Thorntons said it expects to see a “slow” recovery in profitability over the next two years after reporting a fall in annual earnings and as it battles a tough UK market.

In the 53 weeks to the end of December, underlying profit slumped to GBP2.5m (US$4m).

Including exceptional items of GBP3.1m, pre-tax profit plunged to GBP0.9m from GBP4.3m last year.

However, analysts were expecting Thorntons to just break even at the pre-tax level, and as a result, shares were up 4.25% in early trading today.

Investec analyst David Jeary said the results were “better than expected”, compared with its break-even forecast. He maintained his ‘hold’ recommendation on Thorntons’ shares.

Nevertheless, gross margins came under pressure during the year, falling to 44% from 46.2% in fiscal 2011.

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Chief executive Jonathan Hart told journalists on the firm’s earnings call that, despite the margin pressure, Thorntons expects margins to “continue to benefit the business” in the forthcoming year.

He added: “Not withstanding the uncertainty of how the economy will affect business, on balance we expect our overall margins and profitability to slowly recover over the next two years of our transformation plan. We haven’t set any external targets with regard to that.”

Hart suggested the improvement in margin will be down to the company’s ability to adapt its products.

“Over the course of the last year we have made a lot of changes to our products … all of these better practices and the engineering disciplines started to play their part in the second half and that will float through to the next financial year.”

In the firm’s trading update, Thorntons said it had achieved “further success” in growing its commercial channel, the only division to record a sales increase in 2011/2012. The unit now represents 39.1% of total sales.

The firm is aiming for the commercial business, which sells chocolate to retailers including UK supermarkets, to generate over half of its overall sales over the next two years, making it the largest channel.

Hart said promotional activity had generally become less “aggressive” but said the company was still seeing a “significant” amount of promotions in its commercial division.

“The nature of the current retail environment, whether it be in the grocers or indeed in our own stores, is that the consumer is seeking value and has constraints placed upon them in terms of the amount of money they are willing to spend. It’s difficult to believe one can significantly fight against it,” Hart told just-food.

“I don’t think that as a brand we find ourselves any more or any less exposed to that particular requirement. Having said that, in our commercial channel there remains a very significant amount of sales that go through on promotion and we plan our business around that and plan our pricing and our margins around that so it’s not a surprise to us.”

Looking ahead, however, Hart said Thorntons’ was cautious about the prospects for UK high streets and consumer confidence.

“We don’t see that improving any time soon and we are planning for that continue to be weak and we have set out our plans accordingly. It’s difficult to know what degree of headwind we will face heading towards Christmas, but are we in better shape than we were last year internally? Are we better planned than we were last year internally? Yes, and we have confidence that a number of the actions we took to improve margins over the course of the year are and will continue to float through into the course of the first half, but we remain cautious.”

Despite the firm’s optimism, Conlumino analyst Joseph Robinson believes Thorntons is on “an inevitable course of decline”, from being a large retail player, to “smaller mid-market” retailer and wholesaler.

“In the short term, it will continue to experience difficulties in managing this transition,” Robinson said in a note. “The brand is less relevant than it once was, and its decision to focus more strongly on the commercial side of its business – and in particular on selling its products via the grocers – has severely impeded on its ability to extract a premium on its product.”

Separately, Hart touched on the company’s international plans as it embarks on a strategic review of foreign business opportunities and said it will have a focus on Australia, the Middle East and South Africa. 

Thorntons’ share price climbed 5.3% to 28.70 pence at 12:57 BST.