Safilo Group S.p.A. (SFL) Earnings Call Transcript & Summary

Good evening, and welcome to the Safilo Group's First Half 2020 Results. This call may contain forward-looking statements relating to future events and operating, economic and financial results for 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 our multitude of factors. Today's participants are Angelo Trocchia, Chief Executive Officer; Gerd Graehsler, Chief Financial Officer; Barbara Ferrante, Director of Investor Relations. I will now pass the call over to Mr. Angelo Trocchia, Chief Executive Officer. Mr. Trocchia, you may begin.

Thanks very much, and good evening, and thanks to all of you for attending today's conference call on the Safilo H1 2020 results, focused also on the second quarter trading update. Three months ago, we met to discuss the first quarter trading update and how a positive start to the -- of the year was interrupted by the spread of COVID-19, first in China and then since March in Europe, in the U.S. and in the rest of the world. From the outset, our actions have been really focused, first of all, on the health and safety of all our employees for whom we immediately, and in a rigorous way, implemented the safety and the prevention regulations provided by government protocol. Equally important for us was to focus on maintaining business continuity, ensuring production and service level which were clearly fine-tuned according to the different market scenarios while, in a very quickly way, implementing smart working solution for office staff as we are still currently doing. The group has also reconverted some of its production line for the manufacturing of protective mask and visors to support the fight against COVID-19 and the development of some new projects. Cash protection has been a top priority for everyone in Safilo as much as the work to be done to accelerate on the key drivers of our group business plan. As we had anticipated in our communication in May, in the second quarter, business drivers were extraordinary, given the massive shutdown of commercial activities across the world in April and what was indeed a very gradual and patchy reopening of stores in May as lockdowns were in many countries, mainly in Europe. In this -- in the months of April and May, this unprecedented business content results in a net sales drop of approximately 75% compared to the same 2 months last year and in a sharp deleveraging of costs and negative economic performance. This clearly occurred notwithstanding the cost savings plan launched at the end of last year and the contingency measures initiated in March following the COVID emergence. In June, store traffic and conversion rates started to improve with our net sales in the month doubling compared to May and slowing down the pace of the decline compared to June '19 to around 35% on an organic base, excluding the acquisition. In our case, this initial business recovery was clearly led by some European markets where stores were mostly up and running with some clear business driver, which we will discuss later, while the recovery in China, which we have started to experience in April, has been stretching even further, making China our best-performing market in the quarter and in the semester. On the other hand, we have not yet experienced a sales rebound in North America, where the reopening came a bit later than Europe and were also temporary impacted by social disruption. On the other side, the growth of U.S. market is materialized for us in July. Key emerging markets, in particular, Latin America, continued instead to suffer behind the ongoing spread of the virus. In such a challenging business context, we have not stood still, quite the opposite. As in this second quarter, we have moved forward with our medium-term group business plan, laying down additional significant milestones. On top of everything, effective June 1, we closed the acquisition of 70% of Blenders, and this is a milestone after the acquisition of Prive Revaux for us. Blenders is now our digital native eyewear brand, which goes to enrich our proprietary brand portfolio with its strong e-commerce business model. This took place in a crucial moment for our group development and for the evolution that our industry is going through. Blenders offers a compelling price-to-value eyewear product, which appeal to a broad range of consumer with a focus on millennials and generation Z. Blender is, for us, a business accelerator, I will say, a crucial business accelerator, both in terms of providing new state-of-the-art D2C capabilities and boosting our e-comm business. The global pandemic has, without any doubt, elevated the importance of digital as the surge of the e-commerce business has been demonstrating, continuing to grow even today as store reopen and we are working to be a front-runner in this new business opportunity. In these first 6 months of the year, our organic online sales, so without taking into account the acquisition, have grown by around 31% at constant exchange rate after gaining further acceleration in the second quarter at plus 38%, driven by both our U.S. e-commerce business and the group sales via its Internet pure player customers. And at the end of June, if we also include Blenders and just the e-commerce bit of Prive Revaux, our total online sales doubled compared to last year, representing 11% of the group's net sales from around 4% in 2019. So a meaningful progress on our digital transformation strategy while we also kept working on the reshuffle of our licensed brand portfolio. June was, again, the month in which we announced the signing of a new agreement for the design, manufacturing and distribution of Ports branded sunglasses and optical frames in Mainland China. Ports was founded in Toronto in 1961 and was the first luxury fashion label to enter the Chinese market in the early '90s. The brand is a new business opportunity in our brand portfolio as we also look for locally relevant brands in strategically relevant market. Isabel Marant, that we signed in February, is such a brand for France, and now Ports is meant to play a relevant role for us in the fashion luxury segment in China. As we had already anticipated after first quarter in which we reported net sales down by 11.5% with a profit of EUR 5.8 million at adjusted EBITDA level, the second quarter was much heavier, top and bottom line, due to the well-known disruption of the commercial activities we -- I was talking before. Total net sales in Q2 dropped by 53.7% at constant ForEx, taking the first semester declined to 32.7%. This severe top line shortfall resulted in an adjusted EBITDA loss of EUR 34.1 million in the quarter and of EUR 28.3 million in the semester. While in the course of this month, we took all the necessary actions to aggressively manage our industrial and operating expenses, identifying all possible efficiencies across the organization, we also worked tightly and very prudent to protect our liquidity to contain the group net debt, which, at the end of June, at EUR 188.5 million, but importantly, substantially in line with the end of December last year, excluding obviously the impact of the acquisition. I stop here and I hand over to Gerd for additional details and comments on economics and financial results. Gerd?

