Smiths News plc (SNWS) Earnings Call Transcript & Summary

Good morning. And thank you to everybody for joining us today. While the format of this morning's presentation is different to usual, we hope to cover much of the same ground, and I look forward to answering your questions, which we will take at the end of the call. You should all have received a copy of the presentation. But before we get into the detail, I should say that I'm conscious that at the end of February, when our results were closed, now feels like a very long time ago. However, in many ways, this makes the group's position at that time especially relevant and that it provides the clearest benchmark for our exit and recovery from the current period of lock down. With that in mind, in addition to the formal results, we'll also today give an update on the actions we are taking in response to the coronavirus, and I'm happy to take questions on this at that end, too. So by way of an overview of our first half performance. The group has performed in line with our expectations for the first half, albeit that a number of one-off and noncore items have combined to reduce profit on last year. Smiths News, the key engine of our profit and cash was also in line with our expectations, achieving GBP 3.1 million of cost savings and more than meeting its critical target of sustainable efficiencies offsetting the impact of margin decline. And at the center, we have pressed ahead with the changes that have delivered GBP 1 million of savings and with substantially more to come following the sale of Tuffnells. More broadly, these results were delivered in the context of challenging strategic goals, all of which I am pleased to say have been achieved. The strategic review of Tuffnells, which we announced in November, was completed. The sale and leaseback of 7 Tuffnells properties for GBP 15 million was completed in November. And throughout, we maintained our prudent capital management policy, delivering positive cash flow and a reduction in net debt over the period. And so as we entered March 2020, the general context for the group is want to continuing the outperformance by Smiths News being offset by continuing weakness at Tuffnells, with the key strategic goal being to dispose of Tuffnells early in the second half. And then, of course, the world, as we know, changed. But despite that, we completed the crucial disposal in early May. And as a consequence, we are much better placed to manage through the lockdown and deliver shareholder value. I will look in detail at the impact of the COVID-19 pandemic on the group after Tony has covered the financial results for the period. But I would just like to emphasize 3 points now. Thanks to the magnificent efforts of our colleagues, we have maintained a full service to the retailers and communities in all territories. We are working cooperatively across the supply chain to ensure we all come through together and in the best possible shape as restrictions ease. And last, but far from least, despite all the challenges, we continue to trade on a profitable and cash-generative basis. I look forward to giving you a summer update later, but for now, I'll hand over to Tony. Tony?

Thank you, Jon. I will now look at the continuing group's results in a bit more detail. Smiths News adjusted operating profits declined by GBP 0.9 million year-on-year, reflecting a solid core performance that was then impacted by 2 key one-off events. A fall in the income received from news and magazine paper recycling as market price per ton fell by 50% year-on-year. And secondly, a decision by a major discount retailer to remove the news and magazine category from their stores. Aside from these factors, the business continued to perform well with network labor and distribution efficiency savings ahead of target and supplemented by further central cost-savings initiatives. This presented GBP 3.1 million of savings and negated the margin decline. DMD returned adjusted operating profits of GBP 0.5 million, which were in line with management expectations, but down on last year after the loss of the British Airways contract in June 2019. Group operating profit was therefore GBP 19.9 million for the period. I will now consider some other key results in the period. Finance costs increased by GBP 600,000 to GBP 3.6 million due to an additional charge of GBP 900,000 related to the application of IFRS 16. This was offset in part by lower interest charges due to gross bank borrowings in the period being lower. The net impact of IFRS 16 on continued adjusted profit before tax is a GBP 400,000 charge in the period. The tax charge of GBP 3.1 million was GBP 0.5 million lower than last year as a result of lower profits, but the effective tax rate remains at 19%. Consequently, adjusted continuing earnings per share was 5.4p, 0.7p lower than the prior year. In line with our focus on prudent capital management and mindful of the current priority to maintain liquidity, there will be no interim dividend this year. I shall now move on to the next slide, which looks at adjusting items. Pretax continuing adjusting items were GBP 7 million higher than last year at GBP 9.6 million. Network and reorganization costs of GBP 2.3 million were incurred in the period. This primarily reflects the GBP 1.9 million cost associated with the establishment of our shared services center in India. As mentioned earlier, the DMD operation has been temporarily suspended, say, for a few remaining customers, and a significant number of employees have been furloughed. At the half year, a goodwill impairment charge of GBP 5.7 million has been taken against this business, triggered primarily by the COVID-19 pandemic's impact on airlines and airports' future trading prospects. Similarly, our bad debt provision of GBP 0.9 million has been recognized following extensions and delays to payments requested by customers. Finally, the group incurred professional costs of GBP 400,000 related to the buy-in of an insurance-backed annuity relating to WH Smith Pension Trust. This is part of the plan to rationalize the group's pension schemes portfolio. I will now look at free cash flow, both on a continuing and discontinued basis. Overall, the group generated