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Edited Transcript of NZYM B.CO earnings conference call or presentation 8-Aug-19 7:00am GMT

Q2 2019 Novozymes A/S Earnings Call

Bagsvaerd Aug 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Novozymes A/S earnings conference call or presentation Thursday, August 8, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Anders Lund

Novozymes A/S - EVP of Household Care & Technical Industries

* Andrew Fordyce

Novozymes A/S - EVP of Food & Beverages

* Peder Holk Nielsen

Novozymes A/S - President & CEO

* Thomas Videbaek

Novozymes A/S - Exectuive VP & COO of Research, Innovation & Supply

* Tina Sejersgård Fanø

Novozymes A/S - EVP of Agriculture & Bioenergy

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Conference Call Participants

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* Annette Lykke

Handelsbanken Capital Markets AB, Research Division - Medtech Analyst

* Anton Brink

Kepler Cheuvreux, Research Division - Equity Research Analyst

* Ben Gorman

UBS Investment Bank, Research Division - Associate Analyst

* Gunther Zechmann

Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst

* Jonas Guldborg Hansen

Danske Bank Markets Equity Research - Analyst

* Lars Topholm

Carnegie Investment Bank AB, Research Division - Co-head of Research of Denmark & Financial Analyst

* Michael Novod

Nordea Markets, Research Division - Director of Healthcare, Healthcare Analyst & Sector Coordinator

* Nicola Tang

Exane BNP Paribas, Research Division - Analyst

* Sebastian Christian Bray

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Søren Samsøe

SEB, Research Division - Country Head of Denmark and Analyst

* Virendra Singh Chauhan

AlphaValue - Analyst

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Presentation

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Peder Holk Nielsen, Novozymes A/S - President & CEO [1]

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Good morning, and welcome to the Novozymes conference call. Today, we will review our performance for the first 6 months of 2019 and our outlook and key priorities. Our presentation should take around 25 minutes, and afterwards, we will take your questions. My name is Peder Holk Nielsen, and I'm the CEO of Novozymes. I'm joined here today by the Executive Leadership Team and Investor Relations.

Please turn to Slide #2. Before we jump to the quarterly performance, I'd like to take this opportunity to thank all of you who attended our Capital Markets Day in mid-June. We had more than 100 investors, analysts and journalists at the event and many more joining the webcast. I'm sure you can imagine that it has been a busy period since. We're now in the process of executing on the changes to the business portfolio and on the reallocation program, and I'm happy to say we're making good progress on both.

As you've probably seen this morning, we announced a change in the Executive Leadership Team. Prisca Havranek-Kosicek, previously EVP and CFO of Novozymes, has been a strong support in driving the agenda on how to secure the delivery on our updated strategy. But we've mutually agreed she will discontinue her position as EVP and CFO for personal reasons. We wish Prisca every success in her future endeavors and would like to thank her for her time with us over the last 18 months. We expect to announce a replacement soon.

Now let's turn to our performance in 2019. In the second quarter, organic sales declined by 2%. Although this trend is an improvement from the 4% decline in the first quarter, we're not satisfied with the overall performance of our business in this first half of 2019. But we are confident sales will pick up in the second half of the year.

As we've communicated in the revised full year outlook on June 6, the flooding and general softness in the U.S. agriculture business, combined with weakness in some emerging markets, have created headwinds which impact Agriculture, Bioenergy and parts of Food & Beverages negatively.

For the second half of the year, we expect a ramp-up in sales as the Middle East comparison eases, BioAg sales increases in preparation for the 2020 planting season and innovations such as our Freshness platform, Balancius and new Bioenergy products build momentum.

The EBIT margin was 30% for the first half of the year. This was in line with our expectations and supported by one-offs. We maintain our full year EBIT margin guidance of 28% to 29%.

Before we review the individual business areas, let's look at the sales performance by geography. Please turn to Slide #3. Sales to developed markets were flat organically, while emerging markets sales declined by 8% in the first half of the year. The weakness in the emerging markets was partly expected. It is mainly due to the economic constraints in the Middle East, which primarily affects -- affected our Household Care and baking businesses. China had a soft first half, particularly in feed and starch. And Latin America has also experienced softness. Some of that, but not all, was expected.

And now I'll hand it over to Anders for a review of the developments in Household Care. Anders, please?

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Anders Lund, Novozymes A/S - EVP of Household Care & Technical Industries [2]

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Thank you, Peder. Please turn to Slide #4. Organic sales for Household Care declined 1% in the second quarter, by 2% in the first half of 2019. The weakness in the second quarter had been expected as economic distress in some Middle Eastern markets continue to detract from our performance. Adjusted for the headwinds in the Middle East, we saw positive underlying performance which we expect to be visible in the second half of the year.

Sales in the developed markets grew slightly in the second quarter, while sales to the emerging markets declined. Growth in the developed market was mainly driven by North America. In the emerging markets, strong performance in India was more than offset by softness in the Middle East and a few other markets. In general, our sales to emerging markets are more volatile. However, we still see significant penetration potential and continue to invest for the future. The trend in the past years of solid sales growth with regional customers in declining sales to our global customers continued in the first half 2019.

Our Freshness platform is developing well from both a commercial and innovation perspective. The commercial rollout is progressing according to plan, and our research into both broad market solutions is showing very encouraging results. The geographical expansion of our Freshness platform, combined with the annualization of the Middle Eastern headwinds, are the main reasons for why we continue to expect low single-digit growth for the full year in Household Care with an acceleration in the second half.

