Earnings Call: Q3 2017

Oct 25, 2017

Summary

Q3 sales reached $139M, with 3% organic growth (about 4% adjusted for fewer working days); prosthetics led while Bracing & Supports was flat. FY2017 guidance remained unchanged, including 18%–19% adjusted EBITDA margin.

I would like to welcome you to our third quarterly conference call in 2017. As previously mentioned, my name is Jón Sigurðsson, and President and CEO. With me here today is our CFO, Sveinn Sölvason. I will begin by going through the highlights and sales development in the quarter. Sveinn will then go through the financials in more details, and we will end with our guidance for 2017. A question and answer session will follow. Sales in the third quarter of the year amounted to $139 million, corresponding to 5% growth and 3% organic growth, both measured in local currency. We highlight that growth in the quarter was negatively impacted by fewer working days compared to the third quarter of 2016. By adjusting for the difference, the organic growth amounted to about 4%. In the first nine months of the year, organic growth was 4%. Prosthetics grew 5% organically in the quarter, but it should be noted that the comparable quarter in 2016 was strong, with 11% organic growth worldwide. Growth in bracing and supports was flat in the quarter due to the expect negative impact from own distribution companies in addition to slow direct sales in the U.S. Gross profit margin in the quarter was strong, 63% of sale, which is comparable to the average of 2016. EBITDA before special items amounted to $24 million in the quarter, or 18% of sales. EBITDA growth before special items amounted to 4% in local currency. Additional investment in R&D project for high-end products and movements in currency rates are putting pressure on our EBITDA margin in the quarter. Our EBITDA margin net of hedge was negatively impacted by about 70 basis points due to currency. If we look at the growth by segments and geography, we see a good 10% growth in prosthetics and 5% organic growth while bracing and support sales growth was flat. Sales of bionic products in the quarter amounted to 20% of prosthetics component sales. We had good sales growth in EMEA and APAC, with 10% and 9% growth respectively, while sales growth in Americas was flat. I will now further elaborate on sales by business segment and geography, beginning with the business segments. We have added this slide to better highlight sales by segment and to bridge the difference between sales in U.S. dollars, local currency and organic growth. Sales in the third quarter amounted to $139 million compared to $29 million in the third quarter of 2016. To bridge the difference, I begin with organic development, where total organic growth in the quarter was 3%. The prosthetics segment grew by 5% organically in the quarter, which correspond to a three percentage points contribution to total growth. In prosthetics, we continue to see a good performance, even though we are comparing to a strong comparable quarter in 2016, where organic growth amounted to 11%, which was primarily driven by a successful RHEO KNEE 3 launch in the second quarter of 2016. Bracing and support sales in the quarter were flat, with immaterial growth contribution to total growth. As with previous quarters, growth was negatively impacted by the expected sales decline in own distribution company, and direct sales in the U.S. were somewhat slow, partly attributed to the U.S. hurricane season. The restructuring of the distribution companies is expected to be finalized by year-end, with anticipated reduction impact on growth in 2018. The total currency growth in the quarter was 5%. The prosthetics segment grew 10% in local currency, with the addition of Medi, which we acquired in September last year. The addition of Medi corresponds to a 2 percentage point contribution to our total growth. Since Medi was acquired in September last year, this will be the last quarter where we see difference in local currency growth and organic growth. Total growth in USD terms in the quarter was 8% due to appreciation of a few major operational currencies against the dollar, mainly the EUR. Currency movement in the quarter impacted sales growth positively in the amount of $3 million. This corresponds to a positive 250 basis points contributing to our total growth. Now let's look further at each geographic region, starting with Americas. America sales growth was flat in the quarter, which can be attributed to, as mentioned on the previous slide, a strong comparable quarter in prosthetics and the restructuring of our own distribution companies, in addition to slow direct sales in the U.S. with the bracing and support segment. The performance in EMEA was good in the quarter with 10% growth and 6% organic growth. In both prosthetics and bracing and supports, we saw our high-end innovative products growing well. In prosthetics, we furthermore saw growth across all major regions. In the first nine months of the year, we are pleased to see the EMEA region growing above estimated market growth. APAC sales grew 9% and 7% organically after a strong beginning of the year in both prosthetics and bracing and supports. We are seeing good growth in high-end innovative products and excellent growth in Australia. Before I hand it over to Sveinn, let's look at the highlights for the first nine months of 2017. Sales in the first nine months of the year amounted to $450 million, corresponding to 9% growth and 4% organic growth, both measured in local currency. We have seen a good performance in our prosthetics division in the period, which is growing organically above our estimated market growth. In bracing and supports, the impact of our distribution company has been significant in the period, but we continue to see the direct sales part of our business grow in line with the market. EBITDA before special items amounted to $73 million in the first nine months of the year, or 17% of sales. EBITDA growth before special items amounted to 8% in local currency. Currency movements in the period had a negative impact on the EBITDA margin, approximately 90 basis points net of hedge. The integration of the companies we acquired in 2016 is on track and in line with our business case. We are furthermore beginning to see the planned synergies being realized. Now, Sveinn Sölvason, our CFO, will go through the financials in more detail. Please go ahead, Sveinn. Thank you, Jón. Local currency growth amounted to 5%, and organic sales growth amounted to 3% in the quarter. As previously mentioned, sales growth is impacted negatively by fewer sales days in the quarter. If we adjust for the difference, the organic growth rate amounted to about 4%. Gross profit margin was 63%, the same as in the comparable quarter last year. The strong gross profit margin in the quarter is also quite comparable to the average for the whole year of 2016. EBITDA margin amounted to 18% when adjusted for one-time costs of about $3 million, which are related to the efficiency initiatives announced in September. As for previous quarters, we have an impact on our profits with changing currency