Earnings Call: Q4 2016

Feb 8, 2017

Summary

Q4 sales rose 13% in local currency, with Prosthetics leading growth. FY adjusted EBITDA reached $98m; 2017 guidance calls for 4%-5% organic sales growth and a 19%-20% adjusted EBITDA margin.

Thank you. First, I would like to welcome to the Össur fourth quarter conference call. My name is Jón Sigurðsson, previously explained, and I am the President and CEO. With me here today is our CFO, Sveinn Sölvason. I will start by going through the highlights of the quarter. Sveinn will then go through the quarterly financials in more details, whereafter we will go through the full year results and end with our guidance for 2017, followed by a question and answer session. We are happy to close another year with strong operational results. The sales growth in the quarter was good. Sales amounted to $138 million, and sales growth was 13% measured in local currency and 4% organic. Bracing & Supports sales growth was 3%, while Prosthetics growth was excellent, 28% local currency growth and 6% organic in the quarter. Gross profit amounted to $87 million and 63% of sales. The EBITDA was $26 million, or 19% of sales, and grew 15%. Due to depreciation of few major operational currencies against the USD and appreciation of the Icelandic krona against the dollar impacted the operational results negatively. The sales by $2 million and the EBITDA by the same amount, about $2 million in the quarter. We further strengthened our market position in 2016 with the acquisition of Touch Bionics and Medi Prosthetics, and the integration is on track. In December, we signed a seven-year loan agreement with Nordic Investment Bank for 50 million euros. The new loan strengthened our funding structure, and the terms and conditions reflect a strong financial profile and good prospect for the company. If we look at the growth by segments and geography, we see an excellent 28% growth in Prosthetics, while Bracing & Supports grew 3%. Sales of Bionics products in the quarters amounted to 25% of prosthetic component sales compared to 16% in the quarter for 2015. Both EMEA and Americas grew 13%, while APAC grew 11%. Now let us look further at each market, starting with EMEA. The performance in Europe, Middle East, and Africa was good in the quarter. The growth was 13% and 3% organic. Sales grew in line with the market in both product segments and across all major markets. America sales grew 13%, mainly driven by our newly launched products, as previously communicated. APAC sales grew 11%, and we saw a strong growth in both product segments there. Now, Sveinn Sölvason, our CFO, will go through the finance in more details. Please go ahead, Sveinn. Thank you, Jon. Local currency growth amounted to 13%, and organic sales growth in local currency amounted to 4%. We see positive contribution from all regions in all product segments. Also, as a reminder, we have full contribution from both the Medi Prosthetics acquisition and of course, Touch Bionics for the full quarter. We do have impact on our reported USD sales and profits from changes in currency rates, as Jon mentioned earlier, and especially on the EBITDA margin, and I will explain that in more detail on the next slide. Gross profit margin is relatively stable in the quarter, around 63%, compared to also 63% in the comparable quarter last year. The main items affecting gross profit margin are positive contribution from good growth and also product mix within Prosthetics. The impact from Bracing & Supports is neutral in the quarter. Changes in foreign exchange rates have a negative impact of about 30 basis points. EBITDA margin is 19% compared to 20% in the comparable quarter last year, and I will bridge the gap on the next slide. Net profit is up by about 15% in USD terms compared to same period last year. If you turn to the next slide, please. The main items in bridging the EBITDA margin from the comparable quarter last year to the 19% EBITDA margin now are, first and foremost, changes in foreign exchange rates that are impacting margins negatively by about 80 basis points in the quarter, primarily due to a stronger Icelandic krona, and this is a similar effect as we see in last quarter or quarter 3. Then we have temporary negative impact from acquisitions. The impact in Q4 is about 20 basis points negative, as seasonally, profitability for Touch Bionics is actually very strong in quarter 4 and is not for the Touch Bionics business causing dilution to our margins in this quarter. Hence, the overall impact from acquisitions is more positive now in quarter 4 than it was in quarter 3. As previously communicated, we expect the acquired companies to have a neutral impact on our average operating margins in Össur from 2018 and onwards, approximately. OPEX growth was very moderate in the quarter. The net result of all of this is that we have a 15% local currency growth in EBITDA for quarter 4. Cash flow was very good. In the second half of the year, we've had some reversal of working capital investments that came in the first half of the year. Net debt at the end of the year is about $119 million, and the net debt to EBITDA around 1.2 times. Now, if Jón, could go through the highlights- Thank you, Fred. for the full year. Yeah. Let's look at the full year. Sales amounted to $521 million. This is a 9% and 4% growth, measured in local currency. Bracing & Supports sales was $280 million and grew 2%. There was a growth in all regions with ongoing positive impact from the high-end and newly launched products. We launched 37 products during the year, which have further strengthened our product offering. Growth in EMEA was in line with the market throughout the year, while performance in Americas was good. However, it was negatively impacted by the discontinuation of sales of certain product line. Prosthetics sale amounted to $240 million, including 19% and 7% organic growth measured in local currency. Both EMEA and Americas show strong growth throughout the year, with Bionics and newly launched product driving