Olympus Corp

TSE:7733

Earnings Call Transcript 2019-Q1

[Yasuo Takeuchi, executive]

Greetings. My name is Yasuo Takeuchi, CFO of Olympus Corporation. Thank you very much for joining us today for digital conference. During which I am to discuss the financial results of Olympus Corporation for the first quarter of fiscal 2019.

Let us begin by looking at the financial results.

We first take a look at Slide #3. There are 3 main highlights with regard to the company's financial results in the first quarter of fiscal 2019.

Consolidated revenue was up 5% year-on-year in the 3 months ended June 30, 2018. Losses were posted in regard to all profit figures. One factor was the posting of a JPY 19 billion provision for losses on litigation flowing a settlement reached with institutional investors in securities litigations, which is disclosed on July 31, 2018. Another factor was a provision of JPY 3.5 billion recorded in relation to the judgment in litigations involving a Chinese manufacturing subsidiary, information on this factor was disclosed today.

In addition, expenses to the tune of JPY 5.4 billion were recorded for the reorganization of production basis. The Medical Business achieved higher revenue and a double-digit growth in operating profit.

Consolidated operating profit showed a year-on-year increase, if the impact of the aforementioned extraordinary loses is excluded. The most recent settlement reached with institutional investors signaled the conclusion of all outstanding securities litigations and the risks associated with the deferred recording of past losses have thus declined significantly. In reflection of the provision recorded in relation to the securities litigation settlement and the provision pertaining to litigations involving a Chinese manufacturing subsidiary, we revised our full year forecast for all profit figures. I now would like to look at our financial results for the first quarter of fiscal 2019 in a little bit more detail.

So please go to Slide 5. This slide shows our consolidated performance for the first quarter of fiscal 2019. Consolidated revenue was driven by robust performance in the Medical Business and thus rose 5% year-on-year to JPY 180.6 billion. Operating loss of JPY 11.6 billion was posted as a result of the recording of JPY 19 billion, as a provision for loss on litigation associated with the settlement, JPY 3.5 billion as a provision pertaining to litigations involving a Chinese manufacturing subsidiary, and JPY 5.4 billion as expenses for reorganizing production basis. Losses before tax was JPY 14.7 billion, following an increase in net finance costs due to the recording of foreign currency exchange losses and, consequently, loss attributable to owners of the parent came to be JPY 16.7 billion.

Please go to Slide 6. With this slide I will explain the factors that influenced operating profit for the first quarter fiscal 2019. Beginning from the left. Higher sales in the Medical Business and the Scientific Solutions Business had the combined effect of boosting operating profit by JPY 4.9 billion. There is no significant change in the cost of sales ratio compared to the first quarter previous year. Higher selling, general and administrative expenses lowered profit by JPY 4.5 billion. The higher expenses were largely a result of an increase in staff numbers, and following the reinforcement of functions in the Medical Business as well as a rise in R&D expenditures associated with next-generation gastrointestinal endoscopy systems.

In addition to all above, other factors decreased profit by JPY 24.7 billion. These are the factors primarily included: net provision recorded in association with the securities litigation settlement and expenses attributable to the ceased operation of the Chinese manufacturing subsidiary as well as gains in sales from the real estate. As a result of adding currency effects, operating loss of JPY 11.6 billion was posted.

Let us now turn to Slide 7. On this slide, you will see segment performance. Higher revenue and operating profit were achieved in the Medical Business due to a positive growth realized in the GI endoscope, surgical devices and endotherapy device fields. The Scientific Solutions Business posted an increase in revenue combined with a decrease in operating losses and due to a favorable market for industrial product. Lower revenue in the emerging business coupled with the expenses associated and with the ceasing of operations at a Chinese manufacturing subsidiary led, altogether, this business need to record operating losses. The others business saw revenue decline while operating loss increased as a result of the conclusion of external sales of lens units of compact cameras. Adjustments under elimination and corporate include the provision recorded in association with the securities litigation settlement and a provision pertaining and the 2 litigations involving a Chinese manufacturing subsidiary.

