Marina Kagan - Head of Public Affairs
Tony Maher - Chairman and Chief Executive Officer
Dmitry Ivanov - Chief Financial Officer
Daniel Wakerly - Morgan Stanley
Michael Gabovich - Glenrock Asset
Brady Martin - Citibank
Natasha Zagvozdina - Renaissance Capital
Wimm-Bill-Dann Foods OJSC (WBD) Q2 2010 Earnings Call September 2, 2010 8:00 AM ET
Good morning and good afternoon and welcome to today's conference, Wimm-Bill-Dann Foods second quarter results. (Operator Instructions)
Thank you. At this time, I would like to turn the call over to Marina Kagan.
Hello, ladies and gentlemen, and thank you for joining us to discuss the financial results of Wimm-Bill-Dann for the second quarter of 2010. As always, after our presentation, we will be happy to take your questions.
Before I hand the call over to our Chief Executive Officer, Tony Maher, I would ask that you please refer to the cautionary statements included in the press release covering any comments made during this call. Tony?
Thank you, Marina. Good afternoon to those of you joining us from Russia and Europe and good morning to our participants from the United States. The second quarter was defined by two dominant themes.
First of all and mostly importantly, we're seeing a strong and broad recovery in demand across all our business segments and across all categories. This is very encouraging.
Secondly, we continue to face challenges in raw milk procurement. The unusually hot summer and the strong demand had put additional pressure on raw milk prices and availability.
Let's begin with the demand trends. We continue to see very encouraging volume growth across all our segments, dairy, baby food and beverages. In fact, we are now back at pre-prices demand levels for dairy and exceeding those in baby food and beverages.
We are also realizing the benefits of our strategic actions to improve the profitability of our business through pricing and efficiency. More of the investments we made in our product portfolio and our marketing during the downturn are paying off in the form of share gains.
We gained market share in seven key categories including value-added dairy, juice and baby food. This positions us favorably in each of our three segments and it supports our long-term objective of expanding profitability through efficiency gains and greater participation in high-value categories.
We're very pleased with our progress on this front. Our markets are growing again and the strong footing we have built will enable us to capture more of that upside.
The other dominant issue in the quarter, as I mentioned earlier, was the raw milk environment. The abnormally hot summer season adversely impacted raw milk pricing and production in a number of ways.
First, the heat impacted grain production, raising price of feed. Second, the heat impacted production of milk. Cows produced less milk and so cheese, which created a shortage of supply, given the demand was growing. Also, second quarter raw milk prices were more than 30% higher than the same period a year ago.
As a result of the increased prices of raw milk, our gross margin in the second quarter decreased 340 basis points year-over-year. The cost and availability of milk is an ongoing issue, as you know, but we are working with our suppliers to manage through this temporary shortage.
We believe we are in a strong competitive position because of our long-term relationships with milk producers on the one hand and also our mix of higher margin dairy and non-dairy businesses as well.
Now, before we move to the highlights of our performance, let me touch on the agreement we announced with Danone to repurchase 18.4% stake in our company. This agreement represents the amicable conclusion of Danone's investments in our business. Once this repurchase closes, we will move forward unencumbered.
Also, I want to emphasize that we have no intention as of today to float this stock on any public markets. This concerns both ordinary shares and ADRs. Several other options are open to up in this regard. We may cancel the shares, thus reducing the number of shares outstanding, which in effect would be equal to paying dividends to our shareholders. Or we may use them as a tool in an appropriate M&A transaction, driving forward to profitability.
These options will be explored later as there is no immediate pressure to decide now.
Let me now turn to some of our performance highlights. Second quarter Group sales improved 15.3% year-over-year in U.S. dollar terms. On a comps and currency basis, Group sales improved 8.3% year-over-year and 5.2% sequentially. First half revenues are up 17.1% year-over-year. Importantly, this revenue growth was driven by topline improvements in each of our segments.
On a U.S. dollar basis, EBITDA improved to $86.2 million in the second quarter and $159.7 million for the first half of 2010, up about 1% for both periods. EBITDA margin for the second quarter was 13.5%, down 190 basis points year-over-year. First half EBITDA margin was 12.7%, down 210 basis points year-over-year period. However, we are confident that we are well positioned for future margin expansion, as demand continues to rebound and raw material environment normalizes.
