Earnings Call: Q2 2018

Jul 26, 2018

Summary

Q2 sales were $158 million, with 6% organic growth and a 20% EBITDA margin. Growth was strongest in APAC, while delayed launches and distributor pressure weighed on U.S. Bracing and Supports; full-year guidance was unchanged.

Ladies and gentlemen, welcome to the Össur Interim Report Q2 2018 and Consolidated Financial Statements for full year 2018. Today, I am pleased to present our hosts, Mr. Jón Sigurðsson, CEO, and Mr. 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. Gentlemen, please begin. Yeah, thank you. I would as well like to welcome you to the Össur investor conference call, where we will cover the result for the second quarter of 2018. As previously mentioned, my name is Jón Sigurðsson. 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 and end with our guidance for 2018. A question and answer session will then follow. Sales in the second quarter of the year amounted to $158 million, corresponding to 9% growth and 6% organic growth. Prosthetics grew 7% organically in the quarter with a good contribution for high-end products. Our Bracing and Supports grew 4% organically, and we are pleased to see our OA solution growing well globally. Gross profit margin was 63% of sales, compared to 62% in the comparable quarter last year. EBITDA amounted to $32 million, or 20% of sales, compared to 19% in the same quarter last year. The profitability increase is driven by scalability, strong sales growth, and positive changes in product mix. Starting from the left, America's sales growth was I am sorry. Sales amounted to $158 million in the second quarter of 2018, compared to $145 million in the same quarter last year, where total organic growth was 6%. The Prosthetics segment grew 7% organically, corresponding to four percentage point contribution to total growth. We have a good momentum in our Prosthetics segments globally, with excellent contribution from high-end products such as the Bionic and Pro-Flex feet, which were launched in 2017. The remainder of the Prosthetics portfolio also performed well in the quarter. Bracing and Supports sales grew 4% organically, with two percentage points contribution to total growth. After a slow start of the year in Bracing and Supports, the second quarter came in as expected with stronger sales growth. Total growth in dollar terms was 9%. With the change in currency rates, sales growth was positively impacted by $5 million. This corresponds to a positive three percentage points contribution to total growth. Starting from the left, America sales growth was 2% in the quarter. The Prosthetics segment performed well with good growth in both Canada and U.S. In the Bracing and Supports segment, performance in Canada continues to be strong while sales in the U.S. soft-goods business declined slightly. Slow sales growth in the U.S. can mainly be traced to delay in new product launches, which were expected to be launched last year, but have now been launched in the first half of 2018, in addition to lower sales to large distributors in the quarter. We expect sales growth in the second half of the year to be stronger in the Americas, supported by recent product launches. As in the first quarter of the year, our own distribution companies in the U.S. are performing well. Sales growth in EMEA was 7% in the quarter. After a soft beginning of the year, growth was good in the Prosthetics segment across most major regions. In Bracing and Supports, our high-end solution grew in all major regions, while our soft-goods solutions had a slow quarter, the main reasons being slow sales in Compression Therapy in France and rationalization of a limited number of products in selected markets. Growth in APAC was 19% in the quarter, where we continue to see excellent result in both Prosthetics and Bracing and Supports. As in previous quarter, growth in Australia and China has been strong. Over to you, Sveinn. Thank you. Now, in going through the P&L, I will make references to both the second quarter numbers and for the half year. As with the Easter shifting between the comparable quarters, the half year comparison is also very relevant. But it is already covered. Organic sales growth was strong in the second quarter and amounted to 6%, and organic growth rate is 4% for the first half of the year. Gross profit amounted to $99 million in the quarter, and the gross profit margin is 63%, compared to 62% in the comparable quarter last year. Year to date, gross profit margin is also up by a percentage point compared to the first half of last year, amounting to 63%. EBITDA amounted to $32 million in the quarter, or 20% of sales, compared to 19% in the second quarter of last year. I will discuss the margin development for the quarter in more detail on the next slide. The EBITDA margin for the first half of the year is 17%, the same as in the first half of 2017 when excluding special items. Share in net profit of associated companies