DiaSorin SpA

MIL:DIA

Earnings Call Transcript 2018-Q3

[Operator]

Good afternoon. This is the Chorus Call conference operator. Welcome, and thank you for joining the DiaSorin Third Quarter 2018 Results Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Carlo Rosa, CEO of DiaSorin. Please go ahead, sir.

[Carlo Rosa, executive]

Thank you, operator. Ladies and gentlemen, good afternoon, and welcome to our 9-month third quarter conference call.

I will start, as usual, commenting revenues and I will make my initial remarks at constant exchange rate since, as you know, the currency fluctuation had a relevant impact on our business in the first 9 months of 2018. Moreover, let me remind you that the performance, which has been registered this year, includes the positive contribution from the fact that we had 9 months of revenues coming from Siemens' ELISA business, which was acquired in September 2017.

So at the group level, our revenue grew by 9.1% in the first 9 months as a result of the solid sales performance of our CLIA tests, net of Vitamin D, and the ELISA business which has been acquired by Siemens. Now this positive trend of the CLIA ex-D was partially mitigated by some negative trends that we have already discussed in previous calls. One is the Vitamin D volume decline, mainly in the U.S. market as a consequence of the change in reimbursement policies by some of the insurers, and a slowdown in the revenues of the Murex ELISA business in certain geographies, mainly in distribution, and in Brazil. This is associated to 2 events: delay of certain large tenders in one side; and as far as Brazil is concerned, the fact that some of the distributors supplying public tenders in Brazil had issues of credit collection. And therefore, as a consequence, we have frozen some of these distributors, waiting for them to address the problem with the government. And so we have actually stopped shipping some of these ELISA to the distributors.

Now let's talk about Vitamin D. As far as Vitamin D is concerned, as I've already commented in the last financial conference call in August, starting from Q2 this year, we had seen a change in pace mainly due to a recent policy change with one insurance company in the U.S. market. Let me remind you that when we experience in the market a change in the reimbursement policy, we also usually see a reduction of prescription from physician, which is then translated in lower volumes in a period of 12 to 18 months, and Australia has experienced something similar 2 years ago. And this is certainly related to the fact that doctors that -- are recommending not to test or to limit testing of Vitamin D compared to what they used to do when these measures were not in place.

We have no visibility at this point on the strength. We are starting to acquire some visibility certainly in the last month or so. And as we have discussed previously, our current -- what we see currently in the U.S. market, is that we expect that the Vitamin D volume may decline up to 18%, 20% over the next 12 to 18 months. But it's a matter of just waiting and seeing what was the reaction in the market.

Now let's talk about the other geographies, and let's talk about Europe. When it comes to Europe, we had a solid growth. 14% in the first 9 months. Europe proved once again to be a strong contributor to our group revenues, and this is certainly thanks to the vast installed base, the availability of all the products in the region.

As far as the fact that we have initiated the sales of QuantiFERON, certainly not in Q3 but we initiated the commercialization of the product in respect to seeing the benefits starting from Q4.

Now specifically, Italy grew by 9%; France grew by 16%. And it means that in some very key geographies, the business is certainly moving fast. Germany grew 23%. Certainly this is related mainly to the fact that a lot of Siemens' additional business was added in the geography. We had inherited, through Siemens, roughly 800 accounts throughout Europe, of which 60% were in German-speaking countries. And we are working under conversion of these accounts from ELISA to LIAISON. We have 3 years to accomplish conversion. Roughly, 10% of the accounts have already been converted, and we have 15% of the accounts in the pipeline. So we expect roughly 50% conversion by the end of 2019. That said, the ELISA business is flat, the Siemens business we inherited net of conversion.

