Earnings Call: Q4 2017

Feb 6, 2018

Summary

FY sales rose 8% in local currency, with prosthetics driving organic growth; adjusted EBITDA reached $103 million at an 18% margin. For 2018, organic growth is guided at 4%-5% and EBITDA margin at 19%, alongside higher R&D investment.

Ladies and gentlemen, welcome to the Embla Medical presentation for the interim report Q4 2017 and consolidated financial statements for FY 2017. Today, I am pleased to present Jón Sigurðsson, President and CEO, and Sveinn Sölvason, CFO. For the first part of the call, all participants will be in listen-only mode, and afterwards there will be a question and answer session. Speakers, please begin your meeting. Yeah, thanks for that. As already mentioned, my name is Jón Sigurðsson, and we will begin by going through the highlights for the full year of 2017, followed by a more detailed review of the fourth quarter, and end with our guidance for 2018. As already mentioned, the question and answer session will then follow. Sales in 2017 amounted to $569 million, corresponding to 8% growth and 5% organic growth, both measured in local currency. Growth during the year was primarily driven by excellent performance in our prosthetics segment, which grew above estimate market growth or 9% organically. The bracing support segment had a slow year where our own distribution companies negatively impacted growth in bracing and support by 140 basis points. Even so, we are pleased to see our high-end innovative products performing well across our portfolio in both prosthetics and bracing and supports. Gross profit amounted to $355 million or 62% of sales. EBITDA before special items grew by 10% in local currency and amounted to $103 million or 18% of sales. Positive trends in product mix and good sales growth resulted in EBITDA growing faster than sales. Currency movements impacted the EBITDA margin negatively by about 70 basis points net of hedge. Due to changes in our tax environment in the U.S., the effective tax rate was impacted in the quarter and for the full year. Sveinn will elaborate on this a bit later. We have included this slide to highlight some of the progress we have made in our strategic focus areas during the year. This slide and further information on our major milestones in 2017 can be found in our annual report, which we published yesterday evening along with our quarter four and full year financials. Starting with innovation, on the left, we continue to develop new products for both the prosthetics and bracing support segment during the year. In the second half of 2017, we entered into a partnership with IUVO and COMAU to develop wearable bionic bracing for workers in the industrial fields and patients in need of improved mobility. We were granted over 100 patents, have over 30 collaborative research studies ongoing, and had 16 peer-reviewed publications by our research partners. In terms of growth, we closed the year with 5% organic growth. Over the course of the year, we launched over 40 new product solutions to the market with key products such as our highly regarded RHEO KNEE and a new light version of Unloader One. The acquisitions we made in 2016 are now full part of our product offering, and we saw good progress in China with our direct sales model. Within efficiency, we successfully integrated the companies acquired into 2016 and launched efficiency initiatives in September. The initiatives are progressing well with preparations begun to move part of the feet manufacturing and assembly from Iceland to Mexico, and we plan to move our West Coast distribution center in the U.S. to our Mexico manufacturing plant in 2018. Lastly, we finalized the restructuring of our own distribution companies by the end year, end 2017. Next slide, please. Sales amounted to $569 million compared to $521 million in 2016. To bridge the difference, I will begin with organic development, where total organic growth was 5%. The prosthetics segment grew by 9% organically, which correspond to a four percentage points contribution to total growth. In prosthetics, we continued to see a good performance with growth above estimates for market growth. High-end product performed well in the year, which includes the recently launched upgrade of the RHEO KNEE. Bracing and supports grew 1% organically with one percentage point growth contribution to total growth. The direct sales part of the bracing and supports segment continues to grow while we still have a negative impact from our own distribution companies in the U.S. With the restructuring effort finalized, we expect a limited impact on growth in 2018. Total local currency growth was 8%. The prosthetics segment grew 17% in local currency. With the addition of Touch Bionics and Medi Prosthetics, which we acquired in 2016. The additions correspond to a three percentage point contribution to total growth. Total growth in U.S. dollar terms was 9% due to the appreciation of a few major operational currencies against the dollar, mainly the euro. Currency movements in the last year impacted sales growth positively in the amount of $4 million. This corresponds to a positive 80 basis points contribution to total growth. Having said that, over to you, Sveinn. Thank you, Jón. As Jón already covered, local currency growth amounted to 8%, and organic sales