Technical & Pharma sales declined 2% in the second quarter, delivering first half organic growth of 2%. This development was in line with expectations following a strong first quarter. We still expect low single-digit growth for the full year.

That's all for me. Andy, please?

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Andrew Fordyce, Novozymes A/S - EVP of Food & Beverages [3]

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Thanks, Anders. Please turn to Slide 5. In Food & Beverages, we've had a difficult first half due to weakness in our baking and starch businesses. While starch improved somewhat in Q2, the weakness in baking has persisted, countering solid growth in both our Food & Nutrition and Beverage businesses. Overall, second quarter sales declined by 3% organically, resulting in a 2% decline for the first half of 2019 compared with last year.

Sales to the baking industry are challenged by continuing price erosion in developed baking markets combined with economic distress and some share loss in the Middle East. While we had hoped to regain traction in the Middle East, the market contraction has continued and competition for share has also been a factor. Adding to the headwinds, developed market fresh keeping has not yet achieved a new market price point after the expiry of our Novamyl patents leading to higher-than-expected price erosion. We're working with our baking channel partners to maintain value in fresh-keeping while focusing on accelerating penetration in new emerging market bread types to return the business to growth.

For starch, our first quarter was impacted by softness in China and wet weather in the U.S. Midwest. While the U.S. has returned to expected run rates, China remains challenged due to high corn prices. On the positive side, our grain milling launches continue to progress with solid growth of our Frontia product line in multiple geographies, helping to counter contraction in starch refining.

Food & Nutrition delivered growth in both the second quarter and the first half as a whole. The good performance was most notably driven by the increased penetration of our protein ingredient, dairy and plant extraction solutions. Additionally, we continue to see strong demand for technologies feeding into the clean label and healthy food trends. And we maintain our focus on pushing commercial penetration and developing new products to support higher quality and more sustainable foods.

Sales to the beverage industry are performing very well driven by double-digit growth in juice and wine and solid sales in brewing, while sales to the beverage alcohol industry remain sluggish as they are affected by high corn pricing in China.

In conclusion, it's been a dissatisfying first half in Food & Beverages due to softness in baking and starch as well as tough conditions in the Middle East. In the second half, we expect a ramp-up of our sales as we see acceleration in our Food & Nutrition business plus more impact from our efforts in grain milling and vegetable oil processing. Although the negative impact from the Middle East will ease, we don't expect a full recovery from the first half headwinds, and therefore, the outlook for Food & Beverage is low single-digit growth for 2019.

Tina, over to you.

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [4]

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Thank you, Andy. Let's start by looking at Bioenergy on Slide 6. Bioenergy recovered somewhat in the second quarter after a weak first quarter, closing the half year at minus 4% organic growth. For the second quarter in isolation, the business was flat.

In the first quarter, flooding and wet weather in the U.S. Midwest affected our Bioenergy business negatively. This continued into the second quarter with high corn prices and low producer gross margin as a result. So while the U.S. Energy Information Administration estimates that the overall ethanol production volumes are 1% to 2% lower than last year, our customers are down slightly more in the first half due to the first quarter underperformance.

Outside of the North American market, corn-based ethanol capacity expansion in Latin America, combined with our broad technology offering and the yeast platform, is expected to accelerate growth throughout the year. Looking ahead, despite E15 year-round sales now being allowed in the U.S., we expect this to add very little to the 2019 U.S. production volumes. The continued penetration of E15 should provide gradual support to our Bioenergy business in the years to come.

In China, there's progress on the E10 blend as provinces announce implementation plan, but it is still early days. We also have a number of very exciting product launches, but I'll let Thomas tell you more about these game-changing innovations, which are expected to benefit performance in the second half of the year.

So now let's turn to Slide 7 for an update on Agriculture & Feed. As expected, sales in the Agriculture & Feed business remained under pressure in the second quarter of the year, while the agriculture business in decline partly due to tough comparisons. This was somewhat mitigated by improved performance in feed. For the first half of the year, the Agriculture & Feed business declined by 6% organically year-on-year, while in the second quarter, the decline was 7% year-on-year. As communicated on June 6, the wet weather in the U.S. Midwest has had a negative impact on our agriculture business. The very wet soil conditions affect both corn and soybean planting and expected yields, creating short-term uncertainty in the industry.

The new BioAg setup is progressing well with good traction for our key product launches with Bayer for upstream corn and for Latin American soy as well as an additional launch for European wheat here in Q2. We are on track with our Canadian partner, Univar, with a dedicated sales team under the brand Univar NexusBioAg, and we continue constructive dialogue with additional partners such as UPL. So after 4 months with the new structure, the BioAg setup is progressing well in terms of product launches and partners.

Now let's turn to our performance in feed. Feed sales grew in the second quarter. And Balancius, our new gut health enzyme jointly launched with our alliance partner, DSM, was recently approved for the European market.

So to summarize the messages for the 2 areas. While ethanol markets remain volatile with North American inventories elevated and producer margins low, our performance in Bioenergy improved in the second quarter compared with the first. We expect an acceleration in the second half driven by innovation and capacity expansion in Latin America, and we expect low single-digit organic sales growth for the full year.

Agriculture & Feed is also subject to some uncertainty and had a weak start to the year mainly due to the wet weather in the U.S. Midwest. Here, we expect low single-digit decline to flat organic sales growth with an acceleration in the second half driven by innovation and increased sales in BioAg.