Now let's talk about North America. Certainly, as we discussed before, these geographies where we are experiencing the Vitamin D issue and I'm not going to talk about this any longer. But by the same token, we had a continuous growth of CLIA ex-D with a growing installed base in the hospital and midsized labs of the LIAISON XL. And the net-net of the decline of Vitamin D but the increase of revenues of CLIA ex-D, pretty much flattens out this geography. So the growth of the ex-D is able to counter-balance the decline of D, but overall the U.S. is flat. We have -- in the U.S., the good news is that we were able to sign an agreement with Meridian, and this -- we got the approvals by the FDA of the H. pylori product and as a consequence of that, we have launched recently this assay in the U.S. in conjunction with Meridian to go and rapidly convert all the existing customer base of Meridian from aging ELISA to the LIAISON version of the product.

As far as Asia-Pacific is concerned, this region grew 16% in the first 9 months. And certainly, the driver is China, it's CLIA ex-D in China which is growing strongly. We're talking about 16% growth of CLIA ex-D -- for CLIA overall because also Vitamin D is growing strongly in China. And this trend is consistent with what we have announced in the last conference call. So please consider, as we have discussed before, that by the same token, change in business model where we don't sell instruments to distributors any longer but we try to place [ a ready rental ] to drive placement into the Class II market, we have decrease in instrument revenues -- instrument revenues typically for DiaSorin clearly bears much lower profitability. This is a must for us because it's the only way to control actually the shift of focus, obviously, of course in China from Class III to Class II. But overall business, the underlying business, again, CLIA does benefit from it, as I said, growth of 16%.

Now let's talk about 2018 guidance. So we confirm revenue growth of 9% at constant exchange rate and EBITDA growth at 12%. However, we would like to underline a couple of aspects of the business, which have to do with the fact that in quarter 4, there are 2 events that may shift revenues from 1 quarter to the other.

First one is Iran. It has to do with the fact that, that for us, Iran is a very relevant geography. Recently, actually yesterday, a series of measures have been published by the U.S. government. And so we need to understand how to continue to supply this market and through which bank system we can continue to operate. Since as you know, a lot of international banks actually stopped operating in Iran.

And the second one is a very large tender, some of which have been -- which entails a chunk of instrumentation. Some of which have been shipped in Q3. But there is a large installment of -- that has to happen. And we forecast to have it made in Q4. But clearly since it is a lot of instrumentation, we need to understand when that can be fully completed in quarter 4.

Now before giving the microphone to Mr. Pedron, I would like to conclude my comment with a couple of remarks. First one has to do with new products. We have launched so far 4 CLIA tests and we have one additional [ toy ] in the pipeline, which we believe is going to launch in Q4 and then 6 new molecular products. So, so far so good in terms of continuing the effort of launching -- delivering new products to the market.

And talking about business development, we, as you know, have provided lots of color to different projects. The one that I would like the stress is QIAGEN and the collaboration about TB. We have successfully launched the TB in Europe, that's actually happened in -- at the end of September. So we are today engaged in the initial conversion of customers, together with QIAGEN from ELISA to the LIAISON version. I know Peer Schatz has -- did provide colors and comments during his Q3 conference call so I actually invite you to go and check what he said. Things are going well and within the 2 companies are now working together to enlarge the scope of the collaboration and add more content to this line, which we deem as strategic. And we also deem strategic to enlarge menu availability on the LIAISON system with QuantiFERON application. And it has been made public that the next in line for us is a Lyme disease product. We're currently running preclinical testing to verify claims and applicability. But fundamentally the 2 companies are aligned in terms of dedicating R&D money and effort to bring forward new application on the LIAISON system.

Now I would actually give the microphone to Mr. Pedron, who is going to take you through the numbers, and then we're going to take questions. P.G.

[Piergiorgio Pedron, executive]

Thank you, Carlo. Good afternoon, everybody. In the next few minutes, I'm going to walk you through the financial performance of DiaSorin during the first 9 months of 2018, and I will also make some remarks from the contribution of the third quarter. So with that, as usual, I would like to start with what I believe are the main highlights of the period.

