Olympus Corp

TSE:7733

Earnings Call Transcript 2020-Q2

[Yasushi Sakai, executive]

Greetings. My name is Sakai, Chief Financial Officer at Olympus Corporation. Thank you very much indeed, for joining us today for this presentation, in which we will be discussing the financial results in the Olympus Corporation for the second quarter of fiscal 2020 as well as the corporate strategy discussion.

I am going to take you through the financial results as well as the full-year forecast to be followed by Mr. Take (sic) [ Takeuchi ] with his presentation on the corporate strategy.

Key highlights. Consolidated performance was solid with revenue for the second quarter increasing 8% on a bases excluding the effect of exchange rates, driven by the Medical field. As profit lines increased significantly, in particular, operating profit, which is JPY 50.9 billion, a record high in terms of the first half, SG&A expenses decreased by JPY 15.7 billion year-on-year. As a result, the SG&A ratio to revenue stood at 50.5%, marking a considerable year-on-year improvement with a reduction of 5.1 percentage points. There are no changes to the full-year financial forecast announced previously. The forecast for EPS has increased from JPY 46 to JPY 47 due to the repurchase of our own shares back in August.

I will now explain the second quarter results in more details. This shows a summary of consolidated financial results. Consolidated revenue for the first half amounted to JPY 389.2 billion, up 2 percentage points year-on-year due to solid performance in the Endoscopic Solutions, Therapeutic Solutions and Scientific Solutions divisions. In real terms, excluding the effect of FX, consolidated revenue increased by 5% in the first half and by 8% in the second quarter, marking strong growth. Operating profit increased significantly on the back of the decline in one-off expenses, which are posted in the same period of the previous fiscal year and the reduction of SG&A expenses by 5.1 percentage year-on-year through improved company-wide SG&A efficiency.

Profit attributable to owners of parent was JPY 36.1 billion as a result of the significant improvement in operating profit. Significant increases were posted in all profit lines with steady progress made towards the achievement of full year forecasts. Details of results by segment will be explained on the following slide.

Now I will explain results of each segment, starting with the Endoscopic Solutions division. Revenue increased by 3% year-on-year, up now to JPY 206.8 billion due mainly to strong performance in the growth driver China, coupled with Russian demand in Japan ahead of the consumption tax hike. In real terms, excluding the effect of exchange rates, revenue was up 7%, marking high growth.

Operating profit increased by 44% year-on-year to JPY 59.8 billion due to increased revenue, improved SG&A efficiency and delay in expense payments. The operating margin was 28.9%. Excluding the JPY 9.7 billion in costs associated with the plea agreement with the U.S. Department of Justice in the same period of previous fiscal year, the operating profit increased by a considerable 17% year-on-year.

Let us now look at the Therapeutic Solutions division. Sales expanded in all business areas, particularly endotherapy devices, in which sales have been increasing for products which meet market needs in each region, resulting in 3% growth in revenue year-on-year to JPY 108 billion. In real terms, excluding the effect of exchange rates, growth continued towards a 7% increase in revenue. Operating profit was JPY 15.2 billion, up 16% year-on-year, due mainly to the growth in revenue with the operating margin standing at 14.1%.

Moving to the Scientific Solutions division. Revenue totaled JPY 49.7 billion, up 5% year-on-year, and operating profit was JPY 5.4 billion, surging 92% year-on-year. Revenue increased due to strong sales of biological microscopes in Japan and China and sales growth of industrial products, including industrial video scopes and nondestructive testing equipments. A record high for the first half results was posted in operating profit due to the revenue growth, coupled with the efficient control of SG&A expenses.

Next, the Imaging division. Revenue decreased 17% year-on-year to JPY 21.3 billion and operating loss was JPY 5.7 billion. Revenue declined due to the difficult business environment in the mirrorless cameras and a lack of new product introductions, following the restructuring of production bases. Operating loss decreased due to the absence of expenses associated with the restructuring of production bases recorded in the same period of the previous year and the curbing of SG&A expenses. The amount of operating loss was in line with our plans.

For the second half, we plan to introduce several strategic products, including 2 mirrorless cameras in November. We aim to significantly enhance revenue and profit in the second half through the effect of new products and the efficient control of SG&A expenses.

