Hudson Ltd. (HUD) Q2 2020 Earnings Call Transcript

Hudson Ltd. (HUD)
Q2 2020 Earnings Call
Aug 03, 2020, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, everyone, and welcome to the Hudson second-quarter 2020 earnings call. [Operator instructions] Please also note that today's event is being recorded. And at this time, I'd like to turn the call over to Cindi Buckwalter, vice president of investor relations and corporate communications for Hudson. Ms.

Buckwalter, you may begin.

Cindi Buckwalter -- Vice President of Investor Relations and Corporate Communications

Thank you, operator, and good day, everyone. Thank you all for joining us. This morning, we released our second-quarter results. You can find a copy of our press release and the presentation on our website at investors.hudsongroup.com, along with our Q2 financial statements.

On today's call, we will have Roger Fordyce, our CEO; and Adrian Bartella, our CFO. Please note that management may make forward-looking statements regarding their beliefs and expectations as to the company's future business prospects and results. These statements are subject to risks and uncertainties that could cause actual results to differ materially from these statements. Although we believe the expectations reflected in our forward-looking statements are reasonable, we can give no assurance that such expectations will be realized.

We urge everyone to review the safe harbor statements provided in our earnings release and financial statements, as well as the risk factors contained in our 2019 annual report on Form 20-F, which is available on our website. During today's call, we'll refer to both IFRS and non-IFRS financial measures of the company's operating and financial results. For information regarding our non-IFRS financial measures and reconciliations to the most directly comparable IFRS measures, please refer to our earnings release. And with that, I'll turn the call over to Roger.

Roger Fordyce -- Chief Executive Officer

Thank you, Cindi, and good morning, everyone. Thank you for joining us to review our second-quarter 2020 results. When we spoke with you in late June, we have laid forth our plans for rebuilding our business, which included gradually reopening a number of our stores and instituting numerous measures to ensure team members and customers felt safe when they return back to our stores. At the same time, we detailed the many initiatives we have undertaken to significantly reduce expenses across the company to preserve liquidity and ensure the fiscal health of our business.

I'm pleased to share today that we're making progress in all of these areas. We've been working in close partnership with our airports and other landlords to determine when and where to open stores to best serve the needs of travelers, employees, and daily commuters. We have now reopened over 200 stores to date, bringing our total open store count to approximately 450, with additional store openings each week. We expect that traveling trends will be different at every location, and so we will continue to open stores where economically feasible using a pilot test-type of approach to ensure productivity.

We have received tremendous support from our airport partners in this regard. Our ability to reopen new stores each week would not be possible without the support of our field and corporate team members, as well as our business partners. Collectively, this team has been instrumental in working hand in hand in partnership with our airports and landlords on appropriate rent relief and other efficiencies so that we can keep our stores operational. We especially appreciate the efforts of our frontline team members, who have continued to be the Traveler's Best Friend for travelers and essential personnel and who have made sure health and safety remains the top priority for Hudson.

While travel volume increased sequentially in the months of May and June, we are still witnessing passenger volumes significantly below last year, with TSA passenger throughput data, reflecting a volume reduction of about 75% in the last few weeks of July. While this is an improvement over the 81% reduction in the month of June, these numbers still show a very low level of travel as reflected in our sales volume. While we had hoped to see passenger traffic at higher levels by this point in July, the extended closure of the U.S.-Canadian border and the recent increases in COVID-19 cases across the various parts of the U.S. have led to new travel restrictions and quarantines.

The result has been a slight reduction in traffic recently, decreased demand, and significant variability in day-to-day traveler volume. Given the extremely challenging environment and the uncertainty about when travel will fully rebound, last month, we determined that it was necessary to implement the more permanent reduction in workforce. As part of this reduction, we have reduced our workforce by approximately 40% across both our corporate and field staff. In addition to the reduction in force, we have extended the furlough period for several hundred members of our team, with the hope that some or all of these individuals will be called back as business recovers.

