Earnings Call: Q4 2018

Feb 28, 2019

Today, and welcome to the Nomad Foods 4th Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Tapoosh Barry, Head of Investor Relations. Please go ahead, sir. Thank you, Carrie. Thank you all for joining us to review our Q4 and full year 2018 earnings results. With me on the call today are Chief Executive Officer, Stephan Deshmaker and Chief Financial Officer, Sami Zecout. Before we begin, I would like to draw your attention to the disclaimer on Slide 2 of our presentation. This conference call may make forward looking statements that are based on our view of the company's prospects at this time. Actual results may differ due to risks and uncertainties, which are discussed in our press release, our filings with the SEC and this slide in our investor presentation, which includes cautionary language. We will also discuss non IFRS financial measures during the call today. These non IFRS financial measures should not be considered replacing for and should be read together with IFRS results. Users can find the IFRS to non IFRS reconciliations within our earnings release and in the appendices at the end of the slide presentation that is available on our website. Finally, please note that certain financial information within this presentation represents adjusted figures for 2017 2018. All adjusted figures have been adjusted for exceptional acquisition related and share based payment and related expenses and all comments from here on we'll refer to those adjusted numbers. And with that, I will hand the call over to Stephan. Thank you, Taposh, and thank you all for joining us on the call today. Earlier today, we reported Q4 and full year 2018 earnings results. Highlights from the Q4 include organic revenue growth of 4.2%, representing our strongest quarter of the year with solid contribution from both volume and price. Adjusted gross margin of 29.9%, in line with our expectations as gross margin expansion in the base business was offset by acquisition mix. Adjusted EBITDA of €101,000,000 represent an increase of 23% year on year and adjusted EPS of €0.29 per share representing growth of 7%. 4th quarter performance exceeded our guidance, capping a strong end to 2018, which marked a 2nd consecutive year of low single digit organic revenue growth, market share gains and double digit adjusted EPS growth. Importantly, 4th quarter performance reflected broad based strength across the portfolio with 10 of our 13 countries in growth. The innovations that we launched in the back half of twenty eighteen, namely veggie power, pulses and plant protein have been very well received by the trade and with strong early signs of consumer acceptance. We're also pleased with the progress that we're making on acquisitions as we continue to not only integrate on Besse's and Goodfella's, but also strengthen our capabilities to be a best in class acquirer and integrator in years to come. Both brands are posting strong year on year revenue growth with performance ahead of plan, paving the way for another good year in 2019. And finally, our business results continue to drive strong cash generation, reducing our pro form a leverage to 3.8 times as of year end and providing us with a flexible balance sheet to accommodate accretive capital deployment. Overall, we're quite pleased with these results, which continues to reflect the Polo brands and the level of focus and determination throughout the entire organization. Looking back at the performance of our company over the past 2 years, I can say with confidence and with pride that investments that we've been making our people, our brands and our culture are paying off. The strategic prioritization of our corporate SKUs, strong execution of our commercial plans and a cost conscious mindset are combining to drive margin accretive growth while helping fuel our future. We have achieved 8 consecutive quarters of organic revenue growth since implementing this strategy, resulting in 3.9 percent organic revenue growth in 2017 and 2.6% growth in 2018. During each of these years, we gained market share in a growing category, while achieving increases in both price and volume. These results demonstrate the strength of our brands and product offering, the sustainability of our growth model and the durability of our portfolio. Looking out to 2019, I'd like to provide you with a few of our top priorities. 1st and foremost, we expect to deliver another year of top and bottom line growth in line with the long term growth algorithm, which begins with low single digit organic revenue growth. Consistent with the trend that you've come to expect from us over the past 2 years, growth in 2019 is once again expected to be driven by our core portfolio, also known as our mushroom paddles. These categories account for approximately 70% of our sales, carry the highest gross margin market share within our portfolio and have the greatest headroom for growth. While we've made good progress on OCCO, there is further opportunity to increase penetration through continued execution of our growth model. We will look to build on innovation that we brought to market in 2018 by further developing our pipeline in line with consumer trends, notably health and wellness, convenience and sustainability. The trade acceptance to our recent launches has been strong with equally encouraging early feedback from