Eurofins Scientific SE

PAR:ERF

Earnings Call Transcript 2019-Q3

[Operator]

Welcome to the Eurofins Scientific Q3 9-Month 2019 Interim Management Statement. [Operator Instructions] Today, I am pleased to present Dr. Gilles Martin, CEO. Please go ahead.

[Gilles G. Martin, Chairman of the Board & CEO]

Hello, everybody, and thank you for joining our quarterly conference call. While I'm pleased to report on a good quarter, you know we had a very traumatic experience in June. We were criminally cyber attacked that had an impact on many of our servers and forced us to shut down a large part of our IT infrastructure and then clean out what was infected and screen everything and install new IT protection tools, in addition to the ones we had. And that affected, of course, our operations massively for many labs in June and it affected many clients. But we were pleased to see that in the 3 months following, this operations have been restored and the trust of our clients is coming back. We have still some small issues with the new IT security tools here and there, and we're -- our IT teams are ironing that and adding more tools and more servers, et cetera. But things are good and are progressing in the right direction. Of course, the back office systems were the last to restart. We still have a lot of work to do on the collections and dunning and all those things. But also there, we hope by the end of the year, we'll be back to normal state after what was a very serious attack. And we have started receiving the first payment from our insurance. You know insurance is structured in many tranches that are piling up on each other. So I believe the first couple of tranches have been approved and one has been paid, and we think the rest will happen over the next few months. But anyway, we need 6 months because that's the coverage period to assess our damages, and then discuss with our insurers of the exact payment, so this will take some time. The business is very well. If we correct for working days and exclude the Boston Heart, which of course is still suffering from stopping of reimbursements of some tests. We were above 6% in organic growth in Q3. Actually, 6.2% if we correct for the forensics business in the U.K., which could not restart before the end of July. So it's a pretty good quarter for the underlying business. We still have some issues. It could have been more because we, of course, have some productions that will still slow down because there's still some interruptions in Q3 due to the remnants of the cyber attack, a couple of catch-up too, but both probably compensate each other.So overall, in terms of trend, Q3 looks pretty good. On Boston Heart, unfortunately, nothing has really improved. We have the big reductions in revenues and payment for tests occurred in the middle of Q4, so we still have some impact in Q4. Next year, it will be -- the impact will be much less. Also, the company and other companies working in the cardiovascular space were under investigation, and we knew that before we bought the company. And it looks like we're going to be settling this with the government and the private sellers. We have a lot of money in escrow from the acquisition to cover that. Looks like we're going to be settling that soon so we can put this story of Boston Heart completely behind us in the fourth quarter of this year, I believe. And then, we'll rebuild that business and more focus on [ staff pay ] and people or companies who want to pay to not getting sicker, their employees -- preventing illnesses for their employees. But the company will be very small by the end of this year. And next year, the impact, wherever it goes, will be marginal. So that's one good thing that will be behind us. The outlook is good, as you might have read in some of the comments from the -- on the press release, so we think fourth quarter should be good. And we confirmed also that we believe the company can achieve its objectives as we set them for 2019 and 2020. Of course, there are still some uncertainties on the area of what insurance will exactly pay us, when they will pay us. We have to work hard on collections because you can imagine, right after the attack where our turnaround times were not so good, we might not have been pushing our clients enough so we have to improve our collections. But overall, we think things are good.We've had some questions, we've had some people who have been shorting our shares and trying to create noise around the company and whatever, so they ask the question about the company's structure, "Is your company structure not too complex?" And for those of you who are interested, we've added a few slides to our slide show on that, that I can comment now. It's on pages 75 through 78 of the slide show. And we took an example in the U.K. because those guys, apparently, looked in the U.K. and looked at many subsidiaries.So basically, what Eurofins has been doing since we went public 22 years ago, and even more in the last 5 years, is build leadership positions in key markets, for food testing, environmental testing, testing of pharmaceutical product. And in those markets, that when we started we're extremely fragmented, we achieved that by a mix of organic growth and acquisitions. So we ended up buying many companies. And for example in the U.K., you would see on Page 76, one company we acquired was the food, environment, water and pharmaceutical product, I think, of Exova, which has many sites, in Grimsby, Birmingham, Hillington, Camberley, Edinburgh and all those sites were a little bit diversified, too small, some of them too old. And at the same time or shortly thereafter, we had bought another company called ILS, which also had 2 activities in a site that was obsolete and where we wouldn't stay, and we have bought other small companies, one [ in Newtec ].And on Page 77, you see a little bit of the footprint. To the left, there are several sites that we had at the end of 2016. And so what we've been doing in the meantime, we've been building our big hub in Wolverhampton, expanding. We've been able to already collapse quite a few sites in Wolverhampton. And in the same time, in the area of Hull and Grimsby, we've also been able to consolidate Newtec into those sites. We built a new water testing and pharma product testing site in Hillington in Scotland, where we have been consolidating what we were doing in those areas in Camberley and at ILS in Shardlow. So this is basically typical of what we're doing. We still have a couple of sites that will be consolidated. We just bought a big site in London. We spent something like EUR 15 million recently to buy a site that can house all our activities, including those of other divisions like forensics via London in our modern building. That should be our London area campus. So the 2 sites you see near London will be consolidated there. Also, in Hull and Grimsby, we have plans to do something so that by the end of 2020, our footprint will be one lab in the north, one lab in the middle, one Wolverhampton, one London and a good logistics network to serve efficiently the U.K. Obviously, when we did that, all those sites were in different companies, and so we had a lot of intercompany transactions to sell the parts of the business that fit with food, with the food company, et cetera. On page 78, you can see the structure of Eurofins in the U.K. We still have a couple of companies that we will consolidate, like the Harrogate testing that we bought from Covance. In food testing, we will be consolidated with one of our food testing companies. And so that gives you an idea of the legal structure that Eurofins has adopted. In each country, we usually, when we're big enough, we'd have one company serving the pharma industry. If we have different types of services serving the pharma industry, we might have 2 companies because different parts of the pharma industry requires sometime even different regulatory environment, GNP or GMP, et cetera, and they're better in different legal entities. And then food testing is usually split between a large company for the competent center for the hub and some local companies for the satellite laboratories. We also put our buildings in separate legal entities, and they are rented to the different operating companies. And then the finance, controlling, purchasing, et cetera, is done by National Service Center, which is also in a separate legal entity. So that's our structure, which is pretty clear and streamlined, and we strive to achieve an end point where the structure is similar in every country. But this occurs over time. We cannot do it on day 1 because sometimes, we need to build building, expand sites, et cetera. So that's the structure we have. We believe that having relatively small operating companies, with a Managing Director which is in charge of all the aspects of this business is an entrepreneurial model that leads us to achieve better service to clients, faster responsiveness, less bureaucracy, and this is why we have opted this for this model. And it seems to work well for us, and as we saw over the years, it is definitely a positive for our organic growth. So that's on our model, there's a question on that. So I think now I will turn the microphone to you for questions on our third quarter numbers.