Turn please to Slide 8. And now looking at the performance of individual segments in more detail. Starting with Medical Business. Revenue in the Medical Business increased 7% year-on-year to JPY 143.9 billion, as a result of higher revenue in the GI endoscope, surgical device and endotherapy device fields. Performance by region, excluding the impacts of foreign exchanging price, will be discussed on the following page. Operating profit rose 18% in this business, amounting to JPY 27.4 billion because of the higher revenue in all fields. And the operating margin was 19.0%, which is up by 1.7 percentage points.

Go to Slide 9 now. On this slide, you will see the quarterly growth rate of each field in the Medical Business by region, excluding the impact of foreign exchange influences. In the gastrointestinal endoscope field, difficult conditions continued in Japan as a result of sluggish budget execution. Nevertheless, the transnasal and the gastrointestinal videoscope and the colonoscope released in fiscal 2018 are proving to be popular. And we therefore expect to be able to make up for the sluggish 3-months performance during the remainder of the fiscal year.

North American and Europe, performance in the GI field was strong due to the enhancement of sales promotions and sales measures pertaining to maintenance services and other offerings. Operations in Asia and Oceania, meanwhile, continue to be strong in China for growth. And the sales in our surgical device operations in Japan and Europe have benefited greatly from the robust performance of the VISERA ELITE II and the THUNDERBEAT energy device. In North America, despite mainstay products being in the later stages of their product cycles, solid performance was achieved with higher sales stemming from scope sales and effective coordination with Image Stream Medical, Inc. As for endotherapy devices, positive growth was seen in all regions. Performance was particularly strong in North America, where we witnessed growth in the sales of new products, which we have been aggressively launching in response to market needs.

Please turn to Slide 10. The Scientific Solutions Business. For the first quarter, revenue increased 6% year-on-year to JPY 21.1 billion, and operating loss decreased JPY 0.2 billion to JPY 0.4 billion. The rising revenue resulted from solid performance for both biological microscopes and industrial products. Sales for industrial products grew, centered on industrial microscopes and nondestructive testing equipment due to favorable conditions in the semiconductor, electronic component and power generation markets. The higher revenue caused operating loss to decrease.

Slide 11. Performance in the Imaging Business. The Imaging Business posted revenue of JPY 13.9 billion, down 8% year-on-year. Operating loss was JPY 5.8 billion. Compact camera revenue declined 12% year-on-year. Revenue from mirrorless cameras also decreased by 11% due to intensified competition as well as restrictions in our ability to supply products stemming from the reorganization of production basis.

Operating loss of JPY 5.8 billion was due to the expenses associated with the ceasing of operations at a Chinese manufacturing subsidiary totaling JPY 5 billion.

In addition, the operating loss reference shown here does not include the impact on the business, such as sales decline due to restrictions in our ability to supply products. The impact of the ceasing of operations at a Chinese manufacturing subsidiary will linger throughout fiscal 2019. Nevertheless, we are making smooth progress with the consolidation of digital camera production into a manufacturing subsidiary in Vietnam. We will advance production system reforms to realize a structure that can ensure profitability.

Slide 12. Financial position as of June 30, 2018. The recording of loss attributable to owners of parent of JPY 16.7 billion, combined with the issuance of dividends from retained earnings, resulted in total equity declining JPY 23.1 billion to JPY 421.1 billion. The equity ratio was down 2.4 percentage points from March end to 42.8%. Inventories were up JPY 7.1 billion, which is largely attributable to the accumulation of inventories of products to be shipped later in fiscal 2019.

Slide 13, cash flows. Net cash provided by operating activities amounted to JPY 25 billion, primarily due to earnings from operations in the Medical Business. Net cash used in investing activities was JPY 17.4 billion, mainly reflecting payments for purchases of demo products, loaners and other property plant and equipment in the Medical Business as well as the acquisition of urinary tract stone treatment device operations of Cybersonics Inc. to strengthen our urology business. Free cash flow was a positive JPY 7.7 billion.

Moving on to full year performance forecasts, please turn to Slide 15. In our full year performance forecasts, we have made downward revisions to all profit figures as a result of the recording of the provision for loss on litigation in relation to the securities litigation settlement and the provision pertaining to litigations involving a Chinese manufacturing subsidiary under other expenses. Our foreign exchange rate assumptions for the remainder of the fiscal year have not changed. Reflecting the rates in the first quarter, we now project foreign exchange rates of JPY 106 to the U.S. dollar and JPY 130 to the euro on a full-year basis. The forecast for revenue, however, has not been changed.

