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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings. My name is Yasushi Sakai, Chief Financial Officer, Olympus Corporation. Thank you very much for joining us today for this teleconference in which we will be discussing the financial results of Olympus Corporation for the first quarter of fiscal 2020.
So let us begin by looking at the financial results. Slide 3. Here, we can see the 2 main points summarizing results in the first quarter fiscal 2020. Consolidated results for the first quarter are tracking in line with full year forecast with revenue and profit both increasing year-on-year. The positive effects of efforts to ensure greater efficiency in selling, general and administrative expenses company-wide have started to emerge. And the SG&A ratio has improved 2.6% year-on-year to 55.6%. There are no changes to the projections made at the start of the fiscal year since the first quarter performance did show that we are progressing steadily towards the achievement of our full year financial forecast.
I will now explain the first quarter results in further details. Slide 5. Here, we see an overview of consolidated results. Revenue increased by 1% year-on-year to JPY 181.9 billion due to solid performance in the Endoscopic Solutions division, Therapeutic Solutions division and Scientific Solutions division.
Gross profit declined 1.3 percentage points year-on-year due to the impact of changes in product mix, among others. However, we are in line with the full year forecast.
Operating profit increased significantly to JPY 14.7 billion due to a reduction in onetime expenses compared with the previous first quarter and greater efficiency and SG&A expenses. Operating profit exceeded the amount posted in the previous first quarter even if in the base, and they should exclude the onetime expenses or, in other words, other income and expenses.
Profit attributable to owners of parent was JPY 8.6 billion due to the significant improvement of operating profit with all profit figures manifesting strong growth. And the first quarter has gotten off to a positive start for the year.
Slide 6. Here, I will explain progress in the efforts to ensure greater efficiency in SG&A expenses. SG&A expenses for the first quarter decreased by 4% year-on-year to JPY 101.1 billion, and SG&A ratio improved 2.6% to 55.6%. This marks a steady progress in line with our policy to ensure greater cost efficiency under Transform Olympus. This can be attributed heavily to enhance awareness of cost among each employee as part of preparations to undertake measures to boost profitability over the long term, which we are currently examining. We will continue with the company-wide efforts to achieve our full year forecast.
Slide 7. The Medical Business was reorganized into 2 divisions and started operating as such in this fiscal year. For that reason, I will explain financial results for the Medical Business by referring to the 2 divisions of Endoscopic Solutions division and Therapeutic Solutions division. For the purpose of analytical comparison, results for the first quarter and the full year for the previous fiscal year will also be referred to using these 2 divisions. In addition, numerical data for the former Medical Business segment has been included in the appendix and also in the financial data for the first quarter of FY 2020 for reference.
Let us now turn to Slide 8. Here, we will look at the performance of individual segments. Endoscopic Solutions. Sales of gastrointestinal endoscopes and surgical endoscopes were solid, including maintenance services, which drove the company-wide performance and an increase in revenue and profit.
In Scientific Solutions, high sales growth of both biological microscopes and industrial products led into the record-high operating profit for a first quarter. In Imaging, operating loss was reduced due to the absence of production system reform costs in this fiscal year despite the lower revenue due to a decline in sales of mirrorless digital cameras. Elimination and Corporate saw significant increase in profit year-on-year due to the absence of the onetime expenses, which were recorded in the previous year.
Slide 9. I will now explain each segment separately, beginning with the Endoscopic Solutions division. Revenue increased by 3% year-on-year to JPY 95.4 billion due to extremely favorable sales of gastrointestinal endoscopes in emerging countries, particularly China, and increased sales in maintenance services in North America.
Operating profit increased by 2% year-on-year to JPY 21.9 billion due to revenue growth and the appropriate control over the SG&A expenses. The operating profit margin was 23%. The strategic positioning of the high-growth potential in China is increasing every year with the amount of sales, and they are continuing to expand. As a result, we are disclosing the Chinese renminbi exchange rate, revenue in China as well as the growth rate of our China business separately in the financial data from this financial results period.
