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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 of Olympus Corporation. Thank you for joining us today for this teleconference in which we will be discussing the financial results of Olympus Corporation for the third quarter fiscal 2020.
Let us begin by looking at the financial results. Slide 3. This shows the key points of the financial results. Consolidated results for the 9 months were solid, led by the Medical Business. Revenue increased by 6% on a base, excluding foreign exchange impact. All profit indicators increased markedly, in particular, operating profit, which was JPY 78.5 billion, a record high for the 9-month period.
SG&A expenses decreased by JPY 26.2 billion year-on-year. As a result, the SG&A ratio to revenue stood at 49.8%, marking a considerable year-on-year improvement, with a reduction of 5.7 points. Olympus is starting to see a change in the mindset of employees due to "Transform Olympus", a plan aimed at boosting efficiency company-wide and that we are currently undertaking.
Looking at each segment, the Medical field posted record higher revenue and operating profit both for the third quarter and for the 9 months due to the continued strong sales growth in China. Scientific Solutions division also posted record-high operating profit. With regard to full year financial forecasts, projections for revenue and operating profit have been revised upwardly in light of progress during the 9 months.
Slide 4. I will now explain the third quarter results in more details. Slide 5. This shows a summary of consolidated financial results. Consolidated revenue for the 9 months amounted to JPY 595.1 billion, up 2% year-on-year due to solid performance in the Medical and Scientific Solutions divisions. In real terms, excluding the effect of exchange rates, consolidated revenue increased by 6%, marking steady growth. Operating profit increased considerably on the back of steady progress in efforts to increase company-wide efficiency in SG&A expenses and reducing onetime expenses, while at the same time, increasing revenue. This resulted in a record high for operating profit. Profit attributable to owners of parent was JPY 59.1 billion as a result of a significant improvement in operating profit.
Slide 6. I will now explain results for each business segment in more details from the next slide. Slide 7. Let us begin with the Endoscopic Solutions division. Revenue increased by 4% year-on-year to JPY 315.1 billion due to strong performance overseas, particularly China, a strong growth driver for the Endoscopic Solutions division and Russia, where a government-led cancer prevention project is underway.
In real terms, excluding the effect of exchange rates, revenue was up 8% for the 9 months or 10% when looking at the 3 months period of the third quarter, marking high growth. Operating profit increased by 39% year-on-year to JPY 91.6 billion. The operating margin was 29.1%. Even excluding the JPY 9.7 billion in expenses associated with the plea agreement with the U.S. Department of Justice in the same period of the previous fiscal year, the operating profit still increased by a considerable 21% year-on-year.
Slide 8. Let us look at the Therapeutic Solutions division. Sales increased in all business areas, particularly endotherapy devices, in which sales have been increasing for products which meet market needs in each region, and urology, where sales of flexible endoscopes have been strong, resulting in 2% growth in revenue year-on-year to JPY 163.6 billion. In real terms, excluding the effect of exchange rates, growth was 6%. Operating profit was up 9% year-on-year to JPY 22.5 billion, due mainly to the growth in revenue. The operating margin was 13.8%.
Slide #9. I will now explain in further details the Chinese market, where double-digit growth has continued in recent years and which is driving significant growth in the Medical. Olympus entered the Chinese market around 50 years ago and has developed the business there, and while building relationships and trust with local doctors. Sales in the Chinese market increased 3.5x in fiscal 2019 compared to fiscal 2012, with China's share of sales in the Medical Business roughly doubling over the same period, currently accounting for about 12% of sales in this business. China is supporting the considerable growth in -- of the Medical Business as a growth driver.
On the following side -- slide, I will explain the background into this remarkable growth as well as the future potential. Slide #10. This is in China. Health care standards vary according to the classification of hospitals, and patients tend to concentrate in large hospitals or the Class III hospitals. Resolving this situation has been an urgent issue so various actions have been taken.