GBP 9.1 million of free cash flow during the period compared to GBP 5.8 million last year. Continuing free cash flows were GBP 5 million and discontinued cash flows after the proceeds from the capital sale and leaseback were GBP 4.1 million. Adjusted operating profits reduced at Smiths News, and Tuffnells adjusted operating losses increased. Overall, EBITDA increased by GBP 3.2 million, primarily as a result of the transition to IFRS 16, which requires rental charges to be replaced by a depreciation charge. The working capital movement in the period was a GBP 2.7 million cash outflow. Capital expenditure for Smiths News and Tuffnells was GBP 3.2 million higher than last year, reflecting an increase in IT and fleet expenditure in the first quarter in Tuffnells. Smiths News CapEx funds remain focused on replacement rather than growth CapEx spend. The proceeds from the sale and leaseback of Tuffnells properties helped to offset the Tuffnells operational cash outflow in the period. Both lease payments and net interest paid increased materially in the period due to a revised cash capitalization of lease and interest payments under IFRS 16. However, interest payable under the bank facility fell during the period as gross bank borrowings continued to fall. The cash cost of adjusting items in the period was GBP 5 million, down compared to GBP 6.8 million last year. This primarily represented both continuing and discontinued network reorganization costs of GBP 2.8 million, sale-leaseback fees of GBP 1 million and pension buy-in costs of GBP 0.4 million. Finally, I shall now turn to look at the net position -- net debt position of the group at the half year. Bank net debt of GBP 68 million has fallen by GBP 9.5 million compared to February 2019 and by GBP 5.9 million from the year-end FY '19. Term debt represents leverage of 2x, and it remains our intent to continue to reduce this over the medium term. The group has generated free cash flows in the period of GBP 9.1 million, out of which dividends of GBP 2.4 million were paid, and the balance of the cash generated was used to reduce borrowings. Looking below the bank net debt line, the application of IFRS 16 leases accounting standard has resulted in a technical lease adjustment of GBP 77.7 million, resulting in a revised closing debt position of GBP 145.7 million at the end of February 2020. A corresponding rate of use asset is recognized on the balance sheet. All of our bank covenants remain tested under prior GAAP measure at the half year and full year. Looking ahead, we continue to focus on our prudent capital allocation strategy of reducing debt ahead of completing the refinancing of our bank facility by the autumn of 2020. I will now hand back to Jon to give some more detail on the business outlook.

Thank you, Tony. Before we look in detail at the effects of the lockdown on the business, it's important to stress that Smiths News is the exclusive supplier in our territories. There is no alternative distributor should we fail. And therefore, in addition to the commercial benefit of doing so, we have a wider social responsibility to maintain as full as service as possible. As a consequence, our program started by designating the key workers, and we have worked to 4 guiding principles, which ensure we meet our social responsibility while safeguarding the well-being of colleagues and protecting the long-term interest of the business. These principles are: firstly, that the safety of our colleagues and customers is paramount. Secondly, that we have a responsibility to maintain as full as service as possible to our customers and their communities. Thirdly, the mitigating actions must not damage our long-term capability. And fourthly, that we must be mindful of wider supply chain sustainability and work proactively with our partners to that end. In all the choices we have to make, we have borne these principles in mind and taken the action which best aligns with these goals. So how have we done? Well, first and foremost, we have maintained our service to all territories throughout the crisis, delivering to all retailers, which continue to trade with only relatively minor disruption. The social distancing requirements mean we have to introduce new procedures, and these have now embedded in. Looking at the market, at the peak, 10% of retailers closed have now slightly improved to 9%, but I should clarify that these have a disproportionate impact on sales because typically they were among our highest volume outlets and especially so for magazines, the most notable of which was WHSmith retail, the U.K.'s leading retailer of magazine. Our customer service support center in India has also a lockdown to manage through, hence, we have had to put contingency arrangements in place and are currently running a hybrid model with some U.K. and some offshore support. Of course, we have taken substantial measures to mitigate impact on margin. But the short shelf life of newspapers and magazines means that route consolidation is always limited. And unlike other parcel deliveries, we can't elongate the timings of our delivery rooms because to do so we'd miss a critical sale window. In addition, DMD, which supplies airlines and travel points and in-store, our field marketing business, are being temporarily closed, except for a skeleton staff servicing those 2 customers which remain active. Across the group as a whole, we've had to furlough over 500 colleagues. So it is clear that the crisis will have a material impact on at least H2, but the extent of that is uncertain. Margin is impacted by the reduced sales, which follow from retail closures, restrictions on movement and some titles temporarily suspending publications. Total newspaper and magazine revenues are down 25% since the lockdown took place. The cancellation of the UEFA Football Championship will also impact sticker sales, although we should have a compensating benefit next year. Cost savings will help to mitigate. And I can tell you that we are looking at every opportunity in the depots and the center to find sustainable savings within our guiding principles. But the reality is this cannot fully offset the impact at a cost per copy delivered level. Cash flow is further impacted by