our consumers. We have exciting plans to further develop our pipeline in 2019, including the launch of plant protein products in the UK, a new line of Artisan Breadcrumb coatings in our fish portfolio and further modernization of our vegetable offerings. We expect to deliver another strong year of cash flow in 2019 through a combination of EBITDA growth, working capital efficiency and strong overall discipline around cash use. We're happy to see leverage below 4 times, which we expect to decline further throughout the year based on the free cash flow we expect to generate. This leaves us with plenty of flexibility to pursue our M and A ambitions as we see fit. And finally, we will maintain our discipline and focus as we look to successfully navigate another year of raw material inflation, as well as a potential Brexit. I'll first comment on inflation and then provide a few words on Brexit. As we indicated last quarter, the cost of fish is increasing due to a combination of supply and demand factors. This has led us and the rest of the industry to raise price. We continue to maintain a constructive dialogue with our trade partners who are observing similar dynamics in their private label businesses. At the same time, we continue to invest in our brands, elevate the frozen food category and develop our network new management capabilities. While it's still early in the year, we expect our advancement in these areas to enable us to successfully navigate raw material inflation in 2019, just as we did in 2018. Before I turn the call to Sami, I would like to provide some updated thoughts on Brexit. As a reminder, the UK represents 30% of our sales on a pro form a basis with more than half of their sales produced within the UK as a factory in lower staff. Now while the final outcome of Brexit remains uncertain, there are some elements that are fairly clear to us. 1st and foremost, our business model is compatible with the post Brexit world. We have the scale, agility and levers to successfully adapt to Brexit and are prepared to take action as the situation gains clarity. 2nd, we have the necessary contingency plans in place to manage the risk of needs of disruption in the event of a no deal Brexit. Specifically, we have a concrete action plan to ensure uninterrupted service to our customers. This includes building additional safety stocks ahead of March 29. While a no deal Brexit scenario would likely lead to higher products cost during the short term as a result of the WTO tariffs, it would also result in higher prices. Our brands are in good health and we believe we are well equipped to navigate this scenario. In summary, we're very pleased with the results that we reported this morning, have strong momentum in our business and are excited to deliver another year of growth in 2019. With that, I will hand the call over to Sami to discuss our results in more detail and provide our initial thoughts on 2019 guidance. Sami? Thank you, Stephane, and thank you all for your participation on the call today. Turning to Slide 6, I will provide more detail on our key 4th quarter operating metrics beginning with revenues, which increased 21% to €615,000,000 driven by 4.2 organic revenue growth and 17.1 percentage point from the acquisition of Aunt Vessis and Gudfella. Foreign exchange translation offset revenue growth by 0.5 percentage points during the Q4. Adjusted gross margin was 29.9%, declining 160 basis points year on year. Base business gross margin expanded 20 basis points driven by volumemix and price, which more than offset COGS inflation and some residual effect from poor harvest. The 20 basis points increase in base business was offset by 180 basis points of acquisition mix, which we expect to moderate in 2019 as the acquisition enter the base and commercial initiatives are realized. Moving down to the rest of the P and L. Adjusted operating expense increased 8% year over year, primarily due to the inclusion of acquisitions. Within operating expense, A and P increased 10% and indirect expense increased 7%. Adjusted EBITDA was €101,000,000 representing 23% growth versus the prior year. Adjusted EBITDA margin of 16.4% compared to 16% in the year ago period due to the aforementioned factors. Adjusted EPS was €0.29 for the quarter, an increase of 7%, reflecting underlying EBITDA growth offset by higher finance costs in Q4, mainly due to phasing. Turning to Slide 7, I would like to review the P and L highlights for our full year 2018 results. Revenue increased 11% driven by 2.6 percent organic revenue growth and 9.4 percentage points from acquisitions. Foreign exchange translation offset revenue growth by 1 percentage point during the year. Adjusted gross margin was 30.3%, declining 30 basis points primarily due to the effect of acquisition mix of 110 basis points. Adjusted operating expenses increased 5% as disciplined expense management in our base business helped fund investments in A and P. Absolute growth in OpEx was largely driven by acquisitions. Adjusted EBITDA increased 15%. We achieved 50 basis points of EBITDA margin expansion ending the year at a margin of 17.3%. And finally, we delivered adjusted EPS of €1.19 which grew 19% year on year. We are pleased to have reported full year EBITDA and EPS ahead of our prior guidance. Turning to cash flow on Slide 8. We generated €291,000,000 of adjusted free cash flow during