Earnings Call: H1 2020

Sep 7, 2020

Dear, ladies and gentlemen, welcome to the conference call of Medactor Group S. A. On the 2020 Half Year Results. At our customers' request, this conference will be recorded. As a reminder, all participants will be in a listen only mode. And after the presentation, there will be an opportunity to ask questions. May I now hand you over to Medactor's CEO, Mr. Francesco Sicari, who will lead you through this conference. Please go ahead. Thank you. Thank very much, and welcome to H1 results for Medacta. I will go through very quickly on the highlights of this very particular semester we all experienced. And then we're going to dive into the full P and L analysis. So in terms of H1 2020, we already discussed the revenues in July at €134,800,000 with a negative growth of 11% the previous period. This is, of course, a negative growth, but we were all expecting even more negative impact due to the COVID. We have seen and that's probably in the first highlight of today, that not only June July, we're registering double digit growth, but in August, we continued in the same with the same trend. And this is linked to the rigid demand of Orthopaedics and the good expansion that some of our product lines were able to deliver even during this period. Of course, we are all exposed to the changes, which are associated with this pandemic. And we've seen that the future the future remains very uncertain with a situation like the Melbourne area in Australia in a complete lockdown since a couple of weeks. We just expanded there for another couple of weeks, the situation in France, the situation in the U. S. So we remain very, very cautious for the remaining part of the year. At the same time, we've seen solid EBITDA margin at around 24%, and this is thanks to the different initiatives that the company was able to put in place and to really reduce a lot of costs mainly associated to travel and marketing, which have been completely cut during the lockdown period. We are very proud to say that we were able to retain 100% of our workforce, and this is not only critical for all our employees, but it's critical for the rebound effect that we were expecting. And in fact, with those strong months in June, July August, we really needed the full support of our people in the different departments. As you have seen with a lot of news associated with new products introduction, Medacta has had the ability to introduce more than 25 new products in in different markets either in Europe, in U. S. Or in Australia. We were able during the H1 to completely redesign our marketing and especially our education offer, where we shifted a lot of activities from physical to web based and as well we redesigned a lot of the physical meetings. We were able by doing that to retain the attention of our existing customers and to gain as well which is very critical to support our growth. More than €20,000,000 have been invested in CapEx and this, of course, had a negative impact on our free cash flow. We will go a little bit more in details later. But we still can rely on a very strong liquidity position in order to continue to fund our future growth. If we go to the next slide, I wanted to go a little bit more in details about the marketing and the education offer that we were able to redesign for our surgeons. This is, of course, not critical because of the immediate impact of those activities, but because my main focus and my main concern has been to make sure that our pipeline of new surgeons was not drying up during this period because otherwise this will come as a big problem in the months ahead of us. So we discussed those 1800 surgeons attending our online and digital education programs. We completely redesigned the Medacta TV channel. We had those web based more in touch initiatives and that's more on the online activities. But we really redesigned our physical medical education as well. We moved from big labs to very small labs, even mobile trucks in certain countries in order to continue our medical education on cadaver courses. And we have converted some of the big events we had planned in the H1 into a worldwide webinar, for example, on the knee side. We have in the more recent weeks restarted almost completely, although not in all the countries, our classical more surgeon to surgeon medical education. This includes not only the Kravar lab as well the surgeon to surgeon support. And we are very close to finalize and announce additional initiatives in this space that will help us to continue to stay aside our customers while we introduce our innovative products. If we go on the next slide, there is a little bit of delay on my slide. I just wanted to point out on the R and D focus. We mentioned more than 25 new products cleared in H1. This was linked to the MDR deadline, which was expected to be in May 20 to meet this very critical deadline. We have now a new deadline, which is May 2021 for the introduction of MDR. And we will see another very long list of new products that will be hopefully cleared in 1 year from now. Nevertheless, if we look at what we have done so far, we had across all the different product lines significant innovation in the hip side, in the knee side, on the shoulder, on the spine and in our sports medicine. And we have seen as well the most recent clearance for our augmented reality Nexstar solution. This is the 1st FDA cleared augmented reality total knee surgical navigation system. And we had the pleasure to add a very, very positive feedback just last Friday with the first clinical case done in Australia with a very positive feedback. So we are very proud of what we've been able to deliver in those difficult conditions. We go on the next slide, there is what we have discussed more recently about the Nexstar, this unique product that Medacta was able to internally develop with strong collaboration from our surgeons designer group, surgeons that are coming from backgrounds, different geographies and different philosophies as well. This is the first application of many, the total knee application. As we discussed, the solution will be applied to our total hip, total shoulder