Earnings Call: Q4 2018

Feb 5, 2019

Summary

FY18 delivered 5% organic growth and a 19% EBITDA margin, with higher gross margin but lower free cash flow. FY19 guidance calls for 4%-5% organic growth and ~20% EBITDA margin on an apples-to-apples basis, with acquisitions and IFRS 16 affecting comparisons.

Ladies and gentlemen, welcome to the Össur Q4 and full year results 2018. Today, I am pleased to present Jón Sigurdsson, President and CEO, and Sveinn Sölvason, CFO. For the first part of this call, all participants will be in listen only mode, and afterwards there will be a question and answer session. Mr. Sigurdsson and Mr. Sölvason, please begin your meeting. Yeah, thank you. As previously mentioned, my name is Jón Sigurdsson. I would like to welcome you here to this Össur Investor Conference Call, where we will cover the results for the full year and the fourth quarter of 2018. We will begin by going through the highlights for the year, followed by the quarterly results, and ending with our guidance for 2018. Following this, there will be a question and answer session. We are pleased to close the year by delivering on all the guidance parameters. Organic growth amounted to 5% and hence in the upper range of our guidance for the year, and EBITDA margin amounted to 19% as guided. CapEx was 5% of sale and the effective tax rate was 24% for the year when normalized for one-time benefits. The reported effective tax rate was 18% for the year. The key highlights for the year include that sales in the full year amounted to $630 million, corresponding to 7% growth in local currency, 5% organic growth, and 8% reported growth in U.S. dollars. EBITDA grew by 11% and amounted to $115 million, or 19% of sales, compared to 18% last year. We acquired four companies with combined sales of around $70 million during the year. We will go through the guidance at the end of the presentation. As previously mentioned, sales amounted to $630 million in 2018 compared to $569 million last year. The prosthetics segment grew by 7% organic, corresponding to a four percentage point contribution to our total growth. We have a good momentum in the prosthetics segment globally with excellent contribution from high-end products, including the recently launched Pro-Flex LP Align and Bionic PROPRIO FOOT. The remainder of the prosthetics portfolio also performed well during the year. Bracing and supports grew by 2% organic with one percentage point contribution to total growth. Our OA solutions continue to grow well, but sales have been slow in the U.S. and France this year, with lower sales to certain distributors and rationalization sales network in selected market. Total reported growth was 8%. Acquired companies contributed two percentage points to reported growth. With the change in currency rates, sales were positively impacted corresponding to a two percentage point contributing to reported growth. Over to you, Sveinn. Thank you, Jon. As Jon went through, organic sales growth was strong and amounted to 5% for the year, and reported growth was 8%. The gross profit margin was 63% compared to 62% last year. The increase in gross profit margin can mainly be attributed to a positive impact from product mix and the savings initiatives. EBITDA before special items grew by 11% and amounted to $115 million or 19% of sales, compared to 18% last year. I will go through the margin development in more details on the next slide. Goodwill was impaired by about $4 million in the quarter. The impairment is related to an acquisition made in 2012 of a product line that has now been discontinued. The sales impact will be immaterial as a result of this discontinuation. Income from investments in associates amounted to $24 million in 2018, mostly due to revaluation of previously acquired minority shareholdings in companies where Össur now holds the majority of the share capital. The revaluation has no cash flow impact. The effective tax rate was 18%, normalizing for the impact from revaluation of previously acquired shares. The effective tax rate would have been around 24%, which is in line with our guidance. Net profit was strong and amounted to $80 million or 13% of sales, compared to 10% of sales last year. Net profit growth amounted to 38%. Net profit is obviously significantly impacted by the previously mentioned sort of revaluation of minority shareholders. But in summary, a strong P&L for the year. If you go to the next slide, please. The key items affecting the EBITDA margin between the years are positive impact from gross profit margin, mainly driven by a positive development in product mix as our high-end products are growing faster than the remainder of our product portfolio. But also from a stable unit cost in manufacturing and savings from the efficiency initiatives. Growth in sales and marketing expenses is mainly due to investments in sales efforts in new business development and emerging markets. R&D cost increased with investments in R&D projects for high-end products. This increase is not as such visible in the margin bridge as the recent acquisitions have no R&D expenses. G&A expenses grew less than sales, but there is also a slight negative impact on margin as a result of the recent acquisitions. Finally, currency impacted EBITDA margin positively