Arjo AB (publ)

STO:ARJO B

Earnings Call Transcript 2019-Q1

[Operator]

Good day, and welcome to the Arjo Quarter 1 Report Conference Call. Today's conference is being recorded.At this time, I'd like to turn the conference over to Joacim Lindoff, CEO and President of Arjo. Please go ahead, sir.

[Joacim Lindoff, CEO, President & Director]

Thank you very much, and hi, everyone, and welcome to this Q1 call for Arjo. And as always, thank you very much for dialing in today, and I will, together with Jonas Lindqvist, guide you through the Q1 report that we released just half an hour ago.Jonas and I will start by giving you a business update for the quarter and present some highlights from the business. Jonas will then guide you through the balance sheet. We will after that have some words on the outlook for 2019 and finish off with a short summary before we open up for questions. And as always, we aim at keeping this call to an hour and finish no later than 9:00 a.m.So let's start with an update on the business. We've started the year in a solid and positive way. We are continuing our Arjo 2020 journey with high activity level, and we are reporting an organic growth of 2% for the first quarter, which should be seen in the light of a strong comparison quarter from 2018. It is especially good to see that North America continues to show good growth with 6.4% in the quarter where especially Canada has started the year very well. Our largest market, U.S., also continued to perform well with a 4.2% growth, and they also have a very strong pipeline coming into the rest of the year.Western Europe declined organically with 2.7%. Almost the entire decline in the quarter came from U.K., where Brexit uncertainty in the last quarter of the NHS financial year has led to less capital orders than expected and compared to very strong Q1 2018. We did experience softer development in some other markets in Europe as well but for example, France, our fourth largest market performed well at 7.7% organic growth, thanks to good development in, for example, patient handling and service. Without the decline in U.K., Western Europe would have been on par with last year, and we exited the quarter with a good backlog for the rest of the year in Continental Europe, which is Western Europe excluding U.K. Rest of the World is growing at a healthy 8.3% and more markets are developing favorably. In Australia, we had a good start with the performance in the quarter in line with the strong Q1 2018. It gives confidence for the rest of the year. During February, I visited a number of the markets in this region and have firsthand seen the engagement with which our new and old sales organizations are approaching this market. I just care that investments we've made during 2018 to build up sales organization in, for example, Japan, are starting to show results. And as indicated previously, the quarter saw good order intake, and we carry a strong backlog into Q2 and the rest of 2019.The gross margin was 44.1% and in line with Q1 2018. The gross margin was held back slightly due to a somewhat unfavorable product mix with even higher VTE hardware sales and deliveries than in Q1 2018 and continued pressure on the rental profitability in Europe, especially in the U.K. Furthermore, we completed the Acare divestment at the end of February this year. This was slightly later than planned. So the 2 first months of 2019 includes weak Acare numbers where the activity has been slow compared to Q1 2018. Profitability levels for our medical bed capital goods sales will be positively affected as a result of this divestment starting March 2019, as we have stated before.We had continued good cost control in the quarter, and OpEx spend relative to net sales continues to improve. We continue to invest in selling expenses in R&D with good efficiency progress in our admin side. We've had a healthy growth in EBITDA, which grew by 66% to SEK 413 million versus SEK 249 million in Q1 2018. If we exclude IFRS 16 effects, EBITDA would have improved 32% to SEK 328 million, and Jonas will get back to a more detailed breakdown of the IFRS 16 effects shortly. We did not have any restructuring costs during the quarter. We have done continuous smaller changes to our organization, and we'll continue to do so going forward. But these costs are now considered as the part of running business and OpEx, only larger two onetime actions will be booked as restructuring going forward in line with previous communication.Based on the above, we saw EBIT growing with 102% in the quarter, with almost no effect from currency or IFRS 16 on this level. Worth mentioning as well is that the cash conversion is temporarily affected by stock buildup for old orders to be invoiced and some Brexit risk mitigation. This is a short-term effect, which will be taken down mainly in Q2, and the cash conversion is expected to improve during the remainder of the year to be well within our full year targets. Again, overall a solid quarter, with growth, good order intake and strong profit developments.Let me then go into some details and I'm starting off with North America where we, in North America, as previously mentioned, had a first -- a good, strong first quarter. The business grew organically with 6.4%, and both U.S. and Canada are performing well. U.S. continued to grow with 4.2%, driven by good performance in mainly patient handling and medical beds. Canada grew by 15.5% organically, with good development across the board, which is exceptional -- in my eyes, an exceptional performance. Our U.S. organization recently entered into a collaboration with Kindred Healthcare and it's a skill-based operator of acute care and rehabilitation hospitals. Our mutual goal is to help improve quality of care, patient outcomes and efficiencies and services and all U.S. provided solutions will in the first phase of our partnership include capital goods, clinical services, aftermarket and training of key personnel at Kindred facilities. The