Stratec SE

XETRA:SBS

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. I'm Stewart, your Chorus Call operator. Welcome, and thank you for joining the STRATEC conference call regarding today's announcement for the Q3 2018 financial results. [Operator Instructions]I would now like to turn the conference over to Marcus Wolfinger, CEO. Please go ahead.

[Marcus Wolfinger, Chairman of Board of Management & CEO]

Yes. Thanks very much, Stewart, and good morning in the United States, and good afternoon in Europe, ladies and gentlemen. Welcome to our Q3 conference call.Before we dive in to the details, allow me to mention some housekeeping stuff. First of all, I would like to refer to our safe harbor statement, and secondly, I would like to mention that you can download this presentation at this point from the webcast -- website or later on from our website.So today's presentation is actually split into 6 major segments. First of all, we would like to give you an overview, what happened in Q3 and within the first 9 months of 2018, followed by a financial review. Third part is going to be our earnings improvement initiative. Fourth point, I would like to give you an overview of our outlook. And then certainly, the focus for 2018, the remainder and certainly with way more interesting focus of 2019, followed by the Q&A session.So organic sales declined by about 4% to EUR 134.6 million, representing a nominal decline of 9.9% compared to about EUR 150 million after 9 months in 2017. This is mainly coming from a reduction in sales, and we discussed this in detail over the past quarters, again, and I would like to mention 2 things already. At this point, we are very positive about our 2019 development and for the remainder of the year and, even taking the sales decline which is a bit higher than expected for Q3 into consideration the order income for Q4 and for the first 6 months of 2019, already are really promising. That's why we're fairly positive on that. We see some further headwinds coming from the first-time adoption of IFRS 15, and certainly, headwinds coming from FX. The majority actually is definitely coming from reduction in system sales, the weaker Diatron business and a slight -- we see this as definitely temporary slowdown in the demand of our service parts business. However, we see a nice product mix, which helped us very much regarding our margin in the Q3.Again, we see those signals coming from order income that we will see the upturn in growth -- in the growth momentum in Q4, and that's why we want to reconfirm and confirm our guidance given a month ago, and we want to confirm the positive outlook for 2019.Adjusted EBIT margin, down by 370 basis points year-on-year to 12.7%, which is actually already the upper edge of the guidance we gave after our profit warning. So the guidance is an adjusted EBIT margin of around 11% to 13%. It looks like we could catch the upper edge of that.We had some further contract wins and are in the course of very promising negotiations, all of them being in advanced stage, which means we do not just have a full development pipeline with certain market launches in the near future or market launches in the past, which are developing promising in terms of ramp-up rates.Then we have initiated already in summer this year our initiative, which will lead to a pretax cost saving of about EUR 2 million to EUR 3 million from '21 on, and certainly, we will see some initial cost savings already on our way between today and 2021.And I think the most promising in the actual figure showing the development in this company -- and I'm really talking about development activities, it's clearly indicated by the number of employees going up by more than 12% to more than 1,200 employees, which is nothing but development activities, and it's in the light of an extremely full project pipeline. And here, I'm really talking about the contracted development.Financial review. Sales, as mentioned before, changed year-on-year, including IFRS 15 adoption and including FX, about minus 10%. The FX coming -- excluding IFRS 15, about 7%, which means it already gets us a headwind of about 3% as a difference. Adjusted EBITDA down 25%; excluding IFRS 15, down 20%. Adjusted EBITDA margin, 350 basis points down, would mean -- or representing 290 basis points excluding IFRS 15. Sales being -- and actually very, say, linear activities regarding EBIT margin down 30%, which is all again in line with our expectations when we adjusted our 2018 guidance. And again, we are confirming what we said 1 month ago to see a sales decline in the low to mid-single-digit percentage range with an EBIT margin of between 11% and 13%, as mentioned in both cases, as we have a fairly nice order income already in effect in Q4 2018. We'll probably get to the upper edge of that. The adjusted consolidated net income, down 30%; excluding IFRS 15 activities -- or adoption, 25%; EPS of EUR 1 -- sorry, EUR 0.51, down 62%; excluding IFRS adoption, down 58%.Adjustments, in line with we did throughout the year, which means we -- on the EBIT side, we are mainly adjusting for PPA and expenses in connections with the transaction related to the restructuring process and an impairment of about EUR 650,000, which is mainly related to our initiatives to increase earnings between today and 2021.On the net income side, same thing. Adjustments mainly through PPA, now including current tax expenses and deferred tax income leading to consolidated net income from additionally showing only bottom line, consolidated net income from continued operations, EUR 6.1 million and an EPS of EUR 0.51 after adjustment.Financial review. On the sales side, 9 months were affected by 2.2 percent points