growth amounted to 5%. Gross profit margin was 62% compared to 63% in 2016. I will elaborate on the difference on the next slide. EBITDA margin amounted to 18% when adjusted for one-time costs in relation to the Medi Prosthetics acquisition and the efficiency initiatives announced in September. As for previous years, we have an impact on our profits with changing currency rates, which I will also elaborate on a bit further on the next slide. Net profit grew by 13% and was about $58 million or 10% of sales. Good growth and profit can be attributed to strong sales growth in the year, but also due to a $6 million one-time tax benefit, which is primarily related to the changes in the tax environment in the U.S., but also some impact from changes in France. The one-time impact is related to a reevaluation of deferred tax assets and liabilities. As a result, the tax paid for the year was 16%. It should be noted that the one-time benefit from reevaluating assets and liabilities has no cash flow impact. If you go to the next slide, please. EBITDA before special items amounted to $103 million, which corresponds to an 18% EBITDA margin compared to 19% in 2016. The key items affecting the EBITDA margin between the two years are starting from the left side on the slide. Positive product mix contribution from both business segments were offset by temporary cost increases in some of our smaller manufacturing locations. Sales and marketing expenses grew less than sales. We have, during the year, made some additional investments in EMEA and emerging markets, but we also benefit from integration synergies. There was a step up in R&D investment in the year, mainly driven by the acquisitions and investments in R&D projects for high-end products such as bionic bracing. G&A expenses also grew less than sales. Synergies and scalability impacted G&A costs positively. Currency impacted the EBITDA margin negatively by about 70 basis points, which is net of the positive impact we have on partial hedge on Icelandic krona costs. We will now have a look at the quarter four finances in more details. If you can go ahead with that, Jón, please. Yeah. Thank you, Sveinn. This concludes the highlights for the full year, and we will now concentrate on the quarter for 2017. Sales in the fourth quarter of the year amounted to $154 million, corresponding to 7% organic growth. Local currency growth and organic growth are now equal, as the acquisitions made in 2016 are now fully incorporated in the comparable figures. Prosthetics grew 11% organically in the quarter, with an excellent contribution from the recently launched upgrades of the RHEO KNEE. Growth in bracing and supports was 3% in the quarter. Gross profit margin in the quarter was good, 63% of sales. EBITDA amounted to $30 million in the quarter, or 20% of sales. EBITDA growth was strong and amounted to 15% in local currency. Positive trend in the product mix and good sales growth positively contributed to increased profitability in the quarter. The EBITDA margin was negatively impacted by about 20 basis points due to currency. As previously mentioned, the change in the U.S. tax environment impacted the tax-effective rate in the quarter. If we look at the growth by segments and geography, we see an excellent 11% organic growth in prosthetics and 3% organic growth in bracing and supports. Sales of bionic products in the quarter amounted to 24% of prosthetics component sales. We had good sales growth in all regions, where Americas grew by 5%, EMEA grew by 8%, and APAC grew an excellent 16%. I will now further elaborate on sales by business segment and geography, beginning with the business segments. Sales in the fourth quarter amounted to $154 million, compared to $138 million in the fourth quarter of 2016. To bridge the difference, I will begin with organic development, where total organic growth in the quarter was 7%. The prosthetics segment grew by 11% organically, which corresponded to a five percentage point contribution to total growth. In prosthetics, we continued to see a good performance where our recently launched upgrades of the RHEO KNEE are driving growth. Bracing and Supports grew by 3% organically, with a two percentage point growth contribution to total growth. As for the full year, the direct sales part of the Bracing and Supports segment continues to grow while the own distribution companies in the U.S. negatively impacted Bracing and Supports growth. We expect the first quarter of 2018 also to be slightly impacted, but for the full year 2018, we expect a limited impact on growth. Local currency growth is now equal to organic growth as the acquisitions made in 2016 are now fully incorporated in the comparable figures. Total growth in USD terms in the quarter was 11%. Due to the appreciation of a few major operational currencies against the dollar, mainly the euro, currency movement in the quarter impacted sales growth positively in the amount of $6 million. This corresponds to a positively 140 basis point contributing to total growth. Now let's look further at each geographic region, starting with Americas. America sales growth was 5% in the quarter with the prosthetic segment driving growth there. The performance in EMEA was good in the quarter with 8% organic growth in both prosthetics and bracing supports. We saw our