Detection Technology Oyj

OMXH:DETEC

Earnings Call Transcript 2023-Q2

[Hannu Martola, executive]

Good afternoon. My name is Hannu Martola. I'm pleased to present you Detection Technology Half Yearly Report and Second Quarter financials.

As total, our sales reached EUR 25.2 million -- sales, up 10.8% from last year. We resulted EUR 1.4 million in EBIT, slightly more than last year, the EBIT percentage was 5.4%. In altogether, I think we started to move forward, but not enough. And also, we are not satisfied with our profitability.

Looking then various businesses. Industrial sales was slightly down 6%. It was an outcome of actually some reduction in inventories, and also the industrial sales in China was fairly low. We must remember that the industrial sales market in China is actually at the beginning and overall long term looks promising.

And good news is that the demand normalized towards the end of second quarter, so we should look forward for a little better second half. Medical sales was really strong, 22%. It's a big number, but we also must remember that the underlying quarter was soft, so affecting this heavy percentage.

Overall, the market demand was unchanged, but it also then was softening towards the end of the quarter actually globally. And CT applications was the driver for growth. And as I stated, so that the underlying quarter was a bit soft.

Security sales, it was up 5%, actually a little bit less what we anticipated. And also the sales in China was fairly low, which is an important market for us. And -- but the good news is that as we see that towards the end of the quarter, actually, the demand and requests are now sort of strengthening. And we believe that actually now the let's say, the lowest sales period for China security is now behind us. That was the first half, and we look forward into some nice growth also from that market. We had really nice growth in the Americas, and that was very much driving the security sales upwards.

Then as a total, the profitability was affected by a little bit lower sales, not so favorable sales mix. We also had to do and did some credit loss provisions and some onetime spot costs also affected the profitability. But even though despite these one-timers, we actually have to know and will take measures to improve our profitability.

On net sales by quarter, I mean, also visually, we are now getting sort of better. But like I said, not fast enough, but we look forward into actually increasing the growth speed in the next sort of -- coming sort of quarters. Operating profit is still very much down from the target level of 15%.

And then if we look the quarter -- second quarter sales split by business units, IBU represented 15% of DT sales, down 6%. Medical was about 50% of our sales, 22% up and SBU, 5% up, representing 36%. And as I've said before, historically, actually, our SBU and IBU have been bigger than medical business, and that's also something that we look forward into the mid and long term.

On regional split, Americas really strong growth, 58%, Asia Pacific, some grow 7%. And actually, this growth came quite a lot outside China. It was also surprisingly good in India. We look forward into long term a nice business in India. Europe, Middle East Africa was about flat.

On first half, quite much similar numbers than in the second quarter. So EUR 48 million sales, 11% -- 11.4% growth and EBIT, EUR 2.8 million, representing 5.9%. And despite the fact that there were one-timers in both first quarter, second quarter, this is not something we can be satisfied with. And we have started and we'll do actions in improving our profitability.

Business units, IBU minus 5% first half, medical, 18% up and security about 10% up. And the business unit split is very similar than the second quarter out of the total sales.

And then more -- looking more carefully in the numbers, I think there are a couple of things we can highlight here. One is that the cash flow then started to improve quite considerably. We had a 2.4% positive operating activities cash, thanks to the tighter managing of our accounts receivables. Investments were fairly smallish. I mean, at the current rate, we don't have a need to do any capacity increases and so on, thus the need to invest is limited. R&D was 12.2% out of the total sales.

Our strategy highlights. The most important thing for long-term future transactions of DT was the acquisition and closing of Haobo Imaging. We call Haobo Imaging now as DTS. That's DT Shanghai. We now own to be precise, 89.75% of the shares. The 2 founders hold about 10%, they remain leading the business. We have organized the DTS as part of -- actually, our medical business unit. So medical -- the Head of Medical Business Unit, Chen Wu is leading that -- and then aside, I mean, the finances and HR reporting to the relevant functional heads.

We must also note that there will be goodwill, which is generated out of the deal about EUR 12 million, and we will be starting to depreciate the goodwill then quarterly over the 10-year period. So instead of EBIT, we will be then talking of EBITDA, so earnings before interest, taxes and amortization in the future because we are following the Finnish accounting standards, which means that we must depreciate the goodwill, which is different than, for example, what most have been used with the IFRS standards.

We also took the opportunity to move the Oulu operations into a new facility. It's luckily only 200 meters away, but it's a building that has been designed to be an office and factory building, and that will enable us much better to both do our R&D administration as well as our production. And we look forward also for making more of the European -- origin products that are originating from Europe, and we are avoiding some tariffs than in our sales to U.S. and thus having savings plus this is a good way to mitigate any geopolitical risks that might arise. We also expanded the product offering for TDI X-Scan T02 products for our industrial business.