coming from FX and 2.9 percent points coming from the first-time adoption of IFRS 15, leading to an actual organic sales decline of 4.8%, which is mainly coming from all those sectors we discussed through the year, mainly lower system sales coming from some lower demand throughout the entire base and certainly those effects coming from delayed market launch or slower ramp-up curves than initially expected. And I think it's worth mentioning that all those effects are well addressed. We believe that the instrument which has been launched late in '17 is now showing some traction. Forecast looks very positive, and again, we got the confirmation that the planned launch for the product which has been postponed a couple of times this year is now going to happen early in Q1 of 2019. And even all our other customer forecasts are showing some positive trends already for Q4 in terms of order income and forecast after H1 of 2019. We discuss all those positive effects, which have a good likelihood to give us some tailwind in 2019, like the launch of the LIAISON XS instrument, like the cooperation regarding tuberculosis testing between Qiagen and DiaSorin and all those other factors including market launches, and a more and more comprehensive menu on some of our molecular instruments. All that makes us fairly positive.Now discussing the adjusted EBIT and EBIT margin. Adjusted EBIT margin down by 30% year-over-year to EUR 17 million, a negative effect here about EUR 1 million due to first-time adoption of IFRS. Margin declined by 370 basis points, which is mainly negative scaling effect and the increased expenses related to our very strong project and development pipeline.Cash flow doesn't look much better, but here, the positive thing is that we have a fairly nice outlook regarding cash flows for Q4 already, and the operating cash flow is down in line with a sales decline. On the other end, we have some high CapEx spending due to significant capacity expansion here in Birkenfeld as well as some inventory activities to address the outstanding market launches and the ramp-up of certain products, additionally to a necessity to do some inventory management on the positive end because we are launching a new ERP system early this year, which means we have invested, to a certain degree, in inventory on the one hand side to make sure that we don't have any supply interruptions on the other side, certainly because we are expecting and already seeing higher demands for established and new products.Now getting to our earnings improvement initiative. We have segregated that into 3 major blocks on the -- certainly operational efficiencies, an increase of volumes in terms of insourced subassemblies, which means we are back insourcing certain subassemblies, which has been outsourced into our manufacturing site in Hungary, mainly attracting the more complex elements, mainly those ones with high run rate in order to really take advantage of coverage of overhead and earnings made by suppliers. This is an ongoing process. We have already transferred certain subassemblies and will continue to transfer subassemblies. Then certainly, we are streamlining our geographical R&D activities, which means we are growing in certain areas, and we have reallocated certain development activities, which are helping us to save significant costs over time. And then certainly, the implementation of the ERP system, certainly at this point, generating some headwinds, but we would actually expect some tailwinds particularly on the development side already from next year on.Then portfolio optimization. So we have already announced the disposal of our nucleic acid sample preparation business, generating sales of about EUR 2.5 million and an EBIT loss of about EUR 0.9 million in 2017, which is already showing some positive effects in 2018, and certainly the selective discontinuations of some smaller end of life cycle and less profitable products. The impairment on the product side we made is already addressed by that. And certainly, we are very selective here by means of what we do is that we look into the industry-related [ socket cost ] of certain products, which are kicking in independent of the number of sales of those products, and we will certainly continue to be very selective on that end as well.Then certainly, a focused allocation of development resources, which means optimizing our R&D opportunity costs. Here, I'm -- what I'm mainly addressing in this point is that we want to take care of that. Certainly, our business model is a business model which is based upon the fact that we help our customers to increase their return on capital. On the other end, certainly it is not meant that we have to cover all volatilities here. And certainly, we want to address it in a proper contractual manner, which will certainly one -- will certainly be one of the focuses in the future in order to help to decline the volatilities. And then certainly, we want to make sure that we have an optimized risk/reward profile in the development pipeline, which means actually trying to address the things which are needed in an R&D contract in a proper manner. Certainly, at this point, this means that we will reduce the number of smaller development projects within the group in order to take care of those products where we can really be assured that we have an adequate coverage of our opportunity costs.All this means that we are assuming an expected annual pretax cost saving of about EUR 2 million to EUR 3 million from 2021. I think this shows that we are really cautious on that, certainly focused but cautious and please allow me to reiterate that at this point that no personnel measures are -- personnel matters are