by about 20 basis points net of hedging. The combination of strong sales growth, scalability on the cost side, positive impact from changes in product mix, and impact from the savings initiatives were the main drivers of strong relative profitability in the year compared to last year. Next slide on cash flow. Free cash flow amounted to $46 million compared to $60 million last year. The main items affecting the cash flow between the years are first and foremost a positive impact from strong operating results. Now we do have a temporary increase in net working capital, mainly due to higher inventories at year-end in relation to the manufacturing efficiency initiatives as we closed a distribution center and are moving specific manufacturing processes from Iceland to Mexico, which has resulted in a temporary step-up of inventories. Paid income tax is higher in line with higher profits, but also because last year income tax was impacted by some one-time benefits. CapEx was high in 2018 due to investments, again related to the ongoing efficiency initiatives, in addition to some investments in leasehold improvements, I would say above the normalized level. Lastly, net interest-bearing debt was about $180 million at the end of the year, which corresponds to a 1.6 times net interest bearing debt to EBITDA. This concludes the highlights for the year. If you could go ahead, Jón, with the quarterly review. Yeah, thank you, Sveinn. Sales in the fourth quarter amounted to $168 million, corresponding to 12% growth in local currency, 4% organic growth, and 8% reported growth in U.S. dollars. EBITDA grew by 8% and amounted to $33 million or 20% of sales, the same EBITDA margin as the comparable quarter last year. As previously mentioned, sales amounted to $168 million in the fourth quarter of 2018 compared to $154 million in the same quarter last year. The prosthetics segment grew by 6% organically corresponding to three percentage point contribution to total growth. We continue to see a good performance in prosthetics bearing in mind strong comparable quarter in 2017 where organic growth amounted to 11%. High-end innovative products such as bionics and carbon fiber mechanical feet delivered strong growth in the segment globally. Growth in other product categories was also good in the quarter. Bracing and supports grew by 3% organically with a one percentage point contribution to total growth. High-end innovative products continue to be the main growth drivers in the segment. However, as in the full year, sales have been slow in the U.S. and France this year, with lower sales to certain distributors and rationalization effort in selected market. Total reported growth was 9%. Acquired companies in 2018 contributed eight percentage points to reported growth and with changing currency rates, sales were negatively impacted corresponding to a negative three percentage points impact on reported growth. Americas local currency growth of 22% and organic sales growth was 3% in the quarter. Growth in the prosthetics segment was strong with a good contribution for recent product launches. In the bracing and support segment, performance in Canada continues to be strong while sales in the U.S. were impacted by lower sales to a few large distributors. Our own distribution companies continue to perform well after the restructuring was finalized at the end of 2017. Organic sales growth in EMEA was 3% in the quarter. Growth in prosthetics was good in all major market regions during the quarter. In bracing and supports our high-end solutions grew well while our soft goods products had a slow quarter. The main reasons being slow sales in France and product rationalization effort. Organic growth in APAC was 9% in the quarter where we continue to see strong result in both prosthetics and bracing and supports. As in previous quarters, growth in Australia and China has been excellent. Now over to you, Sveinn, regarding the quarter. Yeah. As already covered, organic sales growth amounted to 4% in the quarter and reported growth was 9%. The gross profit margin was 64% compared to 63% in the comparable quarter last year. The increase in gross profit margin can mainly be attributed to a positive impact from product mix and the savings initiatives. EBITDA before special items grew by 8% and amounted to $33 million in the quarter or 20% of sales. The same EBITDA margin as in the comparable quarter last year. The effective tax rate was 9% in the quarter as it was positively impacted by the previously mentioned revaluation of minority shareholders. Normalizing for this effect, the effective tax rate would have been around 25%. Net profit was strong and amounted to $34 million in the quarter or 20% of sales compared to 15% of sales in the comparable quarter in 2017. Now, if you go to the next slide, the big picture on the EBITDA margin development for the quarter is largely in line with the development for the full year. A couple of items that are noteworthy in the quarter. The recently acquired companies had a slightly negative impact on EBITDA margin here in quarter four. There is an increase in G&A cost, which is driven by the acquisitions made in the beginning of the quarter, in addition to investments made in some new business development and investment in specific