Adrian will provide further details about the financial impact of this action later on in the call. While this reduction in workforce was a very difficult decision, we believe it was necessary to ensure the long-term success of our business. I personally want to extend my heartfelt appreciation on behalf of the entire company, to the team members who will be leaving Hudson. The company we are today would not be possible without the contributions and dedication of these individuals, and they will always be part of Hudson's history.

The reduction in force, alongside our ongoing actions to reduce expenses and manage cash flow, are critical in navigating this crisis and positioning Hudson for a full recovery. As we discussed last quarter, we have been working closely with our landlords and industry partners to secure rent waivers and deferrals in order to better align our cash outflow with our significantly reduced sales levels. We truly appreciate the partnership that most of our airports and landlords have demonstrated to date. I look forward to continuing to find ways together to help each other weather this storm.

Adrian will provide further details on the impacts of the rent waivers in a short while. Despite the many challenges the industry is facing, we continue to work with a number of our airport partners on new store development where it makes fiscal sense. For example, we had a recent store opening in Nashville International Airport, the Tennessee Trading Post, which is a tribute to all things Nashville. This locally inspired travel essential store features a variety of products made in and around Nashville, including food and beverage offerings from local vendors, as well as an assortment of local spirits.

We're very proud of our teams who brought this store to life during a challenging environment. In regards to other recent initiatives, we entered the world of automated retailing with the introduction of our personal protection equipment vending machines in airports across North America beginning in July. We successfully completed Phase 1 of this project, now are entering the second phase of this project with plans to roll out to 27 airports in total. The vending machines are stocked with a proprietary line of essential PPE products, providing a 24/7 retailing experience.

We are also beginning to roll out our Sunglass Hut shop-in-shops in our travel convenience stores in partnership with Luxottica, a leader in premium eyewear. The shops feature the Ray-ban and Oakley brands and will provide a convenient way for travelers to purchase this classic eyewear. The first 10 shops will open in the next two weeks, with a phased opening approach continuing into 2022 for up to 250 shops. This new initiative of integrating branded merchandise into our travel convenience stores offers additional growth opportunities for Hudson, particularly in the current environment where low travel volumes make it less economical to open stand-alone specialty retail shops.

You can expect to see more of these branded partnerships moving forward. Lastly, we continue to adapt our business model to the heightened expectation for a contactless shopping environment. In addition to enhancing our Tap to Pay capabilities in all of our stores, we've added self-scanning options and continue to expand our self-checkout capabilities. In a time when so much is uncertain, we want to thank our team members for their continued passion and service to our company and for their ability to adapt and stride to our changing and evolving business.

Our responsibility as an organization is to ensure that we are supporting our team members and customers, and in that regard, health and safety remains a priority for Hudson and is our commitment to our teams as we traverse this new normal. Equally important are the concerted actions we have taken to solidify our financial position and will help us to emerge a more focused business on the other side of this crisis. Thanks in part to the efforts of our business partners and landlords aiding in our recovery. While the near term remains unpredictable, as we have seen time and time again, the travel industry will return.

And we are confident that Hudson will emerge as a leader and innovator in the ever-evolving travel concessions industry. I'll now turn it over to Adrian to review our second-quarter results in more detail.

Adrian Bartella -- Chief Financial Officer

Thank you, Roger. Now turning to the results for the quarter. As Roger noted, our second-quarter results were significantly impacted by COVID-19 and the reduction in travel. Turnover in the second quarter decreased by 87.9% to $61.7 million.

Duty-paid sales were 83% of net sales, representing a higher percentage of total sales than historical levels, as our travel convenience stores have been the first to reopen and the faster to recover. It's important to point out our monthly sales evolution during the quarter. As you can see on the lower left of this slide, in April, net sales bottomed out at 94.6% below prior-year levels. And from there, sales trends improved to a year-over-year decline of 89.9% in May and further improved to a decline of 81.5% in June.