Thank you, Angelo, and good evening to all of you on the call. Let's start from our P&L, and more specifically, for a more thorough overview of our sales. As already said, second quarter net sales declined 53.7% to EUR 114.5 million, dragging down the first semester by 32.7% to EUR 335.6 million. The contribution to these numbers from the acquisition of Prive Revaux effective February 10 and Blenders effective June 1 was a total of EUR 15.7 million in the quarter and EUR 21.2 million in the semester. Our organic performance was equal to minus 60% and minus 37% in the respective periods. Staying on our total net sales and adding some color to the overall performance of our brand portfolio, I'd highlight that after the double-digit growth recorded in January and February by Carrera, Polaroid and Smith, Safilo's own core brand sales declined around 53% in the second quarter and 27% in the first half. The outperformance compared to the rest of the organic portfolio was led by the boost provided by Smith's e-commerce business, while Polaroid and Carrera, each substantially in line with the average decline, were among the drivers of the growth recorded in June in some European markets. Looking at our regions and markets. Our biggest one, Europe, representing 49% of our total business in the 6 months to June. Stripping out the Kering business, our European wholesale revenue declined 55.9% in the quarter and 34% in the first semester. Leaving aside April and May when the business was indistinctly down and focusing on the initial recovery recorded in June, by the beginning of the month, the majority of the European markets had reopened with traffic, and in particular, conversion rates starting to improve. June -- on June, sales in Europe to the independent opticians channel turned slightly positive, clearly driven by the business rebound we recorded in Italy, France, and to a lesser extent, Spain, which were the first countries impacted by the outbreak of COVID-19 in Europe and the first to suffer extensive lockdown measures. In all these markets, what we recorded was, on one side, consumers favoring the purchase of brands in the contemporary and mass cool segment, and on the other, small- and medium-sized towns outperforming historical cities, outlets and shopping malls more affected by the lack of foreign tourists. Among the Northern European countries, Germany recorded in June the strongest improvement, driven, among other things, by the double-digit growth of the online business. Online was a very positive exception also in the U.K., where the commercial activities remained pretty much locked until mid-June with a very slow reopening phase afterwards. Moving to North America. Total net sales represented 38% of the group's net sales, recording a decline of 46.1% in the second quarter and of 26% with constant ForEx in the semester. Looking at the organic wholesale business. This was down 65% in the quarter and 38% in the semester. As noted by Angelo, the month of June was not yet a period of growth for our wholesale activities as store reopenings came somewhat later and with more additional disruptions compared to the business context in Europe. Anticipating a later topic, while the retail activities of our customers in North America experienced a sales rebound in June at the wholesale level, the wait is longer, and therefore, occurring for us in the month of July. What was clearly on the positive side during the entire quarter, including June, was Smith's e-commerce business, up around 40% in the period, allowing for a more moderate total brand decline of approximately 9% at constant exchange rates. In June, the reopening of the brick-and-mortar sports customers contributed to Smith's double-digit sales growth compared to the same month of last year. To give you a sense of how our new acquired businesses of Prive Revaux and Blenders performed in the second quarter compared to their respective businesses last year, both more than doubled their sales compared to Q2 2019. As a reminder, Blenders is basically all-digital commerce, but Prive Revaux is roughly 20% digital; the rest, wholesale, including TV commerce. To note that Prive Revaux made its planned entry into Europe with GrandVision being a key European retail partner for this affordable celebrity-backed eyewear industry disruptor as GrandVision has recently called Prive Revaux. The second quarter remained extremely difficult for the majority of our emerging markets with sales in Asia Pacific declining 65.5% at constant exchange rates compared to the same period of last year and the rest of the world, down 74.3%. In the quarter, our sales performance in Asia was heavily impacted by the complete lack of business in the travel retail channel, which represents around 40% of the regional business, while business conditions remained tough in the majority of the markets, certainly in Hong Kong, Korea, Japan and the South Asian countries. China was actually our best performer worldwide with the month of June gaining further speed compared to April and May, up high single digits compared to the same month last year while the second quarter turning slightly positive. To note, also Australia whose business was up double digit in the month of June. Finally, the rest of the world was heavily affected by the persistence of important outbreaks of the virus in key markets such as Brazil and Mexico. Latin America was down roughly 80% in the second quarter and the most recent news is unfortunately still not very supportive. Same arguments for India, currently the fourth country globally for number of cases, and where retail business is running at about 20% to 40% of the normal level, depending on the stores and location. Trading conditions in the Middle East markets remained patchy and volatile with initial improvements hampered by the persistency also of new cases. Moving to our economic performance. As already highlighted, the massive reduction in sales overproportionately weighed on our industrial and operating cost structure notwithstanding the extensive saving actions we continued implementing in line with the group business plan and the contingency measures we initiated in March, including the extensive use of applicable personnel temporary layoff programs in Italy and across the world. These 2 areas of interventions totaled a relief of EUR 28 million in the semester, of which EUR 9 million were structural cost savings and EUR 19 million due to COVID-related measures. That said, in the second quarter, our gross profit declined 71.2% to EUR 39.2 million compared to EUR 135.9 million last year, while the gross margin decreased by 20.5 percentage points from 54.7% of sales to 34.2% this year. Beyond the strong impact of volume decline, the industrial results was also impacted by around EUR 7 million deriving from higher accruals for obsolescence, product returns, order cancellations and some