involved in that earnings improvement program. To the contrary, actually, we will continue to see some intensive hirings in 2019, particularly because of the very strong deal and development pipeline, and we have a couple of new projects already lined up.So the outlook. For 2018 -- and allow me to reiterate myself. I mentioned that already in the course of the presentation. Sales is expected to decline organically in the low to mid-single-digit percentage range, where adjusted EBIT margin should be around 11% to 13%. Again, in both cases, I mean both -- for both KPIs, we expect to maneuver this company towards the upper edge of that figure. At least for the EBIT margin, we are extremely positive on that. Sales, again, we see that we have a nice order income for the remainder of 2018. And for the first half of 2019, the second half of the year is not yet covered by order income. It's actually covered by forecast. But even those forecasts are looking very promising. And even for those instruments where we had some difficulties in 2018, we see continuous, gradual improvement in the run rate, which makes us very positive that this is not going to be like a lumpy thing but -- and a gradual but continuous improvement in run rate throughout 2019.So first indications for '19, significantly positive organic sales growth expected, numerous upcoming products in terms of launches and certainly, ongoing ramp-up phases. All launches, which are expected to happen in 2019, are actually still on track and confirmed by the customers that at this point, there is no indication about any delays. Then certainly, we see some partial postponement of 2018 revenues into 2019, which means we see some moves of those products, which have initially planned to take up -- take off in H1 of 2018, now showing some nice indications for 2019.On the adjusted EBIT margin side, we expect significant growth. So it should be significantly higher than the level of 2018, very much coming from positive scaling effects, and then certainly, we see some first positive impacts coming from the defined earnings. We already find earnings improvement activities measures, which means that some of those measures which already show some positive effect in 2019.Now getting to the focus of the last 3 months of this year and certainly beyond that. So the most important focus is certainly the reaccelerated top line growth already from Q4 '18 on, but additionally seeing some reductions in the earnings volatilities across all our business units is certainly an important point, which means top line growth and reduction of earning volatilities across all our business units.Then certainly, we are on a good track to further realize the synergies coming from all our different businesses. We got new contracts, and we have this nice ability to do low-level manufacturing within the group, helping us to further improve the gross margin and certainly to attract new customers with the ability to do low-level manufacturing, high-level manufacturing, more complex consumables and so on and so forth. I think I don't need to dive into the details again but this is certainly an extremely attractive offering, which gets confirmed and confirmed over by several customers. So this is a really attractive offering.Then certainly, we want to leverage our expanded platform offering. We got new one platform to the market already. We will start selling that product from mid -- let me say, end of first quarter, the -- we will start selling the first KleeYa platforms to end customers. And certainly, this is not only an attractive platform for diagnostics applications. So we will definitely try to leverage that platform into other markets as well, same thing on the molecular and it's foreseen to happen in about 18 months from now.Then we want to achieve the milestones in development and the market launches within the foreseen time frame. Again, we have a lot of product launches within the next month or already have those product launches. Molecular platform has been launched. It's expected to ramp up significantly in '19, then we see some other instrument launches for -- and we just put a couple of examples on that slide, DiaSorin, Becton Dickinson, Quotient and certainly the KleeYa platform, so nice attractive business. Certainly, it's -- all those platforms are in the first year of its sales and it's not in any case a full year. We will definitely see some further growth with those platforms in 2020 and 2021. However, this year, a number of new platforms and the sheer run rate of those platforms from the beginning on in 2019 makes us very positive about the contribution of the new platforms to the group earnings already in 2019.Then certainly, we want to drive the results from our earnings improvement initiative, implementation of our SAP system, now group-wide. The first business units are already working with SAP. The remainder of the group will follow going live January 1, 2019. I think it's obvious that such a complex project always generates some frictions. However, if we are reviewing things at this point, we are positive that the number of hits will be minor and we are fairly positive to already show some positive effects from efficiency gains and so on already in 2019. That's the plan at this point.And then we want to expand our development capacities here in Birkenfeld. The building is on its way. The first step of the building will be finalized in May, June next year time frame. People may move in, and the second set is then to follow the 12 months following that period mentioned.That gets me to the end of the presentation, and I would like to hand back to Stewart who will explain us how to proceed with the Q&A session.