The strengthening of the euro against all the currencies in which we operate has generated some notable FX headwinds on revenues during this first 9 months of the year, almost EUR 18 million, even if -- as expected -- the impact has been negligible in quarter 3 compared to half 1. This variance has been mainly driven by 2 currencies: the U.S. dollar, which depreciated by 7%; and the Brazilian reais, minus 22% year-to-date. Considering the U.S. trend in 2017 and where we are now, I think it is fair to say that also in Q4, like in Q3, we should not expect a material FX headwind.

Moving to the second point. We closed September year-to-date with an increase in revenues at constant exchange rate of 9.1% or almost EUR 43 million, whereas the growth in the quarter has been 9.5%. September year-to-date EBITDA at EUR 187.1 million recorded an increase at constant exchange rate compared to last year of 7.5%, with a margin at comparable exchange rate of 38.3% versus 38.9% of 2017. Quarter 3 EBITDA of EUR 58.9 million increased by 6.8% at constant exchange rate vis-à-vis last year.

Please note that September '18 EBITDA margin, net of the expenses we booked for the legal action in the U.S. with Meridian have now settled. And net of the tail of the Irish divested -- Irish site divestiture cost, would have been in line with what we recorded last year.

Lastly, we closed September with a strong free cash flow, about EUR 101 million. And a very healthy positive net financial position, just short of EUR 130 million. The net financial position has been affected by the payment of the ordinary dividends for EUR 47 million in May and by a shares buyback program for about EUR 65 million. Please, a reminder, the net financial position does not include EUR 98 million of debt towards shareholders for the extraordinary dividends, which will be paid out in December 2018.

Let's now go through the main items of the P&L. September year-to-date revenues at EUR 494 million grew by 5.4% or about EUR 25 million compared to last year. The growth at constant exchange rate is 9.1% or EUR 42.8 million.

Carlo has already covered the business drivers behind this variance. Gross profit at EUR 336 million grew by 5.1% compared to last year, closing the first 9 months of 2018 with a ratio over revenues of 68%, which is basically in line with 2017 in spite of dilutive effect of the Siemens' ELISA sales and of the price pressure on Vitamin D. This performance, which is slightly better than what we originally expected, is mainly driven by higher manufacturing efficiencies and better geographical and product mix.

Q3 '18 gross margin of 67.1% of revenues is substantially in line with last year. The reduction compared to the previous quarters, which we also experienced in quarter 3 of the last couple of years, is mainly driven by the product mix and by the seasonality of our business, which usually sees lower activities in some geographies, especially in Europe, during the summer months.

Total operating expense is at EUR 179.8 million or 36.4% of revenues, have increased by 5.7% compared to the first 9 months of last year. Please remember that about EUR 11 million of September year-to-date OpEx have been driven by the depreciation of intangible assets coming from the Siemens ELISA and Focus business acquisitions. Net of these elements, the year-to-date OpEx increase at constant exchange rate versus last year would have been 8.5%, and the ratio on the revenues would have been 34.1% against 34.3% of 2017.

September year-to-date other operating expenses at EUR 6.9 million have increased by EUR 2.1 million compared to last year. As just said, the period has been affected by some expenses related to the legal action in the U.S. with Meridian and by the tail of the Irish site divestiture cost.

As a result of what I just described, September year-to-date EBIT at EUR 149.3 million, or 30.2% of revenues, has increased compared to 2017 by 3.1% or EUR 4.5 million. The growth at constant exchange rate is positive for just short of 8.5%.

The tax rate at 22.2% is almost 10 percentage points better than September year-end -- year-to-date 2017, which closed at 32%, and is in line with what's anticipated and discussed during 2017 year-end call. This variance is mainly driven by the positive impact of the Italian Patent Box and the U.S. tax reform, that which we already discussed about in the previous calls.

Year-to-date net result at EUR 116.8 million or 23.6% of revenues, is higher than previous year by EUR 21.1 million or 22%. This increase is the result of what's said so far and of lower net financial expenses, mainly driven by a reduction in interest and FX losses compared to last year and by the revaluation of the participation in our Indian subsidiary following the takeover of its full control from the local partner. We also discussed about these elements during last quarter call.

