Earnings Call: Q3 2018

Oct 25, 2018

Summary

Q3 sales reached $145m with 7% organic growth, while EBITDA before special items rose to $30m and 21% of sales. FY2018 guidance was maintained except CapEx, raised to around 5% of sales; two acquisitions will contribute from Q4.

Ladies and gentlemen, welcome to the Össur Interim Report Q3 2018. Today, I am pleased to present Jón Sigurðsson, 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. Sigurðsson and Mr. Sölvason, please begin. Yeah, thank you. I would like to welcome you to the Össur Investor Conference Call, where we will cover the results for the third quarter of 2018. As previously mentioned, my name is Jón Sigurðsson, and I am the President and CEO, and with me here today is Sveinn Sölvason, our CFO. We will begin by going through the highlights for the quarter, followed by our guidance for 2018. A question and answer session will then follow. Sales in the third quarter amounted to $145 million, corresponding to 7% organic growth. Prosthetics grew 11% organic in the quarter, with a good contribution from high-end products. Bracing and Supports grew 2% organic, where we are pleased to see our OA solutions growing well globally. EBITDA amounted to $30 million or 21% of sales, compared to 18% in the same quarter last year. The profitability increase is driven by scalability enabled by strong sales growth, positive change in product mix, and savings from our ongoing efficiency initiatives. We recently acquired two small companies with combined sales of around $40 million, which will both begin to contribute to our operating income for the fourth quarter of the year. As previously mentioned, sales amounted to $145 million in the third quarter of 2018, compared to $139 million in the same quarter last year. The Prosthetics segment grew by 11% organically, corresponding to a six percentage point contribution to total growth. We have a good momentum in our Prosthetics segment globally, with excellent contribution from high-end products such as bionics and the recently launched version of the Pro-Flex foot. The remainder of the Prosthetics portfolio also performed well in the quarter. Bracing and Supports grew by 2% organically, with one percentage point contribution to total growth. Our OA solutions continue to grow well in Bracing and Supports, but the sales have been slow in U.S. and France this year, with lower sales to certain distributors and rationalization effort in selected markets. Total growth in dollar terms was 5%. With changing currency rates, sales were negatively impacted by $3 million. This corresponds to a negative two percentage point impact on total growth. Americas organic sales growth was 6% in the quarter. Growth in the Prosthetics segment was strong, with a good contribution from recent product launches. In the Bracing and Supports segment, performance in Canada continues to be strong, while sales in U.S. were impacted by lower sales to a few large distributors. Our own distribution companies continue to perform well after their restructuring was finalized in the end of 2017. Organic sales growth in EMEA was 5% in the quarter. Growth in Prosthetics was good in all major market regions during the quarter. In Bracing and Supports, our high-end solution grew well, while our soft goods solutions had a slow quarter. The main reason being slow sales in France and product rationalization effort, as previously mentioned. Organic growth in APAC was 26% in the quarter, where we continue to see very strong results in both Prosthetics and Bracing and Supports. As in previous quarters, growth in Australia and China has been excellent. Over to you, Sveinn. Thank you, Jón. Organic sales growth was strong and amounted to 7% in the quarter, leading to an organic growth of 5% for the first nine months of the year. The gross profit margin was 64%, compared to 63% in the comparable quarter last year. The year-to-date gross profit margin has also increased compared to the same period last year and amounts to 63%. The increase in gross profit margin can mainly be attributed to a positive impact from product mix and the savings initiatives. Special items in the quarter amounted to $6.8 million, out of which roughly $6 million are related to the efficiency initiatives, as previously communicated. The remainder, or about half a million, are related to the acquisitions. EBITDA before special items amounted to $30 million in the quarter, or 21% of sales, compared to 18% in the third quarter of last year. EBITDA growth amounts to 22% on constant currency basis. I will discuss the margin development in more detail on the next slide. The EBITDA margin for the first nine months is 18%, compared to 17% in the same period last year. Effective tax rate was 23% in the quarter and for the first nine months, which is in line with our guidance on effective tax rate. Net profit was strong and amounted to $16 million in the quarter or 11% of sales, compared to 8% of