Slide 10, the Therapeutic Solutions division. We continue to post growth in all domains, and revenue increased by 2% year-on-year to JPY 52.1 billion. Operating profit decreased by 3% year-on-year to JPY 5.7 billion, and the operating profit margin was 10.9%. Profit remained roughly unchanged year-on-year due in part to advanced investment to strengthen functions under the Transform Medical despite efforts to ensure greater efficiency in sales promotion costs.
Slide 11, the Scientific Solutions division. Revenue increased by 7% year-on-year to JPY 22.6 billion, and operating loss recorded in the previous first quarter was turned around to a profit of JPY 1.6 billion. The increase in revenue was due to solid performance in biological microscopes in North America and China, the effect of new industrial videoscopes and large shipments of nondestructive testing equipment within industrial products. In addition, the revenue growth, coupled with efficient control of SG&A expenses, led to a record-high operating profit on a first quarter basis.
Slide 12, the Imaging division. Revenue decreased by 27% year-on-year to JPY 10.2 billion, and operating loss stood at JPY 2.3 billion. Revenue was down due to a tough business environment for mirrorless digital cameras and no new mirrorless products this quarter following the reorganization of production bases. Operating loss was decreased due to the absence of costs associated with the reorganization of production bases, which amounted to JPY 5 billion in the previous first quarter, and efforts to contain SG&A. Although the tough conditions are expected to continue for the remainder of the first half of the fiscal year, we will aim to breakeven in the latter half of the fiscal year by introducing several strategic products and continuing to appropriately control SG&A expenses.
Slide 13, the financial position at the end of June. In assets, property, plant and equipment increased due to the impact of adopting new lease standards under IFRS. Inventories increased by JPY 8.8 billion due primarily to the impact of creating inventory for shipments from the second quarter onward.
Total equity decreased by JPY 11.2 billion from the end of previous fiscal year to JPY 431.2 billion due mainly to the issuance of dividends from the retained earnings and the negative impact of JPY 8.8 million in foreign exchange adjustments caused by the yen's appreciation. As a result, the equity ratio was 45.8%, a decrease of 1.5% from the end of the previous fiscal year. We will strengthen financial position by improving asset efficiency towards the end of the fiscal year.
Slide 14, cash flows. Net cash provided by operating activities was JPY 28.4 billion due to operating profit, particularly in the Medical segment. Investing cash flow was minus JPY 15.5 billion due mainly to the purchase of property, plant and equipment in the Medical segment, which included demonstration products and loaners. As a result of the above, we secured free cash flow in the amount of JPY 12.9 billion.
Next, I will explain full year performance forecast for fiscal 2020. Slide 16. There are no changes to the fiscal 2020 forecast announced in May in light of the steady progress made in performance in the first quarter. Assumed foreign exchange rates for the fiscal year are JPY 106 to the U.S. dollar and JPY 121 to the euro, reflecting results in the first quarter. There is no change to the dividend forecast we made at the start of the period and planning to pay an annual dividend of JPY 10 per share for fiscal 2020, up JPY 2.5.
Slide 17, financial forecast for each segment. There are no changes to the revenue and operating profit forecast for each segment made previously due to progress made toward the forecast in all businesses.
In closing, the Transform Olympus plan got underway this fiscal year, and we are steadily implementing measures that include changes in the governance structure to 3 committee Board structure, shift in the personnel system and reorganization of the Medical segment.
In terms of performance, we got off to a great start with first quarter results as growth in emerging markets, particularly in China, drove revenue growth for the entire company. And we made strides in enhancing efficiency in SG&A expenses.
We will move forward with Transform Olympus on a company-wide basis in unison and work to truly transform the organization based on the new management team established in June. We are planning to explain the corporate strategy in autumn. I will inform you of the schedule at a later date.
This concludes my presentation. Thank you for your kind attention. Let us now begin questions and answers. So we're ready to receive the first set of questions.