Forecasts for operating profit and profit before tax have been lowered by JPY 23 billion. Forecast for profit attributable to owners of the parent has been lowered by JPY 19 billion to JPY 40 billion incorporating the projected tax benefits of the provision for loss on litigation in relation to the securities litigation settlement.

Our initial dividend forecast also remains unchanged, as we still plan to issue a year-end dividend of JPY 30 per share.

Slide 16. Forecast for segment performance. No change to forecast for revenue and operating profit by segment from ones released in May. Provision for loss on litigation associated with the securities litigation settlements and the provision pertaining to the litigations involving a Chinese manufacturing subsidiary have been recorded under elimination and corporate, resulting in a downward revision to the consolidated profit attributable to owners of the parent.

Lastly, some topics of interest for the quarter. Slide 18. On July 23, Rating and Investment Information, Inc. raised the company's issuer rating to single A. Reasons cited included the stable competitiveness of the Medical Business centered on GI endoscopes and ongoing improvements in our financial position by reducing interest bearing debt as well as increased total equity and efforts to enforce corporate governance. This improved rating will enable us to diversify means of funding and allow us to step up investments in future growth.

Fiscal 2019 will be the third year of the 16CSP Medium-Term Management Plan. Despite recording loss in the first quarter, performance was strong in our mainstay Medical Business, and we are making steady progress in the development of next-generation endoscopes. We plan to give an update on each business under 16CSP as well as the initiatives to achieve the plan's goals at Olympus Investor Day 2018, scheduled for September 5. Olympus management stands united in advancing measures to accomplish the goals of 16CSP.

That concludes my presentation. Thank you for your attention.

Now we're ready to have Q&A session.

[Unknown Analyst]

So my first question, actually refers to provisions. So I would like to take this opportunity to ask about the so-called legal risk surrounding Olympus Corporation. So institutional investors' securities litigation related matters are on the behind now. So what's outstanding still? So I would like to know further. And the situation in China, this came as a surprise, so if you would explain, please.

[Yasuo Takeuchi, executive]

Okay. [ Nisa ], thank you very much for the question. Securities litigations involving institutional investors, as you say, it's all complete. We do have some remaining with some individual investors. But in terms of the claimed amount, even that will be no more than JPY 400 million, obviously, it's less than JPY 400 million. So as regards the deferred the booking or recording of past losses, that's it. The situation in China, at the time of the original filing of the lawsuit, the amount of [ claim ] applying the then prevailing foreign exchange that was slightly above JPY 4 billion. So we decided not to make any disclosure about this particular matter, be it a securities report or the consolidated financial reports or whatever -- and whatnot. There's a certain criteria that we applied internally to decide not to disclose, per se. So we were sued first. And in fact, and we decided to file a counter claim as well by Olympus side as well. So that is the overall history. And then we received the notice describing the judgment. In line with the Chinese judicial system, how the notice was delivered to us. And the date of received -- receipt was Friday of last year. And looking at this document, it described the outline of the judgment. And we decided to take a provision against that. I hope that satisfies your question.

[Unknown Analyst]

As to the Chinese matter, why did you decide not to disclose this particular matter? What criteria?

[Yasuo Takeuchi, executive]

Well, basically, we would take into consideration the indiscernible] and the possible business risk. And for instance, in terms of the securities litigation, the settlement amount on the page was JPY 19 billion, but there was therefore the original claimed amounted to JPY 28 billion plus. By and large, the yardstick of about JPY 10 billion on a per case is applied. And therefore, we generally will include various data factors, such as the size of assets involved as well.

[Unknown Analyst]

Okay. Then you also have still -- the outstanding litigations -- several litigations relating to duodenoscopes. And also I understand the DoJ, and the review is still continuing to date, in part. So I mean those -- the one-off on the litigation matters, they are not have been disclosed necessarily.

[Yasuo Takeuchi, executive]

That is true. We have not been disclosing kind of each and every one of them. But by and large, the entire category of duodenoscope litigation risk has been assessed. And we have made descriptions and disclosures about that. That's the company's view.

