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Edited Transcript of SBSG.DE earnings conference call or presentation 15-Aug-19 12:00pm GMT

Half Year 2019 Stratec SE Earnings Call

Sep 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Stratec SE earnings conference call or presentation Thursday, August 15, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Marcus Wolfinger

Stratec SE - Chairman of Board of Management & CEO

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Conference Call Participants

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* Michael Ruzic-Gauthier

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Volker Braun

Bankhaus Lampe KG, Research Division - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. I'm Stuart, your Chorus Call operator. Welcome and thank you for joining the STRATEC conference call regarding today's announcement for the H1 2019 financial results. (Operator Instructions) I would now like to turn the conference over to Marcus Wolfinger, CEO of STRATEC. Please go ahead.

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Marcus Wolfinger, Stratec SE - Chairman of Board of Management & CEO [2]

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Yes. Thanks, Stuart, and good afternoon, ladies and gentlemen in Europe, and good morning in the United States. Welcome to our H1 financial results conference.

Before I start, I would like to mention some housekeeping stuff. You can download the presentation from our website or from the actual webcast.

And before I start, I would like to refer to our safe harbor statement. I think I don't need to read through that. As usual, we are trying to split this presentation into 4 major actual segments. The first one is H1 at a glance followed by some financial details. And then I would like to get you an outlook, trying to address the visible events over the next 18 months and talking our strategy. And then I would like to get you the opportunity to ask some question and trying to answer those question.

2019 first 6 months were relatively successful, let me put it that way, particular taking into consideration that earlier, we said that we want to catch up on the top line growth we lost last year and would probably like to add some 5%. At this point, we managed to show top line growth of 21% in constant currency and nominally 24%. EBIT margin, a growth of 130 basis points to an EBIT margin of 11.5% versus 10.2% after 6 months in 2018.

We had some really successful product launches, which includes the LIAISON XS system and the FACSDuet system. Particular, the second one, our latter got delayed in the quarter of 2018, and the lack of sales we had last year was partly attributable to the delayed launch. Again, no finger-pointing. I think Becton Dickinson and us did the right thing to do the relevant work to make sure that we have this successful product launch. Now as the product is on the market, we see nice development here as well.

Then we really had some nice progress, actually, lately, on the congress of the American Association of Clinical Chemistry (sic) [American Association for Clinical Chemistry], which only ended last week. So we are getting closer to further executions of several contracts.

Then number of employees grew by 8.7%, which actually includes the discontinuation from a balance sheet perspective of our molecular biz, which had been sold. And then we had certainly the successful go live of our new ERP system and certainly, the new construction work to expand capacities here at the headquarter. Stage 1 has actually been brought successfully behind us. The majority of the relevant departments already moved in May. And the second step is actually foreseen to be concluded by mid next year.

Financial review. Top line growth, as mentioned before, coming from about EUR 89 million after H1 in 2018, now EUR 110 million, growth of 24%. Adjusted EBITDA, coming from EUR 12 million to now EUR 17 million, representing a growth of north of 40%. The EBIT margin was a similar growth of 200 basis points, adjusted EBIT in the area of the growth of the EBITDA, which actually shows nice progression regarding the difference between EBIT and EBITDA. As well again adjusted EBIT, growth by 40% then very much driven by certain, let's say, tax payment and other things. EBIT margin, a growth by 130 basis points. And I think we don't have to be worried just to -- already mentioned it, but I will dive into details later on. We shouldn't be worried about that there are still like at least 250 basis points to be achieved for the full year. I think if we are looking into elements like the product mix and particular like dosings which are actually driving the margin in the second half of the year, we are actually exactly where we intended to be at this point.

Post-tax figure, same thing, about 37% consolidated net income and EPS about 36%. So I would say, actually, a linear progression of any earnings cycle coming from EBITDA over EBIT and net income as well as EPS.

Sales. Certainly, we had some positive effects, about 2.4 percentage points coming from FX. On a constant currency basis, growth was in the area of 21.7%, again, very satisfying.

