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Edited Transcript of WDH.CO earnings conference call or presentation 14-Aug-19 12:00pm GMT

Q2 2019 Demant A/S Earnings Call

Aug 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Demant A/S earnings conference call or presentation Wednesday, August 14, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* René Schneider

Demant A/S - CFO & Member of Executive Board

* Søren Nielsen

Demant A/S - CEO, President & Member of Executive Board

* Søren Bergholt Andersson

Demant A/S - VP of IR

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Conference Call Participants

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* Annette Lykke

Handelsbanken Capital Markets AB, Research Division - Medtech Analyst

* Christian Sørup Ryom

Nordea Markets, Research Division - Senior Analyst

* David James Adlington

JP Morgan Chase & Co, Research Division - Head of Medical Technology and Services Equity Research

* Maja Pataki

Kepler Cheuvreux, Research Division - Head of Med Tech Devices Sector

* Michael Klaus Jungling

Morgan Stanley, Research Division - MD, Head of MedTech & Services and Analyst

* Patrick Andrew Robert Wood

BofA Merrill Lynch, Research Division - Director in Equity Research and Head of the EMEA MedTech & Services Team

* Sebastian Walker

UBS Investment Bank, Research Division - Associate Analyst

* Thomas M. Jones

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

* Veronika Dubajova

Goldman Sachs Group Inc., Research Division - Equity Analyst

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Presentation

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Søren Bergholt Andersson, Demant A/S - VP of IR [1]

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Welcome, everyone, and thank you for participating in this conference call, held in connection with our interim report 2019 release this morning. The duration of this call will be a maximum of 1 hour, including Q&A, which mean that I will try to speed up the presentation.

Today, the company, as usual, is represented by our President and CEO, Søren Nielsen, together with CFO, René Schneider, and in addition the IR team.

I'll now hand over to Søren.

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [2]

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Thank you very much, Søren, and welcome, everyone. I will go straight into key takeaways for the first half year where we, as a group, have delivered an 8% growth, and this is driven by recent product launches as well as a generally good performance across the group. All business activities have gained market share and are seeing good momentum in the business.

The hearing aid wholesale business delivered 6% organic growth -- but even more impressively, with an underlying 12% unit growth which represents a very good momentum in the business clearly taking market share in the field. We see a 5% drop in ASP. This is purely attributed to a negative product mix, which has some key factors, one of them, of course, being the slow start to the year we have talked about before, but also as part of the introduction of our new Opn S rechargeable, a significantly higher swap of -- from older technology, rechargeable technology to new one for people that are still in their trial period and some of these price point were not introduced until May. Then we see this effect go on until July, August, but now clearly tailing off. And this has, of course, in itself cost some units but also postponed a little bit the actual uptake and you can say the real growth and momentum in the business, but which we clearly see underlying and with good and strong and feedback to the product. Very happy users that have chosen to return the old technology and try out the new instead, which is in their full right in a typical 30- to 90-day trial period.

Hearing aid retail grew 9% in local currencies of which 7 percentage points is acquisitive and 2 percentage points is organic. Keeping in mind the French health care reform, it did -- had a significant impact on our French retail, and the underlying organic growth, therefore, is 3% and in line with our expectations. We have seen good growth across a number of our countries. I'll get back to that later in the presentation.

Very strong growth in Hearing Implants driven by an outstanding organic growth of 35% in cochlear implants due to the success and continued success of our Neuro system, which is not totally complete in all aspects but recognized as a very strong platform and is gaining trust in the marketplace each and every day. Bone-anchored hearing systems saw a more modest growth of 4% in a slow market with no real new introductions, but this is now for sure being fueled by our just recent introduction of Ponto 4.

Continuous market share gains in diagnostic with 8% growth in local currencies and organic growth following strong growth in North America and Asia.

Our joint venture with Sennheiser, Sennheiser Communications, here in the last year of the joint venture continued to perform well and see an underlying growth of 12% driven by new -- many new wireless products, however, slightly lower profitability due to mix changes and some resource allocations, but also here a good strong momentum going into second half.

We have, due to activities in '18 and acquisitions in '18, seen a very significant increase in our capacity cost within R&D and distribution here in the first half of '19, but the majority of growth attributes, again, to events and decisions taken in '18 and the underlying growth have been more modest while we also foresee a sequential very modest growth moving into second half.

EBIT came out at DKK 1.113 billion, which is a decrease of 9% compared to reported EBIT last year. And that, of course, represents a significant drop in margin. However, correcting for France and the one-off effect there, IFRS as well as currency effects, the underlying EBIT would have been DKK 1.2 billion and a 16.2% underlying margin. And we think that's worth noticing.

We have seen a -- we expect a significant acceleration of the group's organic growth in the second half. This comes from full year effect of product launches, of course, and into these returns of legacy rechargeable products due to swapping to newer and better technology, higher organic growth in retail, of course, both in France but also because a number of the entities have seen a growing momentum during first half and then continuation of the strong growth in implant as well as a continued strong performance in diagnostic.