[Unknown Analyst]

Okay. The question number two has to do with the Slide #8. The Medical Business, local currency basis. If I remember correctly, the Japan or outside of Japan, I think, you have been aiming for 4% on the year-on-year growth. So the actual that was basically in line with your plan. But looking at Page 9, you start to talk about sales promotions. So I would like to make sure what the situations are to see if there is any evidence of the margin erosion, given the lower unit prices. And also, last year, you said that for the Japanese performance, new products have a good effect and they we will be expected.

[Yasuo Takeuchi, executive]

To answer, in the Medical Business, particularly in the Japan domestic the GI scope business, transnasal scope as well as cronoscope, the new endoscope products, they have been assessed very strongly. So the market or the customers -- and they have been responding quite favorably to these new products. So our expectations, as we cited in the beginning of the fiscal year, we said we would expect the good -- the boost coming from these new products. Which means that the actuals that we saw as we close the first 3 months' books, it was a little bit regretful in that we could have -- we would have expected more. But quickly, may I say, that we have remained confident that we'll be able to catch up with this sluggish performance in the remainder of the year. And no evidence of major discounts for whichever product or in whichever region. The margin remains the same, as it was last year.

[Unknown Analyst]

Okay. My last question has to do with the core situations as described on Page 6. SG&A increased, I understand about how your sales hasn't changed and changed -- the cost of sales ratio. But then, I read on the captions the risk related to higher SG&A expenses, among others, R&D expenditures for Medical Business. Is that really a push up factor? If I remember correctly, R&D expenditure in the Medical Business has decreased not increased. So I would like to know more the particulars about that higher SG&A expenses, as you claim on this page, after all the midpoint, therefore, your 16CSP has been passed already.

[Yasuo Takeuchi, executive]

Thank you for the question. R&D expenditures in the Medical Business. Next-generation -- the endoscopy system has been undergoing R&D efforts, duly, so that we are still holding valid our expected timing of the launch of this new-generation endoscopy system. And R&D costs leading up to the launch date has been accumulating a little bit but all within our plans. And as to the headcount, it's not as though we have been quite deliberately increasing the headcount since the beginning of the fiscal year. If anything, we added the headcount in the previous period, who is, [ of course ], now upon us. So on a year-on-year basis, yes, the higher SG&A expenses. However, mindful of the overall situation, sales were up, and so were the SG&A expenses. But all in all, these situations were in line with our expectations.

[Unknown Analyst]

By the way, just one additional note, I understand that there's going to be the Investor Day event in September. I expect that you will talk about R&D. Will you say anything about this new endoscopy system? And also, my overall impression is that, in today's announcement, you talked a whole lot more about new scopes rather than other factors. So have you shifted from being system-driven to scope-driven in your operations?

[Yasuo Takeuchi, executive]

First of all, on the coming Investor Day event in September, I suspect that the situation will be as such we will not be able to go into anything related to that new endoscopy system. We, by the way, have not shifted from being system-driven to a scope-driven operation.

[Unknown Analyst]

I am going to start with my first of the 2 questions relating to the Medical Business in Japan, the rate of growth. In particular, so long as gastrointestinal endoscope business is concerned, as you pointed out in passing, the first 3 months, perhaps, was a little bit slower than you had expected. And in your presentation material, you also make reference to the stagnated, the implementation of the hospital budget in Japan, on one hand. On the other hand, surgical devices, you have the VISERA ELITE II. So the customers seem to have a strong appetite to purchase new products. So that is on the surgical devices side. I wonder, whether there's any difference in the investment appetite or the stance among Japanese hospitals between GI scopes and surgical devices on the other? So excluding the effect of new products, what's going on in this market in Japan?

[Yasuo Takeuchi, executive]

Thank you very much for that question. I take note of the intention behind the question. I am not totally confident, whether I will be able to give you a totally satisfying answer right now, right here. First of all, I do believe in the good effect and of new products launched into the market. But anything beyond that, I -- at the moment, I'm not able to indicate anything in particular, though, I would like to check further within the company, and so that's my immediate answer to you. So you're saying that it doesn't matter, whether it is in the gastrointestinal -- the endoscope business or the surgical device business. The market environment all know is similar to one another. And particularly so in the surgical device business field because the effect of the new product has been coming about quite vividly.