growth. Sales in APAC, Asia and Pacific, were impacted negatively throughout the year due to the change in sales model in China, and the run rate now is quite good, which is shown in the quarter. The gross profit margin was 63% for the year. EBITDA in 2016 was affected by special items amounting to $4.6 million. Adjusting for one-time items, EBITDA amounted to $98 million or 19% of sales and grew 6% measured in local currency over the year. We acquired two great companies during the year, Touch Bionics and Medi Prosthetics. Medi Prosthetics brings a full line of products allowing us to offer a complete lower extremity portfolio to our customers. The addition of Touch Bionics allow us to add cutting-edge upper extremity prosthetics to our already very good range of products. We introduced 35 new end products and product upgrades to the market during the year, including the MyoE3 and XC, as well as two new hip products, Unloader Hip and Rebound Hip. Both are received very well in the market. Exceeding the expectations, our athletic community raised the bar in various events across the world. The Team Össur truly shined at the Rio Paralympics this year in Brazil, winning 26 medals total in numerous events. Now, Fred will go through the full year financials in more details. Yes. 2016 marks a third year in a row where we end up in the upper end of our growth guidance, with over 4% organic growth and a healthy contribution from newly acquired companies elevating our total local currency growth to 9%. To explain the big picture, let's say for our financials this year, we need to look separately at the underlying operations, then the impact from acquisitions, and finally, currency impact. Regarding the underlying operations, we had a positive development in the gross profit margin driven by product mix within Prosthetics. Bracing & Supports is neutral on gross profit margin for the year. OPEX growth, I would say, is on the high side, growing in local currency above our organic sales growth. The high OPEX growth can partly be related to various growth initiatives and operational improvement projects. Impact from acquisitions was substantial on our numbers last year. Both Medi Prosthetics and Touch Bionics on a standalone basis operated at an EBITDA margin in the mid-single digits before being acquired by Össur. Both companies will be fully functionally integrated, and we have been explicit about our expectations for profit contribution from the acquired activities will be on par with the profitability in the Össur business prior to acquisition. We maintain the same expectations, and integration is going well. In total, the impact from acquisitions on EBITDA margin was negative, about 40 basis points for the full year. Lastly, currency impact was a big theme for us last year. Mostly the appreciation of the Icelandic krona impacted our margins negatively, and the total impact was about 70 basis points negative for the full year. Net profit is stable compared to prior year of around $51 million. As previously highlighted, the cash flow and cash conversion was very good in 2016. Jon, if you then could finish off with your guidance. Thank you, Fred. Yeah. The financial guidance assumes the prevailing economic outlook in the key markets and no major fluctuations of major operation currencies. Sales growth is expected to be in the range of 7%-8% and 4%-5% organic, both measured in local currency. In Prosthetics, continued good performance is expected in key markets at or slightly above average market growth, with the newly acquired companies contributing to growth. In Bracing & Supports, we expect all regions to grow in line with or slightly above the market growth. EBITDA margin adjusted for special items is expected to be in a range of 19%-20% of sales. Key assumptions regarding the expected EBITDA margin are for our foreign exchange rate assumptions, impact of newly acquired companies, and margin development in the underlying business. At current foreign exchange rates, keeping all other factors constant, EBITDA margin will be further negatively affected by approximately 60 basis points in 2017 comparing to 2016. The newly acquired companies are expected to impact EBITDA margin positively as a result of increased operational leverage and synergies in relation to integration into the business. Finally, we expect margin improvement in the underlying business driven by product mix and operational leverage. Profitability is expected to be stronger in the second half of the year. Quarter 1 is seasonally our weakest quarter, and this exactly the same goes for the Touch Bionics business. In addition to expected negative impact from foreign exchange rates. CapEx are expected to be around 4% of net sales and effective tax rate is expected to be around 26%, which is in line with previous years. Thank you for listening and we have reached the question and answer session. Thank you. Ladies and gentlemen, if you haven't already and you want to ask a question, could you please press 0 and then 1 on your phone keypad now in order to enter the queue? Then after I announce you, simply ask that question. If you find that question has been answered before it's your turn to speak, just press 0 and then 2 to cancel. There will be a brief pause while questions are being registered. We now go to the line of Christian Ryom at Nordea Markets. Please go ahead, Christian. Your line is open. Yes, good morning. This is Christian Ryom from Nordea Markets. A couple of questions from me. Thank you. The first is with regards to the APAC region, where you've had a couple of weak quarters prior to the fourth quarter, but then saw a recovery in your growth rate there. Can you give us an idea of what we should assume for a more normalized situation going forward for the Asian Pacific region? Secondly, in the report you mentioned a patent dispute with Vincent Systems in Germany. Can you elaborate a little bit on this and then maybe give us an idea of what we should expect, whether this is a