Technicolor SA (OTCPK:THNRF) Q2 2022 Earnings Conference Call July 28, 2022 12:30 PM ET
Company Participants
Richard Moat – Chief Executive Officer
Laurent Carozzi – Chief Financial Officer
Conference Call Participants
David Cerdan – Kepler Cheuvreux
Operator
Ladies and gentlemen, welcome to Technicolor’s Conference Call chaired by Richard Moat, CEO and Laurent Carozzi, CFO. [Operator Instructions] Just to remind you all, this conference is being recorded.
We would like to inform you that this event is also available live on Technicolor’s website with synchronized slideshow. During this conference call, statements could be made that constitute forward-looking statements based on management’s current expectations and beliefs and are subject to a number of risks and uncertainties that could cause actual results to differ materially from the future results expressed, forecasted or implied by such forward-looking statements. For a more complete list and description of such risks and uncertainties, refer to Technicolor’s filings with the French Autorité des Marchés Financiers.
I would like now to hand over the call to Richard Moat. Sir, please go ahead.
Richard Moat
Good evening, everyone, and thank you very much for joining us to discuss Technicolor’s first half 2022 financial results. So let’s start on Slide 4. During the first half, Technicolor’s divisions continued to perform well, producing a good set of results and extending the positive momentum that we saw in our first quarter. So let’s look closely at the results on this slide. Our revenues amounted to €1.601 billion, which was up 8.8% at constant exchange rate driven by strong demand for products and services from Technicolor Creative Studios and Connected Home.
Our adjusted EBITDA totaled €134 million, up €40 million from last year, and the adjusted EBITDA margin improved by 139 basis points at constant exchange rates to 8.4% of revenues resulting from higher revenues and significant cost savings as well as operating efficiencies achieved across all divisions. In addition, our free cash flow improved by €180 million, thanks to better operating performance and lower change in working capital requirements at Connected Home, along with lower restructuring expenses, notably in the second quarter.
Today, our businesses are strongly positioned as leaders in their respective markets, enabling them to face some of the ongoing industry-related headwinds. Specifically, our businesses have benefited from an improved cost base and strengthened operations to navigate continuing supply chain constraints as well as a decrease in advertising spending.
So let’s move on to Slide 5. As we go forward, I’m pleased to confirm this year’s Technicolor guidance. We expect revenue from continuing operations to keep growing. Adjusted EBITDA of €361 million, adjusted EBITA of €161 million, and free cash flow of €217 million. In addition, we are well on track to achieve our run rate cost savings target of €325 million by the end of this year. Through our successful initiatives, we have already achieved €317 million cumulatively in cost savings since 2020.
Now taking a look at Slide 6, we have made significant progress in the partial spin-off of Technicolor Creative Studios, along with the refinancing of our existing debt. Thanks to the overwhelming support we have had from all of our stakeholders, we are well on track to create two leading independent companies with solid foundations for growth by the end of the third quarter of 2022. Once the spin-off is approved, we will move forward with the listing of Technicolor Creative Studios through which Technicolor shareholders will receive 1 share of TCS for each share they own of Technicolor. As we move towards that goal, our next step is to host a shareholders’ meeting on September 6, so that they can approve the spin-off and the new corporate name of Technicolor SA, which will be VANTIVA.
On Slide 7, along with the strategic spin-off, we are refinancing our debt. As you know, our shareholders have overwhelmingly approved the issuance of €300 million unsecured reserved mandatory convertible notes, which amount is fully subscribed by a group of our investors. In addition, we have negotiated two distinct financing packages for the two separate entities. As part of the refinancing process, Technicolor SA has finalized discussions for both VANTIVA and TCS, for VANTIVA, Barclays Bank and Angelo Gordon have committed to provide a €375 million debt package. In parallel, advanced discussions are underway with Wells Fargo to extend the asset-based lending facility for 4 years.
For TCS, the group has obtained commitment for a €623 million floating rate first lien term facility. This facility is composed of two tranches of €563 million tranche and a $60 million tranche. The maturity for both these tranches will be 4 years. In addition, the group has obtained commitment for a €40 million revolving credit facility. The terms of the refinancing of the Technicolor Creative Studios facility, as well as returns on the distribution are the subject of a prospectus to be approved by the AMF. This refinancing aims at providing both the future companies with a more agile balance sheet and adequate capital structures in order to support their own development and their long-term growth ambitions.