Total capacity cost in H2 is, as I said, expected to be in line with capacity cost in first half and, therefore, naturally lowering the growth rate compared to second half last year significantly compared to the levels here in first half.

The outlook for EBIT for 2019 in total, we have chosen to adjust from previously DKK 2.65 billion to DKK 2.95 billion to DKK 2.65 billion to DKK 2.85 billion. And this, of course, is based on an expected very significant improvement in growth and profitability in the second half of 2019. But we, as we see the momentum of the business, feel comfortable that this is the right outlook to guide on and what we will be able to deliver.

We still expect significant growth in our cash flow from operating activities for the year, and with that being able to keep the promise of a share buyback of -- worth a minimum of DKK 1.2 billion. And with the level of acquisitions opportunities continuing to be good and attractive in the marketplace, generally attractive funding, we have chosen to upgrade our gearing multiple target slightly from previous 1.5 to 2 to now 1.7 to 2.2. This is before depreciations related to leased assets, the adjustments coming in from the IFRS 16, and again, we would either have to not do the acquisition we think is right for the business or reduce our share buyback and we prefer to give a little more freedom and therefore of the gearing multiple slightly.

Revenue across businesses, as I said, it's all businesses growing in local currencies, Hearing Devices in total 7%; wholesale being 6% purely organic; retail 9% of which 2% is organic, underlying 3%; Hearing Implants, 17% purely organic; diagnostic 8% of which most is organic. So all in all, good momentum and solid performance in all business areas but, of course, in particular, high in the Hearing Implants noticing, again, 35% growth in the CI business.

Across geography, Europe, North America, Pacific around 6%, but significantly higher in Asia, driven by China and Japan. In North America, it has primarily been acquisition from retail as the negative product mix effect is most substantial in North America, as this is the market on the geography where the premium sales is the biggest and therefore the impact in these effects has been most profound.

And then if we go to the different business activities, just quickly on the hearing aid market in total, we have, of course, seen an extra market growth effect as a one-off effect of the NHS stock building in preparation for Brexit. This will turn the other way once we are somehow on the other side assumably. And therefore, we adjust for this in assessing the underlying market growth, and we see that still being in the expected interval of 4% to 6% with U.S. being slightly below, but there are also some reasons why you should expect slightly higher going into third quarter, some transitions in and out of large retail chain over there will move the needle up. So we are back in the range we feel sure.

Very strong growth in Europe, driven by NHS but also strong unit growth in Germany, Italy and actually a high number of markets. Also in France, which can seem a little contradiction to the French reform, but this, of course, fluctuates a lot between retail wholesale but also new rechargeable that is taking a bigger, bigger share of the market is normally not sold through consignment stock but invoiced right away, which is not how it was in the past and that, of course, move forward invoicing quite significantly when this part of the market is growing substantially.

And slightly negative growth in Australia, modest unit growth in Japan. Estimated without statistic double-digit growth in China. We see a lot of activities in the region and also in our own business. We still see an overall slightly negative ASP effect both coming from channel and geographic mix but, of course, also intense competition also in the premium segment and the independent channel. So this is in line with what we have seen in the past and also see now. However, we are most likely in the upper part of the range as we also see significant number of new premium products being introduced normally have a slightly positive effect on the overall ASP. Retail ASP is varying a lot across markets, but in generally stable within each channel and markets. And the reason why it changed is very often product mix and regulation rather than actual prices line-by-line. That is very big difference across the world.

Now I'm going to go through the French reform details, but just to repeat our assumed negative one-off effect of around DKK 50 million on the EBIT line particularly coming from retail and the main reason for that being the extended trial period, mandatory trial period of a minimum of 30 days pushed to at least a month worth of invoicing into the future. And this, of course, impacted organic growth for the year quite substantially.

Looking at the wholesale business, [I'm honestly --] I'm very happy to see and proud of the 12% unit growth. This shows, again, good momentum and it goes way beyond good sales to NHS in the period. We see that growth to larger retail chains in the Asian region, to independent customers all around the world of mid-priced products introduced last year. However, the weak start to the year and the competitiveness in the premium segment have diluted product mix and also the effect of, again, a significant higher return level or replacement of already sold devices to newer technology, of course, have one-off effect that will tail off during August as we then are out of trial periods, basically all around the world. And sales of previous generation except in markets that are waiting for homologation, which is now basically only in China, we have seen these past generations basically go to 0. So this is an ending story.

Growth, acceleration and improved ASP have been seen throughout the period and in all markets. And we, in general, are very happy with end user feedback and assure we hold the strongest performing audiological product, meaning the actual performance for the hearing impaired as well continue to have strong connectivity opportunities and now also a fully competitive rechargeable solution based on lithium-ion technology. We see a very strong demand for rechargeability spreading very fast in the market both across price points as well as geographies. And in several channels and markets, we are now seeing that more than half of these product families where this is an option being rechargeable. So very strong trend in the market.