What I would like to mention at this point, but again, I will dive into details if we break down the revenue streams later on, that very much driven by very high development and service sales due to achieved development milestones and development targets, we had to recognize revenues very much driven by new rules. I would like to mention IFRS 15 at this point. So we will definitely not show a similar development here as far as development in sales, and service sales are concerned in the second half of the year. So I would like to mention at this point that this -- that the first half of 2019 was definitely heavy of revenues coming from development and service activities.

Again, the positive spin is that, particularly the core rates of our customers regarding established systems literally went through the roof. And like if you see those instruments which have actually been launched already in '15 and '16 and showed weak performance in '18 are now starting to show traction. Same thing for our instruments which have only been launched recently like in 2019 or at the end of '18, very nice progression here as well. So an overall picture from those revenues which are representing the core business of STRATEC by means of instrument sales, it looks very, very positive.

Now breaking down by operational divisions here, as you can see, and we actually reported this in the 6 months report in further detail.

On a systems level, growth is representing about 23%. STRATEC instruments and disproportional effects here, area of 30%. Then the Diatron business performed very nice as well here, mainly based upon new instrument sales of instruments recently been launched or launched in 2018. Service parts and consumables, in line with expectations. And again, and I think I already mentioned that at the beginning, you see that on the chart on the left-hand side as well as on the breakdown on the right-hand side on that slide, that H1 of 2019 was very development-heavy. In service parts and consumables if we take the absolute amount into consideration, nice development as expected.

Now getting down to the EBIT and EBIT margin. H1 EBIT up by 40% year-over-year growth to EUR 12.7 million. Adjusted EBIT margin, in the area of 11.5%. Negative contributors -- sorry, positive contributors, certainly now better economies of scale, and I try -- just would like to get back to 2018 development where we had this -- I mentioned this often in the decoupling of our development activities, of the activities we had to perform in '18 in order to allow us to take advantage of future growth activities like real estate activities, like tooling, like switching to a new ERP system, and so on and so forth. And on the other side, an unexpected weak top line performance, which led to this decoupling of scaling effects, and what we definitely already see here but expect actually an even better development in H2 is actually getting back to real economies of scale at this point. And then certainly, we can show the first results of our earnings improvement initiative, which has actually already been triggered early '18, but we were very careful, and allow me to reiterate myself when I say this had no staff or labor implications.

We are really trying to look into the businesses and to do the right things and to prioritize the right things and to keep prioritize the right things, and that is actually already paying dividend. So we see some positive things already kicking in, whereas the majority of the effects will only be materialized in 2020.

On the negative side, definitely, and I wouldn't even consider this as being negative. It certainly has a negative impact to EBIT and EBIT margin. But from an overall performance activity of the company, it's actually positive, that we continue to have increased development expenses due to high development activities. And again, reiterating myself, we did that already in '17 and '18 to pump a tremendous amount of money into new product development. We start harvesting that now. But I think the contribution of those new products in the future will even be higher. And therefore, we are very positive in -- actually, development investment is a positive indicator of the company's development in 2, 3 and 4 years from now.

On the negative side, we have -- I would consider this as a negative development on the product mix side, but again, not negative long term. It's just a snapshot on what happened in the first 6 months. So actually, what we have is a not satisfying product mix within instruments, which means the margin and the gross margin of the product couldn't keep traction very much as a derivative from the product mix within instruments. Then on the other side, the expected disproportionate growth on the consumable side, consumables versus instruments, we couldn't take advantage of that situation. We expect that -- a better development in the first -- in the second 6 months of the year and in 2020.

And then looking into the actual breakdown of any products, which includes consumables and service part and instruments, compared to the contribution of development activities, all those effects from an overall perspective, perceives that sales mix are not contributing positively to our margin. But we expect a nice pickup in the second 6 months of the year 2019.

Now segment performance. I talked about that already.