First, the State Council of China released the 12th Five-Year Plan in 2011, which aims to promote standardization of local medical institutions and improve medical standards at county level hospitals. In 2016, "Healthy China 2030" and the "13th Five-Year Plan" were announced as a strategy for improving the health of the people, and a policy for strengthening preventive health care was released.
China is promoting early diagnosis and early treatment to improve early diagnosis rates in certain regions and the cancer 5-year survival rate. In 2019, a working plan for improving the comprehensive capabilities for county-level hospitals was released. This plan aims to raise the health care standards of 500 county-level hospitals and 500 TCM hospitals into the same level as Class III hospitals or the Class III TCM hospital.
In line with this trend to strengthen preventive health care, new budgets have been allocated to these Class II hospitals, and construction of new hospitals and capital investments are being actively implemented. This has enabled us to achieve high growth in the medical field, especially in our Endoscopic Solutions division. Since our gastroscope was first used in China in 1972, which is the year of normalization of diplomatic ties between Japan and China, we have continued to strengthen our business foundation in China ahead of our peers. Leveraging the trust we have cultivated over the years, we will strive to achieve further growth in the medical field by actively supporting the education, training of physicians and working with hospitals and academic societies.
Although we expect our business activities to be impacted by coronavirus outbreak in the -- over short term, we do not expect any change in the trend of expanding demand for endoscopic treatment, which is backed by the government policy, and therefore, we aim to grasp the long-term opportunities for growth that this provides.
Slide 11, the Scientific Solutions division. Revenue increased by 5% year-on-year to JPY 76.6 billion, and operating profit surged 62% year-on-year to JPY 8 billion. Biological microscopes performed well in all regions while sales of industrial products increased, driven by steady growth in such products as industrial videoscopes and nondestructive testing equipment. In addition, this segment posted record high operating profit, both for the third quarter and for the 9 months, due to the revenue growth coupled with efficient control of SG&A expenses.
Slide 12, the Imaging division. Revenue decreased by 9% year-on-year to JPY 34.7 billion, while this segment also posted an operating loss of JPY 7.4 billion. The decline in revenue was due primarily to difficult business environment alongside a lack of new product introductions in the first half of the fiscal year caused by the restructuring of manufacturing base.
Loss was reduced due mainly to the absence of expenses for the restructuring of manufacturing base recorded in the same period of the previous fiscal year and to increased efficiency in SG&A expenses, but this was insufficient to improve profitability as much as expected.
Nonetheless, looking solely at the third quarter, revenue was up 6% due to the introduction of new mirrorless products and profitability improved together with gross profit. While the tough business environment continues, including a shrinking of the camera market, we will strive to improve profitability by expanding sales of new products and appropriately controlling SG&A expenses.
Slide 13, financial position as of December 31, 2019. Assets and liabilities both increased due to the impact of adopting new lease standards under IFRS. Additionally, although inventories increased by JPY 14.2 billion, this was due mainly to the creation of strategic inventory toward the end of the fiscal year. Total equity stood at JPY 397.3 billion, down from the end of the previous fiscal year due to share buybacks conducted in August 2019. Based on this, the equity ratio was 40.1%, down 7.2 points from the end of previous fiscal year.
Slide 14, cash flows. Net cash from operating activities increased by JPY 69.2 billion to JPY 105.7 billion due to the generation of operating profit, mainly in Medical. Net cash used in investing activities was JPY 45 billion due primarily to purchases of property, plant and equipment, such as demonstration products and loaners in Medical. As a result of the above, free cash flow amounted to JPY 60.7 billion.
Cash flow from financing activities was minus JPY 29 billion due to share buyback and repayments of borrowings while issuing bonds in December of last year. Going forward, we will utilize various means of financing and prioritize investments for growth, particularly in Medical.