material product or the extent of potential litigation costs? Is this the reason why you're guiding for an adjusted EBITDA margin rather than the reported EBITDA margin? Thank you. Yeah. Let's take the APAC, the relatively weak quarters. Well, first of all, APAC is more dependent on distributors than all the regions, relatively. So there are more fluctuations between the quarters in APAC in general. But the real reason is that we changed our distribution system in China. We ended our relationship with our long-time distributor there, resulted in relatively weak quarters. And now we are on track again. So we have a normalized situation in APAC, although you should assume more fluctuations in APAC than other regions. Regarding the patent dispute, Christian, this is a patent dispute regarding a product that came with the Touch Bionics acquisition in a German market, let's say. And I believe we have quite a strong position in this case. And we will incur some legal costs. We don't expect this to be of any material amount. And this is not necessarily why we've worded the guidance that EBITDA should be adjusted for one time items. As we sit here and now, we don't have any planned one time cost for the year, but you never know if anything comes up. So therefore we choose this wording. So I don't expect this litigation to have any material impact. But we'll update you as we know more. Thank you. Just to remind all participants that if you have a question, could you please press zero and then one on your phone keypad now to enter the queue, and there'll be a further pause while questions are being registered. Okay, we first go over to Thomas Bowers at Danske Bank. Please go ahead, Thomas. Your line is now open. Yes, thank you. Just two brief questions. Can you just elaborate a bit on the CapEx? You had indicated that you would be back at that 3%-3.5% for 2017. Is there any trailing effects from 2016? How should we see this going forward? Is this the new normal? Are we still trending towards 3% or 3.5% on CapEx? Maybe just on tax and how the situation is in the U.S. I know it's difficult to predict what will happen also in regards to the new President and all the stuff with the potential wall in Mexico. Maybe just what's your thoughts here on these issues? Thank you. Hi, Thomas. Thanks for the questions. On the CapEx, we expect to gradually trend back towards the historical average of around 3.5%. We have been above our historical average due to build-out of new manufacturing capabilities in Mexico and a few other events here over the last two years. We expect to be gradually trending towards the 3.5-ish percent. We've guided for 4% just to have some more headroom in the first half of the year. Jon, if you can maybe just comment a little bit on the tax part, perhaps. Yeah, comment on tax. Yeah, thank you very much. It's not an easy, as you realize, Thomas, it's not an easy question to answer. As you are referring to, I presume it's the destination-based tax with a border adjustment, which is in the Republican blueprint. It's really hard to say how much it'd impact us. First of all, it vastly advantages for those who produce or manufacture in U.S. Strangely, as it is written now, and if the NAFTA will hold, nobody knows that at the moment, it will not affect us greatly because de facto, we produce in U.S., even though it's a contractual manufacturer specifically taxed in Mexico under a specific provision from the NAFTA. It's really difficult to say. Having said that, there have been some twittering on specific customs over the Mexican border and 20% or 35%, and we have no indication whether this is realistic or not. If that is going to be the case, it'll have a big effect on the Mexican-U.S. trade. I presume that the U.S. will go out of NAFTA. Thomas, I don't know. The important thing, though, in all this is that we are not worse off, or we are not more adversely affected than our main competitors. We are basically in the same boat there. You would probably know much about it, more about it than we do. I think pretty much everyone is just awaiting what's going to happen, yeah. Maybe just to follow up on, again, the tax issue here. Let's say that Trump is going for a 20% corporate tax level. If we look at this as a potential positive, how much will this impact your current tax level? We pay tax in the U.S. today. Keeping everything else constant, this would have an impact on our effective tax rate. I wouldn't assume any changes in our effective tax rate from the 26% we've guided for until there's more certainty on how the development will be. Trump is, this is more like Republican initiative, and they are not talking about lowering the tax rate from 35% to 20%. They are talking about making this as a destination-based tax. It's like a hybrid, the VAT tax with a border adjustment for those who export. It is completely different taxation than we are looking at in those countries we are operating. It's completely different. You cannot assume that they are just lowering the tax burden from 35% to 20%. It's a complete overhaul. Very difficult to see how it will impact business in U.S. It will probably impact us as manufacturers much less than retailers like Walmart or Best Buy. It's a much bigger issue than we can discuss here. Of course. Okay, great. Thank you very much. Thank you. Thank you. Next question's for the line of at Carnegie. Please go ahead. Your line is now open. Yes. Good morning. Could you briefly talk about the status of your SKU project in the Bracing & Supports division and to what extent it impacted the organic growth in 2016, and to what extent it could impact organic growth in 2017? Could you also just give us the status of your mind-controlled prosthetic project? Thank you. Hi, Nils. Let me answer the first question. We have, let's say, like we've talked about previously, to some extent, we have, I would say, closed down on this first phase or the phase that we've been in on SKU rationalization in the Bracing & Supports business. However, we