Some other events, DT Heartbeat, I mean, employee survey slightly up, as a result, we were promoting the value-based behavior through our leadership courses. And first time, we also have the DT Shanghai employees participating to these programs. We had 2,000 zero accident days in our manufacturing sites. That's a very good result. And also, we are an active member of the Ahlström Collective impact, which is then supporting Unicef global education work.

Then the most important really is that what do we expect from the future? I think overall, the market growth is there. I mean, we expect then shorter-term third quarter industrial to grow, also grow in the second half. In medical, we see quite clearly that our customers, especially Chinese customers in China have been too bullish on the growth. I mean, since pandemic times, the medical growth has been really, really fast in the world. And it has been slowing down.

And what we have now been informed by our customers that they have been too much optimistic and they are now balancing their sort of inventories and so on and the medical for third quarter will decline. And then -- and also then decline in the second quarter as an outcome of that. And then security to have a strong double-digit growth, both in third quarter and second half. And due to this medical temporary event, actually, the total net sales for DT is declining in third quarter, but we still believe that we will be in growth for the full second half, meaning that the fourth quarter then will sort of improve and boost the company into the growth.

On business outlook, as I said, the market information, there has been a -- there has not been information on that's different if I would have a guess. I think security market there growing faster than 5%. It's been so down for so long. Industrial market, 6% probably is a good guesstimate, medical market, 5% or short term, probably a bit less. And as an official guidance, we expect the whole company net sales to decline for the third quarter and to grow for the second half.

The good thing in the -- during this second quarter and also in July really is that there has been now increasing interest in China for security, also aviation. There is Hong Kong is renewing the airport with computed tomography equipment, Hainan Island has 2 international airports that are now moving into use of computed tomography also in the Western China, they are moving.

So despite that there have not been big announcements, despite that actually the security aviation market that has been very much in standstill so far is now moving ahead, and we have customers asking that can we increase our capacity and so for those products.

As financial targets, they are the same, annual sales growth at 10% or better than 10% operating margin at or above 15%. And by operating margin now, we are using EBITDA, earnings before interest, taxes and amortization, as I was explaining, and then out of the net proceedings dividend or return capital is between 30% to 60%.

Thank you. I'm now very pleased to answer to any questions that might arise.

[Arttu Heikura, analyst]

Arttu Heikura from Evli. You mentioned that you have taken actions to improve your profitability or cost efficiency. How clear is the plan today? And from -- I mean, from which rows you are planning to cut costs?

[Hannu Martola, executive]

We have actually -- we have done some small items already. Actually, we closed down the DT Nanjing office last week. We actually established it due to the fact that China has the strategic Made in China 2025 program, and that was actually, China government was subsidizing a lot of companies doing semiconductor designs and so on, we have terrible trouble of getting employees.

And actually, in Beijing and Shanghai, especially was challenging climate. And then we decided that we have to do something if this turns worse, and we decided to actually establish Nanjing that was the right decision. That time then hit the corona, and we were not able to let's say, develop it. We didn't -- we have very many less than 5 employees there. And then after the acquisition of Haobo, we have too many sites in Eastern China, and we decided that, that needs to be closed. So that's 1 item, and it's a sort of start.

We are right now doing planning. We are seeing what we need to be doing. The plan is that we will do the actions during third quarter, and then we would -- and should have a clean fourth quarter. And also many of these actions will also help our fourth quarter and especially help in 2024. And we see these things as necessary to be able to get into our 15% EBIT profitability.

[Arttu Heikura, analyst]

Okay. And what is your visibility to IBUs and MBUs customer inventory corrections currently?

[Hannu Martola, executive]

I think it's -- MBU is more clear because the lead times are longer, and we basically -- we see already the third quarter very much -- let's say, MBU risk more are relating to, I mean, customer payments and so on. I mean if somebody is not paying certain things, then we might delay the shipment and so on, but those are minor things. So MBU visibility is good. IBU is sort of, let's say, shorter term, we have seen that it is now improving. I think we also communicated this after the first quarter, and it should be now the better than for the second half.

Of course, there's the global markets are a little bit less active as we all know that we -- the world was thinking after the first quarter, but still the outlook is for industrial is there's solid items. There's areas like, for example, the battery inspection. That is very hot.

