Bang & Olufsen A/S

CSE:BO

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, welcome to the Bang & Olufsen Preliminary Q3 2018 and 2019 Results. [Operator Instructions]Today, I am pleased to present CEO, Henrik Clausen. Speakers, please begin.

[Henrik Clausen]

Good morning, everyone, and thank you for joining the call today.With me in the room, I have the EVP for Brand and Markets, John Mollanger; Senior Director for Global Finance and Strategy, Marlene Richter; and Director for Brand and Market Operations, Claus Højmark.We've set up the call today to follow-up on the announcement we sent out last night regarding the preliminary results for the third quarter and the revised outlook for 2018/'19.I will start with an update on key elements that impacted us in the quarter and then hand the word to Marlene, who'll take you through the financials, and then we'll go through the outlook for the financial year and finish off with a Q&A session.But before we dive into the details of the quarter, I would like to share a few reflections on where I see the company right now. In terms of products, we have some great and relevant products across all categories at the moment. We have had a limited amount of new product launches during the fiscal year, which has been a deliberate choice. We believe it's been necessary to ensure that we have a more consistent product road map across the product categories. This is to ensure that the products we bring to the market deliver on our core capabilities of sound, design and craft as we know that this is a must for our products to be successful.We want to ensure that our products are more consistent in terms of technology platforms and that we continue to leverage the core capabilities of our technology partners. This means that we are now looking into a year with a strong road map of great, innovative products, which will support the growth of our business.When it comes to distribution and channels, we clearly have had and still have a great need for transformation. Part of this is ensuring that we are in the right type of retail in the right locations and with the right partners. However, there is also a larger task in transforming the way we work with our channels, and how we, together with our partners, become more retail-led and demand-driven, which we've not been in the past. This transformation of our distribution and sales network is an absolute necessity for driving profitable growth in the future.That said, we have clearly been too optimistic in how fast we can transform the business and our ability to deliver high growth during this transition. We will maintain a relentless pressure to ensure this happens the fastest possible way, but the painful lesson we have learned over the last couple of quarters is that it will take time. The good news is that we have the right key partners across our mono and multibrand distribution, and they want to develop our shared business.And finally, when it comes to competencies, we have a couple of great people joining my team, [indiscernible] the new CTO, who joined a couple of weeks ago; and Nikolaj the CFO, the new CFO, who will also join us shortly. I'm convinced that they will add a lot of value and experience with the company, and the company will benefit from that.In addition, I also believe that we across the regions and in other key positions now have a solid team, who can steer the company through the challenges of the transformation we are going through.I therefore continue to believe that we have the right strategy and that we are well positioned in terms of products, distribution and competencies to steer our way through the challenges that we are facing.With that said, let's now have a closer look at the results for the third quarter, and I suggest we move to Slide 4.Revenue in the third quarter was DKK 710 million, which corresponds to a decline of 18%. We had expected that revenue in the third quarter would be impacted by the transformation of the sales and distribution network. However, we did not anticipate a decline of this magnitude. The decline was mainly driven by 2 factors: Firstly, we saw a significant decline in TV revenue compared to the same quarter last year; secondly, our ability to execute on the transformation of the sales and distribution network has not happened in the speed we expected across several countries and regions. I'll elaborate further on these 2 elements on the following slides.On the EBIT margin. In terms of EBIT, we managed to deliver a margin of 4.2% compared to 5.7% last year. Given the circumstances, we do believe this is positive and a testament to the fact that we have structured the business in a way that has made us more resilient to unexpected changes.In terms of free cash flow for the quarter, we had a negative free cash flow of DKK 13 million. We had anticipated a significant positive free cash flow for the quarter. However, the shortfall in revenue and the fact that we have planned our inventory for higher revenue meant that we fell short of our expectations here.Based on the third quarter results and the expectations for the development in the fourth quarter, we now expect revenues for the financial year to decline approximately 10% compared to last year and to deliver an EBIT margin of approximately 4% to 5%. The free cash flow is expected to be negative by between DKK 200 million and DKK 250 million.We have a capital structure target of minimum DKK 500 million in net cash position. And in the third quarter, our net cash position amounted to DKK 517 million. Since the purchase of the share buyback program was to adjust the capital structure and distribute excess capital to shareholders, the Board of Directors have, therefore, decided to discontinue the current share buyback program and will consider potential future distribution to shareholders in connection with the 2018/'19 Annual Report.Now I would like to go into a bit more detail of the key issues we have faced in the quarter. So let's move on to Slide 5. The main issue for us in the quarter was revenue in the Staged category, which declined 34% compared to the same quarter last year. The main reason for this decline was a significant decline in the revenue in the TV category. In the 2 graphs at the bottom of the page, we have shared our sell-in and the retailer sellout unit sales for Europe. There are 2 key takeaways from the graphs. Firstly, and most importantly, our retailers continue to see growth in the unit sales of TVs. If we include models that we no longer have in the product portfolio, the sellout has been 6%. And if we look only at Horizon and Eclipse, the sellout growth was 24%. The second take away is the fact that our sell-in growth has been significantly slower than the sellout growth, which implies that retailers have reduced inventories.The decline in sell-in was not anticipated and therefore, a major reason for the lower-than-expected results. The reasons for the decline in inventory at retail and hence the sell-in revenues was partly due to slower sellout growth than the retailers had experienced in previous quarters and therefore, a certain hesitation is to maintain inventory levels. However, this does not fully explain the development, and we're therefore working to give more insight to explain this. We have partner meetings with all key partners in the coming days in Struer and therefore, have great opportunities to gain further insights during the coming days.The sell-in TV revenue is expected to normalize during the fourth quarter, but the outcome is associated with a considerable level of uncertainty.So let's move to Slide 6. In addition to the challenges we have faced on the TV sales, in the third quarter, we continue to struggle with the transition of our sales and distribution network. We have overestimated the speed at which we've been able to drive change towards a more retail-led and demand-driven sales and distribution network. This is partly related to the pace at which we can transition the retail network to more high-traffic urban locations, where we ensure that we have the right retail traffic and partly related to our internal capacity and competencies to drive adequate distribution development, focused across channels, regions and key partners and not least, our market and channel insight to be able to effectively drive sellout and match this to the sell-in volumes.In EMEA, the negative development is mainly explained by the development in the TV category as I described on the previous page. Of Avant, the transformation of the multibrand channel continues to progress slower than expected. A key reason for the slower-than-expected distribution development, speed in multibrand is a significant issue with unauthorized channels.A substantial tightening of the governance of the flow of products to unauthorized channels has now been implemented, and we expect this to begin to slowly show an effect, which will regain interest for the relevant products.Americas. In the U.S., we have also been too optimistic on how fast the development of the distribution will translate to increase in revenue. Furthermore, the custom installed and B2B revenue fell short of expectations for the quarter.In Australia and New Zealand, we continue to have the same issue as we experienced in the second quarter. The ramp-up on the new master dealer is progressing slower than anticipated and will also impact the fourth quarter of the financial year. China showed growth again in the third quarter. However, also in China, we have a need to drive changes towards a more retail-led and demand-driven sales and distribution network. This is expected to result in a decline in revenue in China during the fourth quarter.And then Marlene will go through the key financials. So please go to Page 8.