You can see similar positive monthly evolution in a sales trend in duty-paid and duty-free on the lower right of the slide. This positive trend continued into July, where total net sales to date were trending down approximately 75% from the prior-year levels. Gross margin was 61.6% compared to 64.2% in the prior-year second quarter primarily due to higher promotional activity on luxury merchandise. Lease expenses decreased by $69.1 million, resulting in lease income for the quarter of $32.2 million, reflecting lower variable rent base on the client sales and rent waivers of $42.6 million received from numerous airports and commuter terminals associated with waived rent payments.

We realize some of you may be interested in more detail on accounting treatment for end waivers, so we have included additional information in the appendix. And as Roger noted, we continue to have ongoing discussion to landlords and rent waivers and deferrals are expected to continue as long as travel volumes remain low. Personnel expenses decreased by 61.3% to $42 million, primarily driven by our expense reduction actions in response to COVID-19. We also received $4.5 million in employee retention credit from the U.S.

CARES Act and subsidies from a similar employee-support program in Canada. The U.S. CARES Act credit helped us to partially offset the expense of health benefits we offered to furloughed employees. Personnel expenses also included $8.6 million of restructuring expense due to the reduction in costs that Roger discussed earlier.

As a percentage of turnover, personnel expenses increased to 68.1% from 21.3% last year due to significantly lower sales levels. Other expenses decreased by 52.5% to $20 million, primarily driven by a reduction in variable selling expenses due to the sales decline, along with our expense management initiatives. As a percentage of turnover, other expenses were 32.4% compared to 8.3% in last year, again, due to the much lower sales volume this year. Depreciation and amortization impairment increased by $8.8 to $98.2 million.

This was primarily due to a non-cash charge of $9.7 million related to impairment of property, plant, and equipment and right-of-use assets, reflecting a reduction in forecasted cash flows due to the impact of COVID-19. Adjusted EBITDA decreased by $132.3 million year over year to a negative $61.7 million, representing a flow-through of only 30%, which was on the low end of the 30% to 50% flow-through range we have discussed in our previous calls. We were able to achieve this primarily due to our cost savings initiatives and the rent waivers. Adjusted EPS attributable to equity holders of the parent was a loss of $0.63 for the second quarter.

Turning to our cash flow and balance sheet. The cash flow from operating activities for the quarter was a negative $11 million, compared to a positive $163.4 million last year. The decrease in cash flow was driven by decline in operating performance due to COVID-19. Capital expenditures decreased to $6 million in the second quarter, compared to $15 million last year.

This capital spend has been reduced to minimal levels to preserve liquidity. Our adjusted net debt, which represents total borrowings, excluding lease obligations, minus cash, was $340 million, including $204.5 million of available cash. Notably, our cash usage was only $21 million in the second quarter, compared to $92.4 million in the first quarter, driven by our significant cost reductions across the company, along with rent waivers and deferrals. We feel comfortable with the current debt and liquidity position, given our strict financial discipline and ongoing expense management, including the reduction in force discussed today, combined with the rent waivers and abatements we are receiving from many landlords.

Looking ahead, we can't currently estimate the duration or extent of travel disruption, so we are not providing guidance at this time. However, we have significantly adjusted our cost structure to align with recent sales trends and the conditions of travel industry today, so we can't provide some commentary on expected expense levels for the year. The reduction in force that Roger discussed earlier is expected to reduce our personnel expenses by approximately $140 million to $160 million on an annualized basis. Additionally, we currently expect to receive approximately $60 million to $90 million in waivers and other contractual rent reliefs in the second half of 2020.

Moving to other expenses, which we have previously said are roughly 50% fixed and 50% variable, we expect to reduce fixed cost by approximately $10 million in the balance of the year. The viable component will be based on sales levels, which are largely driven by passenger volume. With our existing cash balances, expected operating cash flow, and long-term financing arrangements, we believe we have adequate funds to support our current operating plan, make necessary capital expenditures and fulfill debt service requirements for the foreseeable future. In summary, while we continue to experience lower sales levels due to COVID-19 pandemic and its impact on travel, we have reduced our cost structure accordingly to withstand this challenging period.