Next, the financial position as of the end of September 2019. Assets and liabilities both increased due to the impact of adopting new lease standards under IFRS. Moreover, although inventories increased by JPY 8.8 billion, this was due mainly to the impact of building inventory for the remainder of the fiscal year. Total equity was JPY 362.9 billion, down from the end of March due to a share buyback conducted in August. Based on this, the equity ratio was 37.6%, down 9.7 points from the end of March.

Next, the cash flows. Net cash provided by operating activities was JPY 67.3 billion due to the generation of operating profit, mainly in the Medical field. Net cash used in investing activities was JPY 31.4 billion due primarily to purchases of property, plant and equipment such as demonstration products and loaners in the Medical field. As a result of the above, free cash flow amounted to JPY 35.9 billion. Regarding cash flows from financing activities, we conducted a share buyback amounting to JPY 93.4 billion in August. Going forward, we will prioritize resources into growth investments. While keeping track of our investment funds, we will adopt a policy of strengthening allocations to shareholders, gradually raising the level of the total returns and considering flexible purchasing of treasury stock as we do so.

Now the financial forecast for the current fiscal year. There is no change to the forecast for revenue announced in August. Forecast for profit items are unchanged from the previous projections based on the conservative stance due to delays in expenses in the first half, expenses forecast in line with advanced investment under the Transform Olympus plan and the strengthening of IT infrastructure and RA functions. The forecast for EPS has been increased to JPY 47 due to the repurchase of around 80 million of our own shares from Sony and others in August. Assumed exchange rates for the full year are JPY 108 to the U.S. dollar and JPY 121 to the euro, reflecting results in the second quarter. Our year-end dividend forecast remains unchanged from the initial forecast at JPY 10 per share, an increase of JPY 2.50 per share.

Next, forecasts by business segment. We have changed the forecast for operating profit in the Scientific Solutions division in light of the first half results. The forecast for elimination and corporate has been revised after factoring in advanced investment under Transform Olympus. Results were significantly strong in the first half, including a posting of a record-high operating profit. In the second half, we plan to make advanced investment required to implement strategies to expand business and drive growth over the long term, particularly in the Medical field. We also intend to continue working company-wide to enhance SG&A efficiency, a goal we stated at the start of the fiscal year.

That concludes my presentation. Thank you very much for your kind attention.

[Unknown Executive]

Now we are ready to have Q&A time. This is for the first presentation on the Q2 financial results. Let us start with the first person raising hand.

[Unknown Analyst]

So my first question has to do with the progress to date of the reduction of SG&A expenses. As you introduced in your slide, cumulative 6 months total came down by JPY 15.7 billion year-on-year. In the second quarter alone, more than JPY 10 billion worth in the -- that were cut in SG&A expenses. The sort of speed of SG&A, the reduction, this seems to be appreciating. Of course, there is a tailwind now which is in the appreciation of the Japanese yen, so FX impact as well as non-FX and also on the R&D expense reduction as well as other expense reductions. And if I may, the capitalization of R&D expenses as well.

[Yasushi Sakai, executive]

So of JPY 15.7 billion, about JPY 5 billion is the reduction owing to the FX, so that leaves us with JPY 10 billion. About 1/2 of that has to do now with the suppression of indirect expenses such as the reduction in outsourcing fees and the traveling expense cuts and so on. So that leaves us with the remainder of that 1/2 or JPY 10 billion, which is the R&D expense reduction. About 80% of that has to do with the further progress of the capitalization of R&D expenses.

[Unknown Analyst]

So to supplement a little bit, adjusted for FX is a JPY 10 billion reduction. In the beginning of the fiscal year, you said JPY 23.5 billion, the SG&A did a cost reduction; and adjusted for FX, JPY 13.5 billion. So on that basis, already at the closure of the second quarter, the -- you almost accomplished the year and 12 months total as a target. Are you going to keep driving this?

[Yasushi Sakai, executive]

Well, my answer of the cut in the first half, part of that actually had to do with delay in the actual accrual under the occurrence of expenses into the second half. Speaking of the second half of mid or current fiscal year, we know that as a global medtech company, how we have to grow strongly, which in turn requires us to further augment the infrastructure so particularly, in the newly emerging areas and to make investment to solidify our foundation like our investment, IT, the investments. So those are already scheduled for the second half. So I know what we reported to you for the actual on the level of SG&A reduction in the first half, but it is not going to be at the same very high speed happening for the rest of the year. Not to say, but we are now going to suspend the move to drive down SG&A expenses. We will, but we will make investments as necessary and expenses will be incurred as necessary.