[Marlene Richter Christensen]

Thank you, Henrik.As we already talked in detail about the revenue development in the quarter, I will not repeat all the details again. However, just to recap, we had an 18% decline in revenue compared to Q3 last year. And adjusted for currency developments, revenue declined by 19%. This means that the revenue declined by 10% year-to-date.Then we move on to the gross margin. The gross margin for the quarter improved by 4.8% to 49.2%. This was a result of improved product profitability and positive development within the currency. The gross margin improved across all regions in Q3, except from Americas, and that is due to channel mix development.If we then move on to capacity cost. The capacity cost in absolute terms declined by 5% in the quarter but increased as a percent of the revenue due to the shortfall in revenue. The decline was mainly driven by reduced development cost and partly offset by higher distribution and marketing cost in line with overall communicated strategy. The company has highly scalable cost base, and it is a key priority to maintain our controlled cost focus.EBIT. In the third quarter, we realized an EBIT of DKK 30 million compared to an EBIT of DKK 49 million last year. This corresponds to an EBIT margin of 4.2% compared to 5.7% last year. The EBIT margin decline of 1.4% was driven by the shortfall in the revenue in Q3.Then let's go to Page 9. CapEx. Compared to the same quarter last year, CapEx increased by DKK 7 million in the Q3, and that was primarily driven by investment in new product platforms as well as our new e-com platform, which we launched on the 1st of March.Then move to the net working capital. In the third quarter, net working capital increased by DKK 9 million to a total of -- amount of DKK 400 million. That corresponds to 13.1% of the last 12 months' revenue. This level is considerably higher than in the same quarter last year and also high in a historical context. The current level of net working capital is temporary at high levels, consequence of the ongoing transformation of the sales and distribution network and due to the fact that we expected higher revenue in the quarter than realized. The main driver of the increased net working capital compared to Q2 relates to an inventory increase of DKK 80 million. The increased inventory is a consequence of the shortfall in revenue. As previously mentioned, the current net working capital level is higher than expected and will be normalized during next fiscal year.Then move on to the free cash flow. In Q3, the free cash flow was minus DKK 13 million compared to plus DKK 34 million last year. The free cash flow was significantly below expectation. And the main reason for development relates to the shortfall in revenue and therefore, impacting profitability, higher CapEx and increased net working capital as previously mentioned.If we then move on to the net cash position. As a consequence of the free cash flow development during this fiscal year and our share buyback program, our net cash position has now -- has been reduced to DKK 517 million as of Q3. The Board of Directors have, therefore, decided to discontinue the program as Henrik previously mentioned.So that is it for the preliminary financial highlights. So now I would like to hand the word back to Henrik for the outlook for financial year and the closing remarks.