fixed asset write-offs. In the first semester, gross profit declined 44% to EUR 148.6 million compared to EUR 266.2 million recorded in the first half of 2019 with the gross margin decreasing by 9.4 percentage points to 44.3% of sales versus 53.7% last year. Excluding depreciation and amortization, gross profit declined 16.5 percentage points in the quarter and 8 percentage points in the semester. Below gross profit in the second quarter, our selling, general and administrative expenses excluding D&A decreased by 33.7% compared to the same period last year with their incidence on sales drastically increasing from 48.9% to 70.4%. More specifically, selling expenses decreased by 40.4% compared to the second quarter last year, on the one hand, benefiting from the strong adjustment made by the group to all discretionary marketing and advertising plans and activities, on the other, suffering from the more fixed burden represented by the accruals for the guaranteed minima to license source for royalties and marketing contributions. General and administrative expenses decreased by only 7.5% over the previous year period as they included the impact of higher prudential bad debt provisions for an amount equal to around EUR 6 million. Finally, in the second quarter, our adjusted EBITDA equaled a loss of EUR 34.1 million compared to a profit of EUR 21.2 million last year, representing an adjusted EBITDA margin of 29.8% (sic) [ minus 29.8% ] compared to the 8.5% in the second quarter last year. The adjusted EBITDA loss equaled EUR 28.3 million in the first semester compared to the profit of EUR 41.2 million recorded last year, representing an adjusted EBITDA margin of minus 8.4% on sales and a decline of 16.7 percentage points compared to the 8.3% last year. In the semester, D&A, on a reported basis increased as a result of the nonrecurring higher depreciation we incurred in the second quarter for write-offs of some industrial assets following the closure of the Martignacco plant plus higher recurring amortization in G&A in relation to the acquired assets of Blenders and Prive Revaux. On an adjusted basis, excluding the nonrecurring higher industrial depreciation, D&A decreased slightly by 3.4% compared to the first semester of 2019. As just mentioned, higher operating amortization was counterbalanced by last year's write-down of fixed assets, and more generally, by the lower level of CapEx investments we were making. D&A incidence on sales was, in any case, up 2.5 percentage points. In the first 6 months of the year, our adjusted EBIT equaled a loss of EUR 55.2 million compared to the EUR 13.3 million recorded in the first half of 2019. The adjusted operating margin declined 19.2 percentage points from 2.7% to minus 16.5% of sales. Below the operating result in the first semester, net financial charges increased to EUR 11.6 million compared to EUR 2.9 million in the first half of 2019, mainly driven by negative exchange rate differences reflecting the strong appreciation of the euro against the Brazilian real and other emerging market currencies impacting related working capital items, and to a lesser degree, due to the higher average gross debt. The higher incidence on sales of net financial charges were partially counterbalanced by the recognition of deferred tax assets in the period. Ultimately, we closed the first semester with an adjusted net result equaling a loss of EUR 63.7 million compared to the adjusted net profit of EUR 8.5 million recorded in the first half of 2019. The adjusted net margin declined from 1.7% to negative 19% of sales. Let's now move to our cash management and how our group net debt moved in the period. In the first half of 2020, we implemented a strict cash protection approach, which allowed us to close the period with a slightly positive free cash flow generation before the investment we have for the acquisitions. The changes in working capital led to a positive cash flow of EUR 56.3 million, which more than counterbalanced the negative economic result of the period equal to cash outflow of EUR 39.3 million. During the second quarter, our operating cash requirements were driven by the measures we put in place to maximize cash inflows and minimize cash outflows with the result of a temporary positive flow from working capital. On one side, our trade receivables decreased as a result of the continued, although subdued cash collections from our customers and the very weak revenues recorded in the period. On the other side, inventory levels were tightly under control, including reducing purchase commitments and consolidating seasonal collections on fewer SKUs and supplier payment terms were extended, either based on specific negotiations, or where applicable, under government relief schemes. Cash flow for organic investment activities declined to EUR 9.3 million in the first 6 months, mainly related to maintenance CapEx and the rollout of IT systems to support the group's digital transformation strategy. After accounting for the cash payments for the principal portion of the lease liabilities under IFRS 16 equal in the first half to EUR 5.3 million, our free cash flow before acquisitions equaled a small positive amount of EUR 2.5 million, which we consider a great achievement given the very negative business dynamics of the period. Net cash paid to acquire Prive Revaux and Blenders equaled EUR 11.7 million (sic) [ EUR 111.7 million ], taking our total net free cash flow to an absorption of EUR 109.2 million. At the end of June, the group's net debt post-IFRS 16 stood at EUR 188.5 million, a position substantially in line with the one we recorded at the end of December 2019. Excluding the M&A and excluding also IFRS 16, group net debt stood in fact at EUR 27 million versus EUR 31.4 million in March and EUR 27.8 million at the end of December last year. In order to maximize cash management flexibility and responsiveness, as previously commented, in March, we had already fully drawn our term and revolving credit facility equal to EUR 150 million, of which EUR 5 million were repaid in June as part of the term loan's amortization schedule. As a result, at the end of June, we had a cash position of EUR 110.9 million compared to EUR 99.6 million at the end of March and EUR 64.2 million at the end of December last year. Given the high level of uncertainty still surrounding the future recovery of consumption in the different economies and in order to support the funding of current working capital and investment needs for activities located in Italy, we are today in the final stages of negotiations with our key relationship banks for an additional term loan under the framework of the Italian Decreto Liquidità. The new financing would also include a new set of covenants, which would come together with the cancellation of the covenant test in the current debt at the 30th of June 2020. Angelo, back to you for your final remarks.