the year, representing 99% adjusted operating cash flow conversion. Factors contributing to the free cash flow in 2018 included adjusted EBITDA of €376,000,000 a working capital inflow of €32,000,000 CapEx of EUR 36,000,000 cash taxes were EUR 33,000,000 and finally cash interest and other was EUR 48,000,000. Dollars We are pleased to be reporting another year of strong cash flow generation. Before turning to guidance, I would like to spend a moment providing you with some background on IFRS 16. This is a new accounting standard on leases which came into effect on January 1st this year and whose impact will become apparent in our financial results beginning in the Q1 of 2019. For those of you familiar, this fully similar but not exactly the same as the lease accounting standard which companies following U. S. GAAP are affected by. We have summarized the impact of IFRS 16 on our financial in 2019 on Slide 9. Beginning in 2019 and the Q1 to be specific, we will be required to capitalize operating leases onto our balance sheet. IFRS 16 will have a few effects on our P and L. First, it will increase EBITDA by approximately EUR 15,000,000 due to the effect of the lower lease expense, which will be offset by higher depreciation and interest expense charges. The impact on gross profit and SG and A will be relatively minor as this is effectively a reclassification out of lease expenses and into D and A and interest expense. Please keep in mind that the actual impact of IFRS 16 will depend on lease fees that we enter and terminate in 2019, making this figure best estimates, which may be subject to change. When I think all of these factors, IFRS 16 is expected to be approximately EUR 5,000,000 diluted to pretax profit and EUR 0.02 dilutive to EPS. With that, let's now turn to Slide 10 to review our initial 2019 guidance, which includes the aforementioned impact of IFRS 16 and is based on foreign exchange rates as of February 26, 2019. For the full year 2019, we expect the following: organic revenue growth at the low single digit percentage rate, which assumes moderate category growth and continued market share expansion Adjusted EBITDA of approximately €420,000,000 to €430,000,000 which includes the anticipated benefit of €15,000,000 as a result of IFRS 16. When stripping out IFRS 16, adjusted EBITDA is expected to grow 8% to 10%, reflecting growth in the base and contribution from acquisitions. Adjusted EPS in the range of EUR 1.28 to EUR 1.32 which approximately includes €0.02 of dilution as a result of IFRS 16. Implied in our 2018 full year guidance are the following. Base business gross margin are expected to increase for the year, offset by negative mix from acquisition in Q1 and Q2 until we anniversary a full year of ownership mid year. For the year, operating expense are expected to grow roughly in line with sales. Finance costs are expected to be approximately EUR 70,000,000 including approximately EUR 5,000,000 related to IFRS 16. We expect an effective tax rate of 21% and are modeling a share count of EUR 176,000,000. Finally, there are some quarterly variations that we anticipate in 2019, which I would like to bring to your attention for modeling purposes. As you may know, Easter falls 3 weeks later this year versus last. This will result in shipment space from Q1 to Q2 versus a year ago, shipping an estimated 2% of organic revenue growth from Q1 to Q2. 2nd, on a consolidated basis, we expect year on year A and P growth to be greatest in the Q1 with growth moderating throughout the year and declining in Q4. Taking all of these factors into consideration, we expect Q4 to represent the highest quarter in both absolute EBITDA and year on year growth. That concludes our remarks. I will now turn the session over to Q and A. Thank you. Operator, back to you. Thank you. We'll take our first question from Andrew Lazar with Barclays. Good morning, everybody. Good morning, Andrew. How are you doing? Good. Thank you. So in thinking about organic growth in the Q4, obviously quite a bit stronger than we and I think most had modeled. Volume was very solid, but the real sort of upside, if you will, to organic was the pricing piece as that comes through. And it was good to see obviously volume remain positive in the face of that pricing. So I guess two questions on this. One is, what does that sort of suggest to you all about elasticity? Is that running broadly in line with what your thoughts or expectations have been or perhaps is it a bit more positive? And then as additional pricing comes into play as you go through 2019 in light of some of the inflation you're facing, would you expect that sort of dynamic to continue or would we think the organic growth that you get in 2019 becomes increasingly sort of pricing led versus volume? Thank you. So I would read that way, Andrew. Elasticity, it's a bit too early in 2018. However, we started to implement some price increases. So but definitely the bulk of the price increases on the shares in 2019. So talking about 2019, what we've seen so far is early signals in terms of price elasticity is good. But I would put it that way. So it would be a bit premature in 2018. But the more important thing is obviously quarter by quarter you can have some spikes here and there. What really matters for us is obviously the low single digit revenue organic revenue growth that we have in mind. So