Instrumentation top line, growing by very positive 30%, which includes mainly the headquarter in our Swiss manufacturing side. Then the -- our business segment Diatron, which includes Diatron products and our official products of the group. Top line performance here, 22%. And I think the bottom line performance is even more impressive, coming from EUR 2 million of adjusted EBIT to EUR 3.3 million, which represents a growth of almost 70% of the EBIT. And a similar development regarding adjusted EBIT margin.

Smart consumables, a slight decline, which is actually -- which has nothing to say at all. And I can only reiterate myself again when I'm saying this is probably the most important step we did in the past 10 years. And if we're looking in -- if we will look into the rear window mirror in 2 or 3 years from now, we will definitely see this as the right decision actually, as a very meaningful decision in terms of the overall development of the STRATEC Group. And actually, as we achieved already breakeven in 2017, we are very positive to get this into the positive in the second 6 months of year 2018 and actually show a nice top line growth, but -- and again, I can only reiterate myself when I say this is not an important year for smart consumables. The important years for smart consumables will only kick in 2021 and the following years. And we believe that the margin of this segment will actually be -- and I'm really talking about EBIT margin, will actually be accretive to the group's margin from that moment in time on.

And then the other segments which actually don't play a meaningful role in the overall segment, a slight decline. But again, a catch-up effect expected to happen in the second half of the year, probably not getting this into a positive EBIT margin, but at least sales being accretive.

Cash flow and net debt development. Cash flow from operating activities, unfortunately, only up by 8.4% year-over-year, EUR 12.9 million. And this is actually -- an adverse effect is coming from high cash tax payment, then certainly higher investment spendings due to the significant capacity expansion we have here at the headquarter. Again, I just would like to say that this is mainly for development activities and partly for operations, but it's actually not for our overhead functions in the group, which are nicely split over the relevant business unit in the group.

Investment ratio with 12.7% in the first 6 months in the area of the target corridor of 12% to 13% -- to 14% for 2019 and 2020. After that, it should again back significantly and should actually be somehow in the area of where we used to be over the past years. I would like to say about 10% is a nice figure going forward.

Higher net debt position is very actually very much a derivative to the -- a derivative of first adoption of IFRS 16 and some financing of CapEx investments, which is natural taking our real estate activities into consideration.

Now talking about the outlook and the strategy. Group sales -- sorry, this is actually the guidance, which is representing the first slide of the outlook and strategy. Group sales is expected to increase by at least 12%, and allow me to again reiterate myself. This is an at least guidance on the basis of constant exchange rate, and again contributors are certainly those products which are still in a very early stage of their product life cycle, recently launched products are products which have been launched over the past, let's say, 5 years.

Then the guidance toward the adjusted EBIT margin, within the area of 14% to 15% after 13.9% in 2018, driven by positive scaling effects, then the earnings improvement program and certainly negatively -- negative contributors are the high development activities. And again, I would like to mention again that the weaker adjusted EBIT margin after 6 months is leading us in the right direction. We had a product mix in the first 6 months, which didn't allow us to get back to that point, but we are very positive that the product mix, which is foreseen for the second -- in 6 months of the year 2009 (sic) [2019], will get us in the right direction to achieve that EBIT margin guidance.

Investments, again, 14% to -- cover about 12% to 14% of sales, which is disproportionately but expected high. We expect it to get back from 2021 -- on 2019. Till mid-2020, we'll certainly be dominated by our real estate activities, the second stage of our capacity expansion here at the headquarter and certainly high investments in new development projects. And allow me to say that when we talked about a packed development pipeline in '17 and '18, nothing had changed. Even if we managed to get some products to the market and even if we managed to get some development activities over significant or through significant sales gains and successfully passing very important milestones, we managed to keep the development pipeline as packed as it used to be over the past 2 to 3 years, which is actually giving us an indication of the company's growth long term, getting us positive indications, not only for the next 2 to 3 years, which will be addressed by those products which only [hitted] the market or will hit the market by the end of this year, it gets us an indication about the growth of the company with products hitting the market in 2021, 2022 to continue with the relevant growth rate in the area we showed as an average figure over the past years.