Now let’s look at Slide 8, where we dive into the performance of our divisions. And over on Slide 9, starting with TCS, in the first half, TCS proved yet again why it’s the independent global leader in tech-enabled content creation with an award-winning portfolio. During the period, all 4 of TCS business lines worked on many outstanding projects with leading players in the content industry, reflecting the strong industry demand for content as well as the skills and expertise of our talent and our cutting-edge industry technology. MPC teams worked on approximately 20 theatrical and over 35 streaming and episodic projects, and their outstanding work was rewarded with industry nominations and awards. Mikros Animation was involved in the production of 6 features and several episodic series, including Charlie and the Chocolate Factory for Netflix. The Mill contributed to more than 1,900 projects during the first half and 1 key industry awards and Technicolor Games set working with several AAA games companies.
On Slide 10, we’re looking to the financial performance of Technicolor Creative Studios, and you will see that we continue to benefit from increasingly strong demand for original content. In the first half, TCS revenues amounted to €408 million, which was up 29.6% at constant rate compared to last year’s period. If we were to exclude the Post Production business, which we divested in April of 2021, revenue growth was 43.7% at constant exchange rate compared to the first half of last year. This significant improvement was largely driven by a major increase in demand for original content despite the market shortage of talent and the deceleration of advertising spending growth as a consequence of the macroeconomic conditions.
Our adjusted EBITDA margin totaled €61 million, which was up €16 million compared to last year’s period at constant exchange rate. On top of the increase in revenues, our margin improvement from 13.7% to 15% resulted from the positive impacts of multiple operational transformation programs in conjunction with permanent cost reduction measures. However, our first half margin was partly reduced by higher costs required to complete major projects as the shortage of experienced talent caused delays and additional costs.
In addition, lower revenues at The Mill in the second quarter of 2022 reduced profitability. To address these headwinds, we have implemented mitigation actions and MPC and The Mill are actively working on accelerating recruitment and training programs. Looking ahead to the rest of the year, we expect that demand for TCS VFX and animation services will continue to grow significantly. Specifically, MPC and Mikros Animation have already been awarded new projects with more than 85% of the pipeline committed for 2022.
As for The Mill, we are expecting slower growth than initially anticipated given reduced advertising spending. For Technicolor Games, we expect demand for games content to continue growing along with the expansion of our service offering. Meanwhile, across the board, delivering on all projects that are committed will remain the main challenge for the rest of the year.
Now let’s turn to Connected Home on Slide 11. In the first half of this year, Connected Home continued to see business progress with strong demand, in particular for broadband products as people seek to improve their connectivity. And we have seen an increase of broadband as a percentage of our revenue compared to last year’s first half. Connected Home continues to deepen its leadership position by deploying open and innovative technologies for leading network service providers, such as Bouygues Telecom in France. Importantly, we are committed to the science-based targets initiative making Technicolor the only company in the Connected Home space, which has signed the 2050 net zero standard.
Looking at the financial results for Connected Home on Slide 12, during the first half of the year, Connected Home managed to efficiently navigate a very challenging environment. Our revenues totaled €897 million, which represented an increase of 5.8% at constant exchange rate compared to the same period of 2021. While the supply chain constraints and the ongoing chip shortage limited the division’s ability to fully satisfy customer demand, our solid second quarter revenue showed signs that there is improvement in the allocation of supply and in transit times.
In addition, the increase of broadband revenue as a percentage of sales with a strong rebound in North America drove revenue even further. Adjusted EBITDA amounted to €70 million in the first half of 2022 up 14.4% at constant exchange rate or 7.8% of revenue compared to 7.2% of revenues in the first half of 2021. Our margin improvement was mainly driven by operating efficiencies and cost savings, along with an improvement in sales.
Looking ahead, we expect that the demand for Connected Home broadband boxes will remain strong. While we started to see some improvement in supply and delivery, we will continue to collaborate with our clients and suppliers to optimize our processes and mitigate the potential impact on profitability and working capital. In addition, we’re continuing to implement efficiency measures and delivery improvement initiatives in order to mitigate the shortage of components and pricing challenges.
On Slide 13, let’s turn to Vantiva Supply Chain Services, formerly known as DVD Services. Throughout the first half of 2022, Vantiva Supply Chain Services continued to adapt its distribution and manufacturing operations as well as customer contracts, in response to the ongoing decline in disc volume with volumes reducing by 30% compared to last year’s period. However, as part of its strategy to diversify its activities, Vantiva Supply Chain Services has made considerable progress during the first half. In Microfluidics, our new lab in Poland is nearing completions, we’ve gone beyond prototyping. In the Vinyl, we have executed contracts with 2 of the world’s top 3 music companies, Universal Music Group and Sony Music. And we had the launch of our own commercial record pressing in May, which is enabling us to be recognized as a high-quality player in the industry. In supply chain, fulfillment and transportation, we have continued to add new customers, driving supply chain and fulfillment growth in the first half of 2022 as well as year-over-year growth in the freight brokerage business.