[Henrik Clausen]

Thank you, Marlene.For 2018/'19 outlook, please go to Page 11. As stated earlier on this webcast, the third quarter results were below expectations, and we had changed our expectations for the fourth quarter. Therefore, we now expect revenue for the financial year to decline by approximately 10% compared to last year. For EBIT, we expect to deliver an EBIT margin in the range of 4% to 5% compared to our previous outlook of 7% to 9%. The free cash flow is expected to be negative in the range of DKK 200 million to DKK 250 million compared to our previous outlook of more than DKK 100 million.Regarding our 3-year financial targets, we will not communicate anything here, but we'll assess and restate our long-term targets and will revert in connection with the announcement of the annual report for 2018/'19.That was it for us. But before we move into the Q&A and then just for time management, we wish the plan to keep this call at 30 minutes total. I would like to emphasize that we fully understand that you will have many questions. But please note that the figures presented today are preliminary figures, and we might not be able to have clear answers for all of them today.And then we, of course, have the opportunity to provide more information when we announce the interim report on the 4th of April, and of course, subsequent to that we'll be available for further details and questioning.With that, the word is yours. And thank you for listening in.

[Operator]

[Operator Instructions] And our first question comes from the line of Michael Rasmussen of ABG.

[Michael K. Vitfell-Rasmussen]

Now on the execution issues that you are commenting on here. I mean, you're obviously saying that things have gone wrong. But I don't think you actually say very much what has gone wrong. I understand that the logistics part with UPS is working out as it should. So can you maybe describe a little bit more what exactly is going wrong here? And also in the shorter term, what are you going to do about this? Have you done any layoffs? Or do you plan any new hires, on staff, on the back of this? My second question relates to the multibrand store closures. Did you say what that impact was during the year -- third quarter? And potentially, what the impact will be in the year -- in the fourth quarter? And just a reminder on your multibranded channel, how do you expect to see that going forward also into next year, i.e. should we expect that negative impact from closures also in '18/'19?

[Henrik Clausen]

Okay. So we will start from the top. And I'll start with the capabilities.The -- I mean, the foundation for driving the significant change that we are going through from a push- to a pull-driven or retail-led business model requires quite significant step-up from a competence point of view in the company. And we feel that we, over the last couple of quarters, have added the necessary key people at the regional level. So the new regional heads onboarded in Americas and EMEA, complementing what we have in China. And with the strengthening of the central team in Denmark, we feel that we have the foundation in place.And then one thing is bringing people on board, and then another point is bringing people up to speed. So you can say part of the challenge would obviously be getting people up to speed fast enough to engage and drive the change in our environment. We think that we made quite significant progress over the last quarter and expect that to kick in going forward.A second reflection is that it takes 2 to tango. So of course, it starts with our own abilities and competencies in the company. But the change that needs to happen as least for several of the key partners is as significant. And there the realization is that changing a way of operating from a push- to pull- or retail-led is quite significant change across the value chain, between us and the partners, and we can just say we have underestimated that journey. I think, we have learned our lessons, and we have quite clear plans for how that step is going to happen.And now I think there's just a third point, driving the business that we need to going forward, more brand-led retail, outside in, require a stronger foundation from an inside analytics data point of view that we have in place when began the fiscal year. So it's a part of the effort. The last couple of quarters has been building stronger consumer insight, sellout insight into the systems so we can act more consistently on what's going out in -- outside.So the overall reflection is that we -- I mean, we have a quite clear view on what is going to take. And there is no doubt that the building the capabilities has taken longer, and engaging with the partners the right way has, again, been more complex than we had expected. But we feel that the competencies are in place on both sides. Then on multibrand, we not so specifically guide on numbers of doors. I think we can relate any decline in multibrand to actual numbers of doors from a revenue decline point of view. I mean, the issue has been, and we communicated that already in Q4, the quality of execution in multibrand. And part of that is -- the solution to that is being to engage more directly with the retailers and the accounts, and that process is well progressing. I think the next part of that transition has been to build the necessary install positioning, which, again, we feel have been progressing. One of the key challenges we had and I alluded to that earlier is that it's fine that we have the right partners and we have the right motivation, but if the conduct in the marketplace is not so -- consistent, prudent, meaning if there are unauthorized products in the markets, if there's no consistent approach -- the challenge is it's very hard to motivate the competent partners to really build momentum in the business. So we realized that, and that's why the clean-up on unauthorized has been a key priority in the last couple of months. So with that, we think that we should and can expect to see multibrand, as a channel, grow and of course, significantly impacting and supporting the business, On-the-go but to some extent, Flexible as well.