We have just today as well announced that we now during August will launch a new, totally new completely redesigned portfolio of Super Power and Ultra Power instruments for both adults and children based on the Velox S platform for Oticon. And also, as I'm later going to say for a number of the other -- of all our other brands in Oticon as well complemented with now a full remote care solution across iPads and iPhones and Androids where you can do a real-time video-based consultancy fine-tuning of all our 2.4 gigahertz devices, enabling a much better or a more flexible and for many people also better after-care service and contact between human care professional and end user.

So Opn S is out in the field, positive feedback and represent a very strong offer in a very competitive environment, but we feel happy about the performance, and the feedback we get from customers from this very new platform and now complemented with Super Power, Ultra Power and the many launches last year, the end group has across its brand a very new and strong and wide product lineup.

Remote care solution is now being made available worldwide. It is still very different from market to market how much this is taking in and, again, I think the most frequent use still remains to be among larger channels that expect to see productivity improvement but we also see a growing interest from independent dispensers that want to offer this opportunity to take care of users that might live a little longer away or want to have a quick chat and call with their hearing aid professional.

Again, new Super Power, Ultra Power from Oticon named Xceed, the strongest ever seen in a very compact and very robust shape and form. We see very strong improvements in speech clarity, reduction of listening effort, better short-term memory as we have seen with all our other brain hearing technologies. And it is, by all means, a major improvement and step-up when it comes to these categories. [Then itself,] of course, not the world's biggest, but in a number of markets, it still play a significant role. It also play a significant role in connection with our CI position. More CI patients start out with a high power hearing device of some kind and maybe even have a normal hearing aid on one ear and a CI on another. And this is part of being able to have a more complete package for handling of children and people with very severe hearing losses. We also see a cross-solution and another -- number of other additional products coming out to complete the portfolio for this patient group.

New products. Super Power, Ultra Power for Bernafon and Sonic also coming out now and then just a quick comment on continued development towards future connectivity solutions. We are also working very closely with Android, Google to make sure our future products are fully compatible with the upcoming ASHA protocol. We still don't know exactly when it's going to see the market and when we're going to see it in the first phones. This still enables us to use our unique Bluetooth low-energy technology in comparison to ordinary Bluetooth and also the EHIMA work to make even broader standard protocol across consumer electronics is progressing very well.

In the period, Philips have been brought to the market, have launched its first products, and we see a very good interest and good uptake to the customers we have already introduced it to and see a continued work in expanding into new markets. There are some limitations in homologation and other that takes a bit of time, but in general, very good feedback and very good interest.

Retail driven by acquisitions, North America primarily acquisitions, but we continue to do the brand harmonization and see a flat and stable organic growth, but still expect improvements from here. And in Europe. Negative, of course, in France; but strong performance in U.K. and Poland. And then we have seen a real strong and successful adjustment of our Australian business delivering now very significant organic growth -- have grown throughout the period and, therefore, have good prospects for second half.

Implants. 17% growth, primarily driven by CI where we do an impressive 35% organic growth. This is both in export markets winning tenders but also more broad-based in particular Germany and Brazil, but also a number of other markets that show good traction, and we continue to open new clinics and see growing sales to those who we have already worked with, and again, with Ponto 4, we significantly improved the product range on the bone-anchored side.

Diagnostic continues the successful journey, expanding around the world, and that's across many product categories but also through a growing business in service calibration, selling of disposables, et cetera. The most profound growth has been in North America and Asia.

Personal Communication with -- the joint venture, 12% underlying. New products, drop in profit in the first half, but in second half, we think we'll be in line with last year and therefore representing sequentially a significant moment of growth also in the profit.

And with this, the word to René for a little more on the numbers before we return to Q&A.

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René Schneider, Demant A/S - CFO & Member of Executive Board [3]

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Thank you, Søren. So if we look at the income statement, Søren already reviewed for you the 8% growth on revenue. And in order to deliver that, we have grown production costs 5% year-over-year in the first half year. This leads to a increase in gross profit of 10% or 0.9 percentage point improvement in the gross profit margin. This is driven by production efficiencies, both in our wholesale of hearing instruments but also in our diagnostics business as well as the fact that we have a slightly higher share of retail with its underlying has a higher gross margin.

Cap cost -- capacity costs across the lines increased by 15% reported or 13% in local currencies. And we will come back to that on a later slide, whereas, our share of profit after tax and associates, joint ventures, primarily resulting from our Sennheiser Communications, decreased by 26%. This leads to the reported operating profit of DKK 1.113 billion and 15.1% operating margin.

If we look a little bit more on the capacity costs, we have seen an increase in R&D costs driven by decisions taken and expansions made primarily during 2018, driven by, in particular, our establishment of a software competency center in Warsaw. We have also seen a significant increase in distribution cost of 13% in local currency. This growth is driven by a combination of organic growth and acquisitions, again acquisitions in particular related to one large acquisition made in the second quarter of '18. And I can add a little more flavor to the distribution cost growth, approximately 5% of the overall growth is driven by acquisitions.