yes, quarter 4 was very strong. This being said, what really matters for us is to go through throughout all the quarters with that kind of algorithm in mind. But back to the price elasticity, so far so good, I would do it that way. Thanks for that. And then just Does this answer your question? It did. No, that's helpful. Thank you. And then just from a full year perspective, when we think about the type of flexibility that may be in the model, I'm trying to get a sense of how much, if any, incremental potential Brexit costs that you may have sort of built into the model? Is it that you built in some of the contingencies that you've been or that you will take? But obviously, if something goes to the whatever the worst case scenario, I would think that's not built in fully, of course, to the type of guidance. Correct. Just a little more clarity. Okay. Correct. The no deal, what we call what everybody calls the no deal is not in our guidance because by definition nobody knows starting with the politicians nobody knows exactly what that really implies. We obviously have some ideas, but it's really premature. At the same time, we are in any case in terms of Brexit, yes, we're preparing ourselves and in terms of inventory, in terms of the capabilities and all these things. And so we have incorporated a bit of cost no matter what because that's because it's we have to be prepared. So that's with or without any deals. The good news for us is overall in the Brexit in the no deal Brexit scenario is all brands are doing mix really well. We know that we see there is a no deal, there will be tariffs and those with the strongest brands will obviously be the best equipped in terms of price increase. Great. Thank you. And we'll take our next question from Steve Strycula with UBS. Hi, good morning and congratulations on a good quarter. Stephane, curious operationally, it sounds like both of the acquisitions that you recently acquired are tracking ahead of plan. Is that purely distribution growth? Or is there something you're tactically doing in the marketplace that is leading to that revenue outperformance there? And kind of what innovations do you have planned for this businesses for 2019? I'll stop there, but I have a follow-up afterwards. I think to start with, you're absolutely right. And that was part by the way of our plans. We knew that by incorporating these two brands together with the Birds Eye, it would lead to obviously to additional listings. And it's you have just to start with the initial reaction from the trade. Trade told us, fine, We like this idea of incorporating these brands because if you do what you have been doing with the Birds Eye, I think it can only be a win win. And with the trade, in the business, we see the difference. So that's really the first piece. In terms of improvement and all the rest of it, the first manifestation is with these 2 additional brands is obviously they're becoming part of they really have embraced this must be battle strategy which is about focus. So and it means also by the way that we are refocusing some pieces of the portfolio and they understand what it means, so which is good news. They see that it's starting to pay off. Then in terms of the rest of the flywheel, which is obviously improved packaging, improved quality, improved innovation and advertising, it's on its way. So more to come probably in Q2 and Q3. Okay. And then a quick follow-up on the EBITDA bridge that you guys outlined today. Should we think about is there any synergy and factored into that assumption net of the investment spend you had put behind those brands? So again, maybe cost synergies net of the advertising spend you put back into the brands, is any of that baked into guidance? And I'll pass it on. Yes. I mean, Steve, it's baked into the guidance. We'll take the next question, Kerry. And we'll take our next question from John Baumgartner with Wells Fargo. Good morning. Thanks for the question. Hi, John. Sandy, I'd like to drill into the outlook for the 2019 EBITDA a bit more broadly because I think we've been expecting another step up in brand investment for the portfolio and then obviously the Brexit contingencies are there as well. So could you maybe just outline where you see the margin support in terms of synergies versus lean manufacturing versus shared services or anything else going on there? Just kind of your progress overall? Yes. I mean, as I mentioned in the remarks, I mean, we're expecting effectively margin growth over the year. The one element about the investments that we are carrying now in the portfolio is we are really building up on the synergies and the cost saving program that we have put in place in order for us to extract funding to self fund our intervention. And the source of funding are around leveraging, if you want, our strategies as defined. Net revenue management is definitely providing an upside in many areas, whether it is going to be about pricing, whether it's going to be about mix, which we then can use to reinvest. Supply chain productivity is another one. And the other piece is we continue the effort in the area of indirect where we are now the ability to implement some important projects that are effective fueling again to the growth through efficiency that we are now generating. Okay. And then Stefan, just a follow-up. I also wanted to touch on the agreement with