Smiths News plc (SNWS) Earnings Call Transcript

Good morning, ladies and gentlemen, and welcome to the Smiths News plc investor presentation for the unaudited interim financial results for the 26 weeks ended 27th of February, '21. [Operator Instructions] I'd also like to remind you that this presentation is being recorded. Before we begin, I'd like to submit the following poll. And I'd now like to hand to Jon Bunting, CEO; and Tony Grace, CFO of Smiths News plc. Good morning.

Thank you very much. Good morning, everyone, and welcome to our presentation of the Smiths News plc's interim results. The format, I'm sure, will be familiar. After I give a brief review of the headline performance, Tony Grace, our CFO, will take us through the financial results in more detail. I'll then review operational and strategic progress with a particular focus on our management through the pandemic and the impacts it's had on the business and our markets. Lastly, but importantly, I'll cover our capital management policy and our plans to deliver shareholder value over for the medium term. At the end of the presentation, Tony and I will then take questions. So turning to the headlines. I'm pleased to report that we are on track with all the key elements of our business plan despite the continuation of difficult macro trading circumstances. Overall, profit is in line with expectations as a result of careful management of operations throughout the second and third lockdowns and the underlying resilience of our business model. Indeed, the core wholesale operation of Smiths News is ahead of last year, with overall profit down due to the impact of the pandemic on our ancillary businesses. Given that the comparable prior year period predated to COVID pandemic, this is a strong performance from what is the main engine of the business. I'm pleased to confirm that as sales have stabilized, we've once again achieved a critical measure of savings and efficiencies offsetting the margin impact of the decline in core sales. To be doubly clear, we have done so without impact on service, maintaining a full-service to customers throughout the subsequent lockdowns. Meanwhile, our capital management objectives are on track following the successful refinancing in November 2020. So turning to the pandemic, we continue to provide a full and safe service to all of our customers with KPIs at pre-pandemic levels. Importantly, sales in lockdowns 2 and 3 did not see the sharp decline that we witnessed in March to May 2020, with far fewer retailers closing. Travel and commuting retailers, however, remains severely impacted, and they will continue to represent a substantial portion of the decline in the market as a whole. From the perspective of our financial performance, it is the relative stability that drives our ability to reduce costs and maintain controls whilst meeting our service obligations. In this respect, our teams have done a magnificent job as the country gradually returns to more normal patterns, we are confident the progress we have made can be sustained, and with any increase in cost from potentially increased volumes being kept strictly in proportion to the benefits. Beyond the core wholesale operation, our ancillary businesses of DMD and in-store have suffered year-on-year profit impact as a consequence of the pandemic. However, I can confirm they're operating at breakeven or marginally better, and our expectations are not reliant on their recovery in this year. So turning to dividends and capital management. We have been clear that we would pursue a prudent approach to capital management with a focus on maintaining liquidity throughout the pandemic and reducing debt in line with our new banking arrangements. The tight control of cash, debt and CapEx has been achieved in line with our expectations. And as we gradually emerge from the COVID restrictions, we can be confident in the ongoing performance of the business. In that context and, of course, subject to performance being maintained, we are planning for the return to the payment of dividends later in this financial year after the bank financial covenant tests are met at the end of this month. I'll give more detail on these points later in today's presentation, but for now, I'll hand over to Tony to talk you through the numbers.