high-end innovative products growing well. We furthermore saw growth across all major regions in both segments. APAC sales were excellent in the quarter and grew by 16% in both prosthetics and bracing supports. We are seeing strong growth with all major regions performing well. We are also pleased to see excellent performance in China after we recently changed to a direct sales model. So over to you, Sveinn. Thank you, Jón. Organic sales growth amounted to 7% in the quarter, and as previously mentioned, local currency growth now equals organic growth. Gross profit margin was 63%, same as in the comparable quarter last year. The gross profit margin is furthermore comparable to the average of 2016. EBITDA margin was strong and amounted to 20%, compared to 19% in Q4 2016, and I will bridge the margin difference on the next slide. Net profit was about $23 million or 15% of sales. The increase in net profit in the quarter can be attributed to strong sales growth and an increase in profitability, but also as already discussed, the changes in the tax environment in the U.S. We go to the next slide, please. EBITDA, $30 million in the quarter, 20% margin compared to 19% in the same quarter last year. Bridging the difference, starting on the left side of the slide, positive effect from gross profit margin driven by product mix, scalability, and efficiency in our manufacturing locations. Sales and marketing expenses grew less than sales for 3%. Our R&D expenses decreased. The costs are below, we could say, normalized run rate, and we expect the R&D cost to be higher in the next few quarters. G&A expenses grew in line with sales. Finally, currency impacted the EBITDA margin negatively about 20 basis points, which is net of the slight positive impact we have on the partial hedge on the Icelandic krona costs. Go to the next slide, please. Here we have a high-level status on the efficiency initiatives announced in September last year. To recap, the efficiency initiatives are in the areas of manufacturing, distribution, and sourcing and are initiated to further increase scalability and profitability in our business. The program is on track as previously communicated. The main update is regarding our West Coast distribution center in the U.S., which will be moved to the manufacturing location in Mexico during 2018. This will result in a simplification and increased efficiency in our global distribution process, and this we have communicated now internally in the beginning of the year. Next slide, please. Cash generated by operations was excellent in the fourth quarter and amounted to $34 million or 22% of sales, which is slightly higher than in the same period last year. Cash generation is, however, usually or seasonally strong in the fourth quarter. Capital expenditures amounted to $7 million or 4% of sales. CapEx in the quarter was relatively high due to investments related to the efficiency initiatives, in addition to, I would say, above average investments in computer equipment and software in the quarter. Net interest-bearing debt was about $121 million at the end of the year, which corresponds to a 1.2 times net interest-bearing debt to EBITDA. If you could finish off with the guidance on this. Thank you, Sveinn. 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 with growth or at above estimated market growth. In the Bracing and Support growth in the EMEA and APAC regions is expected to be good and the same goes for the expected growth contribution for the high-end bracing support products. Direct bracing support sales in the Americas are expected to grow in line with the market as with previous years. With the restructuring of our own distribution companies in the U.S. finalized in 2017, we expect the distribution companies to have a limited impact on growth in 2018. Bracing support sales are therefore expected to grow in the line with the market in 2018. EBITDA margin before special items is expected to be around 19% of sales. The EBITDA margin is expected to increase compared to 2017, due to favorable developments in product mix, scalability in the underlying business, savings from efficiency initiatives, and synergies from the integration of Touch Bionics and Medi Prosthetics. It should be noted that quarter 1 is seasonally the weakest quarter of year in terms of sales and profitability. Capital expenditures are expected to be around 4% of sales. The change in the tax environment in the U.S. will have a favorable impact of Össur's effective tax rate going forward. Based on the current mix of taxable income, the expectation is that our 2018 effective tax rate will be in the range of 23%-24%, down from historically normalized tax rate in the range of 25%-26%. The ultimate impact of the tax changes in the U.S. is, however, subject to various provisions with further guidance and clarifications expect to be issued by the U.S. tax authorities during 2018. That concludes our presentation. Thank you all for listening. We will now go to the question and answer session. Ladies and gentlemen, if you do have a question for the speakers, please press 01 on your telephone keypad now. The first question comes from the line of Nils Lis from Carnegie. Please go ahead. Your line is open. Yes, good morning and congratulations with a strong quarter. First question on your