points on the same period, thanks to the positive asset generated by price increases and the cost efficiencies in North America and to the result of the [indiscernible] actions implemented on process and [indiscernible] costs as well as working capital management. Net profit, the total adjusted net profit, excluding IFRS 16 impact was EUR 45.1 million, plus 4.9% on 9 months 2022, thanks to the strong operating performance despite higher net financial expenses at EUR 23.4 million compared to the ones of the same period the previous year, of which [ 25 -- 21 ] -- sorry, EUR 21.5 million, mainly related to increase in variable interest rates. Adjusted group net profit was EUR 39.1 million to the growing contribution of minorities to EUR 6.1 million, significantly up to EUR 3.6 million in 9 months 2022. The net bank debt over the last 12 months was EUR 367 million, EUR 415.6 million in 9 months 2020, with a decrease in the last 12 months of EUR 48.6 million, decrease of EUR 45.5 million (sic) [ EUR 47.5 million ], excluding the positive FX asset of approximately EUR 9.3 million and negative M&A assets of approximately EUR 8.2 million related to the acquisition by [ Clapjoy Innovation ] Limited Corporation. Adjusted free cash flow to equity was positive for EUR 6.4 million, negative EUR 24.1 million in 9 months 2022, with an improvement of plus EUR 30.5 million on 9 months 2022, mainly to the higher operational cash flow generation and lower working capital absorption of EUR 34.2 million, following the release inventory in line with our expectation, mainly in North America, partially mitigated by higher CapEx for EUR 13.2 million, almost related to Asia to support the growth and higher net financial expenses for EUR 3.7 million mainly to the interest rate increase. Now we are ready for Q&A section.

[Operator Instructions] The first question is from Niccolò Storer with Kepler.

The first 1 is on India. If you can give us the latest on the IPO process, and which is the expected time table to date? The second one, still related to Indian DOMS IPO. If you can share with us how much of the extraordinary costs reported year-to-date are related to the IPO process? And the last question is on Europe. I've made some calculations, and in Q3, probably we were down organically 10%. So maybe if you can comment on what's behind this drop? If it's just finance dragging down the figure or if it's school? And maybe also if you have a view on how the sellout is doing because we are talking about destocking, but we do not know whether customers are buying products or not.

Good afternoon, Niccolo, and thanks for your question. So concerning question number one, in the IPO, everything is moving on time, and also, I can say, in the best way possible. There is a huge interest in this IPO and in this company. We just finished the road show. And in this moment, we are simply waiting for the green light coming from the SEBI, which is the authority of the market. Once the green light will come, and it is expected in the next maximum the next 10 days, you have to retrocalculate 30 days from the green light to the day of the listing of the shares. So I would say, compared to the information we have shared with you in the last 4, 5 months, no news, good news. And we do expect the listing happening before the end of the year. Concerning extraordinary cost in 9 months results, Cristian, can you please answer and maybe give some detail on this extraordinary costs.

Absolutely. Okay. Relating to the extraordinary cost on [indiscernible] 2023, we have no extraordinary cost related to IPO process. We'll take these costs when will happen, the IPO cost -- the IPO process. They mainly part of the ordinary costs that we [indiscernible] months 2023 [indiscernible] the reorganization restructuring costs in North America. We are facing the reorganization. And in [indiscernible], we are working on to complete the closing of the [indiscernible], the process -- the activity that we hope finalized within 1 year, more or less. The reorganization in Russia due to the commercial reorganization activity. And the other one is a closing activity, legal consensus in North America [indiscernible] that is and consensus that we have received from the past over [indiscernible] that they are the main extraordinary cost that we paid in 9 months 2024.

Okay. Thank you. For what Europe is concerned, I have to ask Cristian if the figures that Nicola reported, so minus 10% in the third quarter is accurate because I don't have you on top of my mind.

Okay. We said at the end of 9 months 2023 and negative, more or less 6%, in line the previous...

How much?

the year-end, 9 months minus 6%, 9 months.

Okay. and the single third quarter?

Should be -- just a moment.

Okay. So while Cristian is double checking the numbers for the third quarter, your question is whether it is divided between Fine Art and School. Yes, proportionately, the reduction is more or less the same. Why this weak performance? So first of all, I have analyzed the trend of the market and FILA performance is in line with the market reduction that is mainly due to the very weak rate of birth that is now affecting all Europe and a weak economy since, I would say, in Europe, especially after June we see very strong sign of recession in many businesses, and this has increased the trend of our customer to strongly destock. And when I say strongly, I really mean strongly and outline this because our expectation for the quarters coming are proportionally improving as from our opinion, customers are over destocking. So they are targeting a very short-term result without considering the impact on service due to their priorities in cash generation, but this is not sustainable. So really, we think the performance of Europe in this moment is worse than the reality, but we'll have a clear measure during the course of 2024. Nothing I think that the sell-out in terms of the product mix is current with our history. Of course, when you see that the number of kids that are attending schools, for example, in Italy and in Spain in the last 5, 6 years have gone down 18%, despite FILA is performing well or taking market share from the competition or from private label there is clearly a limit in this improvement. Again, we need to understand the magnitude of the destocking to better evaluate what will happen in the fourth quarter. Cristian, do you have the number ready for Europe third quarter standalone?