And now I'll hand over to you, Thomas.

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Thomas Videbaek, Novozymes A/S - Exectuive VP & COO of Research, Innovation & Supply [5]

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Thank you, Tina. Please turn to Slide #8. The second quarter was busy in terms of innovation. We commercialized 3 additions to our Bioenergy product portfolio: Innova Force, Innova Fit and Fortiva.

Innova Force is a new yeast that, in combination with our enzymes, deliver the most reliable and flexible solution yet for this industry. Further, the Innova platform was expanded with a dry version of our non-GM yeast, Innova Fit. This yeast enables penetration of markets in Latin America and Europe. The third launch, Fortiva, is a new enzymatic offering in the liquefaction to meet the demand for temperature robust solutions. These innovations gives us an even stronger portfolio supporting this business.

In addition to these 3 launches, we had 5 customer-specific launches. As Tina mentioned earlier, the partnership structure in the BioAg is progressing well. Bayer recently launched 2 new products for the European wheat market scheduled to be marketed in the forthcoming winter season. Both products enhance the interaction between the plant and the microbes present in the soil and are based on the jointly developed corn inoculant technology.

On June 16, we announced the formation of 3 new strategic opportunity areas in connection with the updated strategy. The purpose is to spearhead new business for the long term. We're also in the process of executing on the reallocation of innovation resources across our 30-or-so industry based on the differentiated portfolio [of our] framework. The process of differentiating the pipeline to invest with more impact is progressing well. And we estimate that the number of R&D projects will be reduced by roughly 1/3. By allocating more resources to fewer projects, we increase speed and the likelihood of success, which actually gives a higher net value of the total pipeline. All in all, a busy quarter, and we look forward to adjust our innovation efforts in light of the updated strategy.

That's all for me, and I'll hand you over to Peder.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [6]

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Thank you, Thomas. Please turn to Slide #9. I'll take you through our financial performance for the first half of the year. Our second quarter organic sales declined, as you heard, by 2%, which was an improvement on the 4% decline in the first quarter. Overall, sales came in as expected following the June 6 update to the full year guidance.

Floods and wet weather, as you heard, in the Midwest and some emerging market softness have created headwinds, impacting our Agriculture, Bioenergy and parts of Food & Beverage. Household Care and Technical & Pharma are delivering according to the expectation set out at the beginning of the year.

In reported Danish krone, sales declined by 1%. This includes a positive currency impact of close to 3% and a negative impact from lower recognition of BioAg deferred income and the divestment of the remaining pharma-related royalty in the second quarter.

The gross margin was down roughly 200 basis points year-on-year at 55.1%. This is partly due to the weak top line and partly to higher input costs starting in the second half of last year. One-offs had a negative impact on the gross margin. Price/mix was neutral, and currencies provided a tailwind. Overall, the gross margin of 55.1% was in line with our expectations.

At 30%, the reported EBIT margin came in as expected at roughly 200 basis points higher than last year. However, the reported Q2 margin of 34.4% benefited from one-offs included in other operating income. In addition, R&D cost was impacted by a provision for the cost of an old Bioenergy-related patent case in North America.

We also had cost related to the updated strategy and restructuring. Adjusting for the various one-offs mentioned, the underlying margin was roughly 26% or 150 basis points below the same period last year. The effective tax rate for the quarter was 19%, which is on par with last year.

Net profit was 1% higher, impacted by the one-offs and a hedging loss on the U.S. dollar. Free cash flow before acquisitions in the first half of 2019 was DKK 1.2 billion. That's roughly DKK 300 million up on last year. Free cash flow before acquisitions grew year-on-year as CapEx and trade payables were lower, while trade receivables and inventories developed favorably.

Now let's turn to Slide #10 for the 2019 outlook. We maintain our full year outlook on all parameters following the June 6 adjustment and confirm the expected organic sales growth acceleration in the second half of the year. As mentioned earlier today, it's important to stress that while the business faced some unexpected headwinds in the first half of the year, our forecast for the second half ramp-up have not materially changed.

For 2019, we expect an EBIT margin of 28% to 29%, net profit growth of 3% to 8%, free cash flow before acquisitions of DKK 1.9 billion to DKK 2.3 billion and a return on invested capital of around 23%.

As we previously communicated, we have completed the divestment of the remaining pharma-related royalty. This will not impact organic growth, but it will have a negative impact of around 0.5 percentage point on reported 2019 revenue growth in Danish krone. The proceeds from the divestment are recognized as other operating income and expected to offset the full year one-off cost related to the updated strategy and restructuring. Further, as a result of the new BioAg setup, the remaining balance of the deferred income is 0.

Before we close, let me just quickly summarize our message today. Floods and wet weather in the U.S. as well as softness in a few emerging markets have resulted in a weaker-than-expected start to the year. Organic sales in the second quarter declined by 2%. Although this is better than the first quarter, we're not satisfied with the performance 6 months into the year.

The slow start led us to revise our outlook on June 6 to 1% to 3% organic sales for the full year. This outlook is reconfirmed today, corresponding to a ramp-up in the second half of the year driven by increased sales in BioAg and easing of the Middle East comparison and sales from new innovations in Bioenergy as you heard about Animal Health and the Household Care Freshness. As those innovations build momentum, it will accelerate our growth.