Outlook and strategy for '19. So certainly, when we say reaccelerate top line growth and we did; reduce earnings, well, we did. This is definitely meant on a yearly basis that we want to decline volatilities across our other business units, which is particularly for the smaller business a tough call. Typically, in our industry, things tend to back-end loaded of the year. For STRATEC instruments and for Diatron, we definitely expect the nice development for the second half of the year. But allow me to mention that certainly, '19 was extraordinarily front-end loaded.

Then we want to get the new development and those ones are under negotiation. The contract's into the safe harbor. We want to prepare the path for efficiency gains following our ERP system. And allow me to say that at this point, we are very proud that we had the go-live of the product group-wide January 1, 2019. The first half of the group actually already went live January 1, 2018, without meaningful collateral damage.

I think it's worth mentioning that we are far away to have the same efficiency like we had with the legacy product. I think it's worth mentioning, and it's obvious that the legacy product was a product which has been fine-tuned for a period of 15 to 20 years regarding our needs and our necessities.

In order to get successfully live with our new ERP system, it certainly meant concessions as far as automation and efficiencies are concerned, which means today, we are still lacking efficiency gains, but we are getting better and better each day. It will definitely take us into 2020 until we are at this point where we used to be with the legacy system. And it's definitely frustrating, and I would like to congratulate my team in the group. It's definitely frustrating to see that if, like, as an example, 30% of a department's activities were related to ERP system maintenance, and now we see 70% of the resources being allocated by those steps, it's definitely frustrating.

But I think we are in good shape. We are progressing day by day. And I'm absolutely convinced that the ERP system was the right step to get us into the growth to get us and to prepare the ground for the growth we are intending to show in 2021. It is the right thing to do at this point. And we are extremely proud that the go-live January 1, 2019, went in a way -- it went and barring the consideration of take -- please bear with me when I'm saying that even the growth we showed in the first 6 months of the year were actually the growth of only 5 months because the company was literally down as far as sales is concerned in January of 2019.

Then certainly, we -- particularly in 2019 but the majority actually taking place in 2020, the results from our earnings improvement initiative, and certainly, we are intending to expand development activities and capacities further after the expansion of our real estate activities here in Birkenfeld, the headquarter.

Strategic priorities. Certainly, we want to enable our customers to show significant growth. That's why we are focusing on those areas where the applications allow for growth in the in-vitro diagnostics, let's say, areas like still molecular diagnostics, but consumables particularly in point-of-care and high-density applications. Then certainly, we want to boost our expertise and to grow our technology portfolio with the associated IPR, mainly with the goal to guarantee our partners' freedom to operate in each and every area. Then we want to broaden our product, our value offering without entering into a competitive situation with our partners. So this is mainly happening organically.

But allow me to mention that we keep our eyes open. We are continuously looking into M&A transactions. But we are here very selective from my today's perspective and I'm typically mentioning at this point, I think the market for transaction gets now a bit better than it used to be the case over the past 12 months. And we believe that there are enough opportunities where we can help our partners rather than getting into a competitive situation towards them. Clear point is we don't want to even leave the impression that we are intending to leapfrog our customer in the value chain towards the end customers on the laboratories.

Then certainly, we want to grow our proportion of the service parts and consumables, the acquisitions of smart consumables. They are certainly playing an important role, but certainly, we see some nice tailwinds here from the growing complexity of high-throughput instrumentation and from the growing complexity on the consumable side as far as point-of-care applications and microfluidic applications are concerned. And certainly, through the combined product offering, software instruments and the relevant consumable, we see ourselves in a nice position to take advantage of recurring revenue situation.

Then certainly, customer diversification, one of the goals. We will certainly not turn down opportunities within our big customers, very important customers for STRATEC. But certainly, we are looking into opportunities to drive diversification. Just one example, which is actually looking into the rear window mirror trying to avoid to tell you any secrets here, is that certainly, our veterinary business is performing nicely in the Diatron market, in our Diatron business unit, which was one of those tests to diversify this business and to bring down the dependency of the STRATEC business towards customers representing 5% or 10% or 20% of the revenue cycle.

