Ladies and Gentlemen, Welcome to the Cloetta Quarterly Report Q3 2018. Today I am pleased to present Henri de Sauvage Nolting, President and CEO, and Jacob Broberg, SVP Corporate Communications and Investor Relations. For the first part of this call, all participants will be on listen-only mode, and afterwards there will be a Q&A session. Speakers, please begin.
Thank you, Peter. Jacob Broberg, Head of Investor Relations, here. Today I have Henri de Sauvage Nolting, our CEO, with us. We don't have a CFO today. The new CFO will start as of mid-November, so as of Q4 you will meet and hear more from him. But with that, I hand over to Henri. Please go ahead, Henri.
Yes, thank you, Jacob. Welcome everybody. Q3 results, if we look on the highlights, we can see that with the FX effect we ended up in positive growth. But of course the organic growth is much more interesting and how we are managing the business. So we saw a decline of -3.6%, all coming from the pick-and-mix business, and it was good to see that the branded business did actually grow with 1.6% due to a lot of factors, but one of the main ones is the production volumes.
We could see the operating profit adjusted going up to SEK 190.4 million, and that also comes through into the profit for the period at SEK 132 million versus last year. Cash flow, I'll come back to, there's an Italy effect in there and the net debt over EBITDA was at 2.48. So again, within the target we have on that parameter. If we look at the markets, we could see that, in particular, July and August, the markets declined in most of our core markets.
Those are the markets we can measure, which is measured by Nielsen and IRI/GfK, 2-5 percentage points ish, but very good to see that we grew our market share. I'll come back to that. Pick-and-mix, where there are no external data available, we estimate actually slightly larger effect of market decline. Assortment, we had a negative -3.6% driven by pick-and-mix brands, which is again where our EBIT is generated for the time being, grew with 1.6%. And in such a market, it's important to see, you know, what is our competitive growth.
And in 14 out of the 16 category core markets, combinations, so let's say chocolate in Sweden or gum in Holland, we have been growing market shares. And that is, of course, a good signal that we're getting more competitive in the markets. Then the pick-and-mix declined with 15%. The main thing is still the lost contract in Sweden, the non-promotion policy in Norway due to the sugar tax and the PR over there, and also the market in itself, and the fact that we're also preparing the pick-and-mix business for future growth by integrating, restructuring, and working on improvement of the EBITs. If we then look at the strategic focus areas, it's simple. It's growing the base business, growing the branded products which we're doing.
A lot of focus on strengthening the brands, coming with relevant propositions, coming with innovations, but also just the base business in distribution, pricing, promotion, and starting to give results. We're also increasing the so-called pure media investments. So this is the money we are investing which the consumer is actually seeing. So it's not the money which goes to agencies to develop campaigns or doing market research. This is really the money which is effective because that's the money which gives the results. So we're on our journey to increase the pure media. And then, quite some good core innovations. So innovations on our core business, again, really important, because on the core brands and the core business, that's where we have our areas of strength and competitive advantage.
So we're developing that, and and we can see in particular quarter four, there's a number of really big activities and innovations coming to the market which will also support consequently. Then the cost and margin really important for the funding and for the EBIT development. So the cost efficiency program is in full swing and will continue, also in the coming years. We have had the Swedish krona weakening. We've taken pricing for that to mitigate that, but that is always a few months later than when it comes in. And also the insourcing is actually going really well. That's the insourcing of the Candy King products and some other third-party production. And we can see that we're ahead of plan and coming to the levels of production utilization which are very favorable.
And we now need to, as communicated before in the Candy King integration project, we're going to invest in some extra drying capacity in order to, to do even more insourcing. So that's then the last important area. That's the capacity investment which we are planning for 2019 as previously announced when we did the Candy King integration. We have now in the Nordics put the former Candy King business into our ERP system which also gives us a lot of insights on how to structure and start to get the EBIT up, costs down.
And then next year we will do the same in the U.K. business. And then, last but not least, looking at the EBIT in the former Candy King business, now the combined pick-and-mix business, how are we going to get a better commercial margin in all the markets. There are quite some differences between the markets on that, and we're taking steps to improve the EBIT margin to a better commercial margin in all the markets. So those are the three main areas.