While we continue our focus on delivering the full year outlook, we're executing on the updated strategy called better business with biology. We're making good progress on all fronts. We're focused on changing the business portfolio and thereby position Novozymes for stronger performance in the years to come.

That concludes today's presentation, and we're now ready to take your questions. Operator, please begin.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First question is from Michael Novod from Nordea Markets.

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Michael Novod, Nordea Markets, Research Division - Director of Healthcare, Healthcare Analyst & Sector Coordinator [2]

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It's Michael Novod from Nordea Markets in Copenhagen. First of all, a question on the gross margin. You did say -- highlight for the first half some of the challenges. Could you try to explain also regarding the high input cost -- higher input costs going into the second half? Because there's no doubt, looking at the year-over-year erosion, the gross margin actually feeds some concerns. So maybe just get a better feeling for where you should expect to end for the full year on the gross margin with the knowledge you have now on the input cost side as well.

And then on the different business areas, in particular, Food Bev, Bioenergy and Ag Feed. So going through all your 2019 outlook comments, it seems more than -- more of a challenging environment that things are looking up. So maybe you could just highlight for those 3 areas the single most important factor for each area in order to see this recovery, for some of the areas, very significant recovery in the second half compared to the first half of year.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [3]

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Thank you. I'll take the gross margin question and then the divisional heads can prepare for their single most important growth accelerator.

On gross margin, as I said, we've had some headwinds, including higher input cost. The higher input cost is really about -- it's mostly about chemicals where we saw an increase in our price, the prices we procured at in the middle of last year. And then it's some of our energy spends that are more expensive. We think that will ease in the second half of the year. And of course, all of this is included in our EBIT margin guidance of 28% to 29% for the full year. So an ease on the gross margin pressure in the second half is our expectation, and I think we have pretty good visibility on that.

Then I'll pass it over to Tina to talk about acceleration.

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [4]

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Yes, I can go first. So in Bioenergy, I mean there might not be one, Michael, I hope that is okay, but that is the innovations coming and then it's new capacity getting online in Latin America. But innovations in the North American market is a big part of it. We have progressed well with especially the yeast launches, which we launched the first product 1.5 years ago, and it is going very well and we see a lot of interest in it. And then on top, we also have the new alpha-amylase for liquefaction. So innovations in Brazil is the answer on Bioenergy.

On Ag & Feed, it is a matter of launches. And then for sure, I mean these compared to first half, we do, in general, in agriculture see a stronger second half given that we are preparing for the new season. And then also, we have innovations here both -- most notably, I would say, Balancius, but also the BioRise launches are the big ones here. So timing and launches in Ag & Feed.

And then over to Andy to answer the second.

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Andrew Fordyce, Novozymes A/S - EVP of Food & Beverages [5]

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Yes. So we had always expected a stronger second half in Food & Beverage. And I think the difference that we're experiencing is, of course, the first half, we knew, it would be tough, but it was tougher than we had expected. So for the second half, it's focused on ensuring the work we've been doing in building more business in grain milling and in vegetable oil processing. Those concrete opportunities come to fruition in the second half. And further expectations that our Food & Nutrition business, which is growing nicely, actually even accelerates in the second half. So it's known opportunities that we're working on, executing on those in the new growth areas.

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Operator [6]

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Next question is from Gunther Zechmann from Bernstein.

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Gunther Zechmann, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [7]

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Two questions from my side, please. The first one is on pricing. You spoke at the Investor Day about testing price elasticity a bit more. Peder, I think you had mentioned in the prepared remarks that price/mix was actually neutral, but there are orders to be slightly deflationary. So can you just give an update of what your initial feedback on the commercial side is on testing that price elasticity? That's the first one.

And the second one on, Tina, maybe you could comment on China E10? Any anecdotal evidence of production ramping up there and the kind of growth that you're seeing?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [8]

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So I'll take the pricing question. When we look at the first half, we have, just the reported numbers, we have a lower-than-normal price decline for the total business. That is, of course, an average of a lot of things. And there are pockets of the business, and I would rather not go into details right here, but there are pockets of the business where we are definitely testing price elasticity. And we're also successful in many areas, but of course, that's a complicated grit. And for competitive reasons, I don't think I want to talk about it here.

But I think we're making progress, and we have more planned -- or we have more in our plans. But pricing, despite the lower growth or the low growth in the first half, I think pricing is roughly, I was going to say, in control. And price erosion is actually lower than we've seen for a long time.

And then, Tina, to talk about China.

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [9]

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Yes. So on China, it is still early days, Gunther. But we do see some provinces, Shanxi and Hebei, if I pronounced it correct, planning on rolling out E10 mandates. But it is still early days. We also, as I think we have talked about earlier, have started seeing some new capacity getting online. But it is, as I said, early days, and it's not a big part of our numbers. But it is encouraging that they are starting on, you could say, to implement with provinces going to E10.

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Gunther Zechmann, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [10]

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And Peder, if I can just follow up on the pricing. Do you have any regretted losses on the volume side from increasing prices?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [11]

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Every loss is regrettable, but we also have wins.

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Operator [12]

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Next question is from Lars Topholm from Carnegie.