We are continuing to advance our strategic initiatives and remain confident in the long-term potential of our business model and the resiliency of the travel industry. I will now turn it back over to the operator to open it up to Q&A.

Questions & Answers:

Operator

And we will now begin the question and answer session. [Operator instructions] And our first question today will come from Seth Sigman with Credit Suisse. Please go ahead.

Lavesh Hemnani -- Credit Suisse -- Analyst

Hi. This is Lavesh Hemnani on for Seth Sigman. So just to start with sales growth, I mean, organic sales down 88%, like-for-like down 82%. Can you give us some color on the delta between that, in a 600-basis-point negative impact? I mean, some of it is sort of to net new business, but if you can provide some additional color.

Adrian Bartella -- Chief Financial Officer

Hi, Lavesh. It's Adrian here. So, yeah, the reason it looks -- so we provided additional color on the contribution of organic and like-for-like. So in normal circumstances, like-for-like, as you represent, around 90 to -- in excess of 90% of our overall sales in this quarter because we have closed so many stores.

The like-for-like is actually only calculated on the stores which are open, which is less than half. So this is why you cannot really add those business together. You have to look on the contribution from like-for-like and net new business, which we disclosed in our presentation on Page 14, I believe.

Lavesh Hemnani -- Credit Suisse -- Analyst

OK. That's helpful. So just following up on the margin outlook, I mean, thanks for this helpful color on the moving pieces, especially into the second half. But then considering the lease, there was cost-reduction announcement and the fixed cost reduction of other expenses.

Is there a way to think about the flow-through margin for the back half and probably like into next year? I think you guys mentioned 30% to 50% prior. So just trying to think about how that would look going ahead.

Adrian Bartella -- Chief Financial Officer

So we don't want to provide any guidance. We feel comfortable that the range is still valid. We will do our best efforts to keep and stay as close as possible to the lower end of the range, but we don't want to provide any guidance. We have provided some guidance on cost savings, the personnel expense savings, the big waiver savings expected.

And those savings should help us to achieve our goal. Also, one additional piece of color, the waivers we recorded in the quarter actually represent on departure of the waivers for second quarter. There is additional waivers, which we expect to receive for the second quarter. But we didn't receive the proper documentation on time when we close our books, so we could not record them.

But there is additional upside for waivers coming for the second quarter. So if we wouldn't account for all the waivers, we would technically be even below the 30% -- bottom end of the 30% range.

Lavesh Hemnani -- Credit Suisse -- Analyst

Understood. So just talking about merchandising actions for the second half, I mean, in Q2, the food and beverage penetration expanded considerably. I know some of it has got to do with the initiatives on the grab-and-go offerings. But, I mean, looking at that and looking at the inventory position in Q2, which was down just about 12% given the big sales decline, how do we think about what the merchandising plan is for the second half?

Roger Fordyce -- Chief Executive Officer

So I think the big aspect for us is going to be continuing to focus on the food and beverage aspect of it. We've added grab-and-go uses to just about most of our contracts to date, so we would expect that to continue to be a major driver of the convenience business. But we're also continuing to look at and test and pilot the reopening of specialty stores as well, too, particularly in the uses of electronics, sunglasses, bookstores, etc., and are finding some successes. So I would say that we would expect to have some continued improvement on some of the more discretionary categories as the quarter trend continues, providing, however, that the passenger trends continue to grow and that the specialty stores remain productive.

Lavesh Hemnani -- Credit Suisse -- Analyst

Got it. Thank you for that.

Operator

And our next question will come from Michael Lasser with UBS. Please go ahead.

Michael Lasser -- UBS -- Analyst

Good morning. Thanks. Number one, with the $21 million cash burn rate in the quarter, is that the right number that we should think about as sustainable moving forward if this level of overall passenger traffic persists for at least the near term? Or was there something unique in this quarter that temporarily reduced the cash burn rate?