Moving on to our segment performance, the dairy segment reported second quarter sales of $427.1 million, an increase of 13.1% on a year-over-year basis or 6.3% on a constant currency basis. First half dairy sales totaled $861.6 million, up 15.4% year-over-year and 4.9% on a constant currency basis. Revenue growth in dairy was driven by gains on several value-added products such as drinkable yogurts, curds and probiotics.
Gross margin in the dairy segment in the second quarter declined to 25.1% from 31.4% a year ago. First half segment gross margin was 23%, down from 30.3% a year ago. These declines are largely driven by raw milk purchase price.
In our beverages segment, second quarter sales were $131.3 million, an increase of 13.4% year-over-year or 6.3% on a constant currency basis. First half beverage sales were $239.7 million, a 14.2% improvement year-over-year or 4.1% on a constant currency basis.
Within the beverage segment we are benefiting from a wider portfolio of juice products which are now segmented into four distinct price tiers to support our go-to-market strategy. Gross margin in the beverage segment was 44.2%, up 380 basis points year-over-year.
First half segment gross profit was 43.4%, up 460 basis points from the prior year period. We continue to benefit from the solid foundation we've built in this segment over the last number of years.
In our baby food segment, second quarter sales were $81.4 million, up 32.6% year-over-year and 24.5% on a constant currency basis. First half segment sales totaled $153.8 million, up 33.9% year-over-year or 21.9% on a constant currency basis. Baby food continues to show impressive growth, as we introduced new products and leveraged our strong customer focus.
We saw improved volumes and favorable pricing across virtually the entire segment in the second quarter.
In closing, let me reiterate how encouraged we've been about the improving demand environment and our ability to take share across each of our segments. We're making good progress in these areas. However, we should expect the impact of raw milk situation to continue into the third quarter.
However, we maintain a long-term focus on managing the business, and we are confident that our improving product mix and the strengthened foundations for our operations will enable us to deliver greater profitability levels over time.
Thank you. And I hand the call over to Dmitry for a more detailed review of our financials.
Thank you, Tony. Our group sales increased 15% to $640 million in the second quarter of the same period last year. Sales in dairy segment increased 13% to $427 million from $377 million in second quarter of 2009. The average dollar selling price for baby segment increased 9% to $1.27 per kilo from $1.10 per kilo in the same period last year.
This increase came as a result of pricing we took in the third half of 2010. Gross margin in Dairy Segment fell to 25.1% from 31.4% compared to the same period last year. This decrease is attributable to a sharp increase in the raw milk cost.
Sales in the Beverages Segment increased 13% over last year to $131 million due to strong volume growth and positive exchange rate effects. Average dollar selling price in beverages segment stood almost flat at $0.74 per liter. The gross margin in beverages was 44% for the second quarter of 2010, an increase of 380 basis points over the same period last year.
Relative to the second quarter of 2009, revenue in the baby food segment showed solid growth, increasing by 33% to $81 million. The average selling price in baby food increased 8% over the same period last year to $1.88 per kilo. Gross margin in baby food fell to 47.6% from 48.8% compared to the same period last year, also due to the sharp increase in the raw milk cost.
I will now turn to operating expenses and other components of the P&L. Total selling and distribution expenses increased by 8% in absolute terms to $180 million compared to 2009, driven by increase in transportation tariff. At the same time, as a percentage of sales they declined to 16.9% in the second quarter 2010 from 18.1% in the same period last year.
General and administrative expenses stood almost flat at $34 million. Our EBITDA increased by 1% over the same period last year to $86 million. EBITDA margins decreased 190 basis points to 13.5% compared to the second quarter of 2009 due to the sharp increase in the raw milk cost.
Financial loss in the second quarter 2010 was $10 million compared to $8 million of financial gain in the same period last year. This year-over-year decline is attributable to Ruble remeasurement effect. Interest expenses increased by $3.9 million due to the increased cost of servicing of ruble-denominated debt and ruble appreciation.
Group net income decreased 31% to $36 million compared to $52 million last year. Capital expenditures increased by 34% in the second quarter of 2010 to $40 million compared to the second quarter of 2009. We continue to maintain this level, and we control, and as of the quarter end our net debt was at $843 million and our net debt to EBITDA ratio was 1.1.
Thank you, Dmitry. Operator, we are now ready to take questions.