sales in the comparable quarter in 2017. Net profit growth amounted to 43% and 33% in the first nine months of the year. Net profit is in the quarter impacted by a step-up in value of investments in associated companies, which amounts to about $3.6 million. In summary, on the P&L, there is good progress on all parameters for the first nine months of the year. If you go to the next slide, please, the key items affecting the EBITDA margin between the two comparable quarters are first and foremost, 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 stable unit cost and manufacturing and savings from our efficiency initiatives. Sales and marketing expenses grew 5% in local currency, where the growth in cost is mainly due to investments in sales efforts in new business development and emerging markets. R&D costs decreased by 3% in local currency, where investments in R&D projects for high-end products were offset by shifts in R&D expenses between quarters. R&D expenses in the fourth quarter are expected to be higher and growth will be in line with what we have for the first half of the year. G&A expenses grew by 2% in local currency. Finally, currency impacted the EBITDA margin positively by about 30 basis points net of hedging. The combination of strong sales growth, scalability on the cost side, positive impact from changes in product mix, and the impact from savings initiatives are the main drivers of strong relative profitability this quarter compared to the same quarter last year. On the next slide, you have a high-level status on the efficiency initiatives announced in September last year. In summary, the program is on track. As in the first half of the year, additional investments were made in various manufacturing equipment, and good progress has been made in several spend categories within the strategic sourcing initiative. If we go to free cash flow on the next slide, which amounted to $25 million compared to $18 million in the comparable quarter last year. Please note that the free cash flow bridge excludes special items and impact from the recent acquisitions. The key items affecting the free cash flow between the two comparable quarters are obviously positive impact from strong operating results, reversal of net working capital investment in the first half of the year. Cash tax is higher in line with higher profits. CapEx was higher than in the comparable quarter due to investments related to the ongoing efficiency initiatives in addition to various investments in leasehold improvements and integration of a new CRM software. Lastly, net interest-bearing debt was about $142 million at the end of the quarter, which corresponds to a 1.3 times net interest-bearing debt to EBITDA. If you could now go ahead with the guidance, please, Jón. Yeah. Thank you, Sveinn. Regarding the financial guidance for 2018, we have made one change due to a higher than expected capital expenditures related to ongoing efficiency initiatives, leasehold improvements, and the integration of new CRM software, as mentioned by Sveinn. We expect capital expenditures around 5% of sales for the full year of 2018. The full year guidance is therefore as follows: Organic sales growth is unchanged and expected to be in the range of 4%-5%. EBITDA margin before special items is unchanged and expected to be around 19% of sales. We expect capital expenditures, as previously explained, to be around 5% of sales, and the guidance for effective tax rate is also unchanged and expected to be in the range of 23%-24%. As already mentioned, Össur recently made two acquisitions around the quarter end. Combined sales of those two entities on a full year basis is about $40 million. The acquired companies have a lower full-year EBITDA margin than Össur, and they also have a greater seasonality in their business, where the first quarter of the year is seasonally the weakest and the fourth quarter the strongest. We therefore expect to see a slight increase in the seasonality of Össur next year. Please note that the acquisitions do not impact the parameters included in the guidance, but we would like to emphasize that quarter 4 of 2018 will include sales and profit from the acquisitions and hence quarterly growth measured in dollar will be impacted. Having said that, thank you all, and we can now go to the questions and answer session. Thank you, ladies and gentlemen. If you have a question for the speakers, please press 01 on your telephone keypad and you will enter a queue. After you are announced, please ask your question. Please hold until we have our first question. Our first question comes from the line of Felix Wienan from SFO. Please go ahead. Your line is now open. Hi. Good morning, Jón. Good morning, Sveinn. Felix. How are you doing? Good. How are you? Very good. Thank you. Excellent. Just a couple of quick questions. The first one, overall, a good quarter, by the way. Thank you very much for that. The first question on Bracing and