This gets me to the end of the presentation. And I would like to hand back over to Stuart, our host, and he'll explain us how to commence with the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Michael Ruzic-Gauthier from Berenberg.

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Michael Ruzic-Gauthier, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [2]

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Three questions for me, if I can. Firstly, I was just in -- sorry if I missed this in your prepared remarks. But can you give us a little more on the gross margin development? I understand the product mix, but it's been quite a sharp decline. And I guess, more importantly, can you give us an idea of how you see that trending into H2 and then into next year? Secondly, can you at all quantify what the contribution was for the first half from the new instrument launches you mentioned, the 2 specifically, in terms of growth percentage? And lastly, just from a guidance standpoint, I think we can probably agree that 12% organic now looks extremely achievable coming into H2. And I think about some of the remarks you made of growth on the -- in the first, considering it to be only 5 months, not even 6 given the ERP system. So can you give us any idea why you're being so conservative on the revenue growth there? And is there some slowdown you're seeing? Or is that just pure conservatism?

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Marcus Wolfinger, Stratec SE - Chairman of Board of Management & CEO [3]

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Yes. Thanks, Michael, for your question. Actually, gross margin development is actually the root cause and source of the, what I perceived as a relatively weak, EBIT and EBIT margin development, which is nothing but product mix. And as mentioned before, I would actually [pack off] a negative as cascade coming from product mix. We have a product mix which is not contributing positively to the margin coming from the product mix within instruments, then certainly coming from consumables with the higher gross margin compared to instruments and then with the development activities contributing higher to top line growth in the first 6 months with an even weaker EBIT margin that instruments and consumables. So it's just cascading through and the negative -- negative is certainly a wrong word, the EBIT margin development not yet being in line with the full year's guidance but with the right trend. And if you compare the activities and the gross margin development and EBIT margin development of 2018, which was a weak year, and a strong development, literally only within November and December, contributing so positively to the EBIT margin, we are actually fairly convinced and confident to meet that goal.

The contribution of growth with the new instrument was mainly driven -- and again, this is actually a very back-end loaded scenario. Back-end loaded meaning like contributing only in May and June of 2019 coming from the new instruments. And that's why I would say about 25% of the growth in instruments is actually coming from new products. But this doesn't only include the instruments which is in everybody's mind, the instrument launched from STRATEC instrument, it includes the instruments launched in the Diatron segment as well.

So as mentioned, 1/4 coming from new instruments and about 3/4 coming from established instrument, which actually established, in this terminology mean established by instruments which has been launched prior to 2019. So very nice performance showing on instruments. And I would just -- what about you just mentioned one instrument, which is the Panther Fusion, which was actually already launched in '17, but had unexpected weak performance in 2018 and now really getting traction.

And then actually talking about the guidance, and I think this requires some further explanations. First of all, I want to make the point that we were always talking about at least 12% growth. So even if we would show 20% growth for the entire year, this would still be consistent with our guidance. So if you see -- this way, it doesn't necessarily mean lower growth for the rest of the year, right?

However, I think it makes sense to elaborate a bit further on this. As just described in my remarks, we had a very high contribution to the growth from our development and service activities in the first 6 months of 2019. We don't expect this to repeat in the second half of the year. So I would say it is a fair assumption to assume a somewhat lower growth in the second half of the year.

Lastly, I think there is little doubt that uncertainties in regard to the trade and currency disputes that are happening right now have rather increased in the last couple of months. So to have kind of buffer in the guidance is not necessarily a bad thing. I hope that makes sense for you. And again, this is an at least guidance.

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Operator [4]

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(Operator Instructions) The next question comes from Volker Braun from Bankhaus Lampe.