Question number one has to do with the reduction of SG&A expenditures and the progress to date through the end of the first quarter. Year-on-year, the decrease of JPY 23.5 billion on a full year basis against the previous goal during the first quarter of JPY 4 billion was reduced. Was it, more or less speaking, on track in your view?
The answer is yes. I'd say that the first quarter actual was -- we're on track.
Can you be a little bit more specific in which particular areas you reduced and expect to do so?
Okay. During the first quarter, year-on-year, the further decrease of JPY 3.9 billion in SG&A expenses. R&D, JPY 1.1 billion down in expenses. Through the review of various media commercial activities, such as sales promotion expenses, down by JPY 1 billion. And otherwise, company-wide, there have been various results of expense cutting activities. For instance, the need to reduce travel expenses, JPY 900 million. And among others, and after all, the entire organization has been prepared and moved to curtail costs.
So to supplement further, and so according to business around the year start under the planning, JPY 23.5 billion, had a target on a full year basis, which was broken out into JPY 15 billion from R&D and about JPY 8 billion before SG&A. Now, capitalization of R&D expenses was some JPY 7 billion plus. Now I recognize that this -- the target of the R&D capitalization has been substantially increased. This net debt may have the change in the composition of the full year target.
Okay. So the full year plan aimed to reduce by JPY 23.5 billion. What we have is the actual as we closed the books at the end of the first quarter. So we still have 3 more quarters, and JPY 19.6 billion need to be further reduced in order to reach the target so as against that JPY 19.6 billion. What I can say is that JPY 13 billion thereabout is in the area of R&D expenses. And JPY 6 billion plus, it would be if there further efficiency improvements or the cutting down on sales promotion expenses. Other expenses, including but limiting -- not limiting to travel expenses or the costs associated to the indirect purchasing operations.
Okay. JPY 13 billion to reduce the R&D expenses. Now JPY 23 billion is the capitalization of R&D expenses. That in comparison with the previous year JPY 9.4 billion means -- that means the JPY 13 billion, that's more or less the capitalization, yes?
Well, R&D expenses themselves, they have been reduced. But by and large, it's really owing to the smooth progress of R&D and the projects in line with the plan.
And then what about the timing where this capitalization of R&D expenses occurs? Is there any guidance?
Well, what I can say is that there is an accounting rule that we simply abide by. And for the rest of it, we keep track of the actual progress of the R&D project to determine when to capitalize.
First of all, I am going to start with the question regarding your Imaging Business. I guess all in all, the actual results were within your expectations. Saying this, however, on a year-on-year basis, our revenue was down even adjusting the -- for other income and expenses, still the magnitude of the -- they're negative, and they became bigger for the operating income, that is to say. So I understand that your plan for the Imaging Business is to increase revenue. So that means that the second quarter and onward, I mean, you are looking to the good effect of new products?
Yes. New products having a positive effect of boosting the top line. And also the Shenzhen plant, which, as you know, has been closed down, and the production has been transferred to Vietnam, basically, our aim has been to streamline or reduce the manufacturing costs, factory costs. With the further increase in the volume of production in Vietnam, the magnitude of benefit they will now become bigger. And that did not happen yet during the first quarter, and in turn, I know we have that bigger effects to come about in subsequent quarters.
But looking at the target market, the actual conditions of the market probably are much severe -- much more severe than what you were projecting 3 months ago, which was the start of the fiscal year. So under the circumstances, still need to talk about the positive expectation of the new product sales?
Well, what I say is that our unique, the technology of Micro Four Thirds, they approach. There was a good penetration there of on that lighter weight as well as under the smaller size all having been favored by specialists only because of the added value that we have been able to provide and that we are going to be continuously so with the new products.
I accept that. And then moving on to the second question, Therapeutic Solutions division. You made reference to Transform Medical to enhance the functionality and capabilities. In particular, what did you do in this context during the first quarter? Or what is the full year impact that you would foresee the impact on the P&L at the end of the year coming from these investments?