Supports, the 2% organic sales growth was a bit below what I would have expected. I think you also guided for an acceleration for the second half with the Q2 numbers. Just wanted to hear what's going on there. What held you back? Okay. Yeah. Thanks for the comment, Felix. Yeah, of course, there is no question that 2% organic growth is, we would like to have seen it higher. The reasons for it, I would say, is that first of all, there's an overall softness in the market, and we have mentioned that there is specifically softness in France and U.S., and in U.S. is generally softness. In France, it is due to more like reimbursement changes or development there. The third one is there is a rationalization of product in certain markets. Also there is lower sales to mainly two large distributors. Those distributors are third-party distributors, which we have been weeding out. We have now close to a complete product line, so we are phasing out those third-party distributors. But of course, this is an explanation afterwards, and we would like to have seen it higher. The reason, I guess, is overall softness of the market. Okay, so we shouldn't really expect a significant acceleration in the fourth quarter then from that call? No, not in the fourth quarter, Felix. We expect similar growth rate in quarter four. With that said, we still believe that we are on track to deliver the sort of market growth rate in Bracing and Supports going into 2019 with where we, and we've previously stated market growth to be in the range of 3%-4%, and that we believe we're still on track to deliver that growth rate. The thing we are doing is we are continuing to come out with very good products and we have on very many markets, we have a very good standing on the market and the underlying factors in the market is good. Sure. I understand. Not a problem at all. Then another question for Sveinn, probably, on the profits from associates, there was a revaluation in the shares, a factor worth $3.6 million. Did that also impact the investment in associates line on the balance sheet? I saw that came down from the second quarter, or what drove the change there on the balance sheet? Yes, what is impacting our investment in associated or the impact from investment in associated companies this quarter is the fact that we acquired the remaining shares in a company where we have held a minority share until now. Hence, we are revaluing our prior shareholding, which leads to this $3.6 million impact flowing through our P&L this quarter. We are also recognizing profits from other investments in associated companies, which is at a similar level as we have seen in quarter one and quarter two, which adds up to the total impact you see in the investment from associated companies in the P&L. Understand. The reason on the balance sheet then is that it moves from the investments in associates line probably to another line in PPE and goodwill and- Yes. Basically goodwill, yeah. To some degree, yeah. The fundamental reason for it is that we have been, through the years, we have been taking a position in a very, a minority position in a very promising companies in the industry, which we have located, and we have kind of worked with them. Then when we take the control, then they are much more profitable, and they are much better. When we take control of them, we have to write it off. Sure. Understand. That perfectly leads into the other questions. If you could give some more color around the acquisitions. For example, why are they so seasonal? What drives it? Is it different sorts of products or is it-- It seems to be different, right, from what you have been doing at the moment. I did not get, there is one word that you were breaking off, Felix. Could you-- You were asking about more, basically just more color into the acquisitions, what kind of acquisition it is. Yes, exactly. Do these companies produce products as well, or are they service providers, or clinics? That links into the questions, I do not understand why they are so seasonal, different from a pure product business, probably, right? Well, first of all, okay, let's take the acquisition first. Those are typically a combination of product business and service business, which very many companies in the industry are. So those are mixed. Those are enhancing our distribution of products in certain markets. So they are combination of it. In the seasonality, generally, those are very small companies, and generally, we believe that we can lessen the seasonality as we go. Some of it is just internal, that people just start to send out bills before the year-end. We will, of course, change that. However, in U.S., because of the high deductible, we don't know why, but we see a slightly bigger seasonality in U.S., and we think it is because of the high deductible insurance models that are increasing in U.S. at the moment. Felix, the seasonality in our business is always such that quarter one is weaker, and towards the