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Lars Topholm, Carnegie Investment Bank AB, Research Division - Co-head of Research of Denmark & Financial Analyst [13]

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A couple of questions on my side. In R&D, you mentioned this one-off impact from a patent case in the U.S. Can you specify how big the impact is and maybe also comment on what specific case it's regarding? And then, Tina, regarding your new yeast, which Thomas mentioned will give you access to the Latin American yeast market, how big is that market in total value?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [14]

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Thank you. On the provision for the R&D for the patent case, which is related to Bioenergy in the U.S., I think -- I mean obviously for various reasons, I would rather not give the exact number. But when you look at the hike up in our relative R&D spend, I think you pretty much get a number there for how much we're providing for. It is related to a particular application in biofuels. And we do not agree to the drift of the patent case, but we think it's prudent to provide for it right now.

And then I'll let Tina talk about yeast.

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [15]

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Yes. Lars, so the U.S. yeast market is around USD 200 million, and this is significantly less, also as the enzyme market for corn ethanol is significantly less. I think of the launches which we are having, I mean we both have a non-GM launch; and then we have the Innova Force, which is an enzyme expressing -- which is a yeast expressing 2 enzymes. I think of these 2, it's the Innova Force will lose the bigger part of that. So yeast in Brazil is not very big, and the biggest where we expect most impact from is from the Innova Force.

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Lars Topholm, Carnegie Investment Bank AB, Research Division - Co-head of Research of Denmark & Financial Analyst [16]

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Tina, one additional question. Of your Bioenergy revenue, can you indicate how much of that is U.S. now?

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [17]

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Around 85%.

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Operator [18]

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Next question is from Anton Beck (sic) [Brink] from Kepler Cheuvreux.

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Anton Brink, Kepler Cheuvreux, Research Division - Equity Research Analyst [19]

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First question. Can you be a bit more explicit on the core EBIT in Q2 and the implied margins from that? Is it fair to assume a one-off effect of roughly DKK 350 million?

And then a second question. Listening to all of the major ethanol makers reporting last week and I guess production data that we've seen for July, I must say I fail to understand your positiveness on Bioenergy in H2. You mentioned innovation in Brazil. But I guess to what degree does the output decline in July worry you? We've seen minus 3, minus 3 and minus 6 in the last 3 weeks, and comments by the ethanol makers have definitely not been positive.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [20]

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Okay. On the EBIT margin, just to save you a lot of calculations. Our expectation of the -- or our estimate of the underlying EBIT margin for the second quarter is 25% to 26%. And then I'll let Tina talk about ethanol. Tina, please?

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [21]

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Yes. So you are right that it is a constrained market where some players are pulling back. And we, for sure, also follow the news, as you're alluding to, and also in talks with customers. When we are though still expecting a low single-digit growth for the full year, it is due to that we saw a flat here in Q2 for Bioenergy, and then also we have the innovations coming in. On top of that, we have Brazil with new capacity expected to come online, which is also part of the numbers. But you are right, it is a challenging conditions. But we do expect that with the launches, that we would be able to deliver mid-single-digit growth -- low single-digit growth. However, our expectations are for a decline on the total volumes in the U.S. market.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [22]

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And that's the [total] ethanol volumes.

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [23]

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Yes.

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Anton Brink, Kepler Cheuvreux, Research Division - Equity Research Analyst [24]

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Maybe a follow-up. In a scenario that we would see closures, to what degree would that put your current guidance at risk? I mean are you, to some degree, accounting for closures?

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [25]

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So what you can say, a, closures, we have a bit more than 50% of the U.S. ethanol market, so it depends on who is it that is closing. And then we are taking -- in our considerations, we are looking at less ethanol being produced in the market a couple of percentage points. So that is included. But for sure, as you also know, it is a tight situation in the U.S. ethanol market. And it can go worse, it can go better.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [26]

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I just want to add that I think it's maybe not fully appreciated that we have actually grown a very significant yeast market and been very successful in the yeast market in the U.S. and expect that also these launches will continue to enable growth in the yeast market in the U.S. So this is not a zero-sum game or even a negative game if volumes go down. It's a plus game because we're adding a lot of really, really significant innovation to the yeast space.

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Operator [27]

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Next question is from Annette Lykke from Handelsbanken.

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Annette Lykke, Handelsbanken Capital Markets AB, Research Division - Medtech Analyst [28]

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Just a clarification question on the Bioenergy growth because in your press release on Page 2, it says that you had a negative organic growth in Q2 2019 of minus 1%. And then in your presentation, you say that the organic growth in Q2 2019, Page 6, is 0%. I just want to know which one is right.

And then a question on Food & Beverage. These new bread types, how fast do you expect the uptake to be? Overall, it's my understanding that the food industry is fairly conservative. So how fast should you expect this to compensate for the lack of growth in other areas? And also, could you elaborate of how big is this new potential for new bread types are compared to the existing market you are in today?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [29]

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I think we'll let Andy start with the Food & Beverage question. Andy, please?

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Andrew Fordyce, Novozymes A/S - EVP of Food & Beverages [30]

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Yes. So it's not new that we've been working on new bread types. And in spite of the fact that the first half has been tough overall in baking, we actually see good progress in multiple emerging markets in bread types that are sort of not traditionally Western.

So how fast? Well, we're actually investing more in flatbreads, which is a big category. And we're also investing in things like sugar reduction in bread, which is particularly relevant to many emerging markets for both cost savings and also kind of health effects.

I have to admit that I think the first half, being tougher, it makes us a little bit careful about how we view the overall category within baking. But we do expect a good second half performance in these new areas that will somewhat help us recover from the tough general conditions in Middle East and in fresh-keeping in the developed markets. But I'm still cautious about the full year effect on that.