On Slide 14, our solid financial results show that our operational restructuring and diversification strategy is working. Vantiva Supply Chain Services revenue totaled €296 million in the first half of 2022, which is up 4.5% at current rate compared with the first half of 2021, but down 3.2% at constant exchange rate. While we experienced expected lower disc volumes, the impact of volume reductions was partially offset by disc price increases and pass through cost increases along with the performance of new growth businesses, notably transportation management and vinyl. In the first half of 2022, adjusted EBITDA amounted to €15 million, representing 5.2% of half one, 2022 revenues compared to 3.6% in half one of 2021. EBITDA margin improvement was mainly driven by significant footprint optimization, headcount reductions and higher activity in non-disc businesses.
Moving forward, in 2022, solid year-on-year new release volumes are expected as theatrical attendance continues to normalize, but this will be more than offset by lower catalog volumes, driven by evolving customer and retailer behavior. As part of the group’s plan to accelerate the diversification of the business, the division is continuing to work on significantly expanding non-disc activities. In addition, our financial performance will be improved through continuing cost efficiencies.
With that, I will turn it over to Laurent.
Laurent Carozzi
Thank you, Richard, and good evening, everyone. So I will now provide you with further details regarding our first half 2022 performance.
So let’s turn to Slide 16 to review the key figures. So as mentioned by Richard earlier, our performance in H1 was good despite the ongoing challenges in key components supply, logistics, internal recruitment at TCS and Connected Home and also despite the restricted advertising spending. So, our strong performance was mostly driven by increased demand in TCS and Connected Home and through a successful turnaround plan across the divisions. So this slide presents because we didn’t take us for the semester. One needs to keep in mind that 2021 and 2022 financial reserves include IFRIC interpretation on SaaS implementation costs and these were minor in first half ‘21 and first half ‘22, and that also trademark licensing operations are accounted for as discontinued operations.
So H1 revenues of €1.6 billion increased by €249 million at current rate, with the ForEx impact representing €129 million, meaning that at constant exchange rate, revenues were up €120 million or 8.8%. TCS recorded a strong growth despite lower advertising revenues in the second quarter. While Connected Home was impacted by industry-wide key component shortages and supply chain challenges, which prevented the business from meeting the strong customer demand in full. Our adjusted EBITDA of €134 million was up €29 million at constant rate of 31%, mainly driven by TCS increase. This also reflects compressional efficiencies in all divisions. Helped by the EBITDA increased the adjusted EBITDA of €48 million represents a €33 million year-on-year improvement at constant rate. The EBIT from continuing operations rose to €8 million. It should be compared to a loss of €11 million in the first half of 2021. This resulted from better operational performance despite higher non-recurring costs.
Non-recurring costs amounted for the first half of 2022, €20 million versus €3 million last year, €20 million are composed of restructuring cost of €8 million continuation of the restructuring of the DVD business in Poland and Memphis and of €9 million related to the ongoing spin-off project. As a consequence, net results from continuing operations, was a loss of €77 million, representing still an improvement of €9 million at constant rate.
Let’s look at the free cash flow now. Free cash flow for continuing operations before financial and taxes improved to a negative €35 million. It has to be compared to a negative €215 million in the first half of 2021, so this €180 million improvement reflects the positive impact of several things. The improved operating performance, adjusted EBITDA was up €40 million, the lower increase of working cap requirements, an improvement of €135 million. The change in working capital was €76 negative million compared with a negative €211 million in the first half 2021. Such an improvement from positive variation year-on-year at Connected Home mainly as first half 2021 working capital was not really impacted by the negative impact of reductions in supplier payment terms.
And finally, the lower non-recurring cash outflow, an improvement of €22 million, notably lower cash restructuring, €33 million, principally at the Connected Home and Vantiva Supply Chain Services divisions. So these positive impacts were partially offset by an increase in CapEx of €16 million from €40 million to €57 million. This is mainly located at Technicolor Creative Studios and due to the higher activity and higher head count, and to payment phasing as well. So let me highlight here that over the second quarter, the free cash flow was positive at €90 million. The IFRS debt amounted to €1.1 billion as of June 30 to be compared to €1.096 billion as of December 31, 2021.
Let’s move to Slide 17. So here, we will do a little bit of a focus on revenue. So revenues at €1.6 billion are up 11% at constant exchange rate and constant perimeter, i.e., excluding the post production contribution that was still there in the beginning of 2021 up until April 2021. The revenue increase of €250 million, mainly resulted from €116 million revenue improvement at TCS, excluding Post Production, plus €129 million of positive ForEx impact.