Yes, we confirm 10%, negative. Correct.

The next question is from Isacco Brambilla with Mediobanca.

A couple of questions from my side. First 1 is on net working capital, probably the most pleasant surprise of the release with the sharp decrease in net working capital. Just wondering if you have any specific target in terms of net working capital on sales for the full year 2023, you could share with us? Second question is on North America. If I take the increased performance of the third quarter, we should be in, say, flattish territory. Just wondering if there is any [indiscernible] discontinuation of nonprofitable sales driving this slowdown or if it is a market trend?

So concerning the first question, so the net working capital, as you could appreciate, we are quickly reaching our target that was in the area of 40% on sales, if you recall. I think that we are quickly improving this ratio, and this should not be a surprise because we have SAP now working and efficient all around the world. Last but not least, there are much less frictions in the supply chain. You probably recall the last 2, 3 years, how many problems we have in logistics in shipping. And now the situation is more regular. So the level of safety stock that we have been able to reduce. And so all in all, I think the target -- remember, before COVID, we were targeting something around 38% to 40% of working capital on sales, and we are quickly reaching this level, thus generating very nice cash flow. Concerning North America, the sales, Cristian, maybe you can give us a more precise numbers, but it's not flattish. I think we are growing in dollar denominated, but you have to consider that the dollar has strongly lost value compared to September 2022. But on top of my mind, I think we are between 6% and 7% of lower dollar versus last year. So this clearly has an impact in euro-denominated top line. Yes, of course, the activity we have put in place have substantially worked also on profitable sales. I think we anticipated that we want to be much more efficient in North America also to reach a satisfactory level of service to improve the quality of the business we are managing. Also from an organizational point of view, so an internal organization, we have reorganized the company. We have organized the processes. We have implemented a price increase, and we have implemented a new product with better margins. The result, I think, is extremely positive. As you can see in Page 5, the adjusted EBITDA by geographical area is really a substantial big number. So we are talking of 45%, 46% of EBITDA coming from North America that I think is very important also. Because in North America, the trend of rate of birth is more stable and not expected to go down in the coming years. So before finishing the answer, this morning, during the Board meeting, I was recalling to the Board member that in 2019, we made a substantial acquisition in North America, increasing the level of the debt. Unfortunately, then we fall into COVID period and inflation period. So really, in North America, we have never demonstrated how good was the acquisition we have made. Well, now I think the numbers speak to themselves. I think the step we made in 2019 now put us in a much more comfortable position, safer position that is telling us the company is profitable and more than that can generate very good cash.

The next question is from Alessandro Cecchini with Equita.

The first 1 is about the financial expenses. It's likely that this year to the cash level you are running at EUR 7 million each quarter to reach around EUR 30 million for this year, if I am not wrong. I would like to have your view about the financial expenses for next year, including, I mean, the potential IPO process of the India subsidiary or even without it. So considering your step down in financial costs, lower gross debt, so just if you could elaborate a little bit more on this, of course, at current interest rates. My second question understand, is still about Europe. Sorry about that, but it's important. So third quarter was minus 10%, so very harsh. So if I understood it correctly, you are seeing a better fourth quarter, so positive organic growth in Europe? Or it's still too early to see a revamp of sales due to the end of destocking? My third question is about -- so basically, you are deconsolidating, so we hope that you will end the process in India and then you will consolidate the India business that is fast growing, very nice and so on so. So I was just wondering if you are trying to find a new potential emerging market with similar opportunities to grow there or to expand the M&A? And finally, my last question about North America. So the here, a very, very nice improvement in margins. So we are talking 18.5% in 9 months. probably will reach 70%, so the target already this year. So just looking if there is more room to extract value there or, of course, you are already happy about this level of profitability?

Cristian, can you please answer the first question of Alessandro?

Yes, of course. Alessandro, we confirm the expectation of the interest at the end of the year. In particular, I want to highlight that the scenarios of the interest, variable interest is completely different what we have assumed at the beginning of the year. Because at the beginning of the year, we wer roughly on LIBOR 2.2%, more or less and SOFR, more or less 3.5%. Today, we are on LIBOR that is roughly 3.8%, and on SOFR that is more or less [ 5.1% ]. Considering this variable interest increase, the book managed very well the impact of interest rate because [ this year end ] that we have [indiscernible] agreement covered for [ 6%-5% ], irrespective of 2020 is completely different. We are working to reduce this impact with cash pooling on cluster Europe, working to reduce as much possible [ external line in Mexico ], where we have interest for 50%, and we have seen the decrease of fees in North America. This is the scenario that we are working on, and we can confirm that we reach our target, more or less between EUR 28 million to EUR 30 million. Related to scenario of '24 depend on the success that we hope about IPO process, we consider [ the scaling ] without saving considering the [ scaling ] for EUR 10 million next year, Considering India in our paremeter, the savings will be there. I can confirm this.