collaboration was signed in Q1 2019 and deliveries of high-end medical beds and therapeutic services are mainly planned for Q2 and Q3 this year. We continue to perform on or slightly above our U.S. turnaround and feel that we are well positioned to perform another solid year in North America.Moving over to Western Europe, where we experienced a 2.7% organic decline in the quarter. Growth was held back in some markets in Continental Europe. But on the positive side here, we have France, our 4th biggest market, that grew organically by a healthy 7.7%. As said before, we are confident on our full year plans in Continental Europe, and that we will pick up growth during the remainder of the year based on our good order and backlog situation.As mentioned earlier, U.K. had a strong first quarter with a decline of 8.4% or around SEK 25 million. Brexit uncertainty in the last quarter of the NHS financial year has led to less capital orders than expected and compared to very strong Q1 2018. This is affecting the entire industry, and based on this, we estimate the effect to around SEK 20 million in less capital sales for us during the quarter. In addition to this, we also experienced weakness in our rental business in the U.K. in the quarter.We previously discussed Brexit uncertainty and the challenges in the rental business in U.K. are now assumed to continue during the year, most probably with the year-over-year decline in net sales in U.K. as a result. The management is addressing this as we speak, with the second part of our U.K. action plan, now focusing mainly restructuring the business from a profitability perspective. We also took some important measures to minimize the possible negative effects of a hard Brexit on our customers, for example, by building up stock in the U.K. on both capital and consumables. Based on our current understanding of the Brexit situation, we will now take down inventory levels in U.K. to a more normal one during Q2 and then after that closely monitor the situation.Moving over to Rest of the World, where we saw a strong quarter with the growth of 8.3%. Australia has stabilized and the performance is in line with the strong Q1 2018. We are working towards achieving growth in Australia already during 2019 and my visit there 3 weeks ago confirm that view. Several markets are performing well on net sales than Rest of the World, including Singapore, New Zealand and India. Furthermore, the infrastructure investments made in countries where we want to build our own sales organization are also starting to show results. For example, investments made into the Japanese sales organization during 2018 are setting a clear foundation for future growth and Q1 development was a clear sign of that. We also see a number of our new distributor markets showing good growth, although starting from low levels, but I must say that more is to come, well supported by our product registration process. Finally, the divestment of Acare was completed end of February. This was somewhat later than planned than hoped for, with the implication that we have carried weak Acare numbers through January and February. And as we have stated before, the impact of the divestment will be around negative SEK 80 million on net sales and around SEK 25 million positive on EBIT on full year basis.Moving over then to profit developments and some more details around that. The gross margin in the quarter was 44.1%, in line with Q1 2018. The gross margin was held back slightly due to a somewhat unfavorable product mix with higher-than-expected VTE hardware deliveries and higher than 2018 same quarter. This will however pretty quickly help us drive and increase our consumables sales in the VTE area. As before, we continued to see pressure on our rental business profitability in Europe, especially in the U.K., where mainly our average selling prices have continued to decline. We have internal measures to counterattack the stop, but it will take some time to fully implement. On the positive side, the gross margin was positively affected by higher resource utilization in our production site based on our continued organic growth. And as mentioned previously, the delay in the Acare divestment have impacted gross margin versus plan for January and February this year. And just for reference, in comparable currencies, the gross margin would, in fact, have been around 1 percentage point higher than Q1 2018.The OpEx amounted to SEK 768 million in the quarter, and it's developing according to plan. OpEx in relation to net sales continues to improve and the ratio is improving with 1.1 percentage point compared to Q1 2018. OpEx in the quarter would have, without currency effect, been on the same level as Q1 2018. We continue to invest in our sales organization when new initiatives and full year effects from 2018 has impacted selling expenses. We are, as planned, decreasing our admin spend as a result of the efficiencies gained from projects last year and regular continuous improvements implemented throughout the organization. We've also had an increase in R&D spend during the quarter, which is gross SEK 7 million and net SEK 11 million more. This is related to planned strategic investments in our categories based on the retail product portfolios that we have been discussing before.We report a positive EBITDA development amounting to SEK 413 million for the quarter. We have a healthy increase both with and without IFRS 16 as I commented on shortly before. We did not have any restructuring cost in the quarter. And as stated previously, we expect around SEK 30 million in restructuring costs for the year, where the main part is expected to come in Q2 and Q3. We are currently evaluating plans within those approximate SEK 30 million and will come back with more detailed information after Q2 if needed. EBITDA is up significantly in the quarter, with almost 0 effects from either IFRS 16 or currencies. So with that, Jonas, please take us through the currency effects.