rates, especially the EBITDA margin, and I will elaborate further on that on the next slide. Net profit was about $11 million, or about 8% of sales. If you go to the next slide, please. On this slide here, we have a break to better highlight the changes in the EBITDA margin compared to quarter three last year. EBITDA before special items amounted to $25 million in the quarter, which corresponds to an 18% EBITDA margin compared to 19% in the same quarter last year. The main items affecting the EBITDA margin between the two comparable quarters are starting, moving from the left on the picture, we have slightly positive effect from gross profit margin, mainly driven by product mix. Efficiency in manufacturing was better in the quarter after a temporary negative impact in the second quarter. Currency movement impacted the gross profit margin negatively by about 20 basis points. R&D expenses grew by 25% in the quarter, measured in local currency. As for previous quarters in 2017, the largest portion of the growth is due to, let's say, pro forma impact from the acquisitions made in 2016, as both companies have quite substantial R&D operations. Furthermore, as already communicated during the Capital Markets Day in September, we have started to make some additional investments in R&D projects for high-end products, such as the bionic braces and mind-controlled prosthetics. G&A growth, excluding special items, was flat between quarters, partly due to synergies already realized. Finally, the currency affects EBITDA margin negatively in the quarter by about 70 basis points, which is net of the positive impact from the partial hedge we have on our ISK cost. Again, it's mostly related to a stronger Icelandic krona than in the comparable quarter last year. Lastly, $3 million were expensed in the quarter, as we had already communicated in relation to the efficiency initiatives announced in September, which I will elaborate briefly on the next slide, please. On this slide here, we have a high-level status of the efficiency initiatives announced in September and further detailed during our Capital Markets Day. To recap, the efficiency initiatives are in the areas of manufacturing, distribution, and sourcing. We are initiating these initiatives to further increase the scalability of our business model and to increase profitability. We've already moved into early stages of implementation, whereby the $3 million we're expensing as one-time costs are obviously related to these initiatives. Progress is being made as planned, and we will keep you updated on progress in the quarters to come. In the meantime, there are no changes to the timeline or the estimated financial impact that we have previously communicated. If you go to the next slide, please. Cash generated by operations in the quarter amounted to $23 million or 16% of sales, which is the same result as in the previous quarter. Cash generation in the quarter was good, slightly lower than in the same quarter last year, which is due to some working capital absorption, which we expect to reverse in the next quarter, and also slightly lower profits from operations. Income tax in the quarter amounted to $4 million, which corresponds to a 26% effective tax rate. Capital expenditure amounted to $4 million or 3% of sales, compared to $6 million or 5% of sales in the third quarter of 2016. Net interest-bearing debt was about $141 million at the end of the quarter, which corresponds to a 1.4 times net interest-bearing debt to EBITDA, which is roughly in the middle of the capital structure, let's say, target range that we have. Now over to you, Jón, again, please, on the guidance. Yeah, thank you, Sveinn. No changes have been made to the guidance parameters in the quarter. The financial guidance for the full year of 2017 is therefore as follows: Sales growth in local currency is expected to be in the range of 7%-8%. Organic sales growth in local currency is expected to be in the range of 4%-5%. EBITDA margin before special items is now expected to be in the range of 18%-19% of sales. We expect capital expenditures to be around 4% on net sales this year, and the effective tax rate to be around 26%. Thank you all for listening. We will now go to the question and answer session. Thank you. Ladies and gentlemen, if you wish to ask a question and you haven't already, could you please press zero and then one on your phone keypad now to enter the queue. 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 zero and then two to cancel. There'll be a brief pause while the questions are being registered. Okay, we have a question for today, and that's from Christian Raum of Nordea Markets. Please go ahead, Christian, your line is open. Hi, good morning. This is Christian Raum from Nordea Markets. I have a couple of questions. First of all, on the bracing and support growth in the U.S., can you give us an estimate of what growth would have been excluding your own U.S. distributors? Secondly, when the restructuring has finalized of these own U.S. distributors, by end of 2017, do you expect growth to be back to the market growth in 2018? Yeah, thank you, Christian. First of all, we expect these sales challenges to persist through the year, as we have already communicated. Direct sales for the last two years have been between 3%-5%. The bracing and support segment in Q3 would have grown approximately 2% without the effect and 3% for the first nine months. Regarding the second question, yeah, we expect those challenges to be behind us in the year to come, 2018. Okay, thank you. My second question is on the impact from acquisitions on your EBITDA margin. Last year in Q3, you said that the combined effect of Medi Prosthetics and Touch Bionics was a dilutive impact of around 90 basis points on the EBITDA margin. Can you give us an idea of what the improved efficiency from integration and synergies with these new acquisitions is in a year-over-year comparison? How much of the 90 basis points dilution have you been able to mitigate by now? Hi, Christian, this is Sveinn. What we have said on the synergies is if we take Touch Bionics first, then we initiated or let's say we have completed all changes that we plan to do as part of realizing the expected synergies, which will result in a full-year cost reduction of about $3 million next year. Of which we expect about $1 million to hit our P&L in the second half of this year, which is already contributing in this quarter. As for the Medi, let's say, acquisition, we are also starting to see those synergies sort of flow through our P&L, although again, with expected full impact in 2018. I don't have a detailed answer on exactly such that we can compare to the 90 basis points which we communicated in quarter three last year. These are some rough numbers for you to work with. Okay. Thank you. Once again, if anyone has any further questions at this stage, please do press zero and then one on your phone keypad now. Jón, as there are currently no further questions, may I please pass the call back to you. Okay. If there isn't any more questions then thank you very much for participating and we say farewell from here. Thank you.