Adrian Bartella -- Chief Financial Officer

Hi, Michael. So I think -- so for the balance of the year, we think this is probably something we would think is sustainable. For the balance – for end of July, our cash balance was $200 million. So the implied burn for the month of July was around $4 million, which is more or less close, we did see in June.

But there's a few moving parts, which we need to consider, and we need to consider the deferrals. So we have received around $30 million of rent deferred in the second quarter. Most of them are due in Q3 and Q4 this year. We are still working on further postponements and extension of the due pay dates for those deferrals.

We're also working on converting those deferrals into waivers, which we are successful in many cases. So there are many moving parts, but we want to anticipate -- as you see from our sales trend, we anticipate higher net sales and the revenue inflows, which we think in the worst case now will more than offset the deferrals, should they become due in Q3 or Q4.

Michael Lasser -- UBS -- Analyst

OK. So the net effect of that should be that $20 million a quarter is still a decent run rate to think about?

Adrian Bartella -- Chief Financial Officer

Yeah, I think so.

Roger Fordyce -- Chief Executive Officer

Yes, Michael, I agree. I think that's a good number. Yes, yes.

Michael Lasser -- UBS -- Analyst

OK. And based on having additional few months of operating in this environment, how are consumer -- how are passenger traffic behavior -- passengers behaving differently from what they're buying? How they're buying it? How much they're spending, more importantly, that it can help inform what a more normalized environment might look like as we get into next year? Are there other stark differences, Roger?

Roger Fordyce -- Chief Executive Officer

So with much of our specialty stores remaining closed, it's difficult to understand how that -- I'm going to refer to that as our discretionary spend categories. What we've seen in the core convenience is a slight rise in the food and beverage because of the fact that we have added so much of it and because airlines had stopped serving, in many cases, some of the food and beverage locations were limited in their openings. So we benefited, in many cases, from the expansion of that category. How long that will be sustained remains to be seen.

But we also have seen some improvement in what we refer to as the health and beauty category very as well, too, as our health and beauty care category as the PPE or the personal protection equipment became a stronger part of our sales. Once again, we anticipate that to be sustained for quite a while but, at some point, starting to wane. So I think in the short term, what we saw in the second quarter, at least on the convenience side of the business, will remain the same. And as we move further into the year, we do, hopefully, start to anticipate opening some more of our specialty stores.

And more of those categories starting to balance out. But for most of the convenience business, outside of those two categories, we are still seeing a fairly good balance of product sales across all the categories within the convenience business.

Michael Lasser -- UBS -- Analyst

So if you just look at the convenience business, is spend per passenger up and by how much?

Roger Fordyce -- Chief Executive Officer

So in the convenience stores, it's up a few percentage points. Now one thing I want to talk about that because this is an interesting dynamic. Remember that when I say duty pay, that is not just convenience now, the duty-paid business includes all of our duty-paid specialty as well, too. And that specialty business carries with it a very, very high spend per ticket per transaction.

So the fact that we're driving a higher spend right now, slightly higher spend right now in our duty pay business overall is really a good sign. It means our convenience business is performing very, very well.

Michael Lasser -- UBS -- Analyst

And, Roger, my last question is, as you go out to talk to airport operators and even airlines, what do you think the consensus is on the number of years it will take overall passenger traffic to get back to pre-COVID level?

Roger Fordyce -- Chief Executive Officer

I mean, most of the indications right now are pushing toward the consensus between what I've seen and what I've read. People I've talked to are indicating that 2023 is kind of the year of the return to 2019 passenger levels. Now, I say 2019 passenger levels because it's going to be an interesting dynamic to see how much of a shift there is in domestic versus international, business versus leisure. But I think the overall consensus is that the total passenger numbers here in North America are targeting more like 2023 to be the return of the 2019 levels.