[Operator]

Our next question comes from the line of Jesper Ilsoe from Nordea.

[Jesper Ilsoe, Analyst of Healthcare]

Can you maybe help us understand or add more flavor to what the retailers or distributors in the multibrand network are actually telling you when you try to go more direct and bypass the middleman? So what is the main negative prospect? How do we address that? And why should it change in the coming quarters? Perhaps you can add some more flavor to that.

[Henrik Clausen]

I mean, my reflection is not -- it's not necessarily a question about sort of cutting the middleman to -- just for the sake of cutting. But I think that there is an interest from the quality retailers to engage more directly with the brand from an execution point of view, and we have the same interest. It doesn't mean that we complete all tasks for all partners. There might be specific task around hard core logistics that would be handled for the partner. So the model would be, overall, more direct control, because we want to create and drive a branded experience, and that's in the interest of the multibrand players.So -- and that's being consistent, and that's actually not changed over the last couple of quarters. That's been the starting point for the interest and conversation. The challenge has been, as I alluded to this before, that in a market where the distributors, retailers don't see that the brand control or manage the flow of goods, the presentation of the goods, the unauthorized channels into the market, they're very reluctant to build business, because it will not allow them to retain the margins that they need to on our products. And therefore, we needed to move one step back and ensure that the conduct in the market created the right foundation and therefore, motivation for the professional retailers to reengage with us. So we've been through that process. And then -- since then, we have launched new versions of some of the key products, specifically, the E8 2.0, and first creating a new opportunity for meeting the partners with products that -- in a more clean context. And the expectation is that would gradually build confidence going forward in the channel.

[Operator]

Our next question comes from the line of Poul Jessen from Danske Bank.

[Poul Ernst Jessen, Senior Analyst]

Two questions. One on the multibrand coming back because when we were on the Q2 numbers, mid-January, as I recall it, you said that the agreements between the direct and the indirect distributors on the changes you had versus the larger accounts were now settled on paper. And I also think that you said that you had agreements and indications from retailers that they wanted to put more space and more focus on the B&O products and stores now that the Christmas sales were over. So I was just wondering when having that mid-January, then 1.5 months later, then you totally missed the number. So has it totally changed? Or have you just thought it was much easier? I don't get it, it could change that much. Second question is on the pipeline and thereby, the guidance for the fourth quarter, taking it from, it had to be positive territory to now minus 10% implicit for the fourth quarter. Are there in those fourth quarter numbers any fill-in of new products that has to be in the market by ahead of the summer break?

[Henrik Clausen]

First, on numbers for us -- numbers for Q3 on third-party retailers are not significantly different from we -- what we'd planned.I think we're actually quite explicit on that we would see quite significant impact negatively of the changes in the TPR network, and that was part of the reason for the adjustments we did in Q2. So that will be the first point. Second point, yes, we had agreements, and I'm not sure we used the words signed on paper, but we had agreements with partners on providing more space. And the reflection has been that, will the challenges we saw in the market and an increased inflow of unauthorized and therefore, an increased price pressure in the market, that slowed down those conversations. And therefore, we had to go that one step back and ensure that there was a margin for the retailer that was attractive enough, because we're talking professional retailers, they do their numbers. And of course, they expect a brand like ours to be in control with the market and ensure that the profitability is there. So that required a few extra rounds. So now we are reengaging, not sort of renegotiation or reestablishing relationships, but now we have an opportunity for coming back with specific packages and drive specific retail execution. So that is the process now. And then on Q4, I mean, I'm not going to comment on that specifically. But if you ask me sort of aggressive plans for sell-in of new products built into Q4, then that's not the case.

[Poul Ernst Jessen, Senior Analyst]

Okay. And then when talking to some of the franchisees, then you are planning both launches before and after summer? Or is it something you would confirm? Or has that been a change in the timing versus where you were maybe 6 months ago on when the new product should come?

[Henrik Clausen]

We'll not comment specifically on launches of new products.And I think -- but what you should expect is back to what I said initially that we have a, for us, exciting and relevant product road map for the next year, and that requires new seller launches and definitely, significantly more launches, new, actually, in all categories: Staged, On-the-go, and Flexible into the new fiscal year.I'm sorry, looking at people around here, and I know that there are probably tons of questions out there, but we tried to wrap it up quite fast. That might be our last question. But -- or of course, there are opportunities after the call to reach out, and I am looking at Marlene on the other side of the table. So for specific conversation and follow-up, please reach out. And then, of course, we have the detail, the opportunity after the launch of the results next week to go in even more detail based on the actual accounts.So with that, let's wrap up. And thank you for making the time, probably inconvenient and I'll say hopefully unexpected. But we will be there for questions and following-up, so I appreciate your participation. And have a nice day.