[Operator]

[Operator Instructions] Our first question comes from the line of Suhasini Varanasi from Goldman Sachs.

[Suhasini Varanasi, Equity Analyst]

Just a couple for me please. When you mentioned the insurance, 2 tranches have been approved and 1 has been paid. Can you give some color on how much has been approved and how much has been paid so far? And on the TruGraf reimbursement, you had an announcement on that a few weeks back. Can you give some color on how material this opportunity can be for you on the medium term? And is there any potential earn-out that needs to be paid because the reimbursement has come through?

[Gilles G. Martin, Chairman of the Board & CEO]

Thank you very much. Yes. So insurance, we're not communicating in detail. But I would say, the order of magnitude is, I would say, about 20% maybe of the damages or something like that have been paid. But we're in the early days because we need to assess over the full 6 months period, the amount of damages to file a final claim for the higher tranches, although we might have another intermediate one soon. TruGraf, we are waiting to receive the exact reimbursement value to finalize or update the business plan. And there are, indeed, milestones in the contract when we acquired the company that depend on the level of reimbursement and that depend on the revenues that we will generate with this business. And depending on the reimbursement price, obviously, the peak revenues that we can generate will vary, and can vary anywhere between EUR 50 million or EUR 500 million, so it's -- and depending on the adoption and other factors. So it's a wide range and that's why we've opted not to communicate yet about it. It's also not only [ distance ] because have auditors that worked together with this one in our pipeline for which we also applied for reimbursement under different programs of Medicare. And we think this is very exciting area. And also, our tests in the noninvasive prenatal testing space are starting to come in shape. We're a market leader in Europe, and we think, in America, within the next 12 months, we should also have a good starting point.