In the second half year, we expect total capacity cost to be in line with first half year of this year. And this, of course, means that year-over-year, the cost growth rates will decrease significantly compared to the first half year.

Looking at the effects on profit that Søren already mentioned but just to review once more here. We saw the profits being diluted by product mix, one-off effects and significant investments in R&D and distribution and thus future growth, but it declined 9%, and it was related to the slow start to the year with a negative product mix and ASP and then also the effect of a significantly higher-than-normal return level of products based on the silver-zinc rechargeable technology after we launched Opn S. We increased R&D efforts and distribution costs, again decisions made in '18.

In addition to this, we had a negative one-off effect of roughly DKK 50 million related to the French reform predominantly impacting our retail business. And then actually adding to this but not on this particular slide, we year-over-year have a net negative FX impact of around DKK 50 million.

So on the next slide we are just outlining here for you our usual analysis of what would underlying performance have been in local currencies. On the right-hand side, you would see the margin that Søren alluded to before. When we adjust for restructuring costs in '18 but also effects of the French reform as well as currency year-over-year, this leads to an underlying 8% growth in revenue and a 5% drop in operating profit as well as a margin of 16.2% this year compared to 18.4% in the same period of last year.

Looking at cash flow by main items. We have seen an operating cash flow growing 5%, but this being positively impacted by IFRS 16. So adjusted for this, CFFO decreased by 17%, driven, of course, by the lower profits and also higher receivables from a strong end period. We see a significant increase in cash flow from investments, and this is slightly an artifact driven by the fact that this also includes settlement of loans, and there was a significant settlement of a loan in the comparison period last year when we acquired the before-mentioned asset in the second quarter.

Cash flow from acquisitions and divestments amount to DKK 318 million, so currently at a lower level than last year. And lastly, share buybacks, materially lower than last year, however, as we will see, expected to accelerate significantly in the second half year.

The balance sheet is growing by 16%, but this is 11% impact from the implementation of IFRS 16 under which we are now required to report leased assets on the balance sheet, so that we do now on a specific line item. Total equity increased by 8%, driven by our group profits for the period, but partly offset by share buybacks. If you look at other noncurrent liabilities, you see a significant decrease; however, you see a corresponding increase in other current liabilities, and this is due to the fact that you'll see a shift from long-term to short-term debt in the period.

We have previously indicated what the effects of IFRS 16 would be for the group, and this is fully in line with what we have stated earlier. Now we just report the exact numbers, but the effects are exactly as we have estimated them. And I will only highlight the bottom line, which is on the financial ratios gearing. We have 2 different measurements: one is gearing as we have reported it so far, meaning without the effect of leasing debt on the balance sheet, which is 2.0x at the end of the period. And including that, it is 2.3x

So in connection with this half year report, we have also decided to update our gearing outlook, and this is driven in particular by 2 items. One is the fact that we are reviewing acquisitions opportunities broadly that look attractive for our different business areas. And then in combination with that, we see currently a very attractive access to funding for the business. This leads us to update our gearing multiple to 1.7x to 2.2x, previously 1.5x to 2.0x, measured as net interest-bearing debt relative to EBITDA before the effects of leases, and this is the line that we will be guiding on going forward. But we will, of course, report on both numbers, but we maintain to guide on the net interest-bearing debt that is actually a real debt in banks or cash at hand.

Going to outlook for '19. As Søren mentioned previously, we are very confident that we will see a significant acceleration in organic growth and profitability in the second half year. This will, of course, be driven by now a full half year effect of our many recent product launches, combined with the fact that return of legacy rechargeable products will end in August in our wholesale business. We see accelerating organic growth in our retail business. And we are out of the impact of the reform in France.

We expect diagnostics to continue on the strong growth journey as well as Hearing Implants continuing on the CI side and picking up further pace on the bone-anchored side with the launch of Ponto 4. Combined this with the capacity cost in second half to be in line with first half year will underlying deliver -- help deliver a material growth in profitability in the second half year.

And this leads us then to our final slide that we maintain our expectation to generate organic sales growth above market level in '19 reflecting through the -- accelerating throughout the year. We still expect positive exchange rate effect of 1%. And we have decided to adjust our outlook for reported operating profit to DKK 2.65 billion to DKK 2.85 billion, which was previously DKK 2.65 billion to DKK 2.95 billion. We still expect to deliver substantial growth in our cash flow from operating activities and to buy back shares worth one -- a minimum of DKK 1.2 billion. And then as I mentioned just on the previous slide, we have decided to aim for a gearing multiple of 1.7x to 2.2x as a reflection of the attractive acquisition opportunities and generally attractive access to funding.

And with this, we will continue into Q&A and open the mics for that.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Maja Pataki from Kepler Cheuvreux.