and spine product line as well. And the goal of this solution is really to change the market of the technology with a very, very low upfront capital investment, very much reduced cost per case. So the ability to attack different segments of the market with something which is proprietary and unique. In particular, we mentioned we have a very precise strategy in entering the ASC market in the U. S. Ambulatory surgical center in North America. I believe that was my last slide on the highlights of H1, and I the pleasure to introduce Mr. Corrado Forsett, our CFO, to go over the P and L analysis. Thank you, Corrado. Thank you, Francesco. Thank you. So what you see here is what we already discussed, Francesco broadly discussed the revenue. I would like just to refresh some key numbers and then I'll leave Francesco to give provide more color if needed during the Q and A session. So we say sales declined by 12% at constant currency, driven by the reduction in revenue in the Europe, 70% U. S. Minus 14% and Rest of the World, Asia Pacific registered positive results of plus 6% in terms of revenue. Products, hip and knee revenue were down by 17% and 13%, respectively. Extremities and spine did very well, plus 41% for extremities, shoulder and 11% plus for spine. But let's now have a look at the profit and loss where we will see we can discuss the profitability and the results of the company. The gross profit margin equal to 69.7% shows a reduction by 3.9 compared to prior period. This drop is largely explained by higher D and A as a percentage of revenue. And I think that the reason is clear, the revenue declined, but the number of instruments in the market did not disappear and continue to generate the same amount of depreciation. I would say that this amount can be even higher if we consider the investments we did in this semester semester to prepare for the recovering demand in the next month. At this level, there was also a minor effect deriving from the negative trends in the market and I would say a less favorable composition in terms of revenue, geographic mix, given, let's say, the U. S. Part of revenue declining compared to last year. The savings delivered in the first semester along with the $2,000,000 grants obtained by the governments for the reduced working hours plans helped the company to protect the EBITDA margin. And at the end of the semester, EBITDA was 31 equal to €223,700,000 adjusted to 23,800,000. The adjustments are 2 types of adjustments. The first one is an adjustment for legal expenses, extraordinary legal expenses, which is a positive effect on the P and L. And then we have a negative effect because we released the overaccrual that we did last year for the same lease. So basically, the effect is almost 0 in this semester. Financial results, we see they are in line with prior periods, so nothing to report in this regard. I would spend one second to discuss about the tax you see a positive number in this line, which is strange, but this is due to a one off effect of about €2,000,000 deriving from the Swiss tax reform, which reduced the company tax rate from the is coming from the release recalculation and the release of deferred tax asset and liabilities in accordance with the new tax rate. As we said, Francesco said, we continue to invest. We invested about BRL20 1,000,000 compared to the EUR 26,000,000 last year. And you see that the biggest chunk of investments is composed by instruments and those instruments are needed to basically both cover the demand coming from customers and the expected recovery of the demand that we forecast for the next month. Research and development, we continue to invest, which is the vast majority of the line intangible is more or less in line with last year. I would say there is a slight decrease due to some savings when consulting the fences and some minor delays due to the COVID effect in the first semester. The timing of key projects will be the timing delay of the key projects will be recovered by the end of the year. The free cash flow came in minus €7,900,000 Let's see. Just wait for the free cash flow came in at minus €7,900,000 after we discussed the €20,000,000 investments and additional €10,000,000 of new implants of additional stock. This increase in stock was decided to support both the expected increase in demand and the possibility, possible disruptions from shortage in supply chain in case of second wave of COVID or other issues that could occur in the 2nd semester. The free cash flow adjusted by abnormal was equal to 4.7 minuteus 4.7 $1,000,000 which compares to a positive $3,500,000 of the prior period of adjusted cash flow. As you see here, the net debt of the company remains very low, dollars 1115,000,000 at the at the end of the semester, starting from €106,000,000 at the end of 20 19. As you see, we have €235,000,000 of credit lines, out of which €179,000,000 are committed. So we think that we have a strong liquidity position and I would say that we are ready to sustain the future growth. This brings me to the end of my section. Francesca now will go through the next session for some conclusive consideration. Thank you, Francesco. Thank you, Corrado. I think what matters the most is, of course, our future. We have seen a very good performance in June, July August. This double digit growth is, of course, very positive. And we managed to have this performance, although, as we know, many markets are still not able to work at full speed. So without COVID, the positive effect would have been even bigger. We see in different markets different bounces at very, very like August, which are usually very, very slow. At the same time, we have seen new stops in areas where we were hoping that the situation was normalized. So it is, as I said, extremely unpredictable. And uncertainties around this COVID-nineteen development still in H2, we cannot provide a short term guidance. At the same time, I think we have all experienced how resilient is the orthopedic market in general. I think Medacta was able to show in some of our product lines even positive growth during the pandemic. And if the conditions around us will allow us, we expect good