[Suhasini Varanasi, Equity Analyst]

Do you have any idea on the timing of when the reimbursement pricing will come through please for TruGraf?

[Gilles G. Martin, Chairman of the Board & CEO]

Yes, we think in the next 4 weeks probably. The government, they do what they want. But I think in the next 4 weeks, it's likely to happen.

[Operator]

Our next question comes from the line of Nicolas Tabor from MainFirst Bank.

[Nicolas Tabor, Analyst]

I had a few questions. First, on the [indiscernible] guidance. You still think you can achieve it for 2019, even though it was the impact of the cyber attack in Q2? And then second question, you said I think in the press release for the Q3 that you have strong performance in European environment testing activities. Was there some positive one-offs, like the Lubrizol, that could have triggered some more work? And then third question, I heard there was some strikes in France in October in French clinical and diagnostics laboratories. How did this impact your activity, if it did at all?

[Gilles G. Martin, Chairman of the Board & CEO]

Thank you. Well, yes, I think organic growth is pretty good, it's even picking up. And we were corrected for working days in Boston Heart. We were at 5.5% in the first 5 months of the year. We were at 6.2% in Q3, so that looks good. Of course, it will depend what we'll get refunded from insurance for Q2, if you want to look at that as organic growth. I think it's never going to be really comparable. But for the things that are comparable, I think it's good, and I think it's pretty impressive. In the current state of the economy, that our underlying business is growing above 6%. No, I don't think we have any significant one-off. Lubrizol is -- pure analysis is not really significant. And I haven't heard of a strike impact. I've heard of the impact of the strikes in Chile at our Chilean lab, it's a tiny lab. But that's the only thing I've heard about.

[Operator]

Our next question comes from the line of Will Kirkness from Jefferies.

[William Kirkness, Equity Analyst]

Three questions, please. Firstly, just on -- follow-up on the organic growth point. It looks like unless there was anything one-off, I think, there may have been a little bit of catch-up in some of the businesses, perhaps, in food in Western Europe. But if that momentum continues, given the easier comp, it looks like Q4 should start with maybe a 7%, just wondering if you could give some comments on that. Secondly, regarding free cash flow guidance. I think you need an inflow in the second half, I just wondered about work -- on improving working capital and confidence around that. And then finally, just on M&A, if you're on-track to spend EUR 300 million, and then whether there's been any discussions you've been having around anything that might be noncore. You've previously you referenced some of the genomics businesses before.

[Gilles G. Martin, Chairman of the Board & CEO]

No, we are still having an objective of 5% organic also for Q4. Of course, we will see what we do and we usually do a little bit better. I hope the drag from Boston Heart will be less, over time. I mean it will be definitely next year because the company will be very small, but we still have an objective of 5%. And if we do better, that's fantastic. In free cash flow, yes, the main -- well, there are 2 question marks on free cash flow. One is the reimbursement we'll get from insurance, what we are going to get this year because we still have -- we're missing more than EUR 50 million or EUR 55 million from the profit that we didn't make in June. And, of course, collections because we've not pushed our clients too much when our service levels were not so good, and now we've started to be a bit more demanding and sending dunning letters, et cetera. But we need to catch up on that aspect by the end of the year to get a full view on the cash flow for this year. On the M&A, I think we might be a bit below. We will get to the EUR 200 million added revenues, I believe. But maybe we're spending a bit less than we have planned. We'll see the M&A is not a priority. It was not a priority, anyway. We've reverted back to goal of having EUR 200 million. But after the cyber attack, we decided to let our teams focus on our operations even more and restoring service to clients and deploy new IT software protection and so on. So we're really not focused on acquisitions very much in this second half of the year. We have a good pipeline, obviously, but we are not progressing all of them as fast as we could. And disposals, what we have done, we have put several of our businesses in a shape that we can see what offers we get. And if the offers were very attractive, we could act quickly on those offers. We received a lot of unsolicited marks of interest for some parts of our business that some analysts decided were not really core, and we should consider selling, restructured that a little bit and we did the preparation that is required to be able to execute on a transaction, should we see that some of those offers are attractive. And then if you get one, we need to see that we give the opportunity to all interested parties to also bid for an asset, so we get the best price before we make this decision of keeping it or not keeping it. So that's the status on that.