If you then look at a little bit what we're doing, I took three things out which I think are interesting to talk about. So, as I said, more pure media like-for-like. We can see that we get 10% more bang for our bucks, you could say. 10% of the money going more to consumers. So that's very positive. If we then look at Venco, which is our number one licorice brand in the Netherlands, had not been supported for eight to 10 years.
And now we're on TV, on social media, on outdoor, reclaiming the territory which this brand is owning and strengthening, yeah, the key difference between this brand and its competition. So really good to see that will happen in Q4. In Sweden we've taken our very famous local Plopp brand into the tablet market by introducing Plopp with taste from our candy and other chocolate brands. Also, initially really good results. And as we discussed before, we keep on expanding the Choice for You program where we're giving people next to the original products a choice with 30% less sugar and no sugar. And that's going into Sweden and Norway again with a combined campaign where we're leveraging scale.
That will all happen in Q4, which also means I'm really pleased to see that now that we have higher efficiency on the media budget, that we're also going to increase the absolute media budget in Q4 as we already communicated that we would have a higher absolute investment in the second half of this year. We're now ready to do that to make those investments in a good quality way. So that will happen now in Q4. Then we go to the financial update. So, there's no structure. Candy King has been with us for more than a year. So it actually is quite an easy way to look at it. We can see the organic growth at -3.6 and then compensated by the exchange rate with 5.8. We come to a total of 2.2.
Again, you know, we are looking at the organic growth of Cloetta and we do not steer the business on the exchange rate differences. This is something you have been asking for. We really think we have two businesses within Cloetta. One is the branded and the other one is the pick-and-mix business. If we look backwards into time, which you can see on this chart, from 2016. And that is now the third consecutive quarter where we have growth on our brands. So that is really important because that's where the margin is being made for the time being while we are making the pick-and-mix business ready for competitive growth by increasing the EBIT level. So this is positive news.
I would say first signs that we are getting where we want to be, that we're starting to grow the business and we're going to grow market shares with all the strategic initiatives we have put into place last year. Now, there's also work to be done as you can see on the next one because of course here you then see that we have also three consecutive quarters with negative growth on the pick-and-mix business which, if you go back in history, has been one of the key growth drivers for the top line of Cloetta. And now you see that we have work to be done. Of course, the lost contract is a big one. The Norway sugar tax impact on the promotions is a big one.
But there's also a lot of underlying things we still need to sort out to start making our proposition more interesting and for customers to be willing to pay a higher price for the Cloetta pick-and-mix business in all countries, not only in a number of them. If we then look at the P&L, it's good to see that the net sales of course went up with SEK 33 million, but this is fully driven by the Forex. If we focus again on the organic growth, it's negative with -3.6. Gross profit amounted to SEK 559 million in the quarter, which is SEK 32 million higher than last year. The improvement is mainly coming from the margin effect we get from the retranslation from euro into SEK, but also higher production volumes versus last year.
That's all coming from the insourcing and the growth we have on the packed business. If we then look at gross margin, it's 1.3% higher than quarter three 2017, which then is driven by the production volumes and the higher organic growth in the branded and packed products which has a positive effect on the mix which comes through in the gross margin. Operating profit adjusted is SEK 25 million higher than last year. Again, driven by the higher production volumes in our factories together with cost efficiencies and also the growth of the branded products, of course, trickle down over here.
The operating profit non-adjusted, you could say, is SEK 180 million. There's an improvement of SEK 11 million versus last year. It is lower than the operating profit adjusted because we have SEK 14 million of one-off cost in the quarter mainly related to Candy King. Half of that is the remeasurement of the Candy King earnout, which every quarter we recalculate the earnout consideration. Given the forecast we have, the earnout has been adjusted upwards.
The other half of this one-off cost is related to the Candy King integration, which is still ongoing. We then look at net financial items. They were lower in the quarter compared to last year. The improvement is mainly related to the exchange differences on borrowings and cash equivalents related to the development of the Swedish krona against the euro during the quarter. Corporate income tax, the effective tax rate for the quarter is somewhat lower than last year due to a one-off positive effect resulting from the closure of a previous ongoing tax case.