functions to support a growing business. It should, however, be noted that for the full year, the administrative cost of G&A costs are growing at a slower rate than sales. R&D costs increased with investments in R&D projects for high-end products, which is in line with plan and something we've talked about previously. However, the increase is not captured by, let's say, here in the EBITDA margin bridge, as the recent acquisitions have no R&D costs. Lastly, currency impacted the EBITDA margin positively by about 60 basis points net of hedging. On the next slide, there's an overview of our efficiency initiatives. In September 2017, we announced these initiatives in the areas of distribution, manufacturing, and sourcing, with the overall objective of increasing the scalability and profitability of the business. During the year, the distribution facility on the West Coast in the U.S. was closed, and the operations were moved to our manufacturing facility in Mexico, where savings began to materialize in the second half of the year. Within manufacturing, investments were made in various equipment in Mexico to grow the operations there and prepare the facility to manufacture specific prosthetics components. Consequently, a part of the prosthetics manufacturing was moved from Iceland to Mexico late in the year, with savings expected in 2019. Within the strategic sourcing initiative, good progress was made in several spend categories. Overall, good progress on all the initiatives, although with some slight delayed impact of the manufacturing move. Hence, the realized savings were, let's say, slightly lower than the target of $3 million for the year. However, it is still expected that the savings target of around $6 million in 2019 will be reached. All right. If you go to the next slide. Now, as of January, we have implemented the new IFRS standard, so IFRS 16, regarding leasing accounting, which will affect the reporting of our financial performance quite significantly. The standard will not be applied retrospectively as such, and therefore, the 2018 comparative figures will not be adjusted. However, we will, throughout 2019, continue to report on key financial metrics as they would have been without the implementation of the IFRS 16 standard. We will provide apples-to-apples comparison. In summary, the implementation is expected to increase EBITDA by approximately $19 million and depreciation by approximately $17 million, resulting in an increase in EBIT of about $2 million. Furthermore, interest expenses are expected to increase by approximately $3 million, and therefore, net profit is expected to decrease by about $1 million. Repayment of lease liabilities will be added to financing activities in the cash flow, but there is obviously no cash flow impact from the implementation of this standard. You can see further information regarding, let's say, the impact of all of this in the consolidated financial statements. More specifically, note 33.2 in the full-year consolidated financial statements. If you could finish up, Joakim, please, with going through the guidance. Yeah. Thank you, Sveinn. As already mentioned, Össur recently made the four acquisitions with combined sales of a full-year basis of around $70 million, which will impact our sales and profits in 2019. Regarding the guidance parameters, organic sales growth is expected to be in the range of 4%-5%. In prosthetics, we expect to see a continued good performance in key markets and high-end products, supported by recent product launches. Growth in prosthetics is estimated to be at or above estimated market growth in 2019. In bracing and supports, we expect to see a continued good performance in high-end products. The product rationalization is a selected market and lower sales to a few large distributors, which impacted growth in 2018, are expected to have a minimal impact on growth in 2019. However, as in 2018, we expect the competitive market environment in France and the U.S. to prevail. Continued good performance is expected in other key markets. Growth in bracing and supports is expected to be in line with estimated market growth in 2019. EBITDA margin before special items is expected to be around 23%, excluding the impact of the new IFRS 16 leasing account standard. The EBITDA margin before special items is expected to be around 20%. Apple to apples is 20%. The EBITDA margin is expected to increase compared to 2018 due to favorable development in product mix, scalability in the underlying business, and savings from the efficiency initiatives. The recent acquisitions are expected to have a slightly negative impact on the EBITDA margin. At current foreign exchange rates, keeping all other factors constant, the EBITDA margin is expected to be positively impacted by about 40-50 basis points net of hedging in 2019 when compared to 2018. It should be noted that quarter 1 is and has been historically, seasonally, the weakest quarter of the year in terms of sales and profitability. The recent acquisitions have a greater seasonality in their operations compared to the pre-acquisition Össur business, where the first quarter of the year is also seasonally the weakest, and the fourth quarter the strongest. Consequently, the seasonality in Össur sales and profit is expected to be