(Operator Instructions) Your first question comes from the line of Daniel Wakerly of Morgan Stanley.
Daniel Wakerly - Morgan Stanley
First question is on the dairy volume performance. On my calculations, it looks like year-over-year volume growth was something like 5% or 6% in the first quarter year-on-year and in 2Q something like 2%. Does that sound right? Have I looked at the numbers the right way? And what's the outlook for the next couple of quarter?
I guess you normally get lower yields anyway. In a normal year, you get sort of lower milk production in the fourth quarter, but I guess the third quarter is going to have obviously the heat impact. So are we basically looking at a tough year-on-year issue in respect to getting more milk, being able to actually get what you need, and will things be a lot more normal year-on-year fourth quarter?
Volume, actually in the second quarter was also in the mid-single digits. So it was 4% or 5% up in terms of volume terms. The volume in the third quarter, and we're now past July, is stronger than that actually. Now the question would be September. But volume year-on-year for the third quarter for July-August combined is stronger than it was so far for the second. September remains to be seen. We're just moving into September. So it's not possible to talk about it. But our prognosis is third quarter is likely to be stronger than the second quarter volumes.
Of course, the question about raw milk availability continues to be a challenge and a question for us. But we are working through that. And that's all I can say. I mean the fact that the summer was the piece of the issue, the hot summer. And the other piece was the demand recovery. Any kind of percentage increase in demand for raw milk takes time for the whole production cycle to cope.
That factor is just the reality that cows just don't come from nowhere. It's a long period. So the market and the supply tide is about to get ready. So some degrees of success we're seeing in recovery exacerbates the problem at least as much as much the weather if not more to the weather.
The good news to those people not living in Russia is that the weather has gone back to more normal temperatures, may be a bit cooler to normal for late August and early September. So the 40-degree heat that we had here for practically two months is gone. So we couldn't even see some recovery in milk yields in the coming weeks and months.
Daniel Wakerly - Morgan Stanley
And as a follow up on your pricing, I mean you took some pricing in the first quarter of this year in dairy and that seemed to stick. I am I right in thinking you've taken some pricing or recently to address the increase in low cost? And how are you thinking about? Are you thinking that milk costs sort of a flip up for a quart or two and you'll under recover a bit or are you going to sort of put your prices up now to recover the cost pressure and if milk cost comes down again you'll cut your prices?
Well, the fact is we've actually been taking pricing behind the cost side by quite a bit. And actually, the price inflation started hitting Q4 last year and we took no pricing pretty much in that period of time because we wanted to wait and see. And even since then really, we've been trying to get the balance right between taking pricing and driving demand. And we have not taken pricing any where near in line with the price of raw milk. We've been trying to find other ways offsetting some that through; one through volume and two through overhead absorption and so on.
But obviously, there has to be margin in the business. And pricing in taking pricing is inevitable. But equally, we are anxious to make sure that we can balance right between the need for pricing on one side and the need for pricing demand and keeping demand going on the other. I can tell you also that because of our mix and not just mix within dairy, but we've got a very healthy baby food business. And now we have an extremely healthy beverage business. All of those things combined, have put us in a better state than practically all of our dairy competitors in relation to pricing where largely they don't have anything near the same balance as we do.
So we're not the first to be taking pricing right now. Actually, and we have not been the biggest price increase out there. Actually, quite a number of the local brand have taken much higher price that we have because, quite honestly I think they need to, because milk is such a huge part of their business.
The question is will the carton pricing stick for a long period? There is some benefit of course for the farmers having higher pricing. Also, not all of that goes to their bottomline, because they have increased input cost for the price of grain and they've also had a pretty tough time in the last couple of months with grain yields falling dramatically, which of course drive the price of feed.
But on the other side, if our revenue goes up per kilo, once we get our margins back and we will get our margins back to where they have been historically, then everybody is better off basically.
Interestingly, the price increases that have been taken have not suppressed demand. And I think that's very encouraging. And I think as long as we're (inaudible) keeping the balance right, we could take price increases in line with the raw milk prices in the short term. But I do think if we were to do that with price increases, we'd require a price increase of about 30% year-over-year to do that. That would not have been good for the demand side and probably for our bottom-line actually.
And I'm most prepared to be in a position where we are working to recover our margin side, which we are doing, and you can see quarter-after-quarter we're improving that rather than trying to drive demand, because all of a sudden we've become unaffordable.