end of the year, we see a pickup, and that relates to the general activity level amongst our customers. So the seasonality with these acquired companies is not that much different from our own. Okay, perfect. Thank you very much. All right. Thank you. And good luck with the next quarter. We hear each other. Bye bye. Thanks a lot. Thank you. Thank you. Our next question comes from the line of Ole Bech from ABG Sundal Collier. Please go ahead. Your line is now open. Thank you for taking my question. This is Ole from ABG. I just have three really short questions. Is there a reason why you have such a big inventory buildup? It looks like it's up more than 10% year-over-year and 5% sequentially. If we can just take that one first. No, that is not a seasonality as such. These are just fluctuations we see in our business. Also, just to mention, the fact that we are moving part of our manufacturing from Iceland to Mexico has led to a temporary buildup to some degree, and also because we have been moving our distribution center from the West Coast down to Mexico. These two things have led to the fact that we've had to increase inventory levels temporarily. All right. Thank you. Then just on G&A, it's almost 15% of sales in Q3, and I was just wondering if you have any plans on working this towards maybe, I would say, normal industry levels in the future. There seems to be a little bit of room to improve the G&A here. Yeah, if you adjust for the special items, it goes down to more like 10%. So that's what the relative level you should look at. We are expensing the whole 6.8 million of special items through the G&A line. So the normalized level of G&A is much lower than that as percentage of sales. Okay. But it's still rather high compared to industry peers. Normal is like 4%-5%. Yeah, that's perhaps a reflection of the fact that Össur is a company which is, maybe if you look at our listed peers, a bit smaller, and we have a global model which all is equal, is a scalable model. We've also pointed towards the fact that we expect G&A cost to grow somewhat lower than our top line, which is exactly what we're seeing in this quarter, which is part of the operating leverage we have in the business. Okay, thank you. Then just lastly, just on the B&S segment. So it's a little soft, as you say. Could you maybe shed some light on what you think about the B&S segment long term? Is it going to continue to have low growth, or can we expect maybe some more down the road? Well, we think the market growth there is 3%-4%, and we think that would be the growth going forward. There is a very healthy volume growth, quite higher than this, but there is a considerable price pressure. But going forward, we think that would be reasonable growth rate. All right. Perfect. Thank you so much. You're welcome. Thank you. Our next question comes on the line of Nils Granholm from Carnegie. Please go ahead. Your line is now open. Yes, hello. First question on your M&A pipeline. After these two acquisitions, would you expect to make more acquisitions in the next few quarters? If you could just talk about your M&A pipeline. Secondly, given the acquisitions that you have made here, would you just briefly talk about your willingness to make share repurchases beyond the safe harbor share buybacks that you are doing? A third question regarding these acquisitions. Are you the 100% owners of these companies, or should we include an increase to the minorities in your P&L? Thank you. Okay. Let me take the M&A pipeline, Nils. It is always really difficult to foresee M&A pipeline or foresee what we are going to buy. There is an acquisition appetite in the company. We think that we have done well, and it fits within our strategy. We will see. We have a relatively strong pipeline, but all of those are relatively small companies like those here. If that would go to fruition, then our share buyback would probably not be affected by those we have in the acquisition pipeline. This answer has to be qualified, and will have to be subject to considerable uncertainty. We just do not know. There is a trend in the Prosthetics business. There is a consolidation trend, and we feel that in the market. My answer might be completely wrong. I do not know. This is how it looks like today. Yeah. Just to add, Nils, we are currently at about 1.3 times net debt to EBITDA, and we have stated that we want to maintain, let us say, a net debt to EBITDA ratio between one and two. Theoretically that leaves us open to do share buybacks in addition to the safe harbor program that we have ongoing. Regarding the last question, yes, we are 100% owners of these companies, and you should not expect any step up in the line related to other minority shareholders. Okay, thank you. Just another question regarding this working group that made a proposal earlier this year to increase the access to Bionic products in the U.S. Are there any updates on how CMS is evaluating the feedback they have