If we then look at cash flow, the cash flow from operating profits did improve, mainly driven by a higher operating profit. Here it is important to remember that the comparator was negatively impacted by the cash flow from the now divested Italian business. And this was about SEK 95 million. So that's important to make this like for like, comparable. The cash flow from the investing activities were on a comparable level with last year when adjusting for the fact that Cloetta Italy was divested in the comparative figures. So if we go to a summary of what has happened in Q3 and what we're doing, good to see that the brands are growing now for the third consecutive quarter too early to say, "Well, hooray, we've solved everything."
But I think it's good that we step up, gradually quarter after quarter getting the strength back in the brands and also making better investment choices in the pure media. Going up with 10%. We're not yet at the goals we've set ourselves for that in the strategic five-year plan. But we are, we're certainly improving which gives me also then the confidence that we can actually start to spend on an absolute level more in the next quarter. Pick-and-mix declined, not good. Building it for competitive growth, making the trade-offs between the top line and the bottom line, when we're looking at how we do business across all the markets and at the same time taking cost out, getting more efficiency in.
So that is a project, which we already discussed was going to take us up till 2020, on the insourcing and getting all the synergies ready. The operating profit adjusted improved. Candy King integration is in line with the plan, but will take more time. And then, again, because of the insourcing, as discussed before, part of the SEK 175 million of integration cost is going now into increasing the production capacity. It's not actually the lines which are producing the products because those we have; it's the drying capacity for the products which have to dry between 24 hours and more in drying chambers before we can pack them. And that was it. So we now can open for questions.
Ladies and gentlemen, if you wish to ask a question, please press zero and one on the telephone keypad. Please wait a few minutes for first question to arise. We have a first question from Mr. Nicklas Fhärm from SEB Equities. Sir, please go ahead.
Thanks, operator. And good morning, everyone. Good morning. So, my question is really if you could give us some insight into the disposition of the organic sales developments, in terms of how much of that is volume related, what is the price component, and what is possibly the mix. But in order to make this useful, I would like to start by asking you how much of lost revenue is actually due to the Coop contract, re-recorded in Q3. Could you give us a ballpark number, please? Yeah. So the Coop contract is about 50% of the lost revenue. It's about SEK 35 million- SEK 40 million .
So that is by far the number one explanation for the loss. And then there is a second biggest factor, which is the sugar tax impact in Norway on the promotional activities of the customers. So customers are not promoting pick-and-mix anymore, which is an important part of the volume driving activities. The third one was that we could see, in particular during July, August, that people in the Nordics were staying more in the countryside and there's less pick-and-mix availability in the smaller stores.
But there's also still a lot of integration work to be done, which is sometimes leading to that we're not completely on the ball when delivering products to the stores or that we have out of stocks in a store. That is the fourth explanation I would, I would say. And then, last but not least, we're also looking, of course, at how to improve profitability for the, for the business, going, going forward.
Yeah. Thank you. That, that's very helpful. So if I may, is it a fair conclusion then that pricing is probably up a bit, mix is probably, unchanged or better, but it's mainly a volume issue explaining the, sort of organic, like, like decline in the quarter?
No. I mean, the what I, what I would, what I would like to stress is that you really need to or you, you don't have to, but I'm really looking at this two different business model. Yeah. We have the, let's say, traditional FMCG branded business, which of course is a combination of volume and price, with investments in A&P and where we are making, of course, a lot of profit. You all have seen the P&L of Candy King when we bought them and the profit levels we have on that business, which is then the second leg.
Yeah. They're now completely integrated. It's impossible to make a difference between the former Cloetta business and the Candy King business. So we really look at two different business models, branded and pick-and-mix. And of course, in pick-and-mix, volume is much more a driver because we put the volume into our factories and then get an effect across the whole portfolio of Cloetta with better indirect coverage.
And of course, when factories are running, running at higher capacity utilization, it trickles down in the transfer prices of all the products. But at the same time, we know that we have still optimizations to be done in in some of the markets on the on the pick-and-mix. Yeah. We have merchandise driving around and and that is partly, of course, more efficient when you have more volume in the in the system. On the other hand, you know, we don't think that for the future that we should accept the kind of EBIT level we have in some of these contracts or some of these markets.