reference in our communication now, let's say, or how should I put it? We grow 2% organically in Bracing & Supports. Overall, we see quite positive development in most of our major, or all of our major markets, let's say. However, impacting our organic growth last year was the fact that we stopped selling a certain product end of year 2015, which has also been impacting us throughout the first three quarters of 2016. In the absence of this, our organic growth rate in Bracing & Supports would've been closer to 3% than 2%. I think that's the big picture, let's say, on the bracing support side. Yeah. In the mind-controlled prosthetic, we are not ready to announce any fixed launch date there, but we are progressing. Most of the variables in the timeline are beyond our control, really. Technologically, we are progressing very well. Okay, great. Could I just follow up on the Bracing & Supports business? With an adjusted, say, 3% organic growth in that business, is it fair to say that you're growing slightly below the market growth for the time being? I would think that we are roughly towards the lower end of the market growth, yes. We believe the volume growth of the market is 3%-5%, and we are now in 3. It is not good, and we are not satisfied with it. We should be closer to the higher end Yes or even higher than that. But that is where we are. Where is it that you are not meeting market growth? Is it geographically? Is it a geographical problem, or is it due to certain product initiatives in Bracing & Supports? Nils, I think, let's say, if we look at our global Bracing & Supports business, it is a lot of markets and different trends in each market. The big picture is such that, as we have previously said, that our high-end products, where we are spending our R&D money and focusing on innovation, that is growing very nicely and somewhat above the average growth rate of the overall business, and also partly contributing to the gross profit margin improvement we expect for this business. On the more standardized products, there, the market growth on average is quite good in volume terms. As Jon mentioned, 3%-5%. But in some regions, there is some price erosion around 1%. So net, we have a market growing 3%-4%. Our position is quite stable in all the major markets that contribute to growth in our Bracing & Supports business, I would say. I hope that gives some clarity. In other words, we cannot point at one single reason for that is pulling down the growth. No In the Bracing & Supports. Okay. Just one last question, if I may. The relocation of your shared service center to Poland, is that project on track, and do you expect to take out the cost savings expected in 2017? Yes. Okay, great. Thank you. You are welcome. Just a reminder to all participants that if you have any final questions, please press zero and then one on your phone keypad now. We go to the line of Morten Larsen at ABG. Please go ahead, sir. Your line is now open. Thank you. Hey, guys. Congrats on a fair report. Two questions, if I may. One to Jon. You mentioned on the question around the mind-controlled prosthetics that you were not in control of the timelines. Could you touch a little bit more upon what it is you actually mean when you say you're not in control? Two, on the shared services, just to come back on that, can you mention just specifically what actions you're going to undertake in the shared services center in 2017 and 2018? Thank you. Okay. Morten, it's basically, there's a Class III device. There's a lot of permission we have to obtain, and that is something that is beyond our control, really, how long that will take. Of course, you can control the input you are sending into those instances that give you those permissions. But further than that, you cannot. It's difficult to tell beforehand what kind of demand clinical trials, testing, and so forth are necessary. Follow up on that. Do you mean that there's uncertainty around the market building and the shaping, establishing this as a code? Or is this more of getting the studies done to develop this as a product? Well, no, we are just talking about the timing here. All this is a pretty known process, and there is nothing that indicates that we will not be able to get it through. But this is completely new technology. We have had it in models for quite a long time with good results. We have most of the technology, knock on wood, we have that under control. But now we need to have all the necessary. Now we have permission to take it out to the market, and the timing there is we will get it, but how long it will take is very difficult to tell. That's beyond our control. That's what I meant, really. Not that I would be very surprised if we would get a big no, and we would be stopped. We will not, but the timing is uncertain. Will you be disappointed if it's not on the market in, say, two years? We can't comment on that. We can't comment, Morten Larsen, on the specific timing. That's very difficult for us. Beyond 2 years. The second question- The second question on the shared service center, we had communicated that the changes that we've made or let's say the activities that we've transferred would yield a $1 million savings towards the end of 2016 with full year effect in 2017. We stick to that. Let's say for the activities for 2017 are mostly on the integration side. We're integrating new companies, and those processes, let's say the transaction finance process will, of course, be executed in our new shared service center. So it's already giving us some of the scalability effect that we were after with regards to establishing this operation. But other than that, I wouldn't assume any other impact from this until we communicate something along those lines. Cool. Thank you very much. Welcome. At this stage, I see no further questions in the queue, gentlemen, so may I please pass it back to you for any closing comments. Yeah, then I would like to thank you for participation and good luck with this year we are starting here. Thank you.