[William Kirkness, Equity Analyst]

We don't have [indiscernible]?

[Gilles G. Martin, Chairman of the Board & CEO]

No, we are very well funded. And with the -- the credit lines, we've negotiated at very low rates. We have way more money than we need to execute on our M&A program for this year and next year and our CapEx program. And next year, the operating cash flow should be bigger. So basically, it's even a question with the low interest rates, if we should even consider divesting anything. So the price we get offered for those assets would have to be very attractive for us to go ahead with those decisions.

[William Kirkness, Equity Analyst]

Can I just follow up on your comment around the spend. So you want -- you think you'll get to the EUR 200 million of revenues at a lower spend than the EUR 300 million. Is that just because the margins maybe are lower on these businesses, not because the multiples have fallen a bit?

[Laurent Lebras, Group Administration & Finance Director]

I think it's small because we look at smaller targets, smaller companies that are probably not as, let's say -- the competition for smaller targets in some countries, we're looking at 47 countries, it's pretty broad. The competition for target, smaller targets, is not as high everywhere around the world.

[Operator]

Our next question comes from the line of Murielle Pinard from HSBC.

[Murielle Andre-Pinard]

Just an additional question of the organic growth for this year. You said that you will continue to maintain 5%, but we have no organic growth disclosed around 9 months. What is your assumption of where you are over 9 months to say that you can do 5%? My second question here, regarding clinical there in the [indiscernible] trends. I saw that the government is targeting a minus 5% tariff decrease next year. Do you confirm that? And how it could impact your business in clinical levels?

[Gilles G. Martin, Chairman of the Board & CEO]

Thank you. Well, I think we'll never have an organic growth number for Q2 of this year because we'll never be able to reconstitute a like-for-like. And anyway, this indicator of organic growth, I think, it's an indication for how the business is going and what is the future prospect. So we publish it for Q3 and Q4, and Q2, people can do whatever they want about Q2. And we'll publish the clinical...

[Murielle Andre-Pinard]

If you say -- yes, but if you say -- you do 5% over the full year, you would have to extend which data you take for the cyber attack, so you will take the one you disclosed?

[Gilles G. Martin, Chairman of the Board & CEO]

We will -- we have published the organic growth for the first 5 months of the year, whether it's meaningful comparison. We are publishing it for Q3, we will publish it for Q4, and I think that's the best we can do. And for Q2, people can do what they want. They can add the reimbursement of insurance to revenues if they want to. But although the insurance reimbursement will only be the gross margin, it won't be the revenue. So I don't think there will ever be a true comparable for Q2 of 2019.

[Murielle Andre-Pinard]

So you will not disclose the full year organic growth?

[Gilles G. Martin, Chairman of the Board & CEO]

It cannot be done. It cannot be done. You can't do a like-for-like when there is such events, extraordinary events that happened. But there are many ways to make assumptions, but it cannot be calculated. You can only do it with all kinds of collections and assumptions, and I'm not sure that it can be done, that should be done. And for Clinical Diagnostics, yes, there are discussions. There are also discussions about enabling the clinical labs to do a lot more savings by consolidating because there's lots of restrictions on those labs, for example, to have a phlebotomist in each lab, to not subcontract to hubs, to competence centers more than 10% or 5% of the samples. And a hub and spoke model could be even more powerful if we could subcontract more. This will be a highly politicized discussion between the Union of Doctors and the government. So I think it will be only be known at the end of the year what the net result of all this is and what impact it can have on the bottom line and the top line.

[Murielle Andre-Pinard]

And do you expect any correction for Q4, in France, on the [ service side ] as we see last year?