From an overall size of opportunity viewpoint, if you think about sort of the Western market, there's on the order of 100 million tons of flour consumed every year for bread. In the developing markets, there's an equal, plus probably 50% more, amount of flour consumed that is unpenetrated. So there's actually a pretty substantial long-term opportunity in baking if we're successful in both innovating and penetrating this volume. And that's what we're working on for the medium to long term.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [31]

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Thanks, Andy. And then I think we might have resolved the potential noise around biofuels growth. Tina?

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [32]

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The answer is flat.

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Operator [33]

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Next question is from the line of Ben Gorman from UBS.

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Ben Gorman, UBS Investment Bank, Research Division - Associate Analyst [34]

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Just a few quick ones from me. First of all, in terms of understanding the starch business run rate. My understanding was that, that was quite a significant drag in Q1, particularly in China, and I thought in the 5 months as well. So can you just give an idea of what's changed there in terms of -- is it sugar pricing versus Chinese corn pricing? And are you coming up against easier comps? Just for the first one on that one.

And then just in terms of your sort of run rate in June. Given that we already knew what the 5-months number was on organic, it sort of looks like down almost 8% in June in terms of organic. So could you give an idea of whether basically July is looking better or worse than that at this point?

And then just sort of a quick one on the R&D provision side. Can you just confirm this is just a provision at the moment, it's not a cash out that's not in the cash flow? And also, sort of why now in terms of the provision? And have you ever reversed patent provisions in previous cases?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [35]

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So Andy, starch business, please?

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Andrew Fordyce, Novozymes A/S - EVP of Food & Beverages [36]

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Yes. So the Chinese starch business is based on corn, and it's been a decent place to be over the last few years because they've had quite favorable corn pricing as they had built up substantial corn stocks with some farmer support programs in previous years. And they use the corn to go ahead and produce starch, sweeteners, but also fermented products like organic acids and things like MSG.

Now what's going on now is that the corn prices have gone up significantly for 2 reasons. One reason is they've sort of burned through at least the kind of food-relevant part of the corn stockpile, and they're not really allowing corn into the Chinese market from the outside. And so some of these trade effects is actually hitting the starch producers in China.

From a sweetener viewpoint, they're having trouble maintaining prices because they're competing against sugar, which is more affordable than at least sugar produced from corn in China. And therefore, overall, the market is depressed when it comes to some of the main commodity outputs that they're producing in those markets. And that -- let's see how that develops. I don't have insight on whether it's going to remedy in the short term, but that's what we've been suffering over in the first 6 months.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [37]

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And then I'll take the 2 other questions. You had a question on the June run rate that was low. It may not -- it is actually pretty much as we expected when we announced on June 6. But every year, I think at least most years I've been involved in this, when around July 1, you have customers that will massage their inventory positions. And sometimes that gives a better June and a worse July, and sometimes it gives a worse June and a better July. And our expectation this year, without commenting on July at all, is that we had some weakness in June because of the inventory optimization that went on with our customers around July 1.

Then your next question was on the provisions for the patent case. We have provided because we believe that we are going to pay for the patent case, so it's a provision. Obviously we are now negotiating, and we'll negotiate as hard as we can. We don't think it's fair at all. But it's a negotiation that's going on. So of course, provisions could be returned or could be taken down or could return cash. But right now, it's our best belief what we have put aside as a provision in the second quarter.

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Operator [38]

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Next question is from Jonas Guldborg from Danske Bank.

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Jonas Guldborg Hansen, Danske Bank Markets Equity Research - Analyst [39]

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Three questions from my side. First of all, with regards to your cash flow, your reversal of noncash items is very low in Q2, much lower than usual. So could you put some words on why it's so low?

Then also, you announced some restructuring costs related to your new strategy or the implementation of your new strategy. How much is Q2 affected by such restructuring costs?

And then lastly, maybe you could put some words on how you have factored into your guidance for both Bioenergy and Ag & Feed the current trade war between U.S. and China? Yes, if you could put some word on that, please?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [40]

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Thanks for your questions. If we take them in the reverse order, then the trade war per se is not -- was factored in, but it's factored in because we take stock of the different businesses we operate in. So we take stock of what Bayer is telling us around planting in Latin America in the second half. The buildup for 2020, we take, of course, into account what the Bioenergy business is telling us about the outlook for their businesses. So it's things that are pieced together because we look at the different industries, and I think we have covered them well.

I don't know, but to me, the major part of it is probably in Bioenergy. And as you heard Tina talk about, we're not betting on an increase in Bioenergy -- in biofuels exports to China. So we're kind of booking that, that will not resolve over the year.

Then your first question on the cash flow and reversals, I have agreed with Tobias, who's next to me, that he'll call you and you can take those details offline, if that's okay with you.

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Jonas Guldborg Hansen, Danske Bank Markets Equity Research - Analyst [41]

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That's fine.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [42]

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And on the restructuring cost, that's -- there are some of that in the second quarter. Of course, we have had some help from consultants in developing the strategy update, and we have also paid them for that. We have also started on some of the restructuring programs internally. That's included in the math I did before. When you look at the underlying EBIT margin for the second quarter, you should assume that to be between 25% and 26%. And the restructuring costs that are to come in the rest of the year, we think, are fully accounted for in the guidance we have given you.