Lastly, the September year-to-date EBITDA at EUR 187.1 million is better than last year by EUR 5 million or 2.7%. The variance at constant exchange rate is positive by 7.5%. EBITDA ratio on the revenues is 37.9% at current exchange rate and 38.3% at constant exchange rate. Thus, confirming the strong profitability recorded in the last quarters.

Quarter 3 EBITDA margin at 36.2% of sales has been affected mainly by 2 elements: the impact of the one-off cost just described; and some seasonality in sales in Europe -- mainly Europe; and some product mix. Please remind that Q4 '17 was materially affected by the Irish site divestiture cost. So the growth of Q4 '18 over Q4 '17 is going to be more material than what we have reported year-to-date.

Let me now please move to the net financial position and the free cash flow. We closed the period with a positive net financial position of EUR 128.8 million and about EUR 141 million in cash. The net financial position has been affected by 2 main elements: the payment of the ordinary dividend for EUR 47 million in May; and the shares buyback program for EUR 65 million. As said, the net financial position does not include EUR 98 million debt towards shareholders for the extraordinary dividends which we will be paying out shortly in December. In the period, the group generated EUR 101 million free cash flow vis-à-vis EUR 97 million in 2017.

Lastly, in view of the group operating performance, the management confirms the 2018 guidance for both revenues and EBITDA with a growth at constant exchange rate of around 9% for revenues and 12% for EBITDA. As was mentioned by Carlo, please note that this guidance might be negatively affected by the delay for 2019 of some tenders originally foreseen for Q4 '18, which should -- took place in geographies which are served by our distributor's network.

Now let me please turn the line to the operator to open the Q&A session. Thank you.

[Operator]

[Operator Instructions] The first question is from Romain Zana of Exane BNP Paribas.

[Romain Zana, analyst]

The first question, I'm sorry, if I missed that during the call, is just a clarification of the organic growth component for the group in Q3.

The second question is regarding QuantiFERON-TB and I was wondering if you would commit, let's say on at least a range of the incremental growth that it could bring to your revenue growth in 2019.

And just also a clarification regarding the comments you made regarding some potential postponements of revenues in Q4, I'm referring to Iran, for example. Does it mean that you could actually miss the current guidance, but it could be an add-on to next year? Or it won't be material enough, let's say, to jeopardize the current guidance?

[Carlo Rosa, executive]

Okay. So I will comment on the second and the third question and then P.G. will cover the first. On the effects on TB and contribution for 2019, you need to wait for the 2019 guidance and the plan that we -- we create a new 3-year plan which we plan to discuss in the first half and we're certainly going to give more color to the -- what we expect on -- from TB.

As far as the comment on Q4, look, we have a significant business in Iran. And what we are trying to understand in this because the -- actually the U.S. just came out yesterday with a list of the banks which have been blacklisted. We need to understand how financially we can continue our business in Iran. So far, we expect that, looking at the list of banks, we will be able to continue with some of the current banks, and then we'll be able to make complete shipments in Q4. But I'm just warning that, in case we need to move to different banks, it may take time and that means that our regular business and our regular shipments in Q4 will be moved to Q1. That has nothing to do certainly with losing business, but has to do with the fact that a significant portion of sales, significant for the quarter, would be moved from 1 quarter to the other.

The other one has to do with a very large blood bank tender that -- where that entails sale of a large quantity of systems, some of which already happened in Q3 but some scheduled to happen in Q4. And again, we are waiting for instruction. And we need to understand whether this is going to happen in Q4 or is going to happen in Q1. So we are saying these are events that should not impact our revenues, but there is a shift of these extraordinary components that may be shifted from Q4 to Q1. Now as far as organic growth...

[Piergiorgio Pedron, executive]

Yes. Organic growth, both in Q3 and year-to-date was around 4% to 4.5%. And I believe I didn't mention it in my call, that's why you didn't pick it up.

[Romain Zana, analyst]

Okay. Just a short follow-up to Iran, what is the sales exposure of the group in this country?

[Carlo Rosa, executive]

No, we don't -- it's sensitive information. We don't share that information.