growing trajectory in the remaining months. Extremely relevant for our future is, of course, the buildup for 2021. So the stronger in the focus, not only with the new products we have already cleared, but as well with the additional projects we have in our pipeline. Even more relevant is the restart of the Medactamora education activities, which are the key elements behind our growth together with the continuous expansion of our sales force. We know in many markets, we have just, if you want, scratching the surface in terms of market share. So we have restarted all our hiring plans already in H2 in order to make sure we go back to a very strong momentum in 2021. We have further refocused our activities on the shift from inpatient to outpatient orthopedic procedure in this market. So this is definitely in line with our previous reacceleration in investments in instruments and inventory to support our growth. This was my last slide. So I would like to ask the operator to open the Q and A session. Thank you very much for your attention. And we are both available for And the first question is from Alex Gibson, Morgan Stanley. Your line is now open. Please go ahead, sir. Hi, good afternoon. Thanks for taking my questions. I have three questions. My first one is just on the double digit growth that you talk about in July August, which are seasonably low months. What sort of level of growth would that mean for September to December if the level of revenues that you're seeing today in July August continued for the rest of the year? Would you still deliver growth for the full second half? Or do the comps get that much harder that you need things to actually improve significantly for the rest of the year to deliver growth? That's my first question. My second question is just on the overall investments you're making to reengage with customers and drive business. The planned investments that you have for sales, marketing and education, are they going to be at or above or below the levels of investment that you would have previously spent to drive sales? Here, I just want to understand if you can generate the same amount of business at less cost or if you think you're actually going to spend more to try to regain lost ground? And then my last question is on the breakdown of the double digit growth. Could you perhaps be more specific within the divisions what you're seeing in hips and knees, in particular, these low teens type of growth, higher, lower? Thank you. Thank you, Alex. May I just ask you to I just want to make sure that the first question is clear to me. Are you referring to the H2 growth or the overall yearly growth? The H2 growth. The H2. Yes. So we, of course, have been pleasantly surprised by the the acceleration we had already in June, July August, we were expecting an acceleration, but both the timing and the consider, and this explains if you want or address partially your third question about the breakdown, especially affecting the overall performance in a negative way, of course. So we do expect in H2 to be able to deliver a solid growth if the conditions around us will not further deteriorate. So this, if you link it to the breakdown of double digit, we had very strange growth. We had in some of those months extremely high double digit growth in certain of our core product lines in hips and the following months exactly the opposite in knees. We had regions like Asia Pacific, which was driving our growth or delivering good growth as well in H1 that is now more affected than other markets. You know that both Australia and the Victoria state, the state of Victoria, but as well in Japan, where past month in the region of Tokyo, the COVID spread was reaccelerating. This was negatively impacting mainly the psychology of the patients and the concern. And so we have seen delays and postponement again. So it is very, very difficult to predict the future, but what we have seen is that as soon as the condition allow patients to go back to surgery, then we see those extremely high reacceleration. You are right, July August are usually, in terms of seasonality, less relevant months, but they are usually, in any case, significant enough to support or not semester growth. So I would say we cannot complain and we should be happy of having July August with such a very good performance, which will allow us to potentially address some slowdown in the future months if the situation is going to negatively impact. In terms of marketing in H2, we plan to go back to our normal level of investments in terms of marketing medical education. Those are the key activities that Medacta is building to make sure our pipeline is not, as I said before, drying up. The overall marketing investment, though, is probably still below what we spent last year simply because many of the 3rd party event have been canceled. So we have reallocate some of the resources we usually use for 3rd party refill our pipeline. I hope I did address your question in a proper way. Yes, yes. That's actually helpful. And just following quickly up on that sales and marketing. I think you said, so the overall level of investment would be less than last year. So you're talking about the €60,000,000 odd in sales and marketing you did last year. That should be what we're thinking would come in the second half this year? Yes, absolutely. So we are slightly below overall, simply because some of the activities are still not possible. T and A is recover some of the educational activities we could not do, but there is a limit to that reacceleration. So we are going to have a lower marketing cost overall. That's our expectation. Okay. Thank you. Thank you. And the next question is from David Adelson, JP Morgan. Your line is now open. Please go ahead. Hi, thanks guys. Thanks for taking questions. 