We also are selling our products into the manufacturing of batteries for EVs and anything that moves. And so there are clear growth areas in the -- and this kind of using X-ray in battery manufacturing is very much at its beginning. And it's very, very crucial for the safety and quality of the batteries. We are talking about high powers to check actually during the various stages in manufacturing, the quality through X-ray.

[Arttu Heikura, analyst]

Okay. Then about the new facilities in Oulu. Do you expect to arise some extra OpEx costs during the ramp-up? And then about the EUR 1 million investment, is it all CapEx?

[Hannu Martola, executive]

Yes, the EUR 1 million, I mean, we don't expect any big hits in our sort of fixed cost that we have been a bit also, I must say, clever and lucky how we do it. The CapEx earlier, we announced that we will increase our cleanroom into the existing facility where we are right now. And that was about EUR 0.5 million investment. Now we are increasing the cleanroom space to about double what we thought and the investment is total CapEx is EUR 1 million.

So this is including the previously informed EUR 0.5 million. And thanks to the fact that the premises are much better, much better design. So actually, we -- to be precise, we gained 37% more net space. So we -- in a way, from that point of view, the cost per square meter is going down.

[Sami Sarkamies, analyst]

Okay. Sami Sarkamies, Danske Bank. I have a couple of questions. Starting from recent developments, you hosted a pre-silent call at the end of June, can you wrap up sort of the changes since that pre-silent?

[Hannu Martola, executive]

That's a good point. I think the 2 changes, 2 things. One is that -- well, the risks that we thought that in this kind of like payments that, of course, it's until the last day with somebody paid and so on, thanks to managing a more careful the accounts receivable. So that risk realized.

So we thought that maybe a little bit we would have been able to recognize a little bit more sales, maybe EUR 0.5 million less than -- a bit less than EUR 1 million. So that's sort of a realized and we actually came down to the lower end of the ballpark EUR 25.2 million, but then we were not aware of this medical, medical third quarter and fourth quarter sort of impact.

So -- and this is, like I said, this is mainly the Chinese customers in the Chinese markets that have been bullish, I mean -- and then what's the reason we don't know, but probably they've been guesstimating some government subsidies and so on, that so far has not come. Overall, I think there is not a change in the longer-term picture and the investment schedule for health care in China or in the world. So from that point of view, we are quite comfortable.

By the way -- and then the third item is it doesn't show yet, but the security looks better than what we -- when we had the call in June. So that's the -- that's the good news. When I started to do this report, I saw only the, let's say, the good news on security and then the medical came a bit some days after.

[Sami Sarkamies, analyst]

Okay. If we then dive deeper into the segments, okay. You mentioned that you have become more positive regarding security market. How much of that is already related to third quarter. You're talking about starting aviation CT investments, for example, in China. So how much of that will already impact the third quarter?

[Hannu Martola, executive]

Not very much, quite little. I mean the -- as before, I think we've -- end of fourth quarter like the TSA, U.S. airport and so on, that will be more starting towards the end of the fourth quarter. We might get some little in China for the third quarter basically are so fast, always things when something happens, then it moves fast, definitely for fourth quarter and then for next year and also what we know from some cases that they will -- it will take like 3 or 4 years to really to -- I mean, actually reinstall and rebuild the security systems to an airport. So it's not just a onetime like that. It's big investments. It's a huge amount of equipment and so on. So it takes time.

[Sami Sarkamies, analyst]

And how should we sort of look at the aviation CT potential in China relative to the U.S. market that -- I mean, are those comparable opportunities in size?

[Hannu Martola, executive]

Well, China has less airports and China has not announced any big program. I think the information in the market was before that China would be doing the call Class A airports, meaning the biggest airports in Yangzhou, Shenzhen, Shanghai, Beijing, Chongqing, et cetera first. And -- but there is no such announcement taking place. But now actually, some of these big airports like Hong Kong are moving already.

So naturally, flying is back in China and airports also everywhere they get money from each flying passenger and that helps them to also invest and they need to do something with the airport capacity and also the security challenges and the productivity of the airport, where the CT is actually -- it's like a no-brainer. I mean, that's something you need to do.

[Sami Sarkamies, analyst]

Okay. Then moving into the Medical segment. How weak is the outlook for the second half of the year that -- I mean, it seems that there's been quite a drastic change in the Chinese outlook. So how material drop should we be prepared for relative to last year? And is this like inventory correction?

[Hannu Martola, executive]

This is more inventory correction. I mean short term, yes, it's -- if you look the volumes is a drastic and that's quite natural. Obviously if you have products in stock and you don't need it right now. Of course, you don't want more until you have consumed that stock to the -- that's sufficient compared to the outlook for the demand.