Thank you. So therefore, the Therapeutic Solutions division or the TSD business, we do have to consider upfront investments in order to have the good execution, implementation of the strategy in order for us then to have a clearly defined and proper strategy, and there has been the initial round of the survey necessary and so on the expenses associated with that as well as the infrastructure deployment further necessary. On a full year basis, I'd say, therefore, the due level will continue to may be incurred.
Supplementary question. Are you thinking of spending for the additional head count?
In part, yes.
In part, yes. But then in the next 3 years, are you prepared to make rather sizable investments to enhance the HR available?
My answer is that the order of that will be determined in accordance with the necessities. So nothing particularly has been decided for now.
Your Medical business, be it ESD or TSD, the Chinese business operations may have been growing quite robustly. And throughout your presentations today, you kept on saying they're very favorable or very strong. So what was in the background of the very favorable or the strong performance in China during this first quarter? Would you please give me further background information?
Yes. I'll do that. Chinese business, ESD, which is the Endoscopic Solutions division business in China, some -- the 20%-plus in the growth that was accomplished. I'd say, first of all, that the so-called mid-tier hospitals in China have been visited by the sales reps time after time. So the good effect of those ongoing activities emerged, and that was part of the actual performance. And also on the VISERA ELITE, the system, the launch has been very favorable in actual on the sales. And as to the 4K, the product for which we received the approval from the local regulator, the so-called CFDA last year, the good contribution happened to the first quarter revenue of this year. Therapeutic Solutions division, nearly 10% rate of growth. Here, the overall situations, including the prices, ESD devices, the exemplary the endotherapy devices and/or energy devices, generators. They all have been sold very well. I would repeat that the continuous efforts to have good communication happening with local customers in the market are starting to give us actuals, which are beneficial to us.
So a supplementary question. This is still about China. What you say is that they already executed a strong effort. They're visiting hospitals and so on. They are starting to benefit you. Nothing new, nothing additional be it activities or the additional products in China. So really, I would like to know why the rate of increase was so much bigger in this past quarter -- first quarter in China.
Well, my answer is that it really is not as though it went surprisingly unaware and there was a surprisingly larger rate of growth. Really, it has been our expectation that growth rate in China will be on the double-digit order, and that's our track record in China.
Okay. Then what you are saying is that you already had the internal expectation within the company organization that rate of growth available or coming from China, would be about a level which you actually ended up with?
That is correct. The Medical business in total in China would grow, more or less speaking, at the actual level that we confirmed.
Now my next question having to do with the capitalization of R&D expenses. And you were explaining about the impact that, that would have on the overall cost reduction initiative. Now you increased the amount of R&D, the expense capitalization for this year. What's in the background? Because last year, you started at a certain level of the plant and the R&D expense capitalization, which was reduced. And then this year, the starting level of the R&D expense capitalization was already higher than in the previous year, which was increased even further during your first quarter. So what happened?
My answer. The guidance that we had has always confirm that R&D projects are such that the SDE (sic) [ ESD ] and the projects get closer and closer, into -- in the prepared launch then capitalization is likely to come about more noticeably. Now during the first plan, as we have an R&D project plan where the investment for a certain R&D project was scheduled to be made in the following fiscal period, with a good utilization of available external resources in the so-called concurrent engineering income that was adopted. That front-loaded R&D, the activities, the faster speed of the project execution as well. And that meant that R&D expenses did increase [ in the end ] and this would [ under ] the capitalization of R&D expenses, but efficiency will be superior.
Okay. So what you explained to us on the previous occasion, lest the presentation of your results, it's already starting to give you actual benefits.
Exactly, yes.
Finally, the Imaging Business. On a full year basis, JPY 7 billion is the projected operating loss. Now, during the first half what you said was that losses would still remain. However, into the second half of the fiscal year, with the effect of new products, we'll be able to get to breakeven level. Now on the JPY 2.3 billion operating loss during the first quarter, which is the actual, was it smaller than what you had anticipated, what you expected, or about the same or more severe?