Michael Lasser -- UBS -- Analyst

Thank you very much. Good luck.

Operator

And our next question will come from Kimberly Greenberger with Morgan Stanley. Please go ahead.

Kimberly Greenberger -- Morgan Stanley -- Analyst

Great. Thank you so much. I just wanted to confirm, Adrian, your comments on the month of July. I saw in the press release you talked about passenger volumes in the second half of July down around 75%.

But I thought you said also that Hudson's revenue in July was down 75%. Did I hear that correctly?

Adrian Bartella -- Chief Financial Officer

That's correct, yes. So July to date, it was the full month of July, but July to date, we were 75% down to prior-year levels.

Kimberly Greenberger -- Morgan Stanley -- Analyst

OK. So running maybe similar to, I guess, slightly better, if the first half of July -- I don't know if you have the first half of July passenger volumes. Were they meaningfully different from the 75% decline? Or was July relatively consistent throughout?

Roger Fordyce -- Chief Executive Officer

I can't really – I think the first half of July on the passenger accounts was boosted by the July fourth travel. We saw quite a boost in both sales and passenger levels during that first week or two, and then things kind of leveled out. So right now, the overall month trend, as I said, to your point, we are trending slightly above the TSA throughput on a regular basis.

Kimberly Greenberger -- Morgan Stanley -- Analyst

OK. Great. So we could use that. If we sort of watch that data come out regularly, we could use that as a kind of a rough proxy, it sounds like.

Roger Fordyce -- Chief Executive Officer

Yeah. As we mentioned last quarter, it has been a very, very good benchmark and weathervane for our business, yes.

Kimberly Greenberger -- Morgan Stanley -- Analyst

Great. OK. Wonderful. And then I wanted to ask about the $140 million to $160 million risk savings that you've got.

Can we just sort of take that, divide it by four, and apply an even amount to each of the next four quarters in order to get to that annualized savings number? Or did you experience any savings from the reduction in force in the second quarter that we should keep in mind for the second quarter next year?

Adrian Bartella -- Chief Financial Officer

I think you can use it for this year, for the next two quarters. Next year will depend on the recovery level of the sales. So should the sales bounced back dramatically, then we may need to hire some additional employees. So the savings may be a bit different, but the revenue will also be higher.

But I think for the balance of the year, you can do it this way.

Kimberly Greenberger -- Morgan Stanley -- Analyst

OK. Fantastic. And I apologize if I missed this in your follow-up. Did you mention the -- or quantify what you received from the U.S.

CARES Act so far here in the third quarter? I know you gave the second-quarter benefit do you have maybe a July number for the third quarter that we could think about?

Adrian Bartella -- Chief Financial Officer

No, we didn't mention the July number, and we have received $4.5 million for June. So as we move forward with our reduction-in-force program, the subsidies will obviously go down because many of them are reimbursing us indirectly for the benefits we offer to the furloughed employees. So I think the number for Q3 will be much lower but our expense base also be lower.

Kimberly Greenberger -- Morgan Stanley -- Analyst

OK. Great. OK. Fantastic.

That takes care of my question. Thanks so much.

Operator

And this will conclude the question-and-answer session. I'll turn the call back over to Ms. Buckwalter.

Cindi Buckwalter -- Vice President of Investor Relations and Corporate Communications

Thank you, Paul. Thanks, everyone, for joining us today. This concludes our call. Just a reminder.

You can find a replay of our call on the Investor Relations part of our website. Thanks for joining us and enjoy the rest of your day.

Operator

[Operator signoff]

Duration: 35 minutes

Call participants:

Cindi Buckwalter -- Vice President of Investor Relations and Corporate Communications

Roger Fordyce -- Chief Executive Officer

Adrian Bartella -- Chief Financial Officer

Lavesh Hemnani -- Credit Suisse -- Analyst

Michael Lasser -- UBS -- Analyst

Kimberly Greenberger -- Morgan Stanley -- Analyst

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