So I mean, it will happen third quarter, fourth quarter and then for DT, if we look at the comparable quarters, then it especially looks bad for the third quarter because we had this I mean the comparable numbers for last year second quarter were soft, but they were quite hard because of the push out from second to third quarter last year '22. So the comparison for third quarter is tougher than it's for fourth quarter.

[Sami Sarkamies, analyst]

Okay. Then moving into Industrial segment, maybe a technicality first. When you're giving guidance, are you including the Haobo acquisition? Or sort of is the guidance for your own underlying business?

[Hannu Martola, executive]

Haobo will be included into our finances. Haobo will be reported on the base where the products are being sold. So if Haobo products are being sold for industrial, it's recognized for industrial business unit sales. If Haobo products are sold for medical, it's recognized for medical business unit sales. Haobo sales are in.

We foresee Haobo to be roughly like EUR 2 million for second half. It is a little bit question mark. It can be also, let's say, positive surprise. We'll see, but the business is a little bit different what we have -- so far, Haobo has not had any large accounts as their customers, like big OEMs like global OEMs, so the business is more like onetime sales until we develop Haobo commercialize their products into big medical OEMs, and that takes some time because approval processes, so that's also why we have said that Haobo will start to grow faster in -- from '25 and beyond. But until '25, we believe that Haobo will be growing faster than DT.

[Sami Sarkamies, analyst]

I mean, you said that the industrial segment has kind of like normalized from demand perspective at the end of Q2. So if we exclude Haobo, do you see similar sales to last year or higher in the second half of the year, excluding Haobo?

[Hannu Martola, executive]

Haobo, no, we're seeing them, so I'll comment only on the total DT Group.

[Sami Sarkamies, analyst]

Okay. And then finally, if we think about the full year top line outlook, do you think your double-digit top line growth target is reachable during the full year?

[Hannu Martola, executive]

I think based on this guidance and so on, it would not. I mean, so it would require very, very super good fourth quarter. So I mean, most probably, we will be somewhere in between last year and then sort of some single things. But then there is some answer that related to that also from upside perspective. But according to the official guidance, it's now declined third quarter and there will be growth on second half.

[Sami Sarkamies, analyst]

Okay. And then finally, if we look at margin outlook for this year, I think you were still quite optimistic after first quarter, you were expecting to be somewhat below your target level, how does look now? I mean first half was quite weak, and you're not sort of guiding for strong growth in the third quarter. So what could be a realistic margin level during the full year?

[Hannu Martola, executive]

When -- after first quarter, I think the biggest change really is that we -- the sales has not realized so -- which would, of course, I mean, naturally help, help the EBIT or EBITDA margin. Then as quarters to come, I think we foresee the product mix a little bit turning better, that should be helping and then we need to be seeing that what kind of we do in increasing the productivity in the company on -- both in terms of throughput margin or sales margin as well as leveraging more from our operating I mean, cost and people.

[Nikko Ruokangas, analyst]

Nikko Ruokangas, SEB. A couple of questions as well. So I'll get back to the guidance and your outlook for Q3 and H2. So it includes quite nice improvement from Q3 to Q4. And as you say that there are uncertainties that's continuing, for example, medical segment until the end of Q4, at least. So what makes you confident on improvement in Q4 Q-o-Q?

[Hannu Martola, executive]

I think one is this on medical side, let's say, customer inventory correction. Security, like we talked just a while ago on the -- I mean, TSA is starting to pull also the China security market. Now we see that, that is getting more active. And Industrial, probably, I mean, we see it as it was sort of the before. I mean, these stock corrections are out, and then we are getting help from the Haobo sales. So that's in nutshell.

[Nikko Ruokangas, analyst]

All right. So you expect that medical negative impact from the customer destocking is largest in Q3?

[Hannu Martola, executive]

Yes, as a sort of a comparable quarter point of view.

[Nikko Ruokangas, analyst]

All right. Then I'll get back to the -- your comments on profitability improvement actions. So could you give some kind of estimate of how -- for example, that you will close down the Nanjing in China. So how big impact do you expect from that? And then what are the sizes of the other actions you are taking?

[Hannu Martola, executive]

I think on an annualized basis, a couple of things we have done so far represent a bit less than EUR 0.5 million in cost. And like I said, that's just the start. We are right now in the planning phase with the management and seeing that what -- how can we improve the growth prospects of the company and be more like lean and mean, like I said, more focused and -- but those items, we have no decisions yet, and we are seeing that what really makes sense. But like I said, I mean, the target is to get to this 15% EBIT profitability.