[Operator]

The next question is from Michael Ruzic of Berenberg.

[Michael Ruzic-Gauthier, analyst]

Just a quick one for me. I was just wondering how many of the Siemens accounts you had currently converted from ELISA to CLIA, I guess, percentage-wise?

And as well, just on the large system order, to better understand if that slips to Q1. I guess in terms of percentage of revenues, can you quantify that or be a bit more clear?

[Piergiorgio Pedron, executive]

Let's talk about the conversion. I think I provided some data. I said that we converted today 10% of the customer base. And we have, in the funnel, 50% conversion by year-end. Year-end meaning 2019, okay? So we expect to convert up to 50% by end of 2019, which it means that we will have 1.5 years to convert the remaining accounts. Certainly, the weight in terms of our revenues is not 50-50 because we are converting in Phase I larger accounts so you're going to have -- the revenues is going to outweigh the -- in terms of the number of accounts converted. As far as the -- I think the question was the -- so can you repeat the second question?

[Michael Ruzic-Gauthier, analyst]

Yes. I was just wondering if you could quantify the system order for Q4, how important that was for the revenues, perhaps percentage-wise if that were to slip to Q1.

[Carlo Rosa, executive]

Unfortunately, I cannot do it because this is part of a transaction which involves Siemens. It's part of the Siemens business that we inherited. So I cannot share.

[Operator]

The next question comes from Maja Pataki with Kepler Cheuvreux.

[Maja Pataki, analyst]

I have a couple of follow-up questions, and I'm sorry if I'm asking probably the same questions. Again, Carlo, the postponement -- the potential postponement into Q1, it's related to Iran and what would be the second reason? I wasn't quite sure whether everything is down to Iran or there is another reason.

My second question would be around your molecular performance, which came in below what I was expecting, and you did discuss at the first half results a bit of a seasonality in molecular. I was wondering if you could give us an update and how we should think about it may be going into Q4.

And then the last question would be really relating -- since you're giving us an indication that there could be shipments -- or like the postponement of some revenues moving into Q1. Would you confirm nevertheless the 2019 guidance and then we just have to add Q1 on top of that, would that be the right way to look at it?

[Carlo Rosa, executive]

Okay. So the first, I said that there are 2 events, very different. First one is -- has to do with Iran. And again, I think we covered that. Second one has to do with has to do with a very large tender in blood bank in Asia and this includes -- and this is part of the Siemens business we inherited. And we cannot quantify, it's a significant business, it's done through partnership and therefore we cannot provide more detail. So our -- the question on the table is whether shipments will happen in Q4 or will happen in Q1, that's that. Okay. So we're just moving from 1 quarter to the other quarter.

As far as -- that clearly if it's shifted to Q1 is additional business to what we foresee for 2019.

[Maja Pataki, analyst]

And I mean, you know, we have now -- the world has gone a bit -- slightly crazy and you talk about issues also in Brazil due to debt collection and stopping for the moment with some orders. We've seen Iran. We've seen this large order in Asia. Do you still feel that the 2019 -- that your guidance that you provided 3 years ago for 2019 that -- are you still comfortable with that?

[Carlo Rosa, executive]

Look, Maja, the 2019 guidance, I think you should do it at plain exchange rate, okay, so which is already a complication, entails a growth next year of 10%, okay? And what are the factors -- the add-on factors and what are the risks? The add-on factor is certainly understanding that we have a base business today net of new initiatives, and the new initiative will be launched exclusively in the U.S. and with the Meridian -- the conversion of the Meridian business, the launch of QuantiFERON and some launch of the nuclear products. So we have an increasing growth rate of the business, which is around 5%, okay? And then to that, you need to add the component -- the organic growth provided by, again, TB and end of story. So the question, in my opinion for 2019 has more to do with how -- where Vitamin D in the U.S. is going to go. Because today, I'm making a projection which is based on data that we have seen to date, and we are also making projection on what we have seen in other geographies. So I'm guesstimating that within a certain period of time, Vitamin D volume may go down between 18% and 20%, okay? And then, I think as we have discussed already, my -- from previous experience, I expect that the volume will bounce back. And I always refer to what happened in Australia. Very similar situation. Measures were put in, reimbursement was cut, which is very -- exactly the same as in the U.S. and then eventually bounced back -- the volume bounced back in the following 2 years. But yes, there is a hit that you take when it goes down.