[Gilles G. Martin, Chairman of the Board & CEO]

No we haven't heard anything, haven't heard anything in that direction.

[Operator]

[Operator Instructions] Our next question comes from the line of Allen Wells from Exane BNP Paribas.

[Allen David Wells, Research Analyst]

Most of my questions have been asked, but just 2 quick ones really. You comment in the text about genomics, I guess. It feels like it's been more heavily disrupted and the customers have actually switched suppliers there. I wonder if you could sort of, maybe elaborate on that a bit, is there something specific about genomics that made it more susceptible or at risk of the switching? And then I guess, what your confidence is on getting those volumes back over time? And then secondly, just to clarify on the uncertainty that you commented on, on cash collections. Am I right thinking you expect to get this all back by the full year, i.e., we shouldn't be expecting any negative cash flow impact from that at a full year level? Or do you actually think that might happen, you'll get it back -- you might see an impact, but you'll get back in 2020? Just to understand the timing there, so we're not caught out by any unusual cash flow negatives by the end of the year.

[Gilles G. Martin, Chairman of the Board & CEO]

Thank you, Allen. Yes, so the reason genomics was more heavily disrupted is the turnaround time in the business is in hours, or usually customers place the order for a sequencing run or a probe in one evening, and they get the things the next morning. And so obviously, there's no stock in that type of business. So for 2 weeks, if all labs could not operate, for those 2 weeks, the customers who needed that business had to go and get it somewhere else. And there is always an element of customers, anyway, using different suppliers. But they have taken some [ EBITs ]. It's going to be more work than in any other business to really get them to switch back. The good news is there is that we have a new technology coming up, which is extremely fast and has a lot of advantages for clients. And we're just in the process of deploying the systems around the world. We deployed them in the U.S. and we're deploying them in Europe and Japan, and we'll do that over the next couple of quarters. That gives us an opportunity to win that back. So yes, this is the type of things that we see. It does have an impact on Q3, a significant drag on the genomics business. But we think over 2, 3 quarters, this should -- we should win it back. And the cash collection is a point we've observed. I mean, we have -- our net working capital is a bit higher at the end of September. And now we've put resources, and now it's reasonable to start pushing clients for paying. Now that we're not late in providing results and the labs are catching up in the backlogs of samples that they need to report or process, we can push clients on paying on time. So we do hope that by the end of the year, we'll get back to our objective of being below 5%. I hope we don't [ take ] too much. But anyway, it's a matter of if it's not the case, as you say, a matter of a quarter or 2 to get that back under control. But we do we shoot for getting that back under control by the end of the year.

[Operator]

And as there are no further questions registered at the moment, I will hand over back to speakers for closing comments. Please go ahead.

[Gilles G. Martin, Chairman of the Board & CEO]

Thank you very much, everybody. So far, we didn't get questions on this very pleasant report from the short-sellers. We employ a whole team to do a bit of extra internal controls for Eurofins on our publications of accounts of 500 subsidiaries over the last 15 years, but you're welcome to ask these questions privately if you don't want to ask them here. Yes, overall, I think good for the company. We're achieving a lot on the building of our campuses and competence centers and looking forward to welcoming some of you tomorrow at our Hanborough Campus, which has been significantly expanded this year. And this is something we're working on now for a couple of years. In 2 weeks, we will meet other of you, our other analysts and investors at our Lancaster campus in Pennsylvania, which we have also added about 40% capacity. And we think we will fill this capacity. It's very well positioned on the BioPharma area, where there's a lot of demand. The BioPharma area is very dynamic at the moment. We have -- due to the biologics and all the new registration of products, this is a field that's very exciting. But overall, our different businesses in the world look good. We have built many labs, many startups. And little by little, we see the volumes come up in the startups. So we are positive. We don't see any impact of the economy slowing down in Europe. Apparently, the economy's slowing down little bit, so it's -- the organic growth we generated in Q3 was encouraging. I will just ask one more time if there's any question. And if there is none, I will thank you all very much for joining this call, and I'm looking forward to meeting you personally in the next few weeks.

[Operator]

This now concludes our conference call. Thank you, all, for attending. You may now disconnect your lines.