My answer. Full year and the operating loss of JPY 7 billion, the first half versus the second half. The first half plan, what you're alluding to, is that looking at the actual on the -- from the first quarter then, is it likely to increase the operating loss in the second half -- second quarter, excuse me. My sense is that the actual cost of R&D turned out to be the smaller or the actual -- and the cost for the Imaging Business in total, during the first quarter, there was, if anything, smaller than anticipated, but does not mean that we are not anticipating come the bigger losses during the second quarter.
Okay. So as you have a certain plan for the first half, then the first quarter actual was, relatively speaking, favorable, but not enough to give you concern for the bigger losses in the second quarter.
Correct.
I have been listening to you about the capitalization of R&D expenses. There are multiple interpretations which can be made about that. One particular -- one possible interpretation may be that, practically speaking, the challenge of reducing SG&A this fiscal year is a little bit too much. And so maybe the capitalization of R&D expenses should be increased in order to reach the target. So that's not a sense that you're alluding to, is that correct?
No, not at all.
The reason why I raised this is because the capitalization of R&D expenses was a formula that there must be various items which would have to be looked into. Isn't there ups and downs? And isn't that ever so busy? And what is the approach? Is it sort of like net present value approach that you may take? And what about the product delay?
Well, the first part of the question can be answered by definitively and answering that never for the purpose of accomplishing the cost-reduction goal, we had to resort to the bigger amount of capitalized R&D. There's a clear-cut accounting rule that we follow. So as the project reaches a certain point in R&D, then we would be ready to apply that accounting rule. The budget control over the R&D of the projects is there with a sense of discipline. To repeat my explanation, when a project reaches a certain stage, then it is predetermined that as a rule the capitalization term is ready and to be executed.
Okay. Then that means that I am following up with this further. VISERA ELITE II launched in the U.S. is now on this later tender to take place in the third quarter, which is the outcome of a delay. Has that at all resulted in the capitalization of R&D expenses?
My answer is no.
So something new, some things new. So what are they?
There was maybe endoscopes, surgical devices, new devices that you would sell to the surgical field. If I were to answer the question, I would only say that we are engaged in a portfolio of R&D projects. So here and there, you -- all expenses in all in different projects, and I cannot really identify any particular products.
If I could ask a further question along this line. I think you are investing in Israeli company called Medi-Tate. And I think they are going to go into the clinical trials, and would their R&D expenditures be capitalized as well?
Oh, regarding the particular company that you mentioned in our R&D plan, I think it's going to be quite some time into the future. And therefore, their expenditures are not included in our capitalization.
I see. My last question, I have a feeling that things are lagging behind the ENDO FLEX launch in Japan. I think there is some delay there, and the VISERA ELITE II launch in the U.S. has been postponed to the third quarter. And so I'm wondering if you're doing okay.
Things are moving along the original plan. Thank you.
So even for other surgical endoscopes? Although VISERA ELITE II launch in the U.S. will be postponed to the third quarter and ENDO FLEX is going to come out in the nearest future. Am I correct?
That is correct. No changes to the plan.
My question is in relation to the SG&A expenses. Your plan is to reduce that by over JPY 20 billion over a 1-year period. And I'd like to know the factors other than R&D, the general and administrative expenses, the personnel costs, how much saving are you projecting for the full year? The reason why I'm asking is that for the R&D portion, as has been made clear through earlier conversation, there are many technicalities involved. So there could be some gaps depending on how much saving you can actually achieve. So I'd like to know how much saving you are expecting from other portions, the head count reduction as well as improved efficiency for this fiscal year.
As I briefly mentioned earlier, for the remaining 3 quarters, from the second quarter to the fourth quarter, we are expecting saving of JPY 6.2 billion in the non-R&D portions. And this will comprise of, as I mentioned earlier, streamlining of sales and saving in the sales promotion as well as a reduction in the cost of purchase, the indirect portion.