Thank you, Jon. Good morning, everyone. The first half of the financial year includes a number of significant events, most notably, the completion of our refinancing in November 2020 and our response to the impact of the lockdowns in November and the months after Christmas. So let's now turn to the adjusted continuing income statement. Total revenue declined year-on-year by 11.5%, with 5% reflecting the underlying structural decline of newspapers and magazines and the balance, the continuing closure of retailers located at travel hubs and the more general additional impact of the lockdowns in the period. Adjusted EBITDA, excluding IFRS 16 lease accounting was GBP 20.5 million, GBP 1.2 million down in the same period last year. This was a resilient performance in a challenging environment with planned cost savings dovetailing with incremental cost controls as the business flex to adjust to lower volume. The decrease in EBITDA can be attributed to 3 distinct business drivers: a reduction in margin across all businesses of GBP 8.2 million as a result of the decline in revenue and volume. However, the reduction in volume was partly offset by depot and delivery cost savings within Smiths News of approximately GBP 4 million. A proportion of these costs are variable with volume in nature and we expect these to increase as revenues and volumes recover in H2. The final element is overhead savings of approximately GBP 3 million, a result of the restructuring implemented at the end of FY 2020, including the transfer of activities to a shared service center in India. Operating profit, including IFRS 16, but excluding adjusting items, is GBP 18.9 million, down GBP 1 million year-on-year, which comprises a reduction of GBP 0.5 million for Smiths News and GBP 0.5 million reduction for DMD. Operating margins increased to 3.4% compared to 3.1% in H1 2020, which underlines the flexibility and resilience of the business model. Finance costs increased by GBP 0.9 million to GBP 4.5 million due to the increased amortization cost of the facility arrangement fees of GBP 600,000 and increased interest costs and borrowings of GBP 300,000. Adjusted profit before tax was GBP 14.4 million, down GBP 1.9 million, which is 11.7%. The effective tax rate was 20.8% with a tax charge of GBP 3 million, which is GBP 100,000 lower than last year. Adjusted earnings per share was 4.6p, down 13%. It's worth noting that on a statutory basis, the recovery in financial performance has been more marked. Profit before tax was GBP 16 million, up GBP 9.3 million with adjusted items in the period of GBP 1.6 million, which relates to the reassessment of recovery of the Tuffnells deferred consideration. Statutory earnings per share in H1 2021 was 5.3p, up 3.5p on H1 2020 and higher by 0.7p compared to adjusted continued EPS in the period. We believe we have now established a stable, profitable foundation on which we can build a revised capital allocation policy, which Jon will explain later in the presentation. I will now look at free cash flow on a continuing basis. Free cash flow generation remains one of the company's key strengths and in these COVID-19 challenging times, the company has maintained its clear focus on cash generation and liquidity. And what was a challenging trading environment, the group generated GBP 4.6 million of free cash flow compared to GBP 5 million last year. It should be recognized that the business continues to be cash-generative throughout all COVID-19 lockdowns. Overall, adjusted EBITDA, this time including the GBP 3.9 million impact of IFRS 16 in H1 '21, declined by GBP 0.5 million to GBP 24.4 million. The working capital movement in the period was GBP 4.8 million cash outflow, higher than in the same period last year, and is driven by the timing of the receipts from retailers and payments to partnerships. It's worth noting that during the COVID-19 lockdowns in the period, we did not experience any significant abnormal returns of newspapers and magazines from the closure of retailers. Capital expenditure for Smiths News was GBP 3.2 million lower than last year as the company maintained strict control over cash outflows. CapEx plans remain focused on replacement and maintenance rather than growth CapEx, and total spend will be broadly in line with the annual non-IFRS 16 depreciation chart, which is GBP 4 million. Lease payments declined by GBP 1.2 million -- sorry, lease payments declined by GBP 1 million to GBP 2.9 million as some IT equipment, leases came to an end in the prior year. Net interest paid has increased by GBP 200,000 to GBP 3.5 million, a result of higher interest rates under the new debt facility. Average borrowings of GBP 89.5 million in the first half of the year were 9% lower than in the prior year. Arrangement fees of GBP 2.8 million paid in the current year relate to the debt refinancing completed in November 2020. Tax payments of GBP 2.8 million are higher than the prior year due to an additional quarterly payment made in February 2021. The cash cost of adjusting items in the period was GBP 2.6 million compared to GBP 4.2 million last year. This primarily represented network reorganization cost of GBP 2 million and pension buyout costs with similar outlays expected in H2 2021. Finally, I shall now turn to look at the net debt position of the group at the half year. The business has continued to remain focused on deleveraging, and this is reflected in the amortization schedule in the new buying facility. The first half amortization of GBP 7.5 million was completed in the last week of April. At the half year, closing bank net debt of GBP 70 million, excluding IFRS 16, and increased by GBP 1.5 million compared to last year. However, compared to the year-end, net debt is down GBP 9.7 million as a result of GBP 4.6 million from positive trading free cash flow and discontinued cash inflows of GBP 5.4 million following full repayment of a temporary working capital loan provided to the new owners of Tuffnells. Following the adoption of IFRS 16 lease accounting, property leases on our depots have been added to the calculation of net debt, giving an IFRS 16 total net debt of GBP 101.3 million at the half year. We successfully refinanced a GBP 120 million bank facility for 3 years in November 2020. Our bank covenants continue to be measured under frozen GAAP. And consequently, bank net debt at the half year was GBP 70 million, which represents leverage of 1.8x EBITDA, a reduction from the 2x at the last half year. I shall now hand back to Jon for an update on operational and strategic progress.