new RHEO KNEEs. Could you just talk about what extent there has been any stock filling among customers of your two new RHEO KNEE versions, and to what extent that would result in a slower growth in the next few quarters from your prosthetics division? Also, could you just talk about which technologies that you have added to your RHEO KNEEs. Secondly, on your restructuring cost, is it still a banner that you will incur $6 million restructuring costs in, is it quarter 3 this year? Thank you. Let me start. Thanks for that, Nils. Generally, stock filling is a very limited amount of our sales, Nils. I suspect that stock filling has a very little impact. That is at least if you go to the history. Regarding the new technology, it cannot be categorized as more stability and more adaptability. I do not want to be too technological here, but the technology which the RHEO KNEE is based on is a magnetorheological fluid. While it is really adaptable to the bearer, until now, the stability has been conceived by the user as a little bit less than the hydro-based technology. Now we are completely up to standard there. The stability is as good as the knees that are based on hydrology. I think that covers it. Yes, on the restructuring cost, we still stick to the estimated EUR 6 million in quarter 3. Okay, thank you. Thanks. Next question is from the line of Christian Ryom from Nordea. Please go ahead. Your line is open. Hiya. Good morning. I have a couple of questions. First on the competitive environment in prosthetics. Can you comment on whether you've seen any disruption in the market from the announced merger of Freedom Innovations and Ottobock and recently the FTC probe into that merger? Secondly, on your new tax rate guidance, can you give us an idea of what we should think about the tax rate beyond 2018? Should we extrapolate the new tax rate guidance that you're giving us or should we expect the tax rate to go even lower, given that the statutory rates in both Iceland and the U.S. are lower than what you're currently guiding for? Yeah, thanks for that. Let me take the competitive environment and Sveinn can take the tax rate going forward. The answer to your question is of course something that we have been scratching our head here within Embla Medical. But I think the consensus here within the company is that so far it hasn't had any impact on the competitive environment. Basically, FTC is basically a standstill agreement between FTC and Ottobock, so Freedom is run as an independent company now, and we haven't seen any changes in the business environment as of yet. On the tax rate, Christian, with what we know now regarding the changes in the U.S. tax environment, we would expect our guidance for 2018 to be extrapolated going forward. The tax rate, let's say, is ultimately a sort of a blend based on the different countries we do business. We pay tax in all countries where we have some business, virtually. It might change down the road as the business makes changes. But with the current mix we have today, this is what I would expect beyond 2018 as well. Okay. Thank you very much. Ladies and gentlemen, as a reminder, if you do have any questions for the speakers, please press 01 on your telephone keypad now. We do have a question from the line of Yiwei Zhou from SEB. Please go ahead. Your line is open. The line from SEB, your line is open. Please ask your question. The next question comes from the line of Morten Larsen from ABG. Please go ahead. Your line is open. Yeah. Hi, guys. Congratulations on a very fine quarter. Two questions from my side. First of all, at the Capital Markets Day, you also highlighted this new study that came out of the studying advanced prosthetics, and I was just wondering whether you are seeing any impact from this study in the market out there in terms of demand. Second, on your gross margin, given the high growth and especially your mix, I had expected a little bit more on your gross margin. Can you tell me whether you see any changes to your pricing environment out there? Yeah. Hi, Morten. Thanks for this. In the RAND study you are referring to, Morten, I do not think we will see any short-term effect, but however, I believe we will see an effect. As a short-term, it takes longer time and it is a study which we are using and the industry is increasingly using towards the payers and is used as such and very, very effective and will have an impact. There are more studies being done on the behalf of the industry. As of now, I think it would be very optimistic to say it has any impact so far. It will, and as we mentioned in the Capital Market Day, it is very, very important to see it kind of black on white how much positive effect this new technology, and it is a technology trade-up game. To be able to prove the efficacy of that new technology is extremely important. To conclude that this has something to do with the quarter of the year, that would be too optimistic. I think on the long term, it has absolutely a very positive effect. Maybe if I can just follow up on that, Jón. Do you feel that the market and the payers are accepting the premises from that study? Usually health economic studies are taken with a little bit of a grain of salt, given that it's very reliant on the assumptions you make. Do you feel that the assumption is being