I will now explain financial forecast for the year ending March 31, 2020. Slide 16. Regarding the outlook for the fiscal year ending March 31, 2020, despite factoring in approximately JPY 10 billion in expenses for responding to the market for duodenoscopes, we have revised forecast for revenue and operating profit upward in light of progress during the 9 months. I will explain our response to the market for duodenoscopes later.
Assumed exchange rates for the fiscal year are JPY 109 to the U.S. dollar and JPY 121 to the euro, reflecting results in the third quarter and recent foreign exchange trends. A year-end dividend of JPY 10 per share is forecast for fiscal 2020, marking an increase of JPY 2.50 per share. This forecast remains unchanged from the initial forecast.
Slide 17, forecasts by business segment. We have revised forecasts upward in the Endoscope Solutions division, Therapeutic Solutions division and Scientific Solutions division in light of progress during the 9 months. Revenue and operating profit forecasts have been revised downward in the Imaging division due to difficult business environment. The forecast for Elimination and Corporate has been revised after factoring in upfront investments under Transform Olympus.
Slide 18. I will now explain our response to the duodenoscope market that I mentioned earlier. The FDA issued safety communication to health care facilities regarding efforts to reduce risk of patient infection with duodenoscopes, and Olympus has been undertaking various measures as a medical device manufacturer. These disposable endcap-type duodenoscopes have already been introduced in Japan and Europe, et cetera, and FDA cleared this duodenoscope in the U.S. in January 2020. We have confirmed safety of all the duodenoscopes. However, we will conduct voluntary transition from fixed endoscope-endcap-type duodenoscopes to new disposable endcap-type duodenoscopes and promote the early adoption of the new duodenoscope in order to contribute to patient safety.
Slide 19. Next, I will explain our next-generation gastrointestinal endoscope system, which is of great interest to investors. We have already communicated the functions and other aspects in our corporate strategy. In addition to improving basic functions, such as image quality and operability, this model is a strategic product that promises to become a new standard in endoscopic examination and treatment by incorporating a number of completely new proprietary technologies aimed at achieving both high medical value and high efficiency and economic value.
Going forward, this product is expected to be launched from the markets where regulatory approvals are granted. In the third quarter, Olympus continued to make solid progress and posted record high operating profit as in the first half. In the remaining 2 months of the current fiscal year, the entire company will continue to work together to achieve the full year forecast set out today as well as a 20% operating margin in the full year ending March 2023, a goal set forth in our corporate strategy. That concludes my presentation. Thank you very much for your kind attention.
Now we are ready to start Q&A.
My question number one. So for the October-December period, actual versus the plan for revenue as well as for operating profit, by how much you outperformed in total? And also any -- if any fluctuation by segment, I would like to know that.
Thank you for the question. So I heard you to say October-December period. Basically, in the Medical and Scientific Solutions divisions, the actual was slightly above our expectation, if I may. In the meantime, for the Imaging division, on one hand, there was the positive, the effects in the -- of the new product launch but that increase was not necessarily as much as we may have anticipated, okay.
So in terms of the actual number, I understand, it's JPY 27.5 billion operating profit. So was your original plan somewhere like JPY 22 billion to JPY 23 billion, maybe?
Yes. You are asking about the third quarter operating profit. It was slightly above our expectation.
Question #2. So full year forecast. On Pages 16 and 17, the information is carried. On Page 16, what you said, who was the [indiscernible] for duodenoscopes, there's some JPY 10 billion as a market response. Where is it in Page 17 by segment? And also Elimination And corporate, I think upfront investments associated with Transform Olympus is in here. So would you clarify that, please?
JPY 10 billion for the duodenoscopes. It's in the cost of sales line. For the Transform Olympus upfront investment, basically, these are IT infrastructure enhancement and the associated investments. Thank you very much.
Of course, you said in the line saying cost of sales, but which segment is what I really wanted to know. For instance, it's all to do with duodenoscopes, so it's endoscopes in the ESD. If so, even with the JPY 10 billion earmarked, and therefore this, still, the ESD being able to have beaten the stronger performance by some JPY 5 billion. So we are certain that would make it, effectively speaking, JPY 15 billion boost in ESD.