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Maja Pataki, Kepler Cheuvreux, Research Division - Head of Med Tech Devices Sector [2]

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I would like to start with a question on the return of the legacy product. Could you help me understand how that technically works? Is it people coming back, returning products and starting basically a new trial period, which extends the time until the close of deal? And then second question on the Bluetooth protocol. You seem to be quite optimistic in your comment in the presentation. Does that mean that there has been a bit of an acceleration in momentum since we've been basically waiting for the last 3 years for that to come out?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [3]

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Thank you very much. I will take both. The technicalities of the industry is that most users all around the world that buy commercially have a trial period. We have talked about France where it now has to be a minimum of 30 days, meaning for many it might be 40 or 45. U.S. have tradition for up to 3 months of trial. And it is the user's full right and discretion in this period to return and say, thank you, and then to try something else. Many try more than one. Germany also have a tradition of trying at least 2. And therefore, you get a lot of returns. And you have no commitment to buy for the same supplier. You basically get a credit note and you buy a new one and everything counts as a new sales. And this is the mechanism of what's going on. And again, we have always a pool of users out, and we [accrue] for the expected level of returns. And what we have seen here is a longer and more intense desire to return old Opn S with rechargeability due to these obvious improvements you see both on the audiological side as well as the, I would say, qualities of capacity and charging patterns, et cetera, of our new solution, a significant improvement. And that have left a number of professionals to recommend the user as part of them coming in and what is your feedback and how do you see things going -- to return what they had on trial and buy one of the new ones.

And again, this is a natural mechanism always going on in the industry, but it has been significantly higher in this transition, and that in itself also, of course, for some push a little bit the real pickup of, I would say, volume in new one. It becomes kind of the trial and to see the performance, and this is also part of what we have seen going on. But it's coming to an end now. We introduced a price point 2 and 3 rechargeable during May, and therefore, the longest trial periods end during August and we can clearly see the numbers that things are coming to an end. And we see the underlying uptake, continued uptake of, in particular, rechargeability products being very, very strong. So this is the effect, and this is the transition, and this is what leads to what you as a net result will still see as a more negative product mix than you would expect with the uptake of the new products. So that is that mechanism.

The protocol, I would say, there's no changes to it. Particularly, the EHIMA one, we're just getting closer and closer, and things seem to be on track. And the industry and EHIMA do what it can to make sure that the right code is donated and made, et cetera. What is more accelerated in our plans is the ability to make sure we accommodate for the ASHA protocol once that gets out in the field and make sure our future technologies together with the many different protocols that are now going to exist in parallel are all built in and tested and work well. So this is just a firm statement that we as much support this future Google protocol as we have supported Made for iPhone for many years.

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Operator [4]

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Our next question comes from the line of Annette Lykke from Handelsbanken.

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Annette Lykke, Handelsbanken Capital Markets AB, Research Division - Medtech Analyst [5]

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I'd like to -- you mentioned the competitive landscape there quite some time during this call, and we have all followed the development in the VA channel. I'm just wondering if the competition from, for example, Marvel is stronger than anticipated and can we do any read across from the VA channel to other markets and other channels as well seeing maybe a huge competitor becoming much more fierce than it was maybe the last 3 years or so?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [6]

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I will also take that one. You cannot see a direct read over. VA is an isolated channel that works on its own terms and conditions, limited access for training and sell-in. No opportunity to adjust commercial terms, basically just a white listing of products. And different suppliers have different stand, historical stand in the system. And I think what we see now is the historical strongest player in the channel have a better product than they used to have and, therefore, increased momentum. You can see a number of other players losing momentum.

I see us with Opn S keeping our built up market share over the past 2 or 3 years, and that is, of course, due to the qualities of the products and our services. Is this the end of things? No, we will continue to do whatever is possible within the framework to further improve our performance in that channel.

In all other channels, there are much more things in play. Your total product portfolio strengths, your commercial terms, your general support to customers, and therefore, you cannot take a direct read of the performance in VA into our general performance. And the world is big. We run our business in more than 100 countries. And adding all that together, VA is just one of many, many channels.

We have opened other fronts in the period. We have launched the Philips as one new important things -- that opened new opportunities that did not exist before. And so on -- it is a continuous total game across many geographies, many channels, many product segments.

I think what is most important to notice is a 12% unit growth that goes broad-based across the world and is a testament to the qualities and value of the many new products we continue to bring to market, including the latest Opn S and the Velox platform as well as product build in the mid-priced segment on the previous as well as many of our legacy products selling in typically lower price categories.

A real strong underlying unit momentum and ASP and product mix is always a consequence of many, many different things. And in the period, it has developed negative. But going forward, we expect a significant improvement in product mix and with that ASP.

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Annette Lykke, Handelsbanken Capital Markets AB, Research Division - Medtech Analyst [7]

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Can you sort of deny that you -- that outside the VA have been using ASPs to compete against Marvel whereas in the VA channel it's not an option to [regulate] On prices? And that might be also the explanation behind what you call the product mix and ASP effect.