the need to credit returns to sites which are closed without a compensating resupply. And finally, it remains uncertain what shape the exit from lockdown will take and over what time scale. So in summary, the full extent of the impact is unclear, and it will remain so for a while yet. Subject to there being no significant worsening of the situation, we believe Smiths News operations will remain profitable and cash generative. In the meantime, we are not standing still, but are focusing on 5 clearly defined immediate priorities for the group. These priorities are: firstly, managing through the lockdown as successful as possible. That means sticking to the guiding principles while turning every stone to mitigate the impact. Secondly, preparing the business for the easing of restrictions and a gradual return to more normal trading patterns. The implications of the exit road map for the news supply chain are not yet clear, but there will certainly be a need for ongoing safety measures, while high-traffic flow retailers, such as those in airports, train stations and the high street, may require more permanent solutions. Thirdly, we are pressing ahead with the resizing of the group function. Following the sale of Tuffnells, there will be an immediate GBP 4 million reduction in central overheads. In addition, we've identified a further GBP 4 million of additional savings, and we will look to go further depending on how and at what pace we move towards more normalized trading patterns. Fourthly, the renewal of our banking facilities will, we believe, be less complicated following the disposal of Tuffnells and we'll be working to reach an agreement by the autumn. And lastly, we need a more defined strategy to deliver shareholder value, which gives clarity of expectations to all our key stakeholders. I'm looking forward to working on this over the coming months with our new Chairman, David Blackwood, and my colleagues on the Board. Before I move on to questions, I'd like to take a moment to explain why we are confident in our ability to deliver shareholder value. This slide shows some of the key metrics and achievements of Smiths News over the last 7 years. And the reason I'm keen to share it is that when we talk about a leaner and more focused group, I want to be absolutely clear that this does not mean a smaller or less predictable set of returns from Connect. In fact, quite the reverse. If we look at revenue first, then as we all know, it has declined. But it's done so in a predictable and established pattern. The average revenue decline over the last 7 years has been well within the strategic range of 3% to 5%, which we believe is broadly the rate at which it is possible to sustainably manage compensating efficiencies. And as you can see, the savings we have achieved year in, year out are consistently compensated for the margin impact of those lost sales. The only blip within FY '18, when the group attempted to integrate Smith News and Tuffnells, resulting in distraction and diseconomies of scale. But you will also note that this was swiftly recovered in 2019 when the business returned to its own focus. If we look now at the chart showing Smith News EBITDA over that same 7-year period, it shows the business delivering a consistent level of cash return and with percentage operating margin increasing from 2.6% to 3.2%. The reason for such strong EBITDA performance is that the business model of Smith News operates with a low CapEx requirement and high profit cash conversion. In the past, much of that has been used to support central functions and other projects. But looking ahead, the more focused group will lead to a material reduction in central costs and a greater ability to deliver shareholder value. Freeze from the drag and distraction of Tuffnells, Smiths News is even better positioned to continue delivering the levered returns that have always been the bedrock of the group profit in cash, and we are confident post-COVID-19 that it can continue to do so for the foreseeable future. Since 2019, we have successfully renegotiated all of the key contracts that have come up for renewal on improved terms. And now over 80% of our business is secured until at least 2024. We remain clear that we are the market leader in this sector with the best service to both publishers and retailers and a deep experience and program management team, which understands and is wholly committed to the strategy of service, efficiency and restructure. These are very solid foundations for delivering shareholder value in a measured and transparent way. The proposed rebranding of the group announced today back to its former name of Smiths News PLC is a first step in the process of being as clear as possible on our future direction. So to summarize, before we move on to questions. Over the period, the group has performed in line with expectations for H1, achieving its stated strategic goals, and Smiths News has continued to exceed our expectations. Our current priorities are very clear. Most immediately, we must manage through the lockdown and exit phase of the current crisis without damaging capabilities. Meanwhile, we will press ahead with the resizing of the group's deal savings and look to renegotiate the group's banking facilities by the autumn. Looking ahead, the COVID-19 pandemic and subsequent restrictions continue to cause significant uncertainty for the group and will, of course, impact our performance in the half year. However, Smith News has maintained its service and capability throughout the lockdown, and we expect sales to gradually improve as the current restrictions are eased. The business continues to trade on a profitable and cash-generative basis, and we are working through the requirements for the new normal, at the same time, preparing a clear strategy to deliver shareholder value. As we have said previously, the timing and pace of the exit from the current restriction is inherently uncertain. And it's, therefore, not possible to quantify with any certainty the impact on the full year. However, we continue to monitor the situation, and we will, of course, update the market as appropriate in due course. Thank you very much for listening, and I'm now very happy to take questions.