2, please. So just one of your players has indicated that they've put an eye on pricing as we come out of the other side of COVID. I just made it a bit earlier. I just wanted to get your views in terms of what the pricing environment what sort of pricing environment you're expecting on the other side of COVID? And then secondly, just again on selling and education costs. Have you learned anything from COVID? Or have you just changed the way you do things in COVID? There could be a permanent impact on how you do your sales and marketing education? And what potential implications does that have for your costs and margin going forward? Thank you. Thank you, David. So pricing, I think we are all well aware that orthopedic implants have been under a strong pricing pressure for many years now. We have seen technologies coming in the market trying to protect this price. We have not seen yet a dramatic increase in price pressure. We have some attempts from some hospital administrators, especially in the U. S. Market. This pressure, I would say, did disappear when they posted their own results showing a dramatic increase of their profitability. So in terms of short term pricing, we are not seeing anything new in particular, but it is fair to say that the pricing pressure is already a very strong factor in our market. We did not see a dramatic change. It is possible that in certain markets, this trend will simply redesign of activities, I think we showed how quickly we have been able to redesign our marketing and education activities. I think we did understand as an organization that there are alternatives and additional tools that can complement our offering. Some of the offering is here to stay. It will help us to both either simply increase our exposure by adding those activities on top of what we were already doing. But there are definitely some activities that will be replaced by some of the newer activities that we have launched this year. And we are preparing an announcement about an additional web based activity that will, in my opinion, support a very good level of medical education, while at the same time hopefully allowing us to do it at a much lower cost. So some is already out there. Some other activities will announced hopefully in few weeks and those new activities will help us definitely to further improve our education at a lower cost. And the next question is from Chris Gadler, Credit Suisse. Your line is now open. Please go ahead. Thank you, operator. Good afternoon, Francesco or Corrado. I have now two questions left. The first, just on gross margin going into the second half. Could you provide maybe some of the puts and the takes now that we should think of and all kind of how that develops in the second half now with kind of the relatively solid growth you have seen so far in the second half? And also maybe comments on kind of how mix will impact gross margin? And then the second question is just kind of in your remarks, you mentioned that some of the markets have not been back at full speed. Could you maybe indicate what those markets are and where you basically see still kind of the biggest spec locks, so to say? So if you hi, Chris. Thank you for your question. If you don't mind, I will take on the last question and I will let Corrado elaborate on the gross margin and mix. So while I'm on the phone, I will answer on the country specific situation. So there are some markets which have less of an impact on Medacta, which are still heavily affected. I would say probably the U. K, Spain are example of markets still affected by COVID heavily as a market. At the same time, there are regions within many markets, which are temporarily affected. Australia is a good example. But I think it will help you to understand what's the reality we live on a daily basis, what I'm going to tell you about the U. S. In the U. S, there are states like Florida states, which is almost homogeneously or at least the southern part affected by COVID. But we are facing situations where maybe a surgeon is affected so he's quarantined for 2 weeks. And this has a huge effect if those surgeons are some of our key accounts in the U. S. Market. So that creates, of course, a lot of complexity and impossibility on our side to forecast because those are situations which are really surgeons related, but we know how relevant single accounts can be on a monthly performance of a company like Medacta. So that's a little bit the situation we are facing. It's not only the geography, the country, it's the region and within certain regions are single people and that's the difficulty and the complexity. I'm going to if you're fine with that, I will ask maybe Corrado to elaborate on the margins. Thank you. Thank you. Hi, Chris. Thanks for your question, Francisco Rado. So I would say that about the gross margin of the company, we discussed it before that the biggest impact on the gross profit margin in this semester instruments in the market, plus the additional investment that we had to do to sustain, to prepare for the growth and to say to feed the new customers. So this was a negative effect that we expect for sure to be absorbed by the additional revenue per instrument that we expect to see in the next few months. Now how fast this will happen? It's hard to say because we have a lack of visibility in the next month, but it is for sure expected the positive effect in this regard. In terms of magnitude, I can tell you that I would say more than 2 third of this drop is attributable to the D and A effect of underutilization of instruments. The second component is a more standard, let's say, effect in the market, which is the negative trends pricing. As you know, we normally we are well positioned in terms of geographies because of the mix and the increase in revenue coming from the highest price market is normally helping to set the biggest part of this negative trend. In this specific semester, we have seen U. S. Declining. We have seen Europe declining, but within Europe, we have also seen increasing shoulder and spine. The growth in this product line was, say, in country with pricing less favorable. So what we have observed in this semester is a geographic mix, which didn't offset as we expected due to the change in mix. Now again, is this going to change? We expect this will happen. How fast and how big will be the recovery is hard to say because of lack in visibility. But as we have seen, the increasing, let's say, other Pacific countries should bring the company to a level of