The answer is yes, it's all in the ESD, Endoscopic Solutions division.
Okay. So just to confirm, in the effective real terms, you're talking about JPY 15 billion increase or upward adjustment for the Endoscopic Solutions division?
Yes.
So just over the 3 months period, have -- to accomplish this upward guidance adjustment by JPY 15 billion. So Q3, you kept on saying a slight increase, modest increase, what is slight and what is modest? And if so, how much would you expect that to be outperformed in Q4?
If I may, I would like to defer this response to a bit later. We're checking numbers.
That's fine. Then in the meantime, question #3 for myself, which has to do with the inventory level in the IMD, Imaging business. How much was it at the end of December? How was it in terms of the year-on-year change or the quarter-on-quarter change?
At the end of the third quarter, inventory was JPY 18.6 billion.
Okay. So what is the company's observation regarding that level of inventory? Do you, by and large, consider that this is relatively high, low or what?
We're talking about the third quarter, the situation. The operation was pointing to the new product sales. So inventory, if anything, kind of was built up and this surge is relatively higher than the normal. However, the -- this inventory will be controlled that was sold to the market, that was in the fiscal year-end.
Okay. If I remember correctly, though, at September end, the inventory level was JPY 18.6 billion. No change at the end of December?
Correct.
So I appreciate, kindly, if you would give me the answer to my second question later.
And I do have that answer, by the way. So for the third quarter, the over performance by JPY 6 billion.
So that means in the final quarter you're talking about JPY 9 billion, that's the magnitude of an upward adjustment?
Yes.
Then back to my original question. For the IMD downward adjustment by JPY 2 billion, SSD basically is confirming. So for the third quarter on the ESD as well alone, a JPY 3 billion increase and SSD increase. So I suppose the situation is that, all in all, there's some JPY 5 billion, maybe a little bit less, but almost JPY 5 billion where we saw from the overperformance in the third quarter? That is what you mean by slight or the more or less modest?
Yes.
My question to you has to do with the duodenoscope market response. So according to my calculation, each year, the annual sales of the duodenoscopes is about JPY 10 billion. So given that magnitude, you think that the market response calling for JPY 10 billion. So that's a lot of money that you're willing to spend. So what are you going to do with that JPY 10 billion, which when you say response to the market.
Thank you for the question. Basically, it's the improved safety of the scope. So for that purpose, the recently approved -- the new TJF model and with that removable, the distal cap. What we would like to encourage is to the -- on behalf of the market and the customers replace the older scopes with that new one, have -- with the removable distal caps.
So is that a recall expenses?
No, it's not a recall because what we are trying to do is that we are going to buy back from the market the previous model scopes with the fixed distal cap. And in turn, we're going to -- and have those scopes be replaced with the new removable distal cap on the scopes.
So is that replacement or the transition to be accomplished in the final quarter this year?
We'll -- we will have the allowance provided -- providing for the costs in the -- of that exercise in this final quarter. The physical buyback and replacement of that will be in the 153 period and beyond.
Okay. Then sometime before, I think I heard the company to say that the single-use scope to be launched by 2023, I think it was back in November that you quoted that, are you accelerating the plan?
No, we are not accelerating that plan.
Okay. Finally, about China. I can see how difficult it will be to estimate the magnitude of impact coming from this new coronavirus outbreak in China. But is there anything that you can share with us, just image or sense, whatnot? For your reference, it was yesterday that Boston Scientific made its result presentation.
Among others, they said that in the January-March 3-months period, there is going to be $10 million to $40 million impact in China. And given the typical sales performance in China in the 3-month period, that is about 15% of the 3-months revenue. So I wonder whether it is that sort of the magnitude of impact, 15% to 20%?