[Jonas Lindqvist, Chief Financial Officer]

Thank you very much, Joacim. And regarding exchange rate effects comparing Q1 '19 with Q1 '18, we've had primarily translation effects, when translating the numbers into consolidation of the Arjo Group numbers. The transaction effect comparing with the same period previous year is only minus SEK 1 million on the gross profit.The translation effect, as you can see on the right-hand side of the slide showing the currency effect, is positive on gross profit and negative on operating expenses. As Swedish krona weakened again, our main currencies in the first quarter of 2018 then remained relatively flat to our '18 and has now weakened again around 5% against our main currencies in the first quarter of '19. This of course, explains why sales and gross profits have been favorable and operating expenses unfavorable for again, the translation. The net effect on EBIT or operating profit is SEK 1 million for the quarter. I assume you want me to take IFRS 16 already. As you're aware -- very well aware of, we have adopted new the IFRS 16 into our accounting. For Arjo, it has meant recalculating around 2,500 lease contracts. There has been a substantial amount of work put into this by many people in the organization. We have decided not to recalculate previous year's numbers because that would have added a further substantial amount of work, but instead show key 2019 financial information, both with and without the IFRS 16 effect. We will continue to do so for the remainder of the year until we get comparison numbers that include IFRS 16, that is in Q1 2020.The IFRS 16 impact on Arjo primarily comes from leasing of premises and vehicles. The effect is that we have adjusted lease cost and invoices, made a calculation of the net present value of the debt in the lease contracts and added the steps in the balance sheet in the line, long-term and short-term financial lease debt. These are shown on separate lines in the balance sheet. The corresponding lease assets amounts that has been taken into the balance sheet on the asset side also on a separate line. I said, we, in the profit and loss accounts have taken out the lease costs. What we instead have done is to take in to calculate the depreciation of the leased assets and a smaller amount that's financing cost for the lease debt. This means that the net effects on EBIT is quite small. Instead, the effect comes on EBITDA to be solved before depreciation. Here the effect is SEK 85 million in Q1 and the effect for the full year will approximately be this amount times 4. The net effect on gross profit is positive by SEK 2 million. The net effect on operating expenses is positive by SEK 1 million, and the financial net has a negative effect on SEK 9 million.The EBIT has a positive effect in the quarter of SEK 3 million and that is the same effect as on EBIT today. As I mentioned, the major effect comes from adding back depreciation and that is positive of SEK 82 million, given an EBITDA of plus SEK 85 million at the end of quarter. The total lease liability is SEK 1.239 billion at 31st of March on 2019. And please look into the Note 6 in the Q1 report where you can see -- find more detail from this. Thank you.

