Transition year – major challenges
As announced, HOCHDORF was unable to continue on its growth path and recorded a significant drop in the Group's profitability in 2018. The main factors that led to the lower results were the lack of sales in China in the Baby Care Division, the significantly lower result of Pharmalys Laboratories SA, the delay in the commissioning of Tower 9 in Sulgen, the market distortions and margin losses in the Dairy Ingredients Division and the loss from the sale of the holding in HOCHDORF Baltic Milk UAB. HOCHDORF is still in the process of transforming itself into a "niche player" and continues to pursue this path with dedication. Net sales decreased by 6.6% to CHF 561.0 million and EBIT fell by 56.2% to CHF 18.6 million.
The main contributor to the lower result was Pharmalys Laboratories SA, which was unable to repeat the strong turnover results from 2017. Nevertheless, we remain positive about the future and we believe that developments are fundamentally heading in the right direction. The traditional business of HOCHDORF Swiss Nutrition Ltd saw solid growth in the Baby Care Division despite the loss of sales in China and the lower sales of Pharmalys. The challenging market environment once again had a strongly negative impact on the Dairy Ingredients Division. Lower milk-processing quantities and, in particular, the developments in export subsidies (so-called "Schoggigesetz" or chocolate law) squeezed earnings. The Cereals & Ingredients Division posted a positive result. However, adjustments will also have to be made in this area in the future. The foreign subsidiaries closed the year with negative results, with Uckermärker Milch GmbH being especially disappointing.
In Europe there have not been any significant changes to the environment compared to the previous year. The milk market continues to be characterised by price distortions for fat and protein. This is also the main reason why HOCHDORF decided to sell its production plant in Lithuania. Significant improvements will have to be made at the Prenzlau plant in the coming year. This poses a major challenge, as the price pressure in the retail food industry is very high. Zifru and Snapz will focus on marketing their award-winning products in the Kids' Food area.
The Middle East/Africa region continues to be the focal point of activities in the Baby Care Division. With Pharmalys, we are very well positioned here, and the potential is enormous. We were able to tap into new markets in 2018. The long credit periods for payment pose a challenge in these markets, with growth tying up liquidity. Liquidity is one of the key issues for Pharmalys, and the organisation had to take measures to adapt to this situation.
Asia is still the region with the largest market potential for Baby Care, with China standing out as a particularly attractive market. HOCHDORF has, therefore, already applied for registration of trademarks in 2017 under the new legislation. However, China has declined nearly all trademarks worldwide in the current year. HOCHDORF has also been affected by this, as its trademark registrations are still pending. It is impossible to predict when this will be completed. However, we remain active in this area and we have stepped up our efforts to have our trademarks registered.
Despite the slower growth, we recorded a gross profit largely at the previous year's level. It decreased from CHF 172.1 million to CHF 171.8 million. The new gross profit margin was 30.0% (PY: 28.5%).
Operating expenses were up 16.8% compared to the previous year. This, however, also includes prepayments relating to the new infant formula plant and Tower 9, involving the recruitment and training of personnel. The higher marketing costs for Pharmalys also had an impact on operating expenses. The changes were also influenced by the acquisition of Bimbosan AG and the sale of HOCHDORF Baltic Milk UAB. The total number of employees decreased year-on-year from 695 to 694.
The operating profitability of HOCHDORF has deteriorated significantly for the reasons stated above. In 2018, EBIT fell by 56.2% to CHF 18.6 million. We believe that the Group is on the right track and that results will improve, in particular in the Baby Care Division. The Dairy Ingredients Division remains a challenge due to the changes in the new "Schoggigesetz", or chocolate law. EBIT for 2018 was also adversely affected by the CHF 2.9 million write-down on the sale of HOCHDORF Baltic Milk UAB.
The strengthening of the Swiss franc led to an overall negative financial result. In addition, the Group incurred exchange losses of around CHF 3.0 million resulting from the sale of the holding in HOCHDORF Baltic Milk UAB. It should also be noted that the interest expense for the mandatory convertible bond and the hybrid bond in the Swiss GAAP FER financial statements will not be recorded in the income statement, but rather against the borrowed capital item with the sum of the discounted interest payments.
Operating tax expenses were in line with expectations. The tax expenses decreased in line with the overall suppressed development of the companies. In the year under review, deferred taxes on newly incurred tax losses in the companies were capitalised.
There was also a significant drop in cash flow from operating activities before changes in working capital, which decreased from CHF 56.0 million to CHF 30.4 million. The significantly lower operating results had considerable impact here. Cash flow from operating activities was down year-on-year from CHF 6.0 million to CHF –81.3 million. The main reason for this is the residual purchase price payment for Pharmalys. "Inventories", in particular, have increased considerably as a result of the expansion of business activities. Long credit payment terms in the MEA region (Middle East Africa) pose a challenge here. Nevertheless, the item "accounts receivable" was reduced overall.
In the area of investments, more than CHF 35.5 million was spent on plants/buildings/intangible assets. With the completion of the Sulgen plant, the Group was able to finance the remaining investments from current cash flow. Work on the new T9/can line 2 was largely completed in 2018. For 2019, we are planning largely only replacement investments.
As expected, free cash flow was negative in 2018 due to the construction of the new T9 and the purchase price payments for Pharmalys and Bimbosan. For 2019, we expect a slightly positive free cash flow.
Net debt increased from CHF 0 million in December 2017 to CHF 141.3 million. The hybrid bond and the convertible bond are classified as equity and do not affect net debt.
The equity ratio fell from 53.1% at the end of 2017 to 48.8%. As mentioned above, this is due to the higher level of debt. The final purchase price for Pharmalys was slightly adjusted again at the end of 2018. The reduction is fully attributable to goodwill, which was offset against equity.
The HOCHDORF Group’s financing continues to provide a solid basis for the company’s continued growth.
HOCHDORF has the potential to achieve further growth in all market regions. We are aware that political uncertainties and changed market conditions may have an impact on the companies’ earnings position.