Thank you, Tony. So briefly, just to outline that in this section of the presentation, I'm going to cover 5 topics: firstly, the actions we've taken in managing through the pandemic and the consequences for service and operations; secondly, an overview of its impact on our sales and markets and what it means going forward; thirdly, I'll cover our ancillary businesses and provide reassurance on their prospects; fourthly, capital management policy and our approach to dividends going forward; and then last but not least, our priorities and outlook for the remainder of the year. Starting with the pandemic. On the right-hand side of this slide, you'll see the principles we've established last year, which continues to guide all of our actions. When we spoke last November, we could not have known that there would be 2 subsequent lockdowns and that these principles would remain quite so central to our plans. I'm pleased to confirm that they continue to be met without compromise to the safety of our colleagues or the progress of our business plan. Clearly, the pandemic continues to impact sales and operations with disruptions in shopping, travel, commuting as well as wider social events, including sports that help drive newspapers and magazine sales. The second and third lockdowns were, however, less impactful than the first with significantly fewer retail closures, down to circa 120 outlets from a high of over 2,000 in the early days of lockdown 1. This not only helped with availability in sales, it also supports our cash flow and our indexed-linked delivery service charges. Our contractor delivery model is a further element of resilience, which allows for greater flex in variable costs as volume fluctuate. The removal and consolidation of routes has played a key role in mitigating the impact of reduced margin. The action we took on central costs following the sale of Tuffnells is also flowing through in line with our plan, as are longer-term operational savings in the business. Our ancillary businesses have been harder hit, especially DMD, which serves international travel markets. The impact across all these businesses year-on-year is around GBP 1.4 million profitability terms. Looking ahead, we have kept costs under tight control, and through there, is a year-on-year impact in the period that they're operating at breakeven or growth. And we do not consider them a material risk to meeting our expectations going forward. More widely, we remain cautious and focused in our management of operations as we hopefully exit the pandemic in an irreversible way. Meanwhile, there will be no compromise to our core principles, and we will work with our industry partners to recover as much lost ground as possible, albeit that our plans for the year are not dependent on volume recovery. If we look at sales, the graph on the slide shows the impact of the pandemic on our sales over the last 18 months. As you can see, sales were formally following the established pattern of declines in the region of up to 5% per year. During the first lockdown, sales were dramatically impacted, especially in April and May. At the peak of the crisis in April, magazines were down by nearly 50% and newspapers were down by 18%. Since then, a more stable pattern has emerged, albeit with ongoing sales decline of circa 11%, indicating that the pandemic has reduced sales by circa 6% on top of the established declines. This situation broadly continues and in lockdowns 2 and 3, we did not see a return to the initial reductions of spring of last year. In part, this is because only circa 120 retailers remain closed. That said, you can see the impact of the regional restrictions on magazines in the first quarter of this financial year, and there is some impact here on the timing of on sale dates and monthly publications. One of the benefits of our business model is that we distribute all retail channels, and we are not exposed to one specific channel. For example, travel. The traveling and commuting sector remains severely challenged, and we can all see that. However, we've seen our sales increase amongst independent retailers as consumers have shopped locally. We believe the current picture is broadly positive and compared to many of the retail sectors, shows a remarkable resilience in the level of disruption. Before closing the operational section, I'd just like to cover the ancillary businesses. Firstly, to stress, these typically represent only 5% of our overall EBITDA. Nonetheless, they make a valuable contribution and are complementary to the core wholesale business. As such, we remain committed to their future whilst recognizing they've suffered disproportionately from the pandemic. The impact on DMD sales will be obvious. However, some years ago, we integrated its physical operation in the U.K. into Smiths News. This means there are no