And finally, a €45 million improvement at Connected Home. TCS revenues now represent 25% of the consolidated revenues compared with 22% in H1 2021. Our MPC revenue is more than doubled compared to last year, driven by the continued ramp-up in production of major theatrical projects as well as increasing contributions from all the major streaming platforms. H1 2021, which was suffering from pandemic related impacts on production. At The Mill, the transit revenues decreased at around 6.6% in H1 2022 compared to last year at constant currency. At current rate, they were slightly up, driven by lower year-on-year revenues in the second quarter as activity was restricted by decelerating advertising spending growth and compared with the high base in Q2 2021. At Mikros Animation, the revenues were up, mainly as a result of higher volumes in future animation projects, then Technicolor Games revenue were also higher, thanks to better production capacity.
Connected Home share and considered revenue decreased from 57% to 56% each revenues amounts to €197 million and increased by €45 million at constant exchange rate. The sales were still impacted by the component shortage, prices and the supply chain dislocation. But they also benefited from the first sign of improvement in the allocation of supply and in transit time and from increased share of broadband in revenues, notably in North America in Q2 2022. Vantiva Supply Chain Services decreased slightly, €9 million at constant exchange rates, but it was up €13 million at current rates to reach €296 million.
Vantiva Supply Chain Services now represent 19% of revenues. These volumes declined 30% year-on-year driven by expected market decline, but further exacerbated by inventory depletion from studios in H1 2022. The impact of volume reductions was partially offset by disc price increases and cost increases, along with a good performance of the new growth businesses. Here, we mainly mentioned transportation management, of course. Also note that revenues were negatively impacted by €29 million of change in scope due to the sale of Post Production in IFRIC 2021. Excluding those impact plus [indiscernible], revenues would have been up 11% at constantly.
So let’s move now on Slide 18 and comment roughly on EBITDA performance as I’ve given you quite a bit of detail already on all these changes. So as shown in this slide, EBITDA improved significantly by €40 million, €234 million, excluding the ForEx impact, EBITDA would have increased by €28 million or 31% at constant exchange rate. Growth was driven by revenue improvement, along with operational efficiencies and cost savings for all of our divisions, as illustrated by the EBITDA margin improvement of 139 basis points at constant rate to 8.4% of revenues.
I will not comment on each business performance, as Richard has done it already. So let’s move to Slide 19. We’re going to take you now through all the other lines of the P&L. So adjusted EBITDA also reflects improvement in efficiencies and cost savings as it increased by €33 million at constant exchange rate to a positive €48 million compared to €10 million last year. Our EBIT from continuing operations of €8 million, we compared it to a negative €11 million in H1 2021 improved by €17 million at constant exchange rate. The improvements mainly results from improved EBITDA partially offset by an unfavorable change of non-current items, what we are here two impacts going on different directions. So the first hand, you have restructuring costs, reduced by €18 million compared to last year. We are going towards the end of the Panorama plan, but it’s been more than offset by other non-current items, €9 million this semester mainly related to the ongoing spin-off project and just to be compared to a positive €25 million in H1 2022. Please remember that in H1 2022, we benefited from non-cash capital gain linked to the liquidation of a [indiscernible]. Otherwise, no major change year-on-year. The PPA amortization of €20 million remains monthly flat year-on-year.
Slide 20. Here, the financial results total, you can see that totaled a negative €65 million. In the first semester, it has to be compared to €63 million last year. Income tax amounted to a negative €19 million was €10 million last year. And mainly it reflects the fact that we are increasingly paying tax in Canada and India. Group net results from continuing operations therefore, amounted to a loss of €77 million in H1 compared to a negative €84 million last year. Net gain from discontinued operations amounted to €63 million compared to only €5 million in the first half last year. As you remember, on May 31, the group completed the sale of its trademark licensing operations and received a cash consideration of approximately €100 million. As a result, the group has accounted for trading and licensing operations as discontinued operations as from January 1, 2021.
Slide 21. I assumed previously, H1 2021 free cash flow after tax and interest from continuing operations is €89 million negative, improved significantly year-on-year by €169 million at constant exchange rates. This improvement is driven by: firstly, a lower decrease in working cap requirement plus €143 million notably thanks to Connected Home. Second, an EBITDA improvement, €29 million, Thirdly, lower restructuring cash for €33 million. And finally, mitigated by higher CapEx by €12 million, €4 million rendering cash out at TCS as a result of the higher activity and higher taxes and pension and other various elements and product impact.