profitability more in line with the last results. Overall, we do not expect to recover entirely the gap, but we expect for sure to be more in line with last year. Going down to the profit and loss, of course, this reduction at the gross profit margin level should be at least partially offset by, I will call savings by, but let's say, inefficient and volume effect at the EBITDA level. So the profitability at that level, the EBITDA margin is expected to improve as well. Okay. That's very helpful. Thank you, Corrado. Appreciate it. Thank you, Christian. And there are currently no further And we've received another question from Ruben Boyajan, Finance and Literatures. Your line is now open. Please go ahead. Hello. Thank you for taking my question. How much of the growth you have seen from June is a catch up and how much is going back to normal? And if there is a major catch up effect, is it already over? Or will it continue for a couple of months more? Yes, that is a very good question. And we did dive into this analysis in order to understand how much of this growth was here to stay and how much was just a temporary catch up. The analysis did reveal that we had a significant amount of sales coming from accounts that were not Medata accounts in 2019. So there is definitely a contribution of both. There is, as usual, the contribution coming from 3 different factors: the growth of our base of customers there is the growth of our new customers of 2019 that did contribute at a higher level in at least in the good months of 2020. And then there are sales coming from the surgeons that just started in 2020. So I can tell you the contribution is from all those elements. And when you read those double digit growth, you have to understand that it is coming from countries which are maybe delivering at 30%, 35%, 40% or even 50 percent growth rate. And it's easy to imagine that those countries have a huge portion of this growth, which is a recovery. And so for us, this analysis has to be done country by country, line by line. It's even more associated to new accounts in those lines, which are were already delivering a very solid growth such as spine and shoulder. So we did dive. We are relatively fine with the fact that this growth is not only recovery, but it is coming from new accounts that have been activated in the last semester, which is for me very important because it means they will continue to grow in the second half and more importantly in 2021. Okay. Thanks a lot for these clarifications. Thank you for the question. And we have a follow-up question from Alex Gibson, Morgan Stanley. Just a couple more. And you kind of answered it, but given the backlog that you've seen, are you finding surgeons and hospitals more or less receptive to switching to Medactor if they're spending a lot of their time just trying to get surgeries? How hard is it to actually get those new surgeon accounts on board? Yes. I would say this is, of course, a very important aspect. Surgeons which are playing catch up at 50% plus because they've been blocked for 2, 3, 4 months, they will definitely not take time to go to cadaver courses because they have to do their work. At the same time, we have seen many that were close to switch. They took advantage of the break to fully gain exposure and knowledge about the Bandaqta product. And when they switched immediately after the release of the lockdown, they really started at very high pace. So this played in both direction. And I would say that those which have been busy working in the last 2, 3 months, they are the one which are in our pipeline for the September, October November activities. So the interest has been potentially, let's say, was still part of their mindset, interest in switching to Medacta. They might have postponed by a quarter because of a very, very busy period in recovering their activity. Okay, great. And the very last one for me is, I'm just trying to understand if this is a rebasing of your sales or not at the end of the year because of the need to get new surgeons on board? And I know you don't want to give guidance for 2021, let alone this year. But should we be thinking about 2021 being able to show almost growth over a 2 year basis over 2019? Or is the fact that you haven't got these surgeons on board over the last 6 months make that unreasonable? I'm just looking at my estimate, the consensus estimates and we all basically expect 2021 to be a recovery back to your prior trajectory. In your guidance, you specifically said the growth trajectory shouldn't change. But do you think the absolute level of sales we should think about 2020 being rebasing? I think it is very important to see what's the level of education activity we're going to be able to actually deliver in this 2nd part of the year because we all know that the growth of 2021 will be based at least partially on surgeons that are expected to start in the second half of this year. I would say some of the lines did show a very strong trajectory, which incorporates a lot of new customers that will did not participate in 2019 2020 H1 top line revenues, which means their activity in 2021 will come for 12 months at a decent level of their ramp generation. So I would say that without COVID in a normal year 2021, we should see a good trajectory of growth. The only major question mark we have is how much of educational activity are we able to deliver in these 4 months, which are hopefully back to normal. If we are not able to engage as many surgeons as planned, this might potentially affect our trajectory in 2021. Okay. That's great. Thank you. Thank you, Alex. And we haven't received any further questions on the conference call. Thank you. Thank you all for your participation they gave to the company's performance in H1 and the commitment they have in continue to deliver in H2 in those more challenging conditions. But I've to say I've been very, very proud of the overall reaction of the company. So if there are no additional questions, I would like to thank you all and look forward to speak to you soon next time we have important news to deliver. Ladies and gentlemen, thank you for your attendance. This call