Ocean Beauty for the U. S. Market. Can you go into the details there on that a bit just in terms of entering Infiniti into foodservice and moving on from there? And then I guess in terms of the numbers, I mean how do you think about profitability in the U. S. Versus Europe? And I guess also to what extent is the distribution factored into your organic revenue for 2019? Let's face it, it's going to be it's a starting point. Fintus brand is a global brand, which is good news. It's apparently and has good recognition in the U. S. It's going to be obviously a price it's going to be well priced more as a good high quality product. For the rest, quite frankly, John, it's too early to say. I would say it's early investment in the U. S, which is a huge market. And so at this stage, I wouldn't take too much out of this. It's an encouraging start, but much more to be done obviously. And for us in terms of export, U. S. Is 1 piece. We also believe that we have a lot to do in some of our neighboring countries like Central and Eastern Europe where things like the captain, for example, has a high recognition and potentially also Middle East. So again, back to export, we're also trying very hard to focus beyond the limited number of countries, which was probably not what it was in the past. Excellent. Thanks for your time. You're welcome. And we'll take our next question from Jon Tanwanteng with CJS Securities. Good morning, gentlemen, and very quarter. Maybe to start with the OEM business. Within your guidance, how much impact are you expecting from no deal Brexit? At this stage, 0. So basically, it's impossible to have a clear definition of what it's going to be. As I said, even as the politicians, they have no clue. So we're working very hard, obviously, in terms of what tariffs would entail in all these things. What we know, which is good news, is our model provides us with the right level of agility and flexibility to move within the next 2 years to fully adapting ourselves to whatever notice Brexit would be. And in terms of price, in terms of footprint, in terms of dealing with co packers and all the rest of it. So level of preparedness for the near term is high. That's very clear. So we the priority number 1 for us is to make sure that our customers are not going to be that we're going to be able to supply them. And so we've added a significant number of weeks ahead of what we already have, so additional inventory. So don't be disappointed by the end of the quarter if inventory is increasing. So the working capital obviously will have to adapt itself, but we're doing this for the right reasons. Got it. That's helpful. And then any color on Q1 sales just now that we're 2 months in? How are the markets doing, the new products being accepted in the market? It's in line with our expectations at this stage and in line with our algorithm. Okay. That's right. And then finally, just a little more color on the pipeline and your capacity for acquisitions now. You've been working your leverage down very nicely. How do the valuations and the number of opportunities look in the pipeline compared to say 90 or 180 days ago? To your point, I think we in terms of ratio, we're moving in the right direction. 3.9 is fine. So we know that we'll be significantly lower by the end of the year, which is good, which again recreates the additional M and A opportunities for us. This being said, we will keep all discipline. And so the first piece for us is organic growth. And second is obviously synergy let's say acquisitions need to be fully in line with our strategy. And the priority number 1 is to reinforce our position as the leader in the consolidator of the food industry in Europe. Great. Thanks, Stefan. And we'll take our next question from Bill Chappell with SunTrust. Hi, this is actually Grant on for Bill. Thanks for taking the question. Yes. I was just wondering on the innovation and the consumer that's kind of been buying the innovation, especially the vegetable and plant based protein. Are you finding that that's a consumer that's bought your brands in the past? Is that someone that's new to the frozen category? I guess trying to get out, are those kind of incremental sales to your other branded sales or is that somebody may be switching to a different option? I think the answer, Bill, I mean is that it's going to be both, I would say. We definitely are, let's say, innovating to target new users. Mean, attracting new users is going to be very important and particularly millennials that are very interested by all of these new vegetable forms. And that's going to be really one of the area of focus. The other element is effective for our existing user base is provide them with a broader range of the portfolio. They like our brands. They consume our brands and we have a wider range and I think it's good for them as we have access to a broader range. Got it. Then I guess just one other question on kind of the commodity outlook. Obviously, you said fish is up this year. Is that specific to certain species? Is that across the board? And any other outlook to maybe the crop so far this year? Thank you. Yes, it's across the board. Most of the species are up, I mean, on fish for sure. Got it. Thank you. We'll take our next question from Robert Moskow with Credit Suisse. Hi. Thank you and congrats on a great year. I wanted to know, I think in your