So thanks, Cristian. Concerning the second question, Europe in the fourth quarter, yes. I think the situation will -- in this moment is slightly improving. In Europe, again, you have to consider that Europe has a very specific features in terms of distribution. It's an old type of distribution. It is characterized by thousands of small customers. So what happened in Europe, generally speaking, you can understand a little bit later in time. It is sure that destocking has been massive. So in this moment, of course, customer has taken the opportunity to destock during back-to-school. And of course, as many of them are below the threshold, the reasonable threshold, yes, we see a more regular trend for the last fourth quarter. So I would answer to this question, a slight improvement. Concerning new India, I think that India is a very unique country because it's probably the country in the world with the youngest population. I think that it's not easy to find a country in which you have a rate of instruction that is quickly growing. So it's probably a unique situation. Of course, we enjoy -- we will probably as the IPO, probably as the IPO will touch the very high end of the range that we expect, probably FILA will end up with a higher level of share participation, share interest because we strongly believe in this country. So this is good news. There are areas of the world in which we definitely can do a better job in South America and in Southeast of the world. I don't see any project of the magnitude of India, of course. I see extremely interesting opportunities coming from the old world, so mainly from Europe. This situation, when FILA is commenting probably the best year of its history, in the same time, we see balance sheet and economical situation of direct competitor extremely weak. The reason is because we are exposed to North America, to Mexico and India, while competition is more focused on Europe. And in Europe, the situation is complicated. I see, in the 3, 4 years coming, strong aggregation of the business. And here, we can enjoy great opportunities in the coming years. Concerning U.S., U.S. has reached an extremely and higher-than-average profitability compared to a FILA balance sheet. Clearly, U.S. is a market in which you deal with very few customers. If you are able to manage properly the supply chain and the relationship is a market in which, #1, it's easier to do business when you deal with less customers. It's a market that is more stable in terms of planning. So you have less impact from destocking or from a very long chain of distribution. Still in Europe, the biggest part of the business is made through wholesaler and small retailers. So the fact that after the deconsolidation of India U.S.A. will represent more than 50% of our turnover, but we'll enjoy a super efficient supply chain because we have focused our resources in Mexico and in India. Both countries enjoy almost no duty Mexico, or very low duty to import in North America makes FILA extremely efficient to manage U.S. market and customers' expectations. So I think that we should enjoy this level of profitability. And in the coming 12, 18 months, finally, we will finish the extraordinary cost because we still pay lease for buildings and warehouses that we are not using. And these costs in this moment are falling into the extraordinary. Finally, these leases will end, and this will help us to increase the cash generation and substantially go toward zero with the extraordinary costs. So we are quite positive for the -- for what U.S. market is concerned.

Okay. A follow-up on financial expenses. I didn't understand if it's EUR 10 million reduction year-on-year, including the IPO process or I mean, excluding. So just if you could give more granularity on this? And you spoke about -- during the call about Europe outlook for 2024. So I was asking you if you have some specific actions on profitability because, of course, you look very good in the U.S. while, of course, also due to top line margins in Europe were weaker this year.

In Europe, we don't have offer better. We have some specific commercial action. We are learning from what is happening this year. And we think we are going to be a little bit more aggressive. Again, we are not negative or slightly positive for next year. So for Europe, we see a recovery for 2024. For what is the financial cost is concerned, we really -- at the situation where we are today, we do not consider any more the possibility that the IPO will not happen. We have advanced so much that we do think the IPO now is almost a reality, is effect. So the EUR 10 million less interest rate, which means EUR 2.5 million per quarter, we think now its effect starting from January 2024.

Next question is from Pietro Nargi, Intermonte.

The first 1 is about top line. If my conclusion were correct, the year-on-year organic growth in the third quarter was about 4.5%. So if you could provide a split between the pricing component and the volume. The second question is on profitability. Looking at the Asian market, it seems the Asian market is performing very well in terms of margins, with 20% margins in the third quarter, right below the first half results in terms of the margin. If you could provide the main drivers underlying this strong performance? And the last 1 is about CapEx, if you could provide with an update on the expectation for the full year '23 on CapEx?

Excuse me, can you repeat what year for CapEx 2024 or 2023?

2023.

Okay. So for what sales is concerned, we have a quite negative impact from exchange rate. If you go back to Page 4, our sales are in the area of 3.2%, while if we consider the same or comparable exchange rate, our sales will grow around 7%. It's written in Page 4. And...