[Operator]

[Operator Instructions] First question comes from the line of Falko Friedrichs from Deutsche Bank.

[Falko Friedrichs, Research Analyst]

Three, please. Firstly, could you give a bit more color on which parts of the business should drive the growth pickup in Q4? Secondly, could you update us on how things are progressing at Diatron and your action plan here over the next month in order to improve results again? And then thirdly, could you give a bit more color on this temporary slowdown that you saw in the demand for service parts and consumer both in Q3 just in terms of how often this happens and whether that is really just a 3-month situation?

[Marcus Wolfinger, Chairman of Board of Management & CEO]

Yes. Thanks, Falko, for those questions. Allow me to answer the first -- the last one first because I think this is fairly important. We actually see this in the course of fairly regular Q-to-Q volatilities. Actually, we -- even if we look into the product mix, we saw a nice product mix within the consumables develop nicely, helping us with some tailwinds on the margin. We really see nothing special there. There are no demand decline or anything the like. Our installed base or utilization activities is just kind of inventory management of some of our customers. But even if we look into the run rate of November -- sorry, October and November, we clearly see that this is nicely picking up, and we will see the typical end of year business in this regard. Diatron, I think the situation we had in 2018 was a temporary situation. We are in the course of our budgeting process. We already did the first budget reviews, and we clearly forecast, internally forecast an upswing of the new products. Allow me to look back into the rear window mirror. The issues we had with Diatron in the course of this year was mainly that some of the older products showed a faster sales decline than initially expected. On the other side, we didn't manage to bring the new product to the market in time. That is an overcome situation. We think that the new products will show nice traction. And if we are looking into Diatron's budget for 2019, we already show some sales increases getting us back to the level we were at the end of 2017. Q4, again, throughout the entire installed base, I cannot get you some detailed information regarding isolated projects. But what we definitely see is an increasing demand throughout our entire product portfolio. That's what happened in the first month of -- in the first quarter of 2018. We see the total opposite that the demand throughout our entire product portfolio increases and not just increases in terms of Q4. We see some additional on top demand already for Q1 and Q2. So from my perspective, I think we are through the worst regarding the demand of the products. And again, allow me to reiterate myself. We had some difficulties that we saw some weaker than expected demand for certain products, some postponed market launches, flatter than expected ramp-up costs for certain product that hit us the hardest. But in parallel, we saw some slightly declining demand throughout our entire product fleet. And I think if we are looking into the actual order income and if we are looking into the forecast for next year, we see a way more positive trend than throughout 2018. I hope that answers your question.

[Falko Friedrichs, Research Analyst]

Yes, great. Maybe a quick follow-up. Did I understand it correctly that regarding the product launch by your U.S. customer that was ramping up a bit slower this year, did I understand it correctly that the forecasts are indicating a much better development over the next couple of months?

[Marcus Wolfinger, Chairman of Board of Management & CEO]

It's a definition of much better, but definitely way better.

[Operator]

[Operator Instructions] Next question comes from the line of Michael Ruzic-Gauthier from Berenberg.

[Michael Ruzic-Gauthier]

Just a couple from me. First, I was wondering if you could give me a little more clarity on the phasing of the cost savings out to 2021. Is that mostly back-end loaded? Or should we see pretty even development through the years in that? And secondly, I was just hoping you could give us an update on the consumables business. And maybe within that, I saw that you recently signed a deal with Vortex Bioscience. So I wonder how important is that for you guys and how is that business more generally progressing?

[Marcus Wolfinger, Chairman of Board of Management & CEO]

Yes. Thanks, Michael. Thanks very much for those 2 questions. Actually, the phasing of the cost savings is most likely not linear. So we have some quick hits, which will already be effective in 2019. And certainly, we will have a phase where it's fairly linear. And certainly, we have some more complex measure, which will only show traction in 2020 and 2021. So again, most likely some nice effect already in '19, and then some linear developments and another element of higher traction then in 2020 and 2021. Regarding our Consumables business -- and allow me to dive into the details here, so again, I cannot make statements based upon isolated projects. Certainly, any and all of our projects are calculated on a realistic level, which means any new development and manufacturing projects for consumables are important for us. We certainly -- this is a fairly nicely scalable business. Certainly, manufacturing polymer-based consumables makes way more sense at the upper edge of manufacturing quantities rather than on the lower edge. Certainly, for our Consumables business, the Vortex deal is an important one. From a group perspective, certainly, it is one of those new deals which will help us to make the consumables, particularly the smart consumables business, a nice and an EBIT margin accretive business for the group. However, the acquisition of the former Sony DADC BioScience, now STRATEC Consumables business, has a clear strategic component and it was obvious for us that we will see breakeven only in 2019, 2020. This was the planning from the beginning and margin accretive probably from 2021, 2022 on, and we would like to stick to that. As a matter of fact, we already [ wrote ] even in 2018, we still see some -- we will see -- still see some quarters in our Consumables business, and I'm just talking about the stand-alone Consumables business. We will see some volatilities here and there. On the other side, it's obvious that with the offering we have as a group at this point with instruments, more classical consumables, like tips and cuvettes and more complex microfluidic consumables that we have a unique product offering, which is certainly attractive for a lot of customers, particularly for activities of the clinical diagnostics industries, which only started like 5 years ago and we will definitely not peak out in the next 10 years that we will see more complex consumables driving sensitivity and specificity in our industry and that we will see microfluidic structures even on bigger instruments, and that's certainly taking advantage of that situation.

[Operator]

There are no more questions at this time. I would like to hand back to Marcus Wolfinger, CEO, for closing comments. Please go ahead.

[Marcus Wolfinger, Chairman of Board of Management & CEO]

Thanks, Stewart, and thanks, everybody. This gets us to the end of the Q3 2019 (sic) [ Q3 2018 ] call. Should you have any further questions, please do not hesitate to call our IR department. And thanks very much to participate in the presentation. Have a good day. Bye-bye.

[Operator]

Ladies and gentlemen, the conference is now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.