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [8]

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There's no changes to pricing -- of course, the way rechargeability is priced in VA but is unchanged for previous is there is an additional cost for the accessories needed to charge it. You can see that as a package. So rechargeability lifts the ASP. A strong share of the category for rechargeable hearing aids will drive ASP up. So if anything, you can say the ASP is a key component to growth, and therefore, you will also see a different share in value development as to the unit development.

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Operator [9]

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Our next question comes from the line of Michael Jungling from Morgan Stanley.

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Michael Klaus Jungling, Morgan Stanley, Research Division - MD, Head of MedTech & Services and Analyst [10]

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I have 2 questions. Firstly, on Opn S. You mentioned in your press release sort of a strong uptake or a stronger update towards end of the first half. But if you also look at the app download data and the VA share that was just mentioned, it's pretty hard in my view sort of to be optimistic about the acceleration in growth in the second half -- basically all the data points suggests sort of stagnation. So my question is, what gives you the confidence that the second half does accelerate based on Opn S?

Question #2 is on the EBIT guidance. The revision which is sort of taking off the top end still does suggest to me quite a demanding number for the second half. And if you look at the implied EBIT margin, it could be as high as 22% at the upper end of the guidance, which would be a 7 point improvement from the first half. And if you go back to the last 15 years, the biggest margin improvement that you've achieved first half to the second half has been about 220 basis points, yet the low end and the high end means 400 to 700 basis points. Could you please provide a bridge of how we get to such a strong implied margin expansion from the first half to the second half, please?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [11]

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Thank you, Michael, for your 2 questions. Let me comment first on Opn S. VA and app downloads are only 2 data points. And we have running sales to look at. And actually again, right from the beginning of the launch as we managed to build up capacity on rechargeability have launched across all 4 brands, all 3 price points, we have seen a very solid steadily growing momentum buildup and had it not been for a higher-than-expected return continuing longer of legacy products with the old rechargeable system, you would have seen an even higher growth rate and even stronger momentum. So it's, of course, based on this. And talking to customers that I'm confident of a continued growing sales momentum in our many new products across the many brands.

Then to the EBIT guidance, I don't think you are correct in your 15 years. In 2016, with the launch of Opn in June, we saw a very substantial change of 500 basis points from first half to second half. And remembering that also on the cash side, the picture is quite different, the French reform and so on -- we think, yes, it's realistic to get up to that level as a maximum. But that the range represents exactly that there is very good underlying momentum across all our businesses and our good one-off reasons in first half, French reform, higher return, soft into the year, growing momentum in Australian retail, of course, momentum from Philips launch, et cetera, et cetera, and yes, the full half year effect of that adds together with a flat development sequentially in the cost base is what makes [our firm] that this is the realistic and best guidance that we can give you for the full year expectation for the group.

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Michael Klaus Jungling, Morgan Stanley, Research Division - MD, Head of MedTech & Services and Analyst [12]

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Okay. And when it comes to the sort of implied margin for the second half, would you rather see people towards the low end? Or would you encourage people to perhaps be as bullish as go towards the upper end? It seems to me that perhaps the guidance could have easily been more towards the bottom end, but the fact that you've given us sort of quite a high EBIT at the upper end seems to me that you've got some confidence in the number. But would you rather see people towards the bottom end?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [13]

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We have already put our neck out with narrowing the gap to 200 from 300. There is many moving parts. There is a lot of uncertainty in the [world.] This is the guidance -- we cannot comment on whether one or the other end is more or less likely.

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Operator [14]

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The next question comes from the line of Christian Ryom from Nordea Markets.

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Christian Sørup Ryom, Nordea Markets, Research Division - Senior Analyst [15]

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This is Christian here. I have 2 questions, please. My first is to your comments around the flat cost base from H1 into H2, and specifically your expectations for distribution costs because if I understand you correctly, you're talking about that you expect to do additional retail acquisitions in the second half and have already done so in the first half. So why would we not expect that to add to distribution costs? What other cost items are moving in the opposite direction to allow for flat development in costs from H1 into H2?

And my second question goes to your 2 new products, the Super Power and the Ultra Power. Will those two products be ready for launch in the VA by November?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [16]

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Yes. Thank you, Christian. First of all, we never include non-completed acquisitions. We have no clue whether they complete or not, so we cannot talk about that. The distribution costs, therefore, [if that,] you will have to from new acquisition, you will also have an element of revenue and assumed additional profit. That's why it's not included. So this is based on what we have on board and what we have today. And based on that, of course, we will see -- we have a full year effect of distribution cost on the retail side, and then we'll see a bit of organic growth. But on the other hand, on the wholesale side, we have actually had quite significant introduction cost and our best judgment is that these two things will more or less outbalance one another.