accepted in the market among the payers? Well, I think it's a lot of realism around it. You're pointing at exactly right thing, Morten, because everybody in the market are able to prove that their product and medicine and equipment, that they're saving a lot of cost for the healthcare system, and the healthcare cost continues to rise. So this is always taken with a grain of salt. But this is very respectable. This is something that you can't brush aside because this is a third party independent study, which is not done on behalf of the industry per se. So I think it will help, but of course all those studies are taken with grain of salt. Yes. You are absolutely right. Just briefly on the gross profit margin, we do have a healthy impact in the quarter from product mix. The big picture on the product mix is that all is equal with our prosthetics division growing faster than the bracing division. That helps us on the mix. Also if you look into the bracing and support division itself, there we have what we usually refer to as our high-end products growing faster than the rest of the portfolio. Also having a positive mix impact. But what we've also said is that although we have high growth on the high-end products and bracing support, there is some marginal price erosion in some pockets in the more commoditized product part. But the environment there has not changed. There is no change as such that we've observed in the last few quarters, and don't expect that as such either going forward. Thank you, guys. Thanks. The next question is a follow-up from the line of Nils Smedstuen from Carnegie. Please go ahead, your line is open. Yes, a couple more questions. First one, could you talk about your bracing and support growth for 2018 and also to what extent you expect that division to contribute with better profit margins in the year to come? My second question would be about your launch plan for your mind-controlled prosthesis and your bionic brace. Any news on those two products? Thank you. Yeah, I'll take the first one. If we look at the bracing and support growth in 2018, we're coming out of a year with 1% organic growth rate in bracing and support. What has been holding us back to some extent, it has been the development for what we call our own distribution companies in the U.S. In the absence of that impact, we are growing roughly in line with the market. What we've said is that we expect these difficulties that has resulted from our restructuring effort of these distribution companies to be out of the system after first half of quarter one. Our expectations are that we'll grow the bracing support division in line with market in 2018. On the profit side in bracing support, I refer back to my earlier comment on the main theme there is product mix. Our OA business is growing very nicely, somewhat above the average growth rate for the overall company, and those products typically carry a higher profit margin than the rest of the portfolio. That is the main lever there, and I think you need to just create some assumptions on the relative split of that business versus the rest of our bracing business to extrapolate those trends. I think that is the big picture. Yeah, on the mind-controlled prosthesis, as before, we are working on the regulatory aspect of the mind-controlled prosthesis, and I must say that I wish it would go faster. It's out of our control, and there are some regulatory hurdles we have to pass, and I wish I could give you any guidelines or timeline or deadlines, but I can't. Still, we are very bullish on the technology we have. We feel that we have that pretty much under control. The regulatory side, we don't have that under control because it's not under our control at all, but we are working on it. On the bionic bracing, the bionic brace are working prototype stage still, and we have quite numerous milestones to go. But very cautiously, I would say we might be seeing something in next year, 2019. But it's a shoot in the darkness. Cautiously, 2019. Okay. Yeah. Okay. Very helpful. Thank you. Thanks. Next question is another follow-up from the line of Christian Ryom from Nordea. Please go ahead, your line is open. Yeah. Hi, again. So a follow-up on your R&D investment profile. You, of course, said that the investment level this quarter has been below trend. Can you give us an idea of whether we should expect the level that we saw back in Q3, so around these 5.5% or even higher, when we go into 2018? And specifically, if we talk about the first quarter, you alluded to in your Q4 release that some of the R&D costs have been shifted into this first quarter. So should we expect a spike in R&D investment in the first quarter? Yes. We are somewhat lower than what I think is a reasonable run rate or where we are with our R&D investment at the moment. We expect to grow our R&D cost in 2018 close to double digit. I think this is in line with what we communicate at the Capital Markets Day that we are increasing our investment on the R&D front. Yes, you should model R&D cost more in line with quarter 3 or even slightly above into 2018. Okay, on Q1 specifically. If we see it jump a lot in the first quarter, should we then expect that run rate or is that- Yes. Yeah. Yes. Okay. Great. Thanks. Sure. The next question is from the line of Yiwei Zhou from SEB. Please