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Operator [43]

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Next question is from Søren Samsøe from SEB.

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Søren Samsøe, SEB, Research Division - Country Head of Denmark and Analyst [44]

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First, a question on the Food & Beverage division where you say the weak growth was partly due to price declines in fresh keeping and also starch in U.S. and China. Just if you could say these price declines, if they will also have a negative impact in the second half?

And then secondly, I think you alluded to it before a little bit, but maybe if you could say a little bit more regarding the starch in China. I mean it looks like the scenario of higher corn prices in the second half most likely. And your guidance of 1% to 3% for this division for the full year implies 6% in second half. So what is it that will grow, I guess, double digit for you to reach this guidance?

And then secondly, a question on restructuring cost. If you just say a little bit more of what you're using these restructuring costs. Is it layoffs in headquarter? Or is it more on the business areas? And also if we can -- when you've had these many [division] restructuring cost this year, is that sort of it? Or would there be more next year?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [45]

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Andy, please, starch and price declines?

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Andrew Fordyce, Novozymes A/S - EVP of Food & Beverages [46]

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So in baking, as I've told you, over the last few years we've seen a pretty fundamental change in the fresh-keeping market because of our patent expiry. And we had done, I would say, preemptive price declines with our channel partners to rebase that business. That actually was a more significant price decline over the period than we've seen in 2019. But I think the difference is that we had expected it to stabilize more than it has. So we've seen some declines that were unexpected in our first half. It's starting to stabilize now. We have visibility around how that's impacting the business going forward. Now baking is still going to be a tough area because of that, but that's factored into my low single-digit growth forecast for the full year.

On starch, one thing to think about is, yes, things are tough in China. I don't have great expectations that the starch refining business is going to get very much better in the second half. But another component of the starch business is our grain milling innovations that we launched a couple of years ago, and we've been working very hard on commercial penetration of that opportunity. That actually starts to have a decent impact in our second half as the trials turn into ongoing commercial business, which somewhat tempers the declines in refining. So you kind of have to factor it all together. Yes, it's a bit tough in refining, but we have other things going that have longer-term potential and they're starting to bear fruit.

Now overall for the second...

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Søren Samsøe, SEB, Research Division - Country Head of Denmark and Analyst [47]

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But as grain mill...

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Andrew Fordyce, Novozymes A/S - EVP of Food & Beverages [48]

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Sorry? Go ahead.

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Søren Samsøe, SEB, Research Division - Country Head of Denmark and Analyst [49]

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Oh, I just wanted to know if grain milling was big enough to compensate for the other areas that are probably not going to show that high growth in the second half.

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Andrew Fordyce, Novozymes A/S - EVP of Food & Beverages [50]

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No, like I said, I still -- I expect a kind of softness with -- overall within starch, but it's not just all bad. We've got some good things that are compensating for the corn pricing that's affecting volume in especially China.

Now the other part of the second half is that we actually have quite a bit that we've been doing on Food & Nutrition. And we've also got quite a bit going on in vegetable oil processing, combined with an already planned order pattern effect that has a significant step-up with selected customers in the second half. And that's what's going to get us over to the positive side and help compensate for the weaker first half. I'm not going to end where I originally thought I was going to end, which was to kind of mid-single digit, but low single digit is where we think we'll end based on a much more positive second half of the year.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [51]

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Thank you, Andy. On the restructuring cost, then on June 16, we announced a pretty significant reallocation program in the company where we are reprioritizing, as Thomas was talking about, reprioritizing the different businesses in terms of how we invest in them. And we're also taking out resources in certain parts of the company. So most of the restructuring cost, that is about letting people go. There will be layoffs in Novozymes. In some parts of the company, there will also be significant layoffs. That's going to happen in the third and fourth quarter. I expect most of that, the lion's share of that to be done in the third quarter. I'm sure there will be a few things that will drag into 2020, but by far, the majority of it is done in the second half of this year.

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Operator [52]

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Next question is from Sebastian Bray from Berenberg.

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Sebastian Christian Bray, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [53]

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I would have 2, please. The first is on the underlying EBIT margin of 25% to 26%. I'm wondering why this is down by, I think you mentioned 150, 160 basis points versus last year. And in particular, if the factors responsible for pushing this margin down could be expected to revert or change in 2020. That is my first question.

And my second is on the range of organic growth guidance. To hit the upper end of guidance of 3%, it looks as if Novozymes would need to be able to do 8% to 9% organic growth in H2 of this year. And I'm just wondering if this is something which you view as in the realms of the possible, or if you would say that you're feeling more comfortable with the lower end of the 1% to 3%.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [54]

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Thank you. On the underlying margin for the second quarter, as I said, it's about 25% to 26% or about 150 basis points below last year. Pretty much all of it comes from the gross margin. And as I said, I believe it's a question of input costs that are higher and then it's the lower volumes. The lower volumes have a very significant impact on our gross margin.

As you point out, we expect higher volumes in the second half and going forward, and therefore, we think that will correct itself. And we think we also have good visibility on the input cost. And therefore, we believe that, again, that's built into the guidance of 28% to 29% for this year. Of course, we'll need to take stock of where we are at the end of the year and then we'll tell you about our expectations for 2021 when we get there. But at least that's what we are expecting for the second half. So higher volumes that will help us and then the input cost is -- we're getting that annualized. The high input cost, we're getting that annualized.