[Joacim Lindoff, CEO, President & Director]

Okay. Thank you, Jonas. And let me then give you some other business highlights very quickly. As described before, the Acare divestment is now completed. And besides that, we have some other highlights. We have, during the quarter, received Dementia accreditation for 3 of our products from the University of Sterling, stating that these products are suitable for dementia patients. Dementia is a very serious and growing concern in the health care industry and impacts both caregivers and patients significantly, that this is therefore a very important focus area for us where we want to ensure that we can support caregivers to give the best possible care to patients affected.In addition to this, we have started to launch our dementia care solutions program internally and we intend to launch this externally in Q3 and onwards. With this, we will further strengthen our positioning with our products and solutions in the dementia space. We're also proud to be recognized for our capabilities in development of new products and solutions, Arjo's subsidiary Huntleigh Diagnostics in Cardiff has received the Queen's Award in Great Britain for Enterprises within the Innovation category. The award is for recognition of Huntleigh's new range of digital handheld Dopplers and is obviously a very honoring recognition to our development center in Cardiff that is instrumental in our new R&D setup that we started to implement during 2018.Jonas, balance sheet, please.

[Jonas Lindqvist, Chief Financial Officer]

Okay. Thank you, Joacim. The story regarding the balance sheet this quarter consists mainly of 3 things. The first is that we have had, of course, the impact of IFRS 16. We have also, actually managed to reduce our excessively high levels of cash. And thirdly, we have a slightly higher inventory going up for the quarter. Overall, the balance sheet has grown from SEK 13 billion to SEK 14 billion compared with the same -- in '18. The impact from IFRS 16 is, as I mentioned, a little bit over SEK 1 billion and actually accounts for the entire increase.To say a few words about the inventory, it has increased, as you can see, also in the cash flow statement, which I will show in a minute. There are 2 reasons for this increase. Firstly, as a consequence of the large orders in medical beds, pressure injury prevention and DVT received in recent months to meet the market demand, production has went up. Deliveries of these orders will occur in Q2 and Q3, as Joacim mentioned earlier. Secondly, we have increased our inventory in the U.K. because of the uncertainties around Brexit and the request from our customers to stock up, but now we are aiming to go back to normal levels during Q2.Our cash position has been on the high side earlier. And as a rule of thumb, we aim to have approximately 5% of turnover of cash, which is about SEK 400 million to SEK 500 million. This level has been achieved at the end of Q1 2019. The equity ratio is on 41%, which is almost on the same level as before, including the effect from IFRS 16.Moving over to cash flow. The cash flow from operations amounted to SEK 180 million in the first quarter of '19. This is SEK 88 million lower than in the first quarter of '18. Cash flow before changes to working capital was SEK 100 million higher, but the effects from inventory and paid cost accruals that go into short-term debts have impacted the cash flow in the first quarter of '19. Net investments in the quarter amount to SEK 181 million, of which SEK 141 million relate to fixed assets. This mainly relates to the rental fleet of SEK 110 million, which is about SEK 60 million higher in the quarter than in Q1 '18. The increased rental business, or new rental orders and a rejuvenation of the rental fleet are the reasons for this increase. However, for the full year, we do not expect these investments to be on a higher level than in 2018.Cash conversion for the period is 43.6%. This is a temporary level for the reasons just described, and we expect to be on target for the full year on cash conversion. Thank you, Joacim.

[Joacim Lindoff, CEO, President & Director]