Well, I hear you, but what we know is that, at present, various activities are on hold. And how that in final analysis would impact our operations going forward, there may be the delivery timing, some of them may be affected here and there going forward. But those -- the amount and the impact, different types of impact, we just cannot estimate right now.
2 questions from myself. My first question has to do with SG&A reduction. On Page 5, I think it was, you talked about SG&A reduction at a constant currency or as if the foreign exchange effect is adjusted out.
On the 9 months total after FX adjustment, it's a 6% reduction. In the third quarter alone, 7% reduction in SG&A. Particularly speaking, and the third quarter percentage -- the percent reduction of SG&A must have been quite noticeable. So what enabled you to reduce by this much in the third quarter by 7% after FX adjustments? Doesn't have to be of quantitative, maybe qualitative analysis would be helpful.
Well, thank you for the question. Basically, it's aligned with the trend from the recent past with respect to reduction of R&D expenses, indirect costs, let's say, being such as with outsourcing arrangements and/or travel expenses. So those items. In other words, for the third quarter of this year, nothing particularly noteworthy to -- meant to speak of.
I see. My next question is also cost related. I'm looking at the financial data material and you're showing the number of employees by segment, the changes in the number of employees. For TSD on a quarter-on-quarter basis, apparently, the number of employees is coming down. And I would like to know the reason why.
TSD has been moved to U.S. and is managed by Americans, so I'm wondering if that is having an impact on the number of employees as well. I'm just guessing.
So why is it that the number of employees at TSD is declining is my question?
As for this breakdown of TSD versus ESD, actually, this is not really an apple-to-apple comparison between March 2019 and December 2019. For Medical overall, the numbers you see there do reflect reality. But when it comes to the breakdown on the division basis, it is not that the number of employees has actually come down for TSD.
I see. So going forward, is it likely that people will shift from TSD to ESD? Is that a possible trend going forward?
No. That is not likely. So this is just a matter of accounting method.
So I take it that in reality, the people are not shifting between divisions. Am I correct?
This is Takeuchi speaking. Let me take that question. As you know, the TSD-ESD structure was introduced in fiscal 2020, this fiscal year. Until the previous fiscal year, we had 5 business units. But for the sake of comparison, we showed you the number of employees as of March 2019 as well.
In reality, we did not have that division between TSD and ESD as of March 2019. And that is the reason why this is really not an apple-to-apple comparison. Starting this fiscal year, we have TSD and ESD. But going forward, it's not likely that we are going to see the people shifting from one division to another.
Just looking at the third quarter, the ESD sales and profit, the changes in the endoscope sales and profit. Excluding the foreign exchange impact, sales increased by about JPY 10 billion and profit also increased by about the same amount, I think.
And I take it that there were no particular onetime expenses incurred during the third quarter. So can you elaborate on the reasons for increase or decrease here?
Well basically, ESD had a strong quarter, especially in China, very strong performance in third quarter, continuing on from the second quarter. And also in Europe, particularly in Russia, helped by the government-led oncology project, the performance was strong. So those 2 are the major factors.
I see. Compared to sales, profit seemed to have grown by a large margin. And I guess, this is due to increase in sales, improved efficiency and expenses. And anything else? In other words, were there any special factors, either last year or this year, is my question?
No. There were no special factors. Be it in China or Russia, the products that are selling are scopes, which have higher profit ratio. And we have been successful in managing costs as well, and those are the factors.
I see. Now looking at ESD by region, Europe is strong and I believe that's because of Russia, as I said. But obviously, North America did well as well. What are the reason for that? Although I know that I really should be looking at the trend on a quarterly basis.
In North America, we are carrying out sales promotion activities and they are bearing fruit, the results. And we are promoting refurbished products to middle- and lower-end hospitals, which helped the performance.
Maybe my question overlaps somewhat with one of the earlier questions, but I'm looking at the growth rate of endoscope segment, the older-segment basis on the local currency. Looking at Page 5 of the financial data material, I can see that North America and Europe are strong.