And that's what we're looking at right now so that we get to a better EBIT margin for the business because we have an we have a target to get to 14%. Here we need to make then sometimes the trade-off to take a bit more risk, in 2019 on the top line on the pick-and-mix business in order to, to get a better, better EBIT delivery.
Can I possibly also follow up, with basically the same question, but if you could elaborate on volume versus price and mix in terms of impact on organic growth for your branded goods business only, please?
That's a little bit dangerous because, you know, then I talk, of course, indirectly to my competitors, as well and also our, our customers. It is also , you know, it is so different market by market. Of course, when you have the weakening of the Swedish krona and we take action in Sweden in order to had to compensate for that on the full year run rate, and in other markets where we maybe already have very good margins, we try to be more volume focused.
So it of course we could have those figures, but I wouldn't like our competitors to know exactly what we are doing. But be assured we do like, you know, a professional FMCG company constantly looking at volume and price and seeing what is the best EBIT delivery in a competitive set of the different markets we are operating in.
Sure. Appreciate that. Final question, on the same topic. Would you care to give us some elaboration on any possible impact on volume from at least some more grocery trade going online and the propensity for, you know, customers to actually put in a pick-and-mix bag in the shopping basket, checking out, etc.? Is there any signals or any updates you could give us on consumer behavior that possibly is impacting your organic growth rate already now, please?
No. I mean, at the moment, it's not having a serious impact. But of course, we want to be ready for the future. So we have e-category managers in all of our main markets with a central resource coming from one of the top e-commerce platforms in the Netherlands. We are having several, I call it, experiments, several corporations with the e-commerce players, both the pure players and the e-retailers, in each of the countries to see how is consumer behavior at the moment on the impulse products like candy and chocolate, but also how can we stimulate people in that e-commerce environment to then still buy those, sorry, these impulse products.
We even have an experiment with pick-and-mix ongoing with one of our retailers where people can do actually pick-and-mix online so they can choose from the screen which products they would like to have in the pick-and-mix basket. And then that retailer is choosing those products. So it is very much something of the future. And then the good news is, you know, it is impulse. So we're also very much looking at other channels, at Clas Ohlson which is an important retailer in, yeah, call it do-it-yourself and peripherals. And they're now selling our products. And of course, people are interested to buy our products. So, under control.
All right. I may come back later in the call with further questions. Thank you so much.
Yes.
Thank you. We don't have any more questions for the moment. Ladies and gentlemen, let me remind you that if you wish to ask a question, you have to press zero and one on the telephone keypad. That's zero and one on the telephone keypad. We have a next question from Nicklas Skogman from Handelsbanken Capital Markets. Sir, please go ahead.
Yes. Hi. The comparable for the packaged branded business was quite, or it was very easy. It was -4% in Q3 last year. You do grow this year, but it's you're not sort of capturing the organic sales you lost last year. What is there an issue here?
No. I mean, now you could look at the comparator. I think, if there would be an issue, then we would not be growing our market shares in 14 out of the 16 markets. So that is probably something I would be looking at, so are we growing competitively? And I would say yes. Then of course, I'm not saying that the job is done and that now everything is in place. No. It's only three quarters in a row we're seeing market shares improving, as we said, in a tougher market during July and August.
So that's pleasing to see that we are growing market share. That for me is the ultimate, is the ultimate proof. But this has to continue. And, you know, we're having better people in. We're having more focus on where we spend our media. We're renegotiating contracts with media agencies, research agencies to get costs down. We are now only working with Läkerol with one brand team across all the markets rather than four or five markets doing it on their own and spending costs on agencies or research for consumers. So there's a lot of efficiency coming in that it all then should trickle down, of course, in making our brands more competitive in the markets. But that's probably, you know, we're a two-year journey.
I mean, if I were you, I would only believe this when I would see you two years in a row or at least six out of the eight quarters of Cloetta. But that's very clearly what we are doing on the branded business. Yeah. And again, that, that is where the EBIT margins are very high. And that, of course, then is also trickling down into the bottom line. And at the same time, we're preparing this pick-and-mix business for future competitive growth. And I call that integration. Call that sharpening the proposition, taking the cost down. But it's two very different business models we are working with.