Thanks, Gerd. Thanks very much. I would just like to conclude our presentation by giving you an update on how the business has evolved after the closure of the first semester. Today, we are closing the month of July, which, on a preliminary basis, points to a business rebound with total net sales expected to turn positive compared to the same month of last year. Business performance in North America became a clear driver of the monthly sales uplift followed by positive acceleration in both Europe and Asia. Looking at the third quarter, we hope to remain very vigilant about the reintroduction of localized lockdown and the different paces of the recovery across countries, reason for which we expect our total net sales to decline moderately in the third quarter compared to the same period last year. As the evolution of the current COVID-19 pandemic remains really unpredictable with the potential impact and effects as of today not determined, we are still unable to provide a new outlook for the full year 2020. We remain fully committed to continue to promptly update you on all our stakeholders on the development that the health energy (sic) [ emergency ] will have on the group's economic and financial results. This concludes our remarks, and we are now ready to open the line and take your questions. Thanks for the time being.

[Operator Instructions] Your first question today is from the line of Cédric Rossi from Bryan Garnier.

Yes. Actually, I've got 3 questions. The first one is the monthly trend. So you highlighted the minus 75% in April and May and it seems that you experienced some more abrupt recoveries than your peers with the main news of 35% you were experiencing in June. So how do you explain this more sudden recoveries than your peers? Is it because you are more exposed to the independent optician channels that recovered faster than chains? And by the way, could you just remind us your sales split between independent optician and the chains in Europe and the U.S.? That's my first question. The second one is -- so I understand your cautiousness on Q3. Your main peer said this morning that they did not feel any negative impact from the recent lockdowns, for instance, in Australia or in some U.S. states. So is it also the case for you? Or you are just extremely cautious because of the volatility? And my third question is regarding the obsolescence cost. Do you expect any additional obsolescence cost in H2? So I understand that probably the top line trends should be a bit better, so I assume that probably you could have a relief on that.