slightly increased in 2019. CapEx is expected to be above the historical normalized level of 3%-4% of sales and amount to 4%-5% sales in 2019. The main reason for the higher CapEx level is due to expected CapEx investment in relation to ongoing efficiency initiatives. Based on the current mix of taxable income, the expectation is that the 2019 effective tax rate will be in the range of 23%-24%. Thank you all. Let's now go to the question and answer session. Thank you. Ladies and gentlemen, if you do have a question for the speakers, please press 01 on your telephone keypad and you'll enter a queue. After you are announced, please ask your question. The first question is from Christian Ryom from Nordea Markets. Please go ahead. Your line is open. Hi. Good morning, Jón. This is Christian from Nordea. I have a couple of questions. My first is to your top line, and particularly the growth that you're seeing in the APAC region. Can you talk a little bit about why we're seeing this slight slowdown in growth here in the fourth quarter? Is that only due to the comparison base, or how would you view that? What is your expectations for 2019 for the APAC region? My second question is to the acquisitions that you've announced here in connection with Q4. Are those acquisitions similar in nature to what you announced in connection with Q3? Should we also expect a similar split between bracing and supports and prosthetics as in your previous acquisitions? Thank you. Yeah. Good morning, Christian Ryom. If we start with the APAC region, the run rate there is pretty similar than in the previous quarters, and that comparison is the reason for a little bit slower. Yeah, just to add a bit. Let's say that it's now over a full year since we changed that distribution model in China, which had a positive impact on our sales growth in the region, but we expect continued strong double-digit sales growth from this region going into 2019. Okay. Thank you. Regarding the acquisition. Yeah, this is pretty much similar, the companies we bought in the previous quarter. This is a mixture of a service business, and they are a clinical operation with a small manufacturing facility. Okay. Just for clarity This is what you asked about the split, Christian Ryom. It is more heavily weighted on prosthetics than bracing and supports. Okay. Just a final question for clarification. You say that the combined revenue of the acquisitions that you have made in 2018 is around $70 million. The increment in 2019, what share of those $70 million have you not consolidated already in your Q4 here? The $70 million is a full year impact of all the four acquisitions that we made in 2018. Okay. The increment on top of your- Yeah. It would be $58 million approximately. Yeah. 58 million. Okay. Yeah. Yeah. Yeah. Thank you. Yes. Next question is from Ole Bang from ABG. Please go ahead. Your line is now open. Hi there. Thank you for taking my question. Previously, you've stated the percentage volume of bionics in the prosthetic field. I know that you say it's 24% of value, but can you disclose how many percent of volume it is now? Secondly, M&A pipeline for 2019, how should we think about this? Thirdly, Ottobock and Ekso Bionics, they're both making quite a big push in exoskeletons. Can you please update us on your status within exoskeletons? Thank you. I can take the first one. On the bionics, yes, it's about 24% of value today, our sales of bionics, but it's between 1% and 2% of volume or units sold. It is pretty much the status today. In the pipeline, it is the same as before, that the PROPRIO FOOT will contribute nicely to the growth and also the trade-up and the carbon fiber segment, that will contribute to growth as well. So it's pretty much the same as previously. Regarding the exoskeleton, we have disclosed that we are in a R&D phase with the exoskeleton. There is nothing new to report there, and that will not contribute anything to 2019. About the M&A pipeline as well, we've recently concluded a fair amount of M&A. We have a pipeline, but we don't want to comment too much about how that's going to develop over the next quarters. Okay, thank you so much. Next question is from the line of Nils. Heinz, on the net working capital, let's say there is a step up in 2019, but fundamentally around our working capital dynamics, nothing has changed. The reason we have more working capital investment at year-end 2018 is because we are going through these changes in our fundamental supply chain processes and where we manufacture certain items. So I would expect 2019 to revert to, let's say, the pre-2018 levels on working capital. All else equal, a positive impact on cash flow in 2019. Regarding tax payments, this is more, let's say, a timing difference rather than anything else. Our cash tax rate has been a bit below our effective tax rate because of some specific amortizations for tax purposes in relation to prior acquisitions. So I think that is also safe to assume similar assumptions going into 2019. Finally, on the capital structure policy, you are right. Let's say the implementation of IFRS 16 will change some of these key ratios. When we report our first quarter of the year with the new standards in place, we will look at our capital structure policy. But I don't expect us to change