I think you said July, August, market the market was down to 5% in packaged. Was that correct?
Yeah. In Nielsen.
Yeah. Okay. And what about September?
Yeah. I mean, September was more back to normal so that we can see we had a kind of 0% volume growth in the markets and then a bit of price growth depending on the market. But [crosstalk] And what I don't want . What we try to sketch a picture. You know, what happens with the markets? And of course, you could say, "Yeah. It was warm." And maybe people are then eating less chocolate on your end.
You know, I don't want to hide behind the weather. There's a lot of other things we need to fix which are having a bigger impact than the weather impact. And that's what we are, that's what we're doing. And that's what our investors can count on. So that's why you also don't read in our reports, an effect of weather on business, etc.
All right. Very good. yeah. That's it for me for now. Thank you.
I have a question here from the web where one talks about earnouts for Candy King. When the organic business in pick-and-mix actually declined, is it all coming from the Cloetta pick-and-mix and Candy King shares are performing well? Or how is that possible?
Yeah. So it's first of all, it's important to understand that the total business is on the earnout. So the earnout which we have defined in the deal with the former owners is that it looks at the total volume of pick-and-mix. So old Cloetta plus old Candy King together. How this works is that, in each quarter, we have an S&OP process where we do a sales and operation planning which is looking forward.
If we are seeing now that there is a better forecast in quarter four than we had in the earnout consideration, we adjust the earnout consideration up and of course also down when it will be lower. That is the way this works. Of course, then at the end of this year, so by December, then we know the total volume development and we can calculate the exact earnout consideration which we'll then publish in 2019. No further questions?
Yes. We have two more questions. Next question from Mr. Nicklas Fhärm from SEB Equities. Sir, please go ahead.
Thanks for letting me back into the call. So, my next question would actually be on the gross margin bridge. I understand perfectly that most of the very positive development year-on-year is because of insourcing efficiencies. But still, I was wondering if you could give us an update on any implications from raw material and cost of goods. And implicitly, I guess what I'm asking is if there are any other negative parts in the gross margin bridge which actually means that the effect of insourcing is actually even higher than the total net change year-on-year. Please.
Yeah. Of course, this is a gross margin. Of course, there's many different factors in there. As said, you know, the insourcing was the biggest effect. Then, of course, we can see that some of the raw materials like sugar is going down. So that is a positive. On the other hand, we have a very big business in Sweden, which is buying a lot of the products from Europe where we then see a transfer price, or a negative effect on the transfer price because we're producing in euros and then selling here in Sweden.
And as we explained last time, the way of working in Sweden with customers is that three months after such SEK weakening has started, we can start to negotiate. And then there's an implementation time of three months. So there's always a minimum of a six-month lag in that process. So it's a mixed effect, also the way we work with customers between Forex and raw material.
Then, of course, we also are trying to improve the mix, which is an element we are bringing into our planning that we are looking at. "Okay. How can we improve the gross margins through the, through the mix?" which is something we also within our new marketing organization and planning forward is getting a lot of attention. And, maybe last but not least, it's the whole trade spend. So how can we be more efficient in promotion? So there are different elements where we're working on in order to work on growth margins.
Thank you very much. I guess the production line in Belgium was up and running as of Q2 this year. And I was just meant. I just meant to ask you, is there any particular reason for why we should not expect similar positive contribution to gross margin developments for the coming six months as well?
Well, yeah. We, of course, have the, what is it called? The T minus one principle. But I don't expect, you know, a big impact. I mean, we're running on full capacity. And we're actually making extra shifts in most of the molded network factories, also in the chocolate factories, in order to produce more. And if we have to work weekends or some of the Christmas or New Year days, that also comes at a cost.
But that is a positive problem to have because it means we're selling more branded business and that the insourcing is ahead of plan. Then, as we previously communicated in the Candy King synergies and insourcing, we're expanding now the drying capacity in two of our main factories in order to be able to produce even more than on the production lines we have.
Now, can we also come back to your earlier statement, only on marketing spend and A&P in absolute terms going up in current trading? Does that also imply that you are planning at least for a positive impact on organic sales? Or is this more sort of A&P spending, that's sort of an investment for 2019? How should we look upon that statement from you? Thank you.