[Nikko Ruokangas, analyst]

All right. And then last, relating to that. So you say that you see the -- or was it so that you see the sales mix improving in H2?

[Hannu Martola, executive]

Yes.

[Operator]

We have a couple of questions from the chat. So[ Joachim ] asks about DT's outlook...

[Hannu Martola, executive]

Can you just talk -- I don't hear you well. I think it's -- is your microphone on. At least I don't hear it. Okay. Can you just speak a bit higher -- louder?

[Operator]

Of course, sorry. So about DT's outlook and especially medical in Q3 it was exceptionally strong last year. So no surprise that it is coming down. However, considering this slowdown in demand, our net sales going to decline also from Q2 level.

[Hannu Martola, executive]

So I mean, what we guide is that there will be a decline as total DT for third quarter. And then there will be growth for the full second half.

[Operator]

Could you comment on the likely reasons behind the softening medical demand? It seems to be soft globally, not only in China, where there are other over investments during COVID period and now a longer slump. When do you expect the demand to pick up?

[Hannu Martola, executive]

I think globally, the thing is that the health care is uninvested. I mean it's -- and the fact is that what I have heard from our customer base is that the equipment are even more outdated than they were before corona. So the equipment base globally has worn out despite the big investments during corona time. So there is a big need from that point of view.

The challenge is that the world is out of money. I mean this requires investments. And then, of course, the governments need to be deciding how to do they prioritize between the needs of our people and countries.

So the sort of the market forecast, the market outlook for medical, especially medical CT is strong. How much then out of that growth need will realize this growth is a big question mark, but I mean the 5% is quite realistic actually from that point of view.

Then if we take separately the China market is -- the market believed that the China would have been growing a bit faster. I think the market was counting for some subsidies for Chinese government. Based on last -- they had a big important meeting last week, there were no sort of decisions at least yet or for anything like that. And it can be that some -- you can only guess what has happened, but our guess is that these customers have been a bit too sort of aggressive on being ready for the growth because it's a China system also is that when you get an order, you have to deliver. So you have to be prepared. There's no sort of -- the waiting time is shorter and everybody expects things to happen when they send an order in. And now this kind of extra preparation needs to be melted even though the market is growing.

[Operator]

Could you also comment on the opportunities in India? Do you see this as a significant market for DT in the coming years?

[Hannu Martola, executive]

The answer short is yes. It's an exciting market. India has been, I think, if you read the international financial papers and so on, it's been a promise for long, but it's -- I'm not the only 1 who now believes that now things will happen. India actually has changed a lot of the legislation just before the COVID times, during the corona COVID times, I mean, and for much, much more favoring business, favoring for logistics between the states and also the corporate taxes, all kinds. So there's a lot of things that have been done to boost also the the business.

In addition to that, India has now big government programs for investing into like health care equipment manufacturing. And so India historically has been very strong in software -- very, very strong in software. And now they are moving also more towards being a hub for making of business-to-business equipment and so on. And we look forward of being part of our helping them there.

[Operator]

So we have 1 more question. Could you remind us about historical split of Haobo sales to your business units?

[Hannu Martola, executive]

That's something that I probably don't remember, but precise, but Haobo has been a little bit doing dental for medical, most of it has been industrial. I mean we must remember that this health care, there are approval processes, customers are conservative. And Haobo is a fairly young company. They are super good, and we are so admiring so much the capability of yielding out new products.

And now we are doing together. We wanted -- that's the reason we wanted to actually hold Haobo fairly independent we don't destroy that capability, but we support it through some systems and processes and especially through our customer interface for larger Western accounts, they would not have had possibility to sell into some western major players.

And we already have started -- I have also been personally in these meetings with some of the customers. And -- and also good news is that I must state that even though we also talk today of the spot costs, I mean that are an outcome because of the material shortages we just faced some time ago, everybody companies learned their lesson, medical customers are conservative. They hated new suppliers, getting in new suppliers because various things now they must take them in.

So before, nobody wanted to have a second supplier or 2 suppliers because it's a cost. Now a lot of the companies are interested of getting a new supplier because of risk mitigation, risk purposes. And we believe that we are the 1 that has a good opportunity to capture many of these accounts.

And by the way, we -- this Americas business also is an outcome of very much of getting new accounts that we stated that we won more new accounts during the corona times that we build our competition.

Well, thank you. I think we are now have used the sort of time that we was reserved for us and I think very much for good questions also from our dear analysts, friends here. And look forward to seeing you again after the third quarter and bringing up some good news more in towards on market needs on security and also some clarity for medical business and industrial. Thank you.