go ahead. Your line is open. Can you hear me now? Yes. Yes, we can. Hi. Thank you for taking my question. I have one question regarding the integration of acquired companies. How much cost synergies do you expect to realize in 2018? I remember you expected the beginning to bring the profitability of acquired company to the pre-acquisition level of Össur. Is that still your expectation? Yes, that is still our expectation. The integration of both of these companies have sort of developed largely in line with our plans. We do have the impact in the second half of 2017 from Touch and partly also Medi, and we do expect some positive impact also, particularly in the first two quarters of the year from the integration of these acquisitions. Yes, it is largely in line with what we have communicated previously. Great. Thanks. Sure. Next question is from the line of Felix Venin from SS. Please go ahead. Your line is open. Hi, Jón. Excellent results. Just following up on the question on the acquisitions. Can just remind us qualitatively what you're doing in terms of the operating actions you're taking at these companies now as we move into 2018? Is the majority of the integration already done now? Thank you. Well, the majority of the integration, specifically with regards to the integration of the companies are done. That is in the operational works of the company completely. But then there are some changes we are doing on the operational side of the company that are more on the general company and will affect the acquisition companies as well. But integration as such is done. Both those companies are completely integrated part of Össur, and have been consolidated completely. Excellent. Thank you. Maybe just as a follow-up, how is the cultural fit of the two companies? How is the mood among Touch Bionics and Medi? Are they happy to be part of a bigger group that gives them more firepower in terms of R&D, in terms of a broader product range? How is the mood? If you could describe that. Thank you. Excellent question. Yes. Don't get me started. I think it's extremely important, and we follow it very extensively and try to monitor and steer the cultural fit and the values into our main being part of the bigger company, because very often this is the most sore point in the integrations. To answer your question, I think it's going excellent. It's partly because of it's kind of a sweet spot in the size of those acquisitions. I think our assessment, and we do a lot about those assessment, indicates that our colleagues in those companies, they are very happy to be part of Össur. Great to hear. Thank you, Jón. You're welcome. Next question is from the line of Morten Larsen from ABG. Please go ahead. Your line is open. Yeah. Hi, guys. Just a housekeeping and a clarification question. First of all, you provide the corporate tax. Is this also the cash tax rates we should expect? How do you see that changing? Second, can you provide us some guidance for net financials for the full year 2018? Yes. The cash tax rate, I would expect that to be similar, yes, Morten, from 2019 onwards, the cash tax rate will be a little bit lower in 2018. But yeah, largely the same. For the net financials, yes, if you look at our net financials, we have you need to look at the notes, and there's a few, $3 million if I remember correctly, from exchange rate differences, which is just an impact we recognize over our P&L as sort of regulating for exchange rate impact on some working capital items. So I would not necessarily model that, but just model the interest cost to be similar as in 2017. Thank you. Sure. Next question is from the line of Thomas Bowers from Danske Bank. Please go ahead. Your line is open. Yes, thank you. Just a follow-up on the margin development. Quite strong here in Q4 and moving into 2018. Looking at your EBITDA outlook, with some positive integration impact from Touch, I guess, and also continued positive mix effects, some efficiency impact, and also continued scale. I'm just wondering here, aren't you somewhat overly cautious for 2018 and the 19%? Or anything that we should be aware of, maybe aside from maybe some continued price erosion? Thank you. Thanks, Thomas. We're guiding based on what we think is the most realistic scenario, given the information we have today. Yes, you're right, we will have some positive impact from the integrations. That's correct. We expect to realize benefits from the efficiency initiatives, especially towards the latter half of the year. If we grow our business within our guidance range and manage cost properly, all of this will help us on the margin side. However, referring back to what I said earlier, we have taken a decision to invest more in R&D, and I'm guiding you on and modeling at least double-digit growth on those costs. If you add it all up with the way we see it today is we're most likely to end up at around 19%, which is a full percentage point increase in our operating margin. Okay. Thank you. Thanks. There are currently no further questions registered, so I will hand the call back to the speakers. Please go ahead. Okay, thank you, and thanks for all of you for the participation, questions, and interest. Thank you very much. This now concludes the conference call. Thank you all for attending. You may now disconnect your line.