Daniel Wakerly - Morgan Stanley
Okay. That makes perfect sense. And last question on beverages, can you give us a feel for how much of a one-time this year you're likely to have in the third quarter in respect of volumes. And can you just give us some color on the mix, juices versus water?
Well, water is still a very small part of our business, albeit growing, and we have high expectations of water. Will in a few years become meaningful. We have natural drinkable water from a spring which gives us something unique against our major national competitors. So we see this as being a good long-term play for driving volume and value and share.
I think the juice, certainly did see an uplift in juice, but the general feeling is that juice isn't particularly a winner in very hot weather. Water is much bigger winner, and of course company's soft drinks a bigger winner. But orange juice per say doesn't really cut it when it's 30 degrees outside for you.
So while our beverage business is doing well, we don't believe the category, in the third quarter, as we understand this, actually the second quarter is particularly is definitely better than it was. I mean, it's not declining anymore. But it didn't get the uplift that the water market got or the company's soft drink market got.
We're gaining share in juice and that is absolutely for sure. And it doesn't matter whether you look at Nielsen or Business Analytica or Canadian, they're all showing the same thing. So I think we are benefiting not from weather, but really from demand for our own brands. I think there's probably some uplift in the third quarter, but I think it's very, very little due to weather.
Your next question comes from the line of Michael Gabovich of Glenrock Asset.
Michael Gabovich - Glenrock Asset
How does the Danone merger with Unimilk affect your operations, and does it affect your longer-term 2015 financial targets?
Well, how does it affect our operations? I think that remains to be seen. Obviously Danone were not involved in our business as a competitor, and as a financial investor from a shareholding standpoint. So in that respect, nothing.
Of course, the upside for Danone is probably that they see economies of scale; Russia is a big face, and in that respect giving them economies of scale, putting a large footprint of traditional dairy products mainly together with their own yogurts and desserts together, that's probably some benefit. But I think there's also chances in putting any businesses together.
While I can only speak for what we've seen so far with mergers of this kind, and looking at the juice business, they have not been overly successful where the powers of companies like Coke going together with Multon, Pepsi with Lebedyansky and others, it hasn't been a glowing success so far in relation to the synergies and so on.
And if I look at our baby food business and our beverage business, where we are up against large players, one of them, actually two of them, Danone for example in baby food as well, it hasn't been an issue for us. So I would say overall, there's some pluses and minuses, but there's also opportunities, and we are pretty much optimistic.
We don't really believe that it's a bad thing. We actually think that Danone will bring certain rigor to that business in terms of key business indicators, which would be similar to our key business indicators in terms of returns on invested capital and these kinds of things which elevated the prices the company didn't need to do. That's not good, nor bad, but it's a reality.
So we don't think that it's a bad thing. Between us, we still have roughly about half the market as mentioned by Nielsen. So there's a lot more out there for us both to achieve. So we're not concerned really about it. We think that we've shown over time our ability to compete with everybody, including Danone, and the company is significantly bigger and more global than them.
Your next question comes from the line of Brady Martin of Citibank Moscow.
Brady Martin - Citibank
I just have two questions, one on beverage. I wonder if you can explain really what's happening in that category. When I look at my numbers anyway, in rubles it looks like the price for the third consecutive quarter is down year-on-year.
Corresponding with very good volumes, just wondering if you can explain how much of that is mix, maybe packaging, changes in selling smaller sizes, pushing the price down or if maybe you've taken some aggressive pricing in that segment. It looks like the pricing doesn't explain everything because the margins are clearly at an all time high. So just wondering if you can explain what's really going on in that category.
It's primarily a mix as you say yourself, it's obviously not pricing because the marks are good. But it is mixed in it, a mix of more water, which I feel has some impact on the revenue for the insurance on support. But also we've brought in a four-priced tier at the beginning of the economic challenges that say, which we saw in our market a year or so (inaudible). That's been very successful, but it is also quite profitable.
It's mainly nectars and so on. So the prices are lower, but the margins are good. And actually the more we sell of it, the margins are better because we've got overhead absorption in there also. So in beverages, volumes are excellent and pricing is fine. There is a bit of promoting going on there, I would say generally in the category, perhaps a bit more than usual. But it is primarily a mix issue. But it's not negative. Not everything that is cheap is necessarily bad.