[Unknown Analyst]

My other question has to do with JPY 3.5 billion provision that you decided to take, given the judgment granted relative to that litigation in China, I understand the company is considering to appeal the case. But from the standpoint of expenses booked, after all, you did decide to take a provision. So in terms of booking of expenses relating to this litigation in China, that's it. Is that correct for me to understand or expect that? This is as regards the Chinese litigation.

[Yasuo Takeuchi, executive]

The answer is that, first of all, as to the appeal, we have not made a corporate decision to appeal formally, officially yet, but that is still [ for ] direction that we are looking at. But if we are going to appeal the case, that would mean that we have to spend additional litigation expenses and costs.

[Unknown Analyst]

I have 2 or 3 questions. First, regarding the full-year forecast revisions. Basically, this is in relation to the provisions, JPY 19 billion and JPY 3.5 billion, respectively. Am I correct?

[Yasuo Takeuchi, executive]

Yes, that is correct, 2 provisions. One in relation to the security litigations disclosed at the end of July, and other in relation to Chinese manufacturing subsidiary, which we disclosed today.

[Unknown Analyst]

I see. But looking at the specifics, medical doing better, digital camera weaker. On a full year basis, even without the provisions, I think there are pluses and minuses for sales and operating income on full year basis. What do you think?

[Yasuo Takeuchi, executive]

Well, it's only been 3 months since the beginning of this fiscal year. And therefore, we are not proactively revisiting the forecast. And that is the reason why we have basically retained the forecast.

[Unknown Analyst]

I see. My next question, in relation to the waterfall chart on Page 6. Positives, resulting from higher sales and negatives coming from higher SG&A expenses seem to cancel out each other. What am I to make of it? In Medical Business, yes, it's better. But on a consolidated basis, I think higher sales and higher SG&A expenses will cancel out each other. So it's going to be flat. What do you think?

[Yasuo Takeuchi, executive]

Well, this does not exactly reflect the income statement. Within IFRS, there are other income and expenses, and some of the positives related to Medical Business are included there.

[Unknown Analyst]

I see. So in the Medical Business, in the first quarter, sales increased by 7%; operating income, up 18%. So on a full year basis, because last year the first quarter was bad, so I think you made a good progress, what do you think?

[Yasuo Takeuchi, executive]

Well, of course, excluding Japan, for Medical Business overall should I take it that it's been progressing as planned. Yes, as I said. We saw the progress in line with the expectation.

[Unknown Analyst]

So is it in line with the expectation? Is it better?

[Yasuo Takeuchi, executive]

Well, it's more or less in line with the projection.

[Unknown Analyst]

I see. My last question about the next generation endoscopes. I think the consensus is that it's going to be next fiscal year or the year after that, does that remain unchanged?

[Yasuo Takeuchi, executive]

You're asking about the launch schedule? No change.

[Unknown Analyst]

I see. And you can't comment on that in the upcoming IRJ, am I correct?

[Yasuo Takeuchi, executive]

I'm afraid it's going to be difficult.

[Unknown Analyst]

So you can't comment on that. I see.

[Unknown Analyst]

My first question is on endoscopy in the U.S. The other day, the guideline has been changed, it's been screening for people aged 50 years or older, it's been now recommended for 45-year olds or older. What is the reaction of the payers, the insurance companies, regarding the GI endoscopy screening?

[Yasuo Takeuchi, executive]

I'm afraid, we have yet to put together our official view on that. Conversely, we are not hearing any major changes taking place.

[Unknown Analyst]

Looking at the situation in Japan, I understand that it was below your expectations. As you know, a certain company by the name of F has launched new products last year and this year, and is enjoying good sales in Japan and Europe. Now conventionally, Olympus and this company has been catering different market segments, clinics versus big hospitals. Do you get the impression that this competitive landscape is changing?

[Yasuo Takeuchi, executive]

Well, of course, we are aware that this company that you're talking about is very proactively promoting their GI endoscopy product in Japan and in part of the overseas markets. But in terms of the big picture, big framework that you mentioned, we do not find our market being encroached. We don't see that happening.