Oh, You're right to say, "Well, that's the plan we have for quarter four, yeah, to invest more in the brands also now in an absolute level up the first three quarters." We've been very focused to get the efficiency up. I mean, I don't want to invest in something when too much of the investment is leaking away to, let's say, third parties, of course, are doing an important job. But we now really have the whole marketing organization lined up that more and more of the money has to go into, yeah, what you could we can call it pure media. So that's media which is being seen by the consumer rather than paying an agency.
The second part is that we now also have worked on getting some of these launches really. I call it perfect, but that we're really in a good seat, and only then start to invest. So that comes together now in quarter four. And that's why we're going to invest more in quarter four. But this will be a theme going forward, of course, as well towards 2019. But we do that because we want organic growth on the branded business because that's, again, also for gross margin, a very good way to improve EBIT of this business.
Final question. There's an SEK 80 million buildup of stock in trade towards the end of Q3 this year compared to last year. But at the same time, there's a nice little working capital release in the cash flow statement, compared to quite a negative development, or working capital buildup at least in Q3 last year. Could you just briefly walk us through the main reason for the working capital release given that stock in trade is actually up?
Yeah. The main working capital is Italy. Yeah. So last year, we had Italy in the comparator. You remember that we stripped it out, as divested, to be divested business. But we did not do that in the cash flow. From the top of my head, it's yeah. It's the majority of the cash flow benefit but also the ongoing business. So let's say the retained business or the Cloetta plus Candy King business, we see an improvement in the working capital. But yeah. It's in the order of SEK 4 million or SEK 5 million.
I see. All right. Thank you so much for taking all these questions.
No, no. It's my pleasure. Thank you.
Thank you. Next question from Nicklas Skogman from Handelsbanken Capital Markets. Sir, please go ahead.
Yes. Two more, please. Firstly, on the price increases you've been doing, do you expect to see any sequential positive impact in Q4?
We never give forward-looking statements. But as already mentioned, we have increased prices due to Forex in August. But the way I described how we work with Forex, of course, a lot will depend how the SEK is going to behave in the fourth quarter because we are doing price increases based on an average SEK rate over a three-month period. And then we announce a price increase. And that is then common practice in most of the Nordic markets.
But certainly, in Sweden, what we're talking about, that then isn't a three-month negotiation. So in total, we have about a six-month delay. So if the SEK would strengthen a lot, it will be a benefit for us. If it would weaken, we will have to plan for further price increases. So this is not something which we can predict. Then I will probably be doing another job other than the CEO of Cloetta, right, if I would know where the FX would be going.
Yeah. Okay. So you raised, you announced new prices in August. And then that.
Oh, we implemented a price increase on the 1st of August. So that is in. We will not communicate due to competitive reasons what the price increase was or at which FX level we are. But of course, if the FX would deteriorate, we have to do another one. And if it doesn't deteriorate, or goes below where we have landed that price increase, it could be a help.
Yeah. Okay. Good. And then the last one is on the M&A. When do you think that your balance sheet is ready for another acquisition?
Well, balance sheet is actually ready for another acquisition. That is not what is holding us back. And we've done some fantastic refinancing, some very good commercial paper programs which are giving us access to loans at a very competitive, or extremely competitive rate, I would say. But I'm a believer myself that we first need to integrate the Candy King business in a good way. So that house needs to be 100% on order. We need to have, you know, the business in each of the markets gaining competitive growth.
We need to get the EBIT up, the costs down. And that takes a lot of yeah focus from the organization. And therefore, we are a little bit more careful at the moment by ourselves actively going out and call it hunting or looking for new acquisitions. So that will be somewhere next year that we will be actively going out again looking for acquisitions. But you know, the core is what we have. That needs to grow. And if that grows, we can start to add acquisitions.
Okay. Perfect. Thank you very much.
Thank you, ladies and gentlemen. We don't have any more questions for the moment. If you wish to ask a new question, please press zero and one on your telephone keypad. That's zero and one on your telephone keypad. We don't have any more questions. Back to you for the conclusion, sir.
Okay. Thank you very much for listening and asking questions, and say thank you for today. And speak to you next time. Thank you and goodbye.
Thank you.