Slide 22. to finish off, we have cash and cash equivalents amounting to €168 million and equivalent liquidity amounting to €216 million at the end of the quarter, not that the Wells Fargo line was undrawn as of June 30. Few words on the net debt, which amounted to €1.2 billion, excluding IFRS 16 impact, this is a €1.1 billion as per IFRS definition. And as a final word, as we are today, we’ve managed today to conclude the last part of our refinancing work around raising €623 million. For TCS, I would like very much to thank basically all the people who have helped us with the starting, of course, with the lenders and the shareholders that are proven by extending some of their loans with us that they believe in the story of the company and its development.
Also, our advisers, the likes of Arete, Goldman Sachs, Morgan Stanley that help us all through this journey to complete this. And of course, the team at Technicolor that work well out. We should also pay attention to our friends, the lawyers still continue to drop as we speak, the paper work and have been non-stop working for the last 2 or 3 weeks. We had the likes of [indiscernible] so thank you very much, all of you for your help because it’s been – you help us to pass a very, very structuring point today.
And with that, Richard, I think we are ready to take questions.
Question-and-Answer Session
Operator
[Operator Instructions] We have a first question from David Cerdan from Kepler Cheuvreux. Please go ahead.
David Cerdan
Good evening, gentlemen. I have a question regarding TCS and the advertising activity. Do you think that the trend should deteriorate in the coming quarters? So this is my first question. Second question is related to the wage inflation, which kind of wage inflation do you expect for the second part of the year? And do you have a vision for 2023? And the consequence of that what is the mood of your clients related to this inflation factor? Thank you.
Richard Moat
Maybe if I take the first question, which was I think about the advertising trend, I think it’s difficult to see exactly what the trend is at the moment. I think a lot of large advertising groups are reporting relatively flat trends at the moment, although obviously, we have the World Cup coming up in the autumn and that will be a big driver, we believe, of advertising spend. At the same time, there are some advertising-related groups, which have made profit warning recently. So it’s difficult to know exactly which way the trend is going, I would say that the growth has definitely slowed. But the future trajectory is going to be very dependent on how the global macro economy develops because advertising is very closely correlated to the development of the macro economy. Do you want to talk about inflation Laurent?
Laurent Carozzi
Yes. Yes. And maybe just in addition to your comment, as you know, we have reduced our expectations to our advertising revenues like a few months ago. And the trend we observed at the moment is we are in line or even slightly better than what we have predicted. So we have – we believe that where we are is the right place. On wage inflation, as you know, we had planned with its [indiscernible] yes encompassing many different territories. But we are closer to 8% to 10% in India. We are slightly lower than that in the rest of the world, 6% to 8%. The trend is continuing more or less at the same pace. We haven’t seen any specific deterioration recently. So it stays in line with what we had planned for. Clients are fully aware of that. But basically, as you know, I mean, mainly at TCS because whether the weight of the staff is the heavier in the P&L. We – because of the [indiscernible] mechanism, we’re passing through the incision and the clients do understand that. So this is how it’s been dealt with TCS.
David Cerdan
Thank you.
Operator
Thank you. [Operator Instructions] We have a follow-up question from David Cerdan from Kepler Cheuvreux. Please go ahead, sir.
David Cerdan
Yes. I have a question regarding one of your clients. Are you concerned by Netflix subscription base that was decline in Q2 and the prospect for this client base? Do you see some platform in the need to reduce or maybe increase, is there the project?
Richard Moat
Well, I think that the decline in the base was less than some analysts and observers have been expecting. They also said in their press release that they were going to be maintaining the projected level of spend on content, which I think is good from a Technicolor Creative Studios perspective. I think there is bound to be some people who will be reducing their spend on multiple streaming platforms as disposable incomes come under pressure because of continuing inflation. But nevertheless, I think there is going to continue to be competition amongst the platforms for those subscribers. And that is going to mean that the war in terms of original content is going to continue, and therefore, demand will continue for the VFX services provided by Technicolor Creative Studios. And certainly, in terms of the pipelines, which we see for the remainder of this year and into ‘23, we see no sign of a slowdown in terms of demand.
David Cerdan
Perfect. Thank you.
Operator
Thank you. We have no other questions for the moment. [Operator Instructions]
Richard Moat
Okay. We have no other questions. Thank you very much for listening, and we look forward to speaking to you next time around. Thanks a lot.
Laurent Carozzi
Thank you.
Operator
Thank you. Ladies and gentlemen, this concludes today’s web conference. Thank you all for your participation. You may now disconnect.
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