received from this working group? No. Unfortunately, things in the reimbursement system in Medicare in U.S. moves slower than the financial market. Okay. We do not have any It is a positive news, and it will help us going forward, but it is not a dramatic change, no. Okay. Then just a final question, if I may. in late June, you introduced an updated version of your Proprio Foot, as far as I remember. Can you just talk about how that product has been received in the market? That product has been received very well, and it is contributing to growth. As always, it is not a blockbuster product, but it contributes very nicely to the product portfolio we are offering to the market now. There was only limited number of units that we sort of launched in Q3, and we expect to ramp up over the next coming quarters. But you are not mentioning this product in your interim report. Rather, you are mentioning the mechanical foot, the Pro-Flex foot. The Pro-Flex. Pro-Flex foot. Is that because it is simply just a much bigger contributor and a bigger category compared to the Bionic foot? Yes, it is. Okay, thank you. You're welcome. Thank you. Our next question comes from the line of Christian Ryom from Nordea Markets. Please go ahead. Your line is now open. Hi, Jón and Sveinn. This is Christian from Nordea. I have three questions. I think I'll take them one at a time. Regarding these acquired companies, you say that they will be somewhat margin dilutive. Is that something in their business model? Is there scope for you to improve the profitability of these acquired companies over time? That's my first question. Hi, Christian. These companies, they have good profit margins and sort of close to the profit margins we see in our business today, and are only sort of very marginally dilutive for us, maybe 40 basis points on a full year basis. The reason they are a little bit less profitable is simply that they're just smaller. I think they don't have the same scale and same operating leverage. Yeah, I guess that's the answer to that. Yeah. But is that to be inferred then that as you integrate them into Össur you can improve the operating margins, or will they continue to operate as smaller entities? We'd be careful to make that statement. We can improve their profitability margin somewhat, and that's one of the rationality for buying them. But whether we can get them up to the same level that we are now, I'm not so sure. But we will increase them. They will probably, in the long term, have a somewhat dilutive profit margin, but not majorly so. Okay, thank you. My second question goes to the savings that you're achieving from your ongoing efficiency program. In connection with the half year report you commented that over the first half year, you'd only achieved a very small part of the savings of these 3 million that you're saying for this year, and that this would be more back-end loaded in the year. Can you comment a bit about how much has now been achieved of the 3 million in these first nine months, and how much is still to be achieved in the fourth quarter? Yes, Christian Ryom. I think a safe estimate to put in your models is that for first half of the 3 million, yes, it's slightly more back-end loaded, but there was probably roughly 1 million for first half of the year and then the remainder in the second half of the year. I think that's what you can put in your models. Okay, so we should expect a roughly similar impact in Q4 as in Q3? Yes. My final question goes to this joint venture that you have with Comau regarding industrial exoskeletons. I understand that you are about to launch your first product here. Can you comment a little bit about what your expectations are for this, and also how it will impact your P&L? Will this is something that will be accounted in part of sales or will come in as income from an associated company? I think we should be very careful to give you any guidance on that, really. This is a more future. The impact was on the long term, but the sales channels are not established. Even though we are coming out with some products, it'll take us a long time to break ground for it. Yeah. It is still a minority investment for us in this cooperation. Yes, technically it would flow through like you described into our P&L. But as Jones said, this is still a, let's call it, a more futuristic investment, and we will see the benefit further down the line. Okay. Thank you very much. Thank you. Just to remind you, ladies and gentlemen, if you wish to ask a question, please press 01 on your telephone keypad. We will have a brief pause while questions are being registered. As there are no further questions at this time, I will hand the calls back to you, speakers, so you can do your closing comments. Well, that was nothing else than saying thank you very much for participating and good questions, and we see some of you in our workshop. Thank you very much. This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.