Yes. And then, sorry, VA and the SP, UP question. Yes, this is launched commercially included in U.S. before September 1 and with that being an option to introduce in VA, which we will do in the November release.

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Operator [17]

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The next question comes from the line of Sebastian Walker from UBS.

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Sebastian Walker, UBS Investment Bank, Research Division - Associate Analyst [18]

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I've just got one, please. So in the hearing aid business, could you comment on what the growth was prior to the launch of Opn S? And what growth has been after the launch of Opn S in the division?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [19]

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We don't comment on that. But I can say it significantly improved on momentum. And again, the return, of course, take it down net wise, but the momentum buildup -- instruments shipped out -- is a very significant uptake we have seen.

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Sebastian Walker, UBS Investment Bank, Research Division - Associate Analyst [20]

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Great. And can you just comment on whether growth was negative prior to the launch of Opn S?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [21]

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It was not good. It was a weak start to the year.

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Operator [22]

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The next question comes from the line of Veronika Dubajova from Goldman Sachs.

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Veronika Dubajova, Goldman Sachs Group Inc., Research Division - Equity Analyst [23]

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I'll keep it to 2. My first one is actually a bigger picture one. I'm just surprised to hear you talked about looking more actively at M&A. And just curious, Søren, to get your thoughts on how you're thinking about the priorities? What areas are of interest? And is this a sign from you that you are starting to see some bigger assets coming to market? Or is this mostly you looking? So what's of interest and why now?

And then my second question is just to follow up a little bit on Seb's question, if I can. It'd be great to understand kind of how the exit momentum was at the end of the half year and whether you have seen a continuation of that growth as you look at July and August. Clearly, given the importance of the top line to the guidance for the second half, it would be good to understand what you've seen since you've closed the half year.

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [24]

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Thank you very much. Let me first -- M&A is, you know, opportunistic. And you should more see our comment as we expect the level to at least be in line with what we have seen over the past 2, 3 years. It can come in retail. It can come in other business areas. We will see and we see what come in. What we want to make sure is we have the freedom to operate -- that we don't have to either reduce our appetite in acquisition if they make sense or we would have to reduce our share buyback and therefore adjust a little bit on the gearing multiple and therefore the comment. We are as active as we have been in the past 20 years. Should a big opportunity occur, we will, of course, look. I have no expectation of such, but you never know what can happen. This represents an outlook with a continuation of what you have seen in the past period.

And exit momentum. First of all, again, please note the 12% unit growth. We have seen a continued strong momentum and further acceleration also on the unit side and leave the half year very strong. We see an improved ASP coming in towards the end. And had it not been for the significantly higher return rate of legacy products longer than typically seen and therefore impacting May, June negatively, we would have seen even higher momentum coming into first half. But the underlying, including new products, is very good and very strong.

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Veronika Dubajova, Goldman Sachs Group Inc., Research Division - Equity Analyst [25]

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And if I can just follow-up on that, Søren, and you've seen that continue in July and August?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [26]

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I will not comment on July and August yet, but we have a good momentum in the business. It continues, and we feel comfortable that growth -- half year growth both sequential will be further strengthening of the momentum for the previous mentioned reasons. But also looking at last year, the weakening of the momentum did happen into the end of '18 and therefore, you also need to look at the comps when we talk of -- about significant higher organic growth. But sequentially, we, of course, have full half year with a growing -- continued growing momentum, and that's what we base our guidance on.

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Operator [27]

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The next question comes from the line of Patrick Wood from Bank of America.

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Patrick Andrew Robert Wood, BofA Merrill Lynch, Research Division - Director in Equity Research and Head of the EMEA MedTech & Services Team [28]

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Just 2 for me, please, if I can. The first would be, in the second half of the year, if you feel that either there are more opportunities to invest or if alternatively growth isn't quite coming through as you would have hoped, will you keep the capacity costs flat still? I mean, I guess my question is, if you have the opportunity to invest more because you see the prospects of growing faster, would you put that OpEx to work? I'm just curious which you'd rather protect basically, the top line or the margin structure? So that's the first question.

And then the second question is just for November, obviously, we're expecting an update then. Just generally what you're expecting the FDA to come out and say? You've obviously had a lot of dialogue with them. I'm just curious what your own expectations are there.

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [29]

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First of all, when we do acquisition, we always expect them to add positively to the business we already have, meaning being part of growing both top line and EBIT. So if that comes in, it will add further to our results. So there's not -- of course, long-term good idea, short-term very dilutive. You will be less -- hesitant to do, but that's always a consideration. And I see no special judgment this half year than others.

On the FDA OTC, yes, we are getting closer to the review expected the end of the year. We still have no idea how FDA will -- what will be on labeling, what will be on the product side to make sure that whatever user interface you will have to an OTC device, how do you make sure it's safe for the user, what is the guidance that have to be given if you move into apps and others and self-feeding kind of things which goes beyond what we have seen so far, very primitive pressure push button type of products, we don't know, and we still haven't seen any draft. So we expect a draft that will tell guidelines.