[Unknown Analyst]

I see. My last question is on the profitability of the Medical Business. I'm looking at Page 8. In first quarter of fiscal 2017, because of the onetime expenses related to the acquisition, there was an expense totaling about JPY 2 billion. So apple to apple, I think, the operating margin has remained unchanged year-on-year. But by product, surgical devices were strong, while endoscopes were weak. So in terms of product mix, I suppose this has been a rather challenging quarter. And yet, you were able to attain the operating margin remaining at the same level year-on-year. What is the reason for that?

[Yasuo Takeuchi, executive]

Well, I think what you just mentioned is in relation to what we commented as guidance at the beginning of this fiscal year. We referred to special factors in the previous fiscal year. And therefore, we said that the operating margin is to grow larger than the sales growth. So as I said earlier, things are proceeding in line with our internal projection.

[Unknown Analyst]

I am looking at Page 9. As many people have already asked, looking at the GI endoscopes and surgical devices, the highest growth is in Asia and Oceania. And for GI endoscopes, China seems to be very strong. So do I understand correctly that China is driving the surgical devices as well?

[Yasuo Takeuchi, executive]

Well, aside from the question of difference in market size, in terms of growth rate, China enjoys very strong growth rate, close to 20% in all fields.

[Unknown Analyst]

That is for both GI and surgical devices.

[Yasuo Takeuchi, executive]

Yes, that is correct.

[Unknown Analyst]

On Page 12, you were talking about inventories, plus JPY 7.1 billion. You said that you are building up inventories for second quarter onward. So in terms of Japan versus overseas and by business, is this basically medical overseas?

[Yasuo Takeuchi, executive]

Yes, this is in relation to the shipment pattern in accordance with the demand. This hasn't changed much from the past. Compared to the first and third quarters, second and fourth quarters tend to be stronger. So as part of the supply chain, because we want to level the production volume, we build the inventories in the first and third quarters to prepare for the second and fourth quarters. On a full year basis, especially for Medical Business, fourth quarter is the strongest quarter. And therefore, inventories are built towards the fourth quarter in accordance with the demand projection.

[Unknown Analyst]

I see. My last question. Similar questions about Medical Business. Well, looking at the earnings report of various medical device manufacturers in Japan, I get the impression that the business is very strong, including Nihon Kohden. But looking at your result, it seems to be there are pluses and minuses.

[Yasuo Takeuchi, executive]

Surgical devices are strong. Our [indiscernible] GIs are benefiting from new products. And yet, you are saying that overall budget execution is rather sluggish.

[Unknown Analyst]

I'm not sure, if this a question to be asked to you, but I'm wondering, what the investment appetite of hospitals in Japan is. I thought it's strong, am I wrong?

[Yasuo Takeuchi, executive]

Well, regarding the impact of the NHI drug price revisions, they have been favorable for the Medical device overall. So it's not hurting the medical device business. As you said correctly, we believe that the impact is more positive. And as was asked earlier, GI endoscopes are weak and surgical devices are strong. And what are the reasons, was one of the questions asked earlier. Looking at GI endoscopes, yes, this is in relation to the budget execution. I think there is a big impact of the product life cycle or the generational aspect.

[Unknown Analyst]

So you think that the investment appetite for new products is strong?

[Yasuo Takeuchi, executive]

Yes, I think so.

[Operator]

Since there are no more questions, we will end the Q&A session. Before closing, I'd like to invite Mr. Takeuchi for the closing remarks.

[Yasuo Takeuchi, executive]

Once again, thank you very much, everyone, for your participation despite your busy schedule. Looking at the results for the first quarter, as has been announced, because of the one-time expenses related to things of the past, unfortunately, we recorded a loss. But in Medical Business, especially in relation to the GI endoscope life cycle matters, the difficult situation continues, but through new products, we do see a steady progress overall. And in fact, we do expect a recovery in the second half.

So in summary, as far as the business is concerned, things are proceeding as forecasted at the beginning of the fiscal year. And we are going to have the Investor Relations Day on September 5. We have not firmed up everything to be reported there yet, but we hope to make it a useful day for you. So your participation is awaited. Thank you.