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Volker Braun, Bankhaus Lampe KG, Research Division - Research Analyst [5]

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First is regarding smart consumables. Would love to get a bit more insight on the structure of the revenues there. It's quite lumpy at this stage. I think there's a lot of development still included and maybe less product-related revenues. By when should this be a more recurring revenue stream? And I would also assume that this business in itself should be more likely margin-accretive rather than dilutive. So could you give us a -- maybe a time line how this would evolve over the next, let's say, 3 years by when should we see margin accretion?

And second is regarding development and services costs, which can vary depending on the pipeline, obviously. You mentioned a somewhat slower contribution in the second half. But on the other hand, you also mentioned a well-filled pipeline. So how does that fit together? Is there an acceleration in 2020 again? Or how does this develop?

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Marcus Wolfinger, Stratec SE - Chairman of Board of Management & CEO [6]

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Yes. Volker, thanks very much. And actually, your questions are allowing me -- both are actually allowing me to elaborate a bit in the depths, which are absolutely making sense in order to understand the business. You are absolutely right that smart consumables, the business unit and the revenues of the business unit include a certain proportion of development activities, and certainly, things like tooling, sales, and so on and so forth.

When we acquired smart consumables in 2016, which was actually the former Sony DADC Bioscience business, we clearly said that on the one hand side, we already have a nice revenue stream, which was, at the time, actually dominated by a number of smaller customers, but already at the time, included customers like a bioMérieux just as an example.

Certainly, after the acquisition, we focused very much into 2 segments. One segment was actually the well-funded start-ups, where the actual activities are leading in the direction of fast turnover rate, making sure that each and every milestone is funded well and that each and every milestone already achieves the relevant margin.

On the other side, certainly, we focused more on what we call the blue-chip business, which is actually the cooperation with the big diagnostics companies where certainly, the -- let me say, the iteration cycles are slower. It takes longer to sign a contract. It takes longer to prototype, longer tooling, and so on and so forth. Then that gets me back to the point we already said when we acquired that business is that on the one hand side, with that we want to contribute more from consumables, particularly in area where the complexity of instrumentation declines, and we want to participate in the same value chain but from a different angle. It means lower contribution from instruments, higher consumer from consumables, and particularly taking into consideration that one of the -- in the meantime, already achieved acquisitions goal was to allow our partners to reduce their risks by us assuming that risk of integrating the smart consumables on instrument. And that was actually very successful, which means we got a lot of those blue chips on board, but the development is actually ongoing. And here like supplies of prototype parts, and so on and so forth or invoicing of tools is, by definition, very lumpy if you have a limited number of projects within that company. But allow me to mention, and again, I already mentioned that in the course of my presentation that we expect margin accretiveness least 2021 if things are going smoothly, which typically never happens to me. Margin accretiveness could actually kick in already 2020. And from a strategical perspective, I think this is -- allow me to reiterate that this is probably the most meaningful activity we undertook in the past 10 months.

Then getting to service and development activities and recognition of revenues. And I already complained a lot about IFRS 15, which is definitely a hurdle for a company of our size and shape with relatively long-lasting development activities and high overall contribution in percent, development revenues versus actual operational business like sales of consumables and sale of instruments, that percentage is actually affecting us in a way that our revenues, particularly coming from development and service activities, are getting more and more lumpy. As we achieved such important goals in the first 6 months as far as development is concerned, 2 product launches, several products being brought through important phase case, we had to recognize these revenues.

And as mentioned before, second 6 months will definitely not be as development-heavy as the first 6 months were. But, however, the overall contribution of development activities will continue to be high, but certainly not as high as this was the case in the first 6 months. I hope that makes sense.

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Operator [7]

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

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Marcus Wolfinger, Stratec SE - Chairman of Board of Management & CEO [8]

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Yes. Thanks, Stuart. This gets us to the end of the presentation and Q&A session. Thanks very much for your interest, ladies and gentlemen. If you have any further questions, please do not hesitate to call us or our IR department. We are here for you. Thanks very much.

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Operator [9]

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