We expect and hope that it will be with the same strong requirements for claim documentation for technical files, for quality and safety requirements, full -- good manufacturing practice, inspections, et cetera, et cetera. So basically no difference between doing real hearing aids and OTC devices. That is our expectations.

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Operator [30]

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The next question comes from the line of David Adlington from JPMorgan.

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David James Adlington, JP Morgan Chase & Co, Research Division - Head of Medical Technology and Services Equity Research [31]

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Two, please. One, bit more difficult probably, but just in terms of the evolution of gross margin through the second half of the year, any sort of help you can give us around the various moving parts there. I think it would be useful (inaudible) to where you're sort of planning in terms of coming out with gross margins for the full year. And then just a -- just on financial expenses, maybe could you just give us a help in terms of the expectations for where you'll end up in the year for financial expenses?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [32]

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Could you please repeat the last one, David? It was really difficult to hear your line. It was not very clear.

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David James Adlington, JP Morgan Chase & Co, Research Division - Head of Medical Technology and Services Equity Research [33]

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Yes. Just on financial expenses for the full year, where you think you're going to end up?

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [34]

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Okay. I think René will take both.

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René Schneider, Demant A/S - CFO & Member of Executive Board [35]

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So just on gross margin, as you see in the first half year, it is a reflection of both production efficiencies but also the relative growth between retail and wholesale. And as you know, we have seen a large retail acquisition effect in the first part of this year. So this means that it's very difficult to predict but on the wholesale side, on an isolated basis, you will probably see, an increased gross margin if we see a positive ASP effect. However, you can also have a situation where our wholesale business would be growing faster than underlying organic growth in retail and thus counterbalance that. Therefore, it is extremely difficult to actually give a clear guidance on.

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [36]

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Also, if I may add, a large [enough] difference between the actual unit cost of the more expensive devices, so improved product mix also carry on a bit of extra on the production cost, whereas, the more lower-priced units, in particular for export tenders and others, actually have quite lower. So unit cost -- unit growth is good for gross profit as well, which is why you see the improvement this half year despite of the negative ASP. So there's many components in the equation which makes it a little difficult to have very precise expectations.

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René Schneider, Demant A/S - CFO & Member of Executive Board [37]

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On the financials, you should expect full year [DKK 200 million] to DKK 240 million net, but, of course, impacted by the implementation of IFRS 16 which we saw was DKK 22 million in the first half year.

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Søren Bergholt Andersson, Demant A/S - VP of IR [38]

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I think we are ready for one final question.

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Operator [39]

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Our final question will be from Tom Jones from Berenberg.

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Thomas M. Jones, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [40]

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A couple of parts though, I'm afraid. It was just on the leverage ratio. You've upped it by 0.2x EBITDA and cited M&A potential as a factor there, but also you kept your buyback guidance at a minimum of DKK 1.2 billion. How have your free cash expectations changed? Have they come down as well? Or is this increase in the net debt to leverage -- net debt-to-EBITDA ratio purely related to higher M&A expectations?

And then the sort of [a related] question. Is this increase from 1.7x to 2.2x kind of the new normal? Or should we just think that this is the temporary blip-up perhaps relative to some M&A you've got your eye on that and then in the longer term, say, 2021 and beyond we should expect this to come back down into the 1.5x to 2x range as being your sort of normal range?

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René Schneider, Demant A/S - CFO & Member of Executive Board [41]

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Yes, so I would say the slightly increased ratio is the reflection of the buyback and the acquisition level. So there's no underlying change in our internal assumptions on the cash flow from operations where we still expect a significant increase year-over-year. But of course, just like for profits, we expect a significant improvement in the second half year. And then for now, the 1.7x to 2.2x is, let's say, our guidance. And the new normal, it's not per se intended as a short-term adjustment. This is what we look at now. And with the current funding levels, we believe this is the right level for our group.

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Thomas M. Jones, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [42]

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Okay. Perfect. And just quickly to follow-up, the timing -- the spacing of the buybacks, given you've only done -- sort of basically DKK 1 billion to go, what was the thinking behind that? I mean, the share price hasn't exactly been super strong in H1. And if you're expecting a materially better back half of the year, what was the thinking behind weighting it so heavily toward Q2? H2, sorry.

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Søren Nielsen, Demant A/S - CEO, President & Member of Executive Board [43]

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Well, it is timed in accordance with the cash flow and profit. And like we have on the profit side a much higher second half year, this will also reflect in our cash flow and thus also how we buy back shares. So what we are going to buyback resembles a lot what we did actually in the second half year of last year.

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Søren Bergholt Andersson, Demant A/S - VP of IR [44]

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So that concludes our call. Thank you very much for your participation in this call. And feel free to reach out to IR in case you have any questions. And here you'll see our roadshow schedule for mainly on the buy-side if you want to meet us out there on the road. So thank you. Have a great afternoon. Bye-bye.