amounted to $1 million in the quarter. The profit is from a few minority investments in both technology and distribution companies, and we expect similar profit from these investments going forward. However, subject to some fluctuations between quarters. Income tax amounted to $6 million, corresponding to 23% effective tax rate, compared to an effective tax rate of 25% for the comparable quarter in 2017. Hence in line with our guidance on effective tax rate. Net profit was strong and amounted to $20 million or 12% of sales, compared to 9% of sales in the comparable quarter, and grew by 49%. In summary on the P&L, there is good progress on all parameters for the first half of the year. If you go to the next slide, please. EBITDA amounted to $32 million in the quarter, which corresponds to a 20% margin compared to 19% in the second quarter of 2017. The key items affecting the EBITDA margin between the two comparable quarters are, starting from the left, positive effect 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. Sales and marketing expenses grew 4%, where growth in cost is mainly due to investments in sales efforts in new business development and emerging markets. R&D expenses grew 9%, mainly due to investments in projects for high-end products such as Bionic Bracing. G&A expenses grew 3% times the operating leverage from at least sales and marketing cost and G&A. Currency impacted the EBITDA margin positively by about 40 basis points net of the hedge we have on the Icelandic króna. The combination of strong sales growth, scalability on the cost side, and positive impact from changes in product mix are the main drivers of strong profitability in this quarter compared to the same quarter last year. Now, if you go to the next slide, please. Just a quick status on our efficiency initiatives. Basically, the program is on track. As in the first quarter of the year, additional investments were made in various manufacturing equipment, and good progress has been made in several categories relating to initiatives within strategic sourcing. The West Coast distribution facility in the U.S. has now been closed and moved to our Mexico manufacturing facility, where savings are already beginning to materialize from this initiative. If you go to the next slide, please, on cash flow. Cash generated by operations in the second quarter of the year amounted to $23 million or 15% of sales. Changes in net working capital negatively impacted cash flow generated by operations, partly due to a temporary increase in inventory relating to the efficiency initiatives. CapEx amounted to $6 million or 5% of sales. CapEx in the quarter was relatively high due to investments related to the efficiency initiatives, in addition to various investments in leasehold improvements and integration of a new CRM software. We expect lower CapEx in the second half of 2018. Net interest-bearing debt was about $134 million at the end of the quarter, which corresponds to a 1.3 times net interest-bearing debt to EBITDA. Now, Jón, over to you again on the guidance, please. Yeah, thank you, Sveinn. There is no changes have been made to the financial guidance. The full year guidance is as follows, as previously. Organic sales growth in local currency is expected to be in range of 4%-5%. EBITDA margin before special items is expected to be around 19% of sales. We expect capital expenditures to be around 4% of sales, and the effective tax rate to be in the range of 23%-24%. Thank you all. Let's go to the question and answer session. Thank you. Ladies and gentlemen, if you wish to ask a question, please dial 01 on your telephone keypads now to enter the queue. Once your name has been announced, you can ask your question. If you find it is answered before it is your turn to speak, you can dial 02 to cancel. Once again, that is 01 to ask a question or 02 if you need to cancel. Our first question comes from the line of Christian Ryom of Nordea Markets. Please go ahead, your line is open. Hi, good morning, this is Christian from Nordea. I have a couple of questions on your Bracing and Supports sales and one question on the efficiency program. On the Bracing and Supports sales, you mentioned that you have implemented some product rationalizations in this report. When exactly have you implemented these product rationalizations, and how do you expect them to impact your sales going forward? Secondly, also on Bracing and Supports, you mentioned that some of the sluggishness in U.S. sales is due to low sales with a couple of large Bracing and Supports distributors. Do you expect this to improve in the second half? I will come back with my final question on the efficiency program. Thank you. Yeah. Regarding the product rationalization, we are going through an SKU rationalization project. We initiated that a couple of years back, and we are taking the long tail out and getting rid of some, first of all, overlapping products, and secondly, low profit margin