I was referring to the third quarter, not the first.

Quarter stand-alone, that number, I don't have in front of me, sorry, especially because I'm not in the office today. So Cristian, can you please answer because I don't have this number in terms of resources.

[indiscernible] your assumption. We have an increase of [indiscernible] [ 31 ] the end of June and EUR 4 million [indiscernible] only 1 quarter.

Yes. I was talking about 4.5% year-on-year organic growth in the third quarter that is compensated by a reduction of about 7.4% due to FX, meaning the year-on-year growth is negative by roughly 3%. So my point -- my question is about the pricing component and the volume one. So if you could split the organic growth across these 2 components.

No, I think we are not able. But anyway, I really have hard time to understand the question because 93% of our sales or 70% of our sales are outside Europe, which means that you have analyzed by currency and by product mix and by -- also by price mix because, for example, in India, the unit price is much lower than in Europe. So I think to talk about a single trend worldwide is really meaningless. So it's a kind of analysis that we do not perform it makes sense by country. So unless Cristian is able to answer, I am not really in a position to answer how much is volume? How much is price? Because again, in India, unit price is much lower, and then you have to consider the exchange rate. While coming back to your question on margins, yes, in Southeast of the world, margins are definitely growing. And I think I explained this in the recent -- in 1 of the recent call. There is definitely an improvement. There is, #1, an operational leverage for especially in India. When a company grow between 30% and 40%, of course, the overhead percentage tend to have a lower impact. Then the company now has reached a threshold, which is recognized a leader in terms of innovation, in terms of image. And in terms -- now it represents a bit the rising star. So we have been able to increase prices versus competition. In the past, there was much more sensitivity on prices, especially in India, while now our consumers tend to ask for our product. Last but not least, India has not suffered like Europe from the consequences of Ukraine war. The reason is very simple. We have -- there is a ban on Russian raw material, while in India, there is no ban on Russian raw materials. So the inflation of raw material in India is much lower than the inflation we have in Europe. So clearly, this has helped a lot the improvement of our margins. For question #3, Cristian, maybe you can answer about CapEx, please.

Okay. Yes. Related to composition investments at the end of September 2023, the main part are related to the terms of development. You remember that we had EUR 25 million. We have roughly EUR 10 million by Amazon land, is the capability of the company. And our expectation for 2023 is to conform our budget that is roughly EUR 30 million of your EUR 33 million roughly.

[Operator Instructions] The next question is from Sabrina Jada Calcina, Intesa Sanpaolo.

I have a question on the pricing policy in the U.S.. I know that you probably don't need to change any price/mix there. But I was wondering if you're thinking to apply, sooner or later, the same price/mix in Europe or an entry-level price product?

Sabrina, for your question. So if I understood well, your question is, if we are going to increase further prices in United States, no, because we have increased prices last time in January 2023. We are happy now with the new pricing structure. And we are -- I think we are stabilized. There is a kind of pressure from customers for price reduction that we are not accepting for the simple reason that there is some pressure on salaries to compensate the recent inflation. So we don't see any logical ground to reduce prices, not considering also the impact of interest rate and so on. So we think that level of profitability we have reached in North America is sustainable and it's okay for us. For your question of product mix, whether to consider to launch product more in the entry level section, if I understood well your question.

Yes. Yes.

No, we are considering for Europe because we think that there is a growing demand due to the clear recession that is going on in Europe and the fact that inflation has opened some space to the competition that we want to close. Please let me highlight that this does not mean that we are going to reduce our average margin. We are going to launch probably new product in the entry-level section, but keeping our percentage margin stable. In United States, we don't need to do that because we are already in a level that is extremely competitive in North America, like in India, by the way. India and United States for the distribution features are already extremely competitive markets. And if I could guess the price positioning for the consumer in North America is almost half of Europe already today. Our competition is made by the private label. Private label in North America historically is very well distributed, has reached more or less 30% of the market share, while Europe is still sitting around 18%, so much lower, but above 30% private label has very hard time to find new market share or to gain market share. So there is a kind of stabilization. We face this competition now for almost 15, 20 years. As I said, it's a very competitive market. So already for 15 years, we have been forced to position ourselves very competitive against private label. In India, just for your information, but it's important, the competition, the market is dominated by local manufacturers. Local manufacturers do not have the tradition to produce private labor because there is no space for private label to compete against the local leader as the market is so competitive that we enjoy very high volumes, but also very minimal margin to guarantee the profitability. So in India, the pressure is historically very strong on prices. And it's probably the lowest price market in the world, even lower than North America.

Mr. Candela, there are no more questions registered at this time. I turn the conference back to you for the closing remarks.

Then I thank all of you who have attended this call. And I think we're going to meet soon during the meetings. Thanks a lot.

Thanks a lot.