Thank you very much, Jonas. Let me now then move over to outlook of 2019 and sum up the presentation. As I note with the outlook, where we have no changes to our previously communicated outlook for the year, organic sales growth for 2019 is therefore expected to be in line with 2018 levels of approximately 3%. On the cost side, we expect our operating expenses to continue to somewhat decline as a percentage of net sales in 2019. As stated before, the absolute OpEx number will increase between 2018 and '19, mainly driven by further investments in selling expenses that over time will drive profitable net sales and of course, further investments in R&D. We will, of course, continue to work with all cost lines, especially admin, to make continuous improvement to support the guidance on OpEx. All in all, including details presented over the last 20 minutes, we feel more comfortable today than on our previous report when it comes to our ability to fulfill 2019 guidance and thereby also our mid-term financial targets also in 2019. So with that, let me just make a short recap of this presentation. We are off to a good start in 2019. North America have started the year with good net sales and order intake development with solid plans and pipeline in place for the rest of the year, both in the U.S. and in Canada. We are seeing some weakness in Western Europe, mainly related to our U.K. business. We expect the softer or slower start in Continental Europe to be temporary, and I am confident that our plans will result in growth in Continental Europe for the full year. The development in the U.K. is very dependent on the further Brexit uncertainty and current low investment levels in capital goods. Focus here will be put on driving profitability also during this circumstance. Rest of the World is showing healthy growth with a number of markets driving a positive development. It is also very good to see Australia back on par with a strong Q1 2018, with good plans to turn this market back into growth already in 2019. Our OpEx and EBITDA are developing well in the quarter, in good alignment with our plans and financial targets. And overall, I am pleased with our performance in the quarter. The plans initiated as a part of our Arjo 2020 plan are showing results. And the global teams are engaged and ready to deliver on targets during 2019 and onwards. So with that, thank you very much for the attention, and we now open up for questions, moderator.

[Operator]

[Operator Instructions] We'll take the first question from Kristofer Liljeberg from Carnegie.

[Kristofer Liljeberg-Svensson]

It's Kristofer from Carnegie. First, this -- with the U.K. market, how do you see that impacting the outlook for sales growth this year? I know you have talked about organic growth being in line with 3%, but at the Capital Markets Day, you've been up a little bit for that maybe being conservative? So that's one thing. And related to U.K. also, do you expect to improve earnings in the U.K. despite weaker sales? And then some housekeeping question. If you could give us the M&A-related part of amortization of intangibles? Also, did you say that the FX impact on gross volume was 1% negative? If so, what's the reason for that? It had some negative hedges. And also just to make sure that I did hear you correctly that you said operating costs were flat, adjusted to the FX?

[Jonas Lindqvist, Chief Financial Officer]

Okay, Kristofer. Let me start off by addressing U.K. We have -- and let me put that in the full context of the full year and also relating back to the Capital Markets Day. U.K. has proven even more difficult to understand than what we actually thought. So there has been in the end of the quarter, which is the end of NHS financial year, a lot less -- there was capital goods being sold into the NHS structure based on this uncertainty. We see a very confused market in front of us. We are not really sure where the U.K. will go, but we are taking the assumption that the trend that we're seeing now will not necessarily improve over the year that much. That is why we are stating that we believe that we will now will see a decline in the U.K. year-over-year between '18 and '19. The -- that is, however, something that we discussed during the Capital Markets Day as one of the factors why we didn't want to go out and say that we had a fantastic possibility to further increase on our guidance. That was one of the areas where we thought we -- that could be hampered or taking it down a little bit. But with that said, Kristofer, we are exiting the quarter with a very solid backlog. Our development in the U.S. and North America especially, are developing slightly better than planned. So as I said in my closing remarks to the presentation, I feel more comfortable today than I did after presenting the Q4 report when it comes to our full year guidance. The U.K. development as such and on the profitability in the U.K., we will focus a lot on driving profitability from a lower net sales perspective. So the percentage from a profitability in the U.K. is, in my view, it's quite possible that, that will go slightly up. However, from absolute numbers, if we lose net sales, if we do that, then that could have an effect. But again, we feel more comfortable today on our full year guidance and that also includes our short or our mid-term financial targets that we have around EBITDA that we will be able to fulfill that also with this change.The questions now on gross profit is because of the -- on the 1% decline that you had or the increase if we would have 1803 currency effect that is because different currency mixes that we get out when we're invoicing versus the cost what we're having. So if we would have just stayed exactly the same in 1803, passing 1803 then we would have had a margin, which would have been 1 percentage point higher. So obviously, we are running off to the 44.1% that we have, and those 44.1% is something that we intend to improve over year to continue, as we have said before, to slightly improve on our absolute gross profit level or gross margin level for the full year 2019. When it comes to the OpEx side, we have the SEK 768 million in the quarter, if we deduct the translation effects of that, which is SEK 43 million, it would be ending up on exactly the SEK 725 million that we have last year on OpEx. And we are -- we need to check into the A part of your question, Kristofer, and we'll revert in the back end of the telco, okay?