And you have been talking about the new product, and I'm wondering whether or not some of the customers are holding back orders in anticipation of the new product, new launch. And since the products are at the end of the life cycle, on a local currency basis, you said that sales are expected to be flat in Europe and the U.S. Does that assumption remain valid today?
Are customers holding back orders in anticipation of new launch? Well, we are carrying out sales promotion to prevent that from happening. And your second question, yes, we expect the sales to be flat.
So should we assume that as for the fourth quarter, the sales in North America and Europe would slow down somewhat?
This is Takeuchi speaking. I would like to take that question.
In Europe, among ESD products, broadly speaking, there are GI scopes and surgical scopes. And the new product launch that was described earlier basically is GI scopes. And just looking at GI, we do not expect big growth year-on-year. But when it comes to surgical imaging products or scopes, we believe that some growth can be expected.
I see. My second question is regarding the single-use device. Boston Scientific has obtained approval for the single-use duodenoscope in the U.S. and Europe as well. Any comment on that? Some talk about the cost being the disadvantage, but Boston Scientific is talking about possible increase in the reimbursement price as well as room for improvement in terms of cost reduction. So including that, do you have any comments?
Again, this is Takeuchi speaking. I would like to take that question. Boston Scientific's disposable duodenoscope, we are watching the development very closely. You mentioned the reimbursement price to go up, that is being rumored. But as reality, we have yet to see that happen. And how many units are being sold? Well, so far, it appears that Boston Scientific is not aggressively promoting this product. I think it's something for the future.
But there is a cost issue as well as the production capacity issue, and therefore, we doubt that Boston Scientific would immediately embark on promoting this. But of course, we will continue to watch this carefully.
In the interest of time, the next person will be the last questioner.
Let me just focus on China. I'm looking at Page 5 of the financial data material, and obviously, Endoscope in China is growing at a surprising rate, 26% in the first quarter, 33% in the second quarter and 56% in the third quarter. Through the baseline, the previous year was low but this is really astonishing.
Is this because the product is being promoted to, not just Class III hospitals, but to semi-Class III, Class II and Class I hospitals as well?
Basically, yes. So theoretically, this momentum should be maintained in the fourth quarter as well.
But there is a concern about the coronavirus outbreak. And so in terms of the hospital infrastructure, obviously, they are focusing more on hematology. And there is more string -- stricter requirement for the cleaning and disinfection. So what is your expectation regarding the growth in the fourth quarter?
As was mentioned earlier, the impact of the coronavirus outbreak is very hard to predict. You are correct. As part of the impact, hospitals will be prioritizing what to purchase. And so what to do with endoscopes, obviously, would be a valid question. And our sales and marketing activities will be constrained and supply chain would be constrained as well, obviously. So we don't know to what extent we can actually deliver the product. These are all of the possible impacts that we should expect for the fourth quarter.
And so there is a possibility that the growth will be lower than what has been the case in recent months. But conversely, because of the stronger requirements for cleaning and disinfection, more time for reprocessing and therefore need for more endoscopes.
Are you already seeing the sign of postponing the procurement?
Again, this is Takeuchi speaking. As was mentioned earlier, the impact is there. We do expect that. But how much of an impact? We can't say precisely at this juncture. Currently, our China office is still closed. And the workers there are working from home and that will continue until the end of this week.
And as is being reported by news media, hospitals are in confusion, logistics are in confusion and disruption. So as you say, maybe some of the hospitals can't afford to think about purchasing endoscopes especially for the rest of the fiscal year. In February and March, the Scientific Congresses on endoscopy and GI-related conferences have all been canceled. And so we do expect rather significant impact. But on the other hand, there are signs of special demand to address the new virus, for example, for bronchoscopes. Still, we don't know whether we can deliver the products. So we don't know how much of such special demand could be met, we don't know. Maybe we can talk more in more detail in about 1 month's time.
[Statements in English on this transcript were spoken by an interpreter present on the live call.]