Okay. So I will answer the first 2, I think Gerd is going to comment on the last one. In terms -- I think that you have summarized well. I think that we saw the big dip in April, May, as I said. Then in June, we had minus 30% -- minus 35%. So all we saw there. We see a rebound in July, I think, for 2 reasons: first, a strong Europe rebound; and then even a stronger rebound in U.S. So I think U.S., especially, there is really a positive -- we see a very, very positive trend in July. Obviously, we are structurally more dependent to opticians. So 60% -- roughly 60% of our net revenue is generated in the opticians and this is why we have this over effect in July. With reference to Q3, look, I think here, I mean, as I said, U.S., independently from what is happening on the virus, we see positive. But for example, we were seeing positive in Europe. Now during these days, I mean some announcement in Spain, some more cases also which are going up in Italy. So honestly, I think the level of uncertainty is so high with the reality changing every day, which I think this is why we are taking this kind of consideration into account when we talk about the Q3. Everyone of us, as I said, we really -- we will keep updating as long as we see that things will get better. But I prefer in this phase to be a little bit more prudent because it's very difficult to really understand if something is going to happen again in Europe, then the impact may be big. So I think that we stick to our view on the Q3 hoping that the virus -- the situation and the virus will get better. I leave to Gerd to comment on the obsolescence.

So on the obsolescence, let me say that in principle, we have been able to manage very tightly the inventory, which is why inventory has been a positive contributor also to our free cash flow. We already saw that clearly in Q1 for the drivers we explained at the time. But even in the second quarter, we have been able to sustain the level of inventory despite the abrupt slowdown in sales. What we have not been able to do in the second quarter is to benefit from strong closeout sales, neither from any scrapping activities because scrapping, clearly, physical activity during the lockdown is something that we haven't done. Closeout sales have been pretty close in the period along with the market. We have accrued in the first semester -- so the obsolescence expense in the P&L was approximately EUR 4 million in the semester, higher than last year, and we had approximately EUR 1 million higher than last year in the second quarter. I believe that we have been prudent in our obsolescence provision. So there is no -- there has not been any, let me say, explosion of obsolescence costs compared to our regular accruals, but we have been prudent. And then depending on how the sales will develop in the second half of the year, if they develop well, then I think there could be a positive impact. Otherwise, I do think that we have a sufficient level of provision on the books.

The next question is from the line of Marco Baccaglio from Kepler.

Yes. I have a couple of clarification to ask. First is what is the impact of acquisitions on your July sales? I think that we've seen the rebound of revenues. From your wording, the acquisitions are included while last year they were not there. Second question is you are experiencing, obviously, a decline in receivables but flat payables based on what you said about the extended payment terms. Can you give us an idea of what was -- what is the benefit and whether this is, I think, a temporary one, but how much was that impacting your net financial position? And the third one is if you can give us an idea of how much is the SACE, state-guaranteed loan, that you are negotiating in terms of total amount, maybe just a rough number.

Thanks very much. I take the third. July month is very strong without the acquisition. If we are, the acquisition is even stronger, but we see both growth in organic and expand on the acquisition. So overall, it's positive independently from the very positive effect that we got from the acquisition.

On the second question, the observation is correct. Of course, we have, on the one side, a decrease in accounts receivable because we have invoiced less sales. But on the other hand, we have been very intent on collecting cash. There is still quite a significant amount of overdue from customers to us because we have seen, let me say, relatively few actual defaults of customers or actual bankruptcies of customers, but we have seen many instances of customers requesting to delay payments or requiring to delay payments. Well, on the other side, clearly, the accounts payable balance slightly higher than at the end of the year even if we have reduced the expenses, which reflects the trend of having postponed payments either where it's possible under the law, on the other side, where it has been possible, thanks to the relationship with the suppliers. I would say that the net effect between all of the working capital is worth somewhere in the range of EUR 30 million. That is, let me say, a temporary benefit. On the SACE loan, let me disappoint you on the exact amount. We are, I think, very far along with the process. We have basically a term sheet, which is agreed. We have the respective credit approval steps in the coming weeks. As this process has, however, not been completed yet, I will prefer to leave the actual size and any other detailed information to the closing of the transaction, which we will promptly publish with a relevant press release. But in any case, we are aiming for a significant amount, which would effectively bridge the company even if we would envision some potentially more negative scenarios on the macro environment.

[Operator Instructions] The next question is from the line of Domenico Ghilotti from Equita.