the level as such. In other words, the impact of the accounting changes should be neutral to the way we look at how we want to run the business with regards to financial leverage. The figures will be different, but the- The philosophy will be the same. Philosophy will be the same, yeah. Okay. Then just a follow-up question on your M&A. You announced two acquisitions in your Q3 report, so it is correctly understood that you have made two additional acquisitions here in Q4? That's correct. We made 4 acquisitions in 2018, one at the very end of Q3, one in the very beginning of Q4, and we talked about both of these in our Q3 reporting, and then we've done 2 additional acquisitions towards the latter half of Q4. Yes. Okay, thank you. Thanks. Next question is from the line of Felix Wehmann from SEB. Please go ahead, your line is open. Yes. Morning, gentlemen. Thank you very much for another strong quarter. A couple of short questions from me, please. The first one on your manufacturing facility in Mexico. Can you just update us there where you are in terms of capacity utilization or whether you expect any more efficiency gains from that side? That's the first question. Yeah. We have a sufficient capacity in Mexico, and the development of that facility is one part of the initiative we are running at the moment. Okay, excellent. The other question on bracing and support. I know that you do not disclose the margins for that business, but underlying margins, you have been working so much on it over the past couple of years with changing the product, phasing out older ones that are heavily price competitive and so on, changing the distribution mix, et cetera. So the underlying margins of that business, have they improved over the last couple of years? Yes, they have. The gross profit margin has improved, but of course, the capacity is still there. But the gross profit margin is slightly gone up, yes. Okay. The last question relates to M&A as well, but rather to the past acquisitions that you have done on M&A integration. If you could comment on the businesses that you have acquired in the first half of the year, businesses like medi, for example, in Germany or the hand and arm business in the U.K., how the integration has been there on the operational side, but also on the cultural side into the Össur organization? Yeah. It's fully done. The only thing to describe it is that it's just done. It's fully in line with our business case and even better than the business case in both of those instances. And you've managed to maintain the key people that you wanted to keep and added the product into your sales people, et cetera? Yes. That's gone very well. There was a slight, in the US business, it came a few months later. The sales increase was delayed a few months, but that was all. Excellent. Thank you very much. You're welcome. Just as a reminder, if you do have a question for the speakers, please press zero one on your telephone keypad now. The next question is from the line of Yu Zhao from SCB. Please go ahead. Your line is now open. Good morning, gentlemen. Thank you for taking my question. I have two questions on acquisitions. Firstly, could you please give us a guidance on the purchase price allocation impact on the 2019 guidance? Since you have made four acquisitions during 2019. Secondly, the margin and dilutive impact also from the acquisitions. Now you have guided 20% EBITDA margin exclude the restructuring costs. Thanks. Yeah. Thanks. Regarding the acquisitions, the balance sheet is obviously impacted by these acquisitions, and we have about a little over $100 million of goodwill added to the balance sheet. We have not done the PPA yet, but I expect about 20% to be allocated to amortizable intangibles, which you should then reflect that in your model. But we will update you on the PPA as we conclude that during the year. The impact of the acquisitions on our financials, as previously stated, these acquisitions will add about $70 million on a full year basis, and we expect them to be slightly dilutive on our margins, so largely in line with what we communicated after quarter three, when we announced the prior two acquisitions. Just a follow-up on the PPA. Is it fair to assume you will downgrade your EBITDA margin during the year when you include the PPA, when you have a view on the impact from 20%? These sort of amortizations will, and whatever assumptions we apply in the PPA, I don't expect that to impact our EBITDA margin as such. It will impact our earnings and EBIT and all that, but it shouldn't be a material impact if you assume that 20% of the goodwill will be allocated to amortizable intangibles. Okay. Thank you. Yes. There are currently no further questions registered. So I'll hand the call back to the speakers for any closing comments. Please go ahead. Yeah. Thank you for the questions. As a final remark, we will be on the road this week for a visit a few European countries in relation to the quarterly results, and in the next couple of months, we will be presenting at a couple of conferences. Please reach out to our investor relations team if you would like to meet us or if you have any questions after this call. Thank you for listening, and have a good day. This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.