product. In addition, it was decided to rationalize certain limited number of products in selected markets, affecting U.K. and Nordic regions. On the large distributors, we have been, although that is more in other parts of the market than U.S., we have been fading out products which we are selling as a distributor, other manufacturers. The rationalization will impact sales in Bracing and Supports in 2018 only, and that is in the neighborhood of, what is it? $1 million. $1 million, yes. Up to $1.5 million, yeah. Yeah, just to add, this is a concentrated effort that is ongoing and we will have concluded this by the end of the year. So it is about $1 million, $1.5 million, so nothing material as such. Okay, thank you. Just to be clear on the large U.S. distributors, do you expect an improvement in the second half of the year? What should be expected there? We expect an improvement in Bracing and Supports sales in the second half of the year. Yes. This is still an ongoing trend to some extent that our direct business is growing, where we go to market through a direct sales force, but through these distributor sales which is not a very big part of our overall bracing sales in the U.S., that has been under some pressure. Okay, thank you. On the efficiency program, can you confirm whether you still expect to realize around $3 million in savings from the program this year? How much of these savings have you realized year to date? Yes, we stick to the numbers we have already communicated. We have realized, let's say, it will be slightly more back-end loaded, let's say the $3 million. But maybe it is fair to say that we have had in our P&L now about one third or something like that of the $3 million, and the rest will come in the second half of the year. Okay. Thank you very much. Thank you. Thank you. Our next question comes from the line of Thomas Pounce of Danske Bank. Please go ahead. Your line is open. Yes, thank you very much, and good morning. Just to stay on the Bracing and Supports. I remember in connection with the Q1 that you had some late Q1 product launches, and those were expected to positively impact in Q2. Now I'm just wondering, are we seeing a further delay in the U.S. where you have seen some positive impact in EMEA, or how should I see this? Then just maybe could you just elucidate on the Bracing and Supports growth in the U.S. alone, as you have 2 percentage points overall. So what is the Bracing and Supports? Is that a negative impact for negative growth for Q2? Then maybe finally, just what's actually the estimated impact on the growth from the extra sales days during the quarter due to the impact of the Easter holiday in Q1. So how much of an impact do you expect to have seen here in Q2? Thank you. On the Bracing and Supports growth in the U.S. and the reference to product launches, yes, we reiterate, let's say the same message as in Q1, that we expected these launches to come in late 2017, but they came late Q1. Hence, we expect this to have our growth rate in the second half of the year. So it's basically the same explanation as in Q1. These products came at least a quarter later than we expected. So that is why we make the reference to this in the report now, and we expect this to help our growth rate in the second half of the year. And this is mainly in relation to the U.S. part of our business. Okay. Then maybe on the B&S growth that you had in the U.S., could you disclose that? Yes. That is declining slightly in the U.S. Okay. On the extra sales days for Q2. If we would have had the same number of sales days, our organic growth rate would have been around 5% instead of 6%. Okay, perfect. Then maybe could I just, on the CapEx, you are still at 5% for the first half. Yeah. Given that you are guiding 4%, are we looking at 3% for H2 or is CapEx maybe going to be slightly above 4% for the full year? What has driven our CapEx up in the first half of the year is all the preparation and all the investments that we've needed to do in Mexico to be able to absorb the activities we are moving from Iceland. Also the investments related to moving our West Coast distribution facility into our manufacturing facility in Mexico. These investments have already taken place. That is the principal driver of CapEx being above the average. I expect somewhat lower CapEx in the second half of the year, and then still expect it to be around the guided number as relative to sales. Perfect. Thank you very much. Thanks. Thank you. Once again, if there are any further questions on the line, please dial zero one on your telephone keypads now. Okay, there seem to be no further questions, so I'll hand back to our speakers for the closing comments. Yeah. Thank you for your questions and participation. We just want to quickly highlight that we will be on the road in the fall where we will be presenting at a couple of conferences in Europe and the U.S. 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.