Then in essence, you asked about our guidance, the 1% to 3%. And in our book, the 1% to -- both 1% and 3% are in play. There's uncertainty. And of course, coming in with minus 3% for the first half, I understand why we end up talking a lot about risks and, of course, there are risks. But there are also very significant opportunities. And as you heard, Tina talk about yeast. You heard Anders talk about the Freshness platform where I think we have a very solid ramp-up plan that's going to add a lot to Household Care. You heard Andy talk about that despite some softness in some of the businesses, there are also concrete order patterns that we think are very solid for the second half that will build good growth in the second half. So there are certainly also upsides. So we think both 1% and 3% are in play as we look in the business going for the full year.

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Operator [55]

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Next question is from Nicola Tang from Exane BNP Paribas.

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Nicola Tang, Exane BNP Paribas, Research Division - Analyst [56]

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Thanks for taking my 2 questions, they're both for Tina. In BioAg, I was wondering whether you had a sense of your -- the inventory levels of your customers, particularly given the fact that the U.S. planting season was potentially a bit weaker so that planting in both applications may have been lower than expected? And whether that means that they would send back product or perhaps keep it until next year?

And then the second question was on feed. It seems like this business improved from what's been a challenging few quarters. I was wondering whether this is an underlying improvement or was mainly a contribution from Balancius or whether it was just a case of easier comps.

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [57]

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Yes. So on BioAg, you are so right that inventory levels are something we are looking at. We have every year, you could say, we make return provisions. And we do have increased these return provisions this year, here in Q2, so they are included in the numbers given that, as you say, planting has been very different compared to earlier years. So it is included in the numbers and, yes, return provisions are increased.

On feed, the business is improving. But I think for the -- especially in Q1, it was a tough comparison to last year. And the improvement is coming from, yes, Balancius, where we see good traction, good interest, lots of players are trialing the products. We also have reoccurring customer on it. So that's going well. But then it's also -- but I would say, especially here for the first half, it is the comparison in Q1 where Q1 '18 was due to an import license, as we have talked about earlier.

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Nicola Tang, Exane BNP Paribas, Research Division - Analyst [58]

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And then just a follow-up, thinking about feed for the rest of the year, how should we expect that to develop? I suppose the comps get easier and Balancius ramps up?

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [59]

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You should expect some growth. But overall, for the Ag & Feed segment, we are estimating a low single-digit decline to flat organic growth. That's super difficult to say, but that's what we expect. But feed, slight growth.

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Operator [60]

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Next question is from Virendra Chauhan from AlphaValue.

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Virendra Singh Chauhan, AlphaValue - Analyst [61]

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So I had a question with respect to the guidance, but I just overheard someone ask exactly the same question. But then I thought, overall guidance, I was looking at just the Household Care as well as the Bioenergy segment. So there's been a lot of talk about, I mean, in your guidance that annualization of headwinds that we saw in H2 of '18. So -- but when I look at the numbers, especially with respect to Household Care, it doesn't seem that H2 '18 was particularly weaker than maybe H1 '18.

And similarly, in Bioenergy level, a significant difference in H2 versus H1. So just looking at the guidance that you have given at the H1 '19 performance as well as the comps that we have in H2, what kind of gives that kind of a confidence for you guys to get to still low single-digit growth, I think, in both Household Care as well as Bioenergy?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [62]

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Thank you. We'll let Anders start. Anders, please?

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Anders Lund, Novozymes A/S - EVP of Household Care & Technical Industries [63]

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So thanks for the question. We basically landed as we expected in the second quarter. Now the composition was a little different than when we did the original budgeting. We saw some weakness in China and Latin America, but we also saw some stronger performance in India and in North America.

When we talk about guidance, there are sort of 2 elements for why we continue to guide low single-digit growth in Household Care. One relates to a ramp-up of Freshness where we have, what we believe, are very solid rollout plans and we are quite confident that, that will materialize. And the other thing is that, as we've also talked about before, the annualization of the sales that we had in the Middle East of '18, we are getting out of that as we get into the second half of 2019. And those 2 are the main contributors to why we continue to guide low single-digit growth for household.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [64]

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Tina?

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Tina Sejersgård Fanø, Novozymes A/S - EVP of Agriculture & Bioenergy [65]

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And on Bioenergy, it is a matter of capacity getting online in Brazil and then it's a matter of innovations getting impact in the market.

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Peder Holk Nielsen, Novozymes A/S - President & CEO [66]

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Thanks very much, Tina. And I think this brings us...

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Virendra Singh Chauhan, AlphaValue - Analyst [67]

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Can I have a quick follow-up?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [68]

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Okay.

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Virendra Singh Chauhan, AlphaValue - Analyst [69]

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Yes. So on the rollout of Freshness specifically, could you give me a bit more color as to what commercial activities in H2 would you -- are you banking on for that kind of momentum?

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Peder Holk Nielsen, Novozymes A/S - President & CEO [70]

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So we're not giving any specific guidance on where this is being rolled out and to the magnitude of that. But what we are saying is that we are on the plan for Freshness and it's going to be material. And then we'll -- that's one of the major reasons for why we believe in the pickup of growth in Household Care.

Thank you. And I think that bring -- or that does bring us to the end of this session. Thank you so much for your questions. And we're looking forward to seeing hopefully a lot of you as we get on with our roadshows today and tomorrow and the following couple of weeks. But thank you very much for your attention today and for your good questions. Thanks.