So the effect of this in 2019, in my opinion, is still to be seen and evaluated. And this is why we are careful. From what we see today, I believe that the 2019 guidance that we have given, provided that again, we have good outcome from TB which is starting very well, and the viability in this transaction with Meridian which pretty much is opening up the U.S. market to H. pylori working with Meridian conversion, it's -- I have a positive, positive feeling about 2019 and the guidance.

[Maja Pataki, analyst]

Right. And on molecular?

[Carlo Rosa, executive]

I'm sorry, yes. Question number two was about molecular. You see, the problem with molecular is that, as you know, as I've discussed a few times, we bought the molecular business which has 2 components. One is ASR [ famous ] and [ famous ] ASR. The other one you have the kits. As far as the -- we don't break it down but as far as kits are concerned, there is a growth, which is significant as 20% growth worldwide of this product line. Then you have the ASR. Where ASR, you're really at the mercy of the end-user, which, guess what? Very large end users are the very large labs in the U.S. that they use it for LDT. And there you see dynamics which are difficult, honestly, to predict because LDT means that they develop their own tests so you don't -- difficult to understand and project efficiency. So how much of your reagents are actually turned into assays that they report and therefore consumption. So historically, when we bought this business, this ASR, the ASR in the U.S. was growing double digit, okay? What we have seen this year is that this ASR component is not growing, actually, specifically, with 1 account is declining. And the net-net effect is that we are diluting the growth of what is the strategic business, which is the kit business. It's still less than 10% of our overall business, so it does not have a great impact, plus or minus on the growth. It's very positive on the kit side. There is this ASR component which is difficult, honestly, to predict. Great, great, great cash cow, not necessarily so strategic, but we're diluting sometimes the good result of the kit.

[Maja Pataki, analyst]

And Carlo, at second quarter call, you were kind of expecting that the ASR business would, at some point in time, see an acceleration in this year. Just as you pointed out the lumpiness and the big -- the big customers. But do you still believe that at some point in time we're going to see a turn effect or do you think this is something that is going to remain sluggish?

[Carlo Rosa, executive]

I think it will not -- my expectation in 2019 is that this is not going to be a drag. And the reason being is that there is a large contract that was awarded to us, they are doing validation. Again, some of the big labs. And this should cover some of the negative impact that we have seen from reduction of use by other accounts. So in my projection, ASR should not be a drag, should probably continue to grow in low single-digit, and I see it as a cash cow. And that -- and this would allow, clearly, the kit performance to be more visible. Keep in mind that we have the influenza syndrome as everybody else. So we are carefully watching what is going to happen with the influenza this year. It was a light season in the Pacific and I think we are all waiting to see how the influenza will do in this winter. And so it does impact I think the business of a lot of companies that, actually play into the molecular space, ex blood banks.

[Operator]

[Operator Instructions] The next question is a follow-up from Michael Ruzic of Berenberg.

[Michael Ruzic-Gauthier, analyst]

Just a quick follow-up from me. I think the market has been kind of spooked by these potential delays in Q4. I think it would be really helpful, maybe not splitting them out but just together if you could quantify in terms of a headwind if both were to go in the negative case and flip to Q1, do you think there would be a 1% headwind to sales? Does that feel about right? Or would it be more or less?

[Carlo Rosa, executive]

More or less 1 percentage point.

[Operator]

[Operator Instructions] Mr. Rosa, there are no more questions registered at this time.

[Carlo Rosa, executive]

Thank you, operator.

[Operator]

Ladies and gentlemen, thank you for joining. The conference is now over. You may disconnect your telephones. Thank you.