additional fixed costs, and therefore, with careful management, DMD is running a skeleton operation at breakeven. As and when travel returns, we would expect to pick up. But in the meantime, the risks are contained. This situation with in-store is similar with the pandemic causing major retailers to remove outsource merchandising often to safety reasons. And thereafter, they need to reconsider their needs. In-store has greater fixed cost than DMD, but have sufficient ongoing contracts to cover these. And indeed, the business made a small contribution in the period. In summary, the outlook for these businesses remains uncertain, but we believe there is more upside than risk. And importantly, we are not dependent on their recovery to meet our profit and capital management expectations. So turning to capital management. Our capital management remains a key priority following the successful refinancing in October 2020. And by way of further context, the securing of all major contracts last year gives us high levels of cash flow visibility for the next 4 years. Combine that with the resilience we have shown through the pandemic, and the result is that despite the challenging conditions, our goals for cash, maintenance CapEx and debt are all on track. Indeed, further to the period end, the first debt amortization payment of GBP 7.5 million was made in April of this year. Looking to our policy, which I'm pleased to outline today, our objectives are: the reduction of net debt to 1x EBITDA by the end of FY '23. And we'll do that through the strong free cash flow, which supports GBP 15 million of annual amortization payments on term loan A. And then the application of any cash from the Tuffnells deferred consideration and the pension surplus against Term Loan B. This will then allow us to maintain net debt at around similar levels beyond 2023. We plan to maintain CapEx in line with depreciation of circa GBP 4 million per annum. Any additional CapEx required for growth will achieve a return of at least our adjusted cost of capital. And then returning to payment to dividend from the second half of this financial year with a dividend cover of 2x. However, under the terms of our current banking facilities, our ability to make dividend payments is restricted to GBP 4 million in FY '21 and GBP 6 million in FY '22 and FY '23. In the event there is excess cash after having applied the policy, we would look as a matter of policy to return this to shareholders in the way of special dividends. So our strategy for shareholder value is founded on 3 distinct components. The cash benefit of reduced interest payments, boosting profit before tax, potential capital growth from a stronger balance sheet underpinning our valuation and share price and then the restoration of dividend payments from later this financial year and in the event of excess cash, the returning of special dividends to shareholders. So if we look at our priorities and outlook, our operational priorities for H2 are clear and within our control. They are to manage through COVID-19, ensuring any increased costs from increased volumes are kept strictly in line with the sales benefits. Maintaining progress on securing efficiencies without compromise to our service KPIs, which give us our market leadership. And then the close control of our ancillary businesses such as any recoveries are welcomed extra but without ongoing risk. Shareholder value remains a key focus for our capital management plans. And in that regard, we have balanced objectives that meet the needs of all stakeholders. We plan to strengthen the balance sheet with target debt of net times, 1. And in line with our confidence in the business and, of course, subject to continued trending in line with expectations, we're expecting to return to payment to dividends later in this financial year. So in terms of the outlook, the prospects for ongoing trading as COVID restriction ease are clearer and more positive than they've been for some time. Trading for the year to date is in line with the Board's expectations and on track to meet market expectations for the full year. I would just like to say before closing, a special thank you to Tony Grace for his commitment and contribution to the business as well, of course, for his personal support to me in my time in this role. As you all know, Tony has taken the decision to retire. And we'd like to take an opportunity to thank Tony for the huge role he's helped us play in navigating through immense challenge and change over the last 3 years. It's very much to his credit we've come through stronger and clearer in our direction and prospects. And on behalf of the Board, we'd like to wish him well in his retirement, and I'm delighted to be around for a good number of months yet to enable a smooth handover. After that, I'm very happy now to take any questions.