[Kristofer Liljeberg-Svensson]

Good because I think previously that was stated in another notes in the report.

[Joacim Lindoff, CEO, President & Director]

Let us come back to that at the end of the telco. Otherwise, if we don't manage that, people make sure that you have that information ASAP, okay?

[Kristofer Liljeberg-Svensson]

Yes.

[Operator]

We will take the next question from Annette Lykke from Handelsbanken.

[Annette Lykke, Medtech Analyst]

I am still little uncertain on the sales mix and the impact on overall margins and you had a pretty strong growth in the U.S. Can you -- I mean, you had a 360-basis-point increase in EBIT margin. If I calculate right, you had 200 basis points coming from FX. And I'm just curious, where the other ones are? I'm simply trying to figure out that the rather strong margins you have here in Q1, how sustainable are they for -- in terms of improvement for the rest of the year? And then if you could elaborate a little bit more on Australia?

[Joacim Lindoff, CEO, President & Director]

Absolutely. First of all, on an EBIT level, with the currency effect is evening out because we have a positive of plus SEK 42 million in -- on our GP, and we have a negative on our OpEx of minus SEK 43 million. So on an EBIT level, we actually have a slight negative when it comes to currencies. So I do feel that we are not -- I mean there are things that are working against us on the 44.1% on gross profit. And as previously said, it is our firm intention of getting us above with a slight improvement versus the 44.6% that we had for the full year on 2018 to get that up slightly, and we intend to continue to improve -- or not improve, but to have an improved ratio between OpEx and net sales also for the full year. So I would say that we are well in line in the quarter with those plans and that we continue to follow them. So I don't see this as an extraordinary quarter in any way on it. And on Australia, it is very good to see that Australia is actually performing on par with a strong Q1 2018. I spent almost a week down in Australia in the end of March together with parts of my management team and we went through the plans that we have for the full year, and I feel comfortable as before that we will start turning Australia back into growth after a fairly disappointing 2018.

[Annette Lykke, Medtech Analyst]

Okay. And just maybe just a final question. On your OpEx, you're down of net sales of 1.1%. Is that sort of level we should expect for the full year that you're indicating in your outlook? Is that a slight decrease?

[Joacim Lindoff, CEO, President & Director]

I think that we have been very good at -- in not controlling cost, but keeping to our plans on OpEx. So it's difficult to give you a number. I rather speak with the guidance that we have given that we will slightly improve that as a ratio over the year. What we can see, if you look down, is that we are -- there is an increased selling expenses as expected based on the activities and the full year cost from '18. Admin given the initiatives down in '18 and also what we continuously improve is improving in a good way. Where we do have a net increase, a fairly significant one with SEK 11 million is within R&D because the quarter has seen a lot -- quite a few pre-studies that we obviously can't capitalize, so that is the major difference in R&D and that will obviously go up for now. But the gross for R&D will be around the 2.5% that we have indicated.

[Operator]

[Operator Instructions] It appears there are no further questions at this time. I'd like to turn the conference call back to the speaker for any additional or closing remarks.

[Joacim Lindoff, CEO, President & Director]

Thank you very much. I then would like to have Jonas just in to answer the first question on amortization from Kristofer. Ready, Jonas?

[Jonas Lindqvist, Chief Financial Officer]

Yes, thank you. Amortization on acquired assets in the balance sheet amount in the first quarter to SEK 24 million, and it's consistent with the level that we had for the full year, last year that ended up within SEK 100 million in total for 2018.

[Joacim Lindoff, CEO, President & Director]

Thank you, Jonas. With that, then just before we're closing, short sum up. We have a solid start with the continued growth, especially in the U.S., which is very good to see and we gained stability in Australia. We see a good profitability development in the quarter. We continue to perform on or slightly above our Arjo 2020 plan. And we, as said, remain confident on our full year guidance and the financial targets that we have set for the mid-term. So it's a good start, and I look forward to the coming quarters of 2019 and beyond. Thank you very much.

[Operator]

This concludes today's conference. Thank you, everyone, for your participation. You may now disconnect.