And we have the price is actually by European standards are probably pretty decent there. They're at around for that product 100% (inaudible), they are somewhere around $1 per liter, which is a pretty high price.
Brady Martin - Citibank
Maybe if you can also explain what's happening with selling distributions, expenses and when I see that as well, I guess between 2007, 2008, beginning 2009 get used this to you getting good savings in general administrative expenses. Then kind of reinvesting that in selling and distribution. Now that volumes seem to be coming back, it looks like you're not doing that any more, is there something specific going on in selling and distribution, are you spending a lot less in advertising, or is this a reflection of cost cutting and why is that falling?
Marketing and advertising, if I go back to Mr. Kotler who invented the four Ps, one of the Ps is price. And it's always a balance between above the line and below the line activity. And give you that mix right. In the case of beverages and baby food, we are spending, we don't break it out, but we are spending substantially behind the brands in above the line and some below the line as well.
But in the case of dairy, clearly price increases. If we are deferring price increases, are taking lower prices, then may be our cost of goods is going up. If we've been back to be more appropriate than spending $1 million dollars in TV ad, that's where we're at. And I think is the question getting that balance right, not too little advertising, not too much. Not too much pricing not too little. It's a balance really, it's not, I am not saying we'll always get it right, but actually right now by and large with the demand moving in a very positive way.
Even though we are taking some price increases, we think that, that's important to try to keep that balance between support for the brand in TV and other places, against the need for offsetting significant input cost. And that's where we are at. We see that as marketing as well. And some of our value added categories are getting the same kind of marketing as usual.
But especially in the traditional dairy, we cannot at one level be taking less than the deflation, price increases at the same level, for putting the same amount of money behind the TV, because it wouldn't offset, when the affordability issue comes into play.
So it's trying to get the balance right between the two things, the price and the promotion if you like in terms of advertising.
(Operator Instructions) The next question comes from the line of Natasha Zagvozdina of Renaissance Capital.
Natasha Zagvozdina - Renaissance Capital
I had a question about the cash flow statement and the movement in the working capital, mainly understand and within the volume growth, so it must be explained by that. It would seem an increase in inventory is very substantial than receivable. Could the company please provide some color on the reasons for that?
Natasha, Dmitry will go into may be the details, but just to give you some sense, our receivables in terms of number of days are actually the lowest they've ever been. But of course, our revenues are up, and there is some currency aspect to that, but underlying revenues are up. And also more and more of our business is done directly rather than food distribution business where we're getting paid to the credit (inaudible) different.
But if I look overall, our receivable days are lower than they were a year ago. They are the lowest actually. Dmitry is just showing you they are the lowest that they've ever been.
Of course, inventory is something that is going up, driven by two things, increased demand on one side and also some hedging in raw material prices. We'll come out of the period with higher stocks, which we'll do, but we didn't actually, because otherwise we would have had a problem.
In the period, we came over with higher stocks in June with out things like sterilized milk, powder milk and so on and also becoming more juice concentrated, because we did expect demand. Even from the fourth quarter last year, we really expected that the market was going to recover in juice faster than most (inaudible) things.
So we became juice concentrated, because we buy direct from manufactures in China and South America. So there is quite a big lead time. So we decided then to increase (technical difficulty), and it's been remarkably fortuitous, because the volumes increased ahead of our expectations as well.
So I think there is more inventory out there. But actually if you take the simple number, what we look to is the operating cycle. Our operating cycle is also down right now.
Our operating cycle is 25 days, the lowest in the history of the company,
Absent this line, it's a very good number. So obviously in a growing business, you are going to have those investments in working capital. But obviously on receivables, I think there is no issue of bad debt. We are getting paid on time.
There will be some at that of year. We have an agro division for sugar beet and grain and so on. And we would be carrying stocks which we're going to sell at certain times, which are the right times to sell. So there will be the wagon there as well. But nonetheless, it's more of a positive thing. There are positive reasons, I should say, rather than negative reasons that our working capital has decreased.
Ladies and gentlemen, once again thank you for joining us today. A replay of this call will be available through September 16, 2010. All the information to access the replay can be found on the invitation that were sent to you or on our website. Should you have any further questions, please do not hesitate to contact us. Thank you and good bye.
Thank you for participating in today's conference. You may now disconnect.
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