opening remarks, you said that list prices are in place now, list price increases are in place starting in Q1. But then I think you also said that discussions are ongoing with retailers regarding price. Does that mean that you are looking at taking more pricing during the course of the year? And I don't know, maybe you touched on this already, but is there a lag in Q1 between price and inflation? And when do you think that lag would be caught up? Thank you, Robert. Maybe I wasn't clear enough actually, sorry for this. So overall, we are, let's say, in line with our expectations and our expectations is that in some countries we would have all our price ready by the end of the year even before. And in some other countries it would take more time. Structurally that's always the same in Europe. So you have countries like U. K. Which probably you can put it in place as I said, in Q4. And in countries like France, for example, structurally, you have to wait until the very end of Q1, which is what we have. But overall, we're very much in line with our expectations. We're getting there overall. Some countries, obviously went faster than expected, some others went a bit more slowly than expected. But yes, I think it's in line with expectations. And in the what's important to say is also in the countries where we already put some prices, let's say, again early signals and that you can imagine it's something that we are monitoring very closely. We're checking the price elasticity. It seems to be moving in the right direction. But again, too early to say and absolutely crucial for us. Okay. So as we try to model your gross margin, and I know there's some noise with the acquisition, which is dilutive, should we assume that, I don't know, that your gross margin eventually catches up and levels out because you do have some it looks like you have a couple of factors in the first couple of quarters that are diluting it. And then does it catch up eventually? And then if so, should we then be modeling most of the leverage from the SG and A line to get to your 8% to 10% EBITDA growth? Yes, let me take that one. I mean, the fact is that the gross margin overall, as I mentioned, for the year will be up. And in total, it's going to be up for the base actually just to be very clear. In total, our gross margin in half 1 will be down in total and it's going to be up in half 2, okay. And you're going to see the effect of the acquisition indeed, I mean, playing off from that perspective is the mix driven by the acquisitions. Okay, Understood. Thank you very much. You're welcome. We'll take our next question from Brian Holland with Consumer Edge Research. Thank you. Sorry, good morning. Good afternoon where you are. A quick housekeeping question on the uptick. Forgive me if you touched on this earlier in finance costs in Q4. Q4, what was that tied to? It's primarily due to phasing of accounting and that's primarily it, I mean, overall. So there's nothing to be concerned for the year ahead. Okay, perfect. Thank you. And then most of my questions have been answered, but just want to ask a follow-up around the pricing component on the fish side. Is it too early or do you have a sense the competitive landscape fairly in lockstep with you with respect to what they're pushing through such that you're pretty comfortable with where you're positioned on the other side of that? Is that fair to assume everyone's moving with you guys directionally? The answer is yes. And because everybody is confronted with the same issue, which is obviously price I mean COGS are increasing. Okay. And last one for me. On the plant based side, which seems to have been a really successful launch for you, I'm just curious, what's the competitive landscape there like? Are you a first mover kind of in the sub segment that you're playing in there? How crowded is that? And how much room do you feel like you have to expand over time sort of in that need state, if you will? Actually, we definitely believe it's a category that has a great future. That's one thing. Definitely, our brand will play well with this category and together with our distribution obviously. And when you think about it, plant protein, which is even better, it's a P protein for us, which I would argue is even better than some other vegetables. We're definitely very confident that even if and to your point a lot of people are starting to get in, we have what it takes to be the number 1 in the category. It plays all the right trends in terms of health and wellness, sustainability and all these things together with frozen food by the way. Understood. Thank you. You're welcome. That concludes today's question and answer session. At this time, I would like to turn the call over to Mr. Stephane Dechmaker. So thank you for joining us on the call today to review our Q4 and full year results. We're pleased to have reported a 2nd consecutive year of growth and have an ambitious agenda ahead of us in 2019 to continue our journey. Thanks to the investment that we've been making in our brands and the collective effort of nearly 5,000 employees, I'm proud to say that we're well positioned to deliver another year performance in line with our long term growth algorithm. Thank you and I look forward to updating you on our Q1 results in May. This concludes today's call. Thank you for your participation. You may now disconnect.