I see. So in the first quarter, R&D accounted for JPY 1.1 billion. The remainder, JPY 2.8 billion is non-R&D. And for the second, third and fourth quarters, JPY 6.2 billion in total. Am I correct?
Yes. That is correct.
And one more question, if I may. In Imaging, you recorded the impairment loss of JPY 500 million. Can you elaborate on that as well as what is the inventory date as of -- or inventory days as of the end of June?
The impairment loss in Imaging given the state of profitability in that segment, we are applying the impairment of assets rather conservatively.
I see.
And with regards to the inventory days as of the end of June, around 5.8 months. That is the turnover.
Is that worse than as of the end of March?
Yes. Compared to the end of March, it has increased. In other words, it has worsened.
I have 2 questions. First is on ESD. I'm looking at the advanced markets. And could you comment on how the results in the first quarter did compared to your plan? And in the third quarter, you will be launching the VISERA ELITE II in the U.S. And what do you expect will be the effect of that in the results for the second half as well as next year?
The growth rates in Japan in ESD was 1% in the first quarter. As you know, our GI endoscope products are at the late stage of the life cycle. And last year, it was negative. So given that, the results in the first quarter were stronger than our expectation. The factors include strong sales of -- or strong sales efforts for peripheral products, which bore fruit. And in North America, the growth rate in ESD was 2%.
The drivers were?
Again, as the products are in the late stage of the life cycle, product life cycle, there were many challenges that were successfully met through the sales promotion efforts. And in fact, we saw the revenue from the service contracts increasing with the revision of the generic repair, pricing, et cetera. These efforts again brought about positive results, resulting in better performance than we had expected. In Europe, the ESD growth was about 2%. And here again, packaging with the maintenance services, the co-promotion proved to be effective, resulting in maintaining the growth rate to 2%. The VISERA ELITE II has already been launched in that market, and that made contribution and so did 4K product.
I see. So with the launch of VISERA ELITE II in the U.S. in the third quarter, you expect a positive contribution there. Am I correct?
Yes. That is our expectation as well.
I see. My second question is on TSD, Therapeutic Solutions division. Earlier, you said that there was the advanced expenditures, advanced investments. But you are expecting the operating margin to increase this year. So how -- on a full year basis. So while absorbing the increased expenses, how do you intend to achieve this growth? How confident are you in achieving that second quarter onward?
Sorry to have kept you waiting. For TSD, you are correct. We are incurring advanced expenses, but on a total full year basis, SG&A is to be kept to the same level as in the previous year while ensuring growth in sales, growing the top line. And we'll do that through expanding, strengthening the product portfolio as well as addressing GPOs and others in a strategic manner. These are the promotional activities taken by our marketing people. Through these, we would like to achieve the top line growth. And in addition, the cost of sales ratio should be improved. In the previous year, there was a onetime -- one-off expense incurred in the fourth quarter, if I remember correctly, which hurt the cost of sales ratio. But that factor would not be repeated this year, and therefore, we can expect an improvement in the cost of sales ratio, which should contribute to the growth in the second half.
I have a follow-up question. So you are seeing an increase in the capitalization of the R&D expenditure. And at the same time, you're not changing your forecast on depreciation for the full year from your original forecast. But with the launch of new products, I thought the depreciation expenses would go up as well. Am I not correct?
After capitalization, you are correct. With the launch of the product, depreciation will start. For this year, there has been an increase over the forecast regarding our capitalization, but the launch and depreciation would be next fiscal year.
I see. So you're saying that the product launch will be next fiscal year?
Yes. That is with regards to the increment portion to the original forecast.
So additions to the forecast, that will be launched next fiscal year?
That is correct.
So the capitalization that you are incorporating in the regional forecast, those would be launched this year. And you are not providing any guidance on the depreciation for R&D? Am I correct?
That is correct. [Statements in English on this transcript were spoken by an interpreter present on the live call.]