[Operator Instructions] And just while John and Tony take a few moments to review those investor questions submitted already, I'd like to remind you the recording of the presentation, along with a copy of the slides and the published Q&A can be accessed via our investor dashboard on the Investor Meet company platform. I'd also like to remind you that your feedback is really important to the company. And immediately after the presentation has ended, you'll be redirected for the opportunity to provide feedback in order of the company can better understand your views and expectations. And Jon and Tony, before we move on to some of the questions submitted during today's event, we did receive a number of pre-submitted questions from investors. And perhaps if I could start the Q&A session off with those. The first one reads as follows: Given the balance sheet is heavily negative net tangible assets and the bank borrowings are expensive at 0.5% to 6% above LIBOR. We did not make more sense to rapidly reduce debt and refinance it at a cheaper rate before resuming paying dividends?

I'll take that one, Jon.

Okay.

Good question. Thank you. First of all, the margin is not the 5.5%. That is the headline rate, but because of the good performance of the business and strong cash management and the ratchet within the facility, it's actually an ongoing margin at the moment of about 4.25%. Still on the high side. And yes, probably if we went into the market and the market allowed us to do so, we could probably take 100, 125 basis points of that. However, we have a very clear plan here on achieving 1x EBITDA in terms of our leverage. We've talked about getting there by FY '23. We believe, actually, there is the opportunity, not certain that there is the opportunity that we could get there quicker. And that's because of 2 things. First of all, let me talk about the structure of our debt, and then I am going to explain. So we have a GBP 45 million Term Loan A, which amortizes GBP 7.5 million every 6 months, as I said already, with the positive repayment being made in April -- on April 29. So that will continue to amortize at GBP 15 million per annum going forward. By the end of November of this year, and it is -- that facility will set at about GBP 30 million. So that's good to hold that for. Secondly, term loan B, which is GBP 35 million, and that what we see as a [ bullet ] repayment. However, in the event that we receive the deferred consideration from Tuffnells and GBP 6.5 million of that is due again in November of this year, that must be leased against Term Loan B. We also have the likelihood of a surplus from the defined benefits funds, which has been subject of a buyer and is in the process of windup. And that could be another GBP 9 million that we receive sometime in H1 of next year. It is feasible that by November, we will have reduced our debt to about GBP 50 million. So GBP 50 million through amortization and GBP 15 million through the receipts of Tuffnells and deferred consideration surplus and the pension surplus. Plus, on top of that, it would be an RCH. However, markets are lowing and such like, we will look to refinance at the nearest opportunity, but we have a clear plan to get to 1x EBITDA through the amortization schedule and the receipt of these funds.

Fantastic. Thank you very much indeed. The next question we've got here reads as follows: Can you expand further on the current status of DMD and in-store?

Sure. Yes. Happy to take that. So as I mentioned in the presentation, both businesses are either running at breakeven or making a small contribution, and they're operating with a skeleton team. We are not benefiting from furlough in any way and haven't throughout this financial year. And we are largely waiting for those markets to come back. So if you take DMD, which services the airlines and airport market, we can all understand why volume and demand has disappeared over the last few months. Equally, I think we all recognize there is lots of pent-up demand for people to start flying again, whether that's the holidays or business trips or everything else. So we are confident the market will come back. And therefore, we're managing our cost base to ensure that it's not a risk in the interim period.

Thank you, Jon. Next one we have here is, are there further steps planned to improve your operational efficiency?

Yes. So if you look at our -- for those of you that have followed our stock for a while, you know over the last 8 years, we've got a really strong track record of delivering on our numbers and managing to offset margin decline through operational efficiencies, and we're on plan to do it again this year. We tend to operate in 3-year cycles when it looks at our operational efficiencies. So if we take the cycle we're starting now, so for the next 3 years, we've got absolute detail for where our GBP 5 million of savings will come from next year. We've got a recent amount of detail for the year after and then headline savings probably for year 3. Typically where they come from are, firstly, in our operational savings. So all of our warehouses operate activity-based costing, which means as volume declines, we know exactly which processes we have, which should reduce by which amount by location. So that's the first thing. The second thing is we also constantly look at the -- at the physical infrastructure that we've got and the number of warehouses we've got. And typically, we take some physical infrastructure off the map to drive some efficiencies, and we would expect to do some of that over the next 3 years. If we then look at our head office costs, well, we did a major restructure of those in the summer of last year. And you've seen some of the benefits of that now. We took that decision because we felt that this year would likely be more volatile given the pandemic and we wanted to establish the right cost base, and I think that's proven to be the right decision. And going forward, we'll continue to look at ways in which we can drive efficiency. So for example, we have a shared service center in India. And we allocate roles there where we feel we want that role that would benefit from the labor arbitrage of having provided in India. Now at the moment, for all the reasons we understand, there's a very human tragedy going on in India. And now would not be the right time to add more roles into that area. In fact, actually, we're providing support to our colleagues, and I've just set up a hardship fund to support our colleagues out in India. But in the medium term, when COVID is maintained and controlled, I should say, in India, then we would see an opportunity to do some more outsourcing there. We have a proven track record of taking at least GBP 5 million a year out of our cost base, and I'm confident we'll do that for at least the next 3 years, which is our operational cycle.

That's great. Thank you very much, Jon. And Tony, I think you've probably covered this one off already., So this is as possible as we can get to net debt to 1x EBITDA before the end of full year 2023?

Yes. I think I said already that if the deferred consideration is paid in the manner it's contractually applies to be and the pension surplus come in, we have a good chance of getting there quicker, perhaps even within the next 9 to 12 months.

That's Brilliant. Thank you. And then the final one we got here again, and just touching on those cost savings, I think you just mentioned, Jon. But you've been very successful historically taking out costs to match the decline in newspaper, magazine margins. How sustainable are these cost savings going forward?