[Unknown Analyst]

Okay, I take your point. Now looking at your Medical Business. In the second quarter, the 3 months period, I'm looking at this financial data, the supplement book, Page 3. Here, what I see on top of the page, your income on the Medical segment and the P&L, shows that 18.7%, that was the Q1 the actual. And then the OP margin in the second quarter was 28.4%, which is significantly high. Maybe if it is not exactly so analogously on the record high, but the Medical Business, that is where given the overall larger scale of the business that you operate, the percentage cut in SG&A expenses, they should have more noticeable the benefit and progress. Now so in this regard, are you going to continue to cut down the expenses in the Medical field, as you did in the first half?

[Yasushi Sakai, executive]

As you say precisely, Medical Business is our largest business line, and that is where having the benefit of the expense, the reduction has emerged to be more noticeable. Now at the same time, having whatever happened to the [ QLIA ] related expenses, which have to be incurred, will also have the more noticeable impact. So what I am trying to hint at is that it is not likely that momentum or the speed of this expense cut will continue in the Medical Business field at the same very high pace for the remainder of the year.

[Unknown Executive]

Thank you. Shall we move on to the next person to have now his questions?

[Unknown Analyst]

I have 2 questions today. I understand the corporate strategy discussion is going to be important to the program. So for now, I'm going to ask questions regarding your first half results. Speaking of SG&A expense reduction, 8%, the reduction in SG&A, the expenses at the -- on a constant currency basis, of course, I understand about the timing in income, the delay in the actual accrual of expenses. But of all different SG&A on the expense items, where are they that you started to see the early benefits of expense cut in the first half?

[Yasushi Sakai, executive]

Thank you. Let me try to answer in the following here way. Because of the efficiency improvement, outsourcing-related fees decreased, for one. Number two, we have been always now also looking into more efficient way of having meetings in that we have the very large-scale global business operations. There are people that tend to move about taking business trips quite actively. But with the introduction of the web means, so from having conferencing and so on, the decline in the trip and trouble on the expenses and transportation-related expenses here and there have been -- have worked down. So on the overall indirect expense reduction, the 3 that I just mentioned started to give us early noticeable benefits or improvements.

[Unknown Analyst]

Question #2. This is in reference to the second quarter, very indeed favorable sales in the domestic market, and you did make reference to ramped up demand due to having the hike of consumption from the tax rate in Japan, be it ESD versus TSD or ESD, surgery and endotherapy. What I would like to know is the effect of that ramped up demand created by the expected hike in consumption tax in the second quarter.

[Yasushi Sakai, executive]

I understand the purport of your question. But after all, it is sort of difficult to identify in which exact monetary amounts you would understand that. But first half, the gross recorded in the domestic business: ESD, 6%; TSD, double-digit growth; whereas 1 year earlier, negative from the percentage level. So indeed, we had much more aggressive or favorable the outcome. At least certainly part of it must have had to do with the expected rise from the consumption tax customers hurrying to have now buy devices before that higher consumption tax.

[Akihiro Taguchi, executive]

May I supplement that answer? My name is Taguchi, COO. Be it ESD and/or TSD, yes, there was a last-minute demand matter purchase before the hike in the consumption tax rate. ESD, for the clinic and office use, the customers did purchase before the hike in the consumption tax rate. Now to what the sum amount, it's difficult to identify. So I'm not going to mention any particular monetary amount, but the effect was there.

For the TSD, for disposable, consumables and some medical institution or facilities decided to place bigger orders than usual. So we recognized that there was effect there. However, all in all, as Mr. Sakai explained to you, ESD, or the mainstay gastrointestinal on the endoscope system, is in year #8 already. That's always really severe indeed to continue to sell, but it did not drop into the negative zone. That's one point that I wanted to mention. For TSD, surgery, endotherapy and those are the subcategories, they continuously -- the positive growth, they have been sustained.

[Unknown Executive]

Okay. Let's move on to the next person, seated in the middle of the room.

[Unknown Analyst]

I have quick questions. Now there's about 3 of them. Point number one, you have been talking about the expense cut, SG&A cut and the delay in the actual payments to be made. By how much? I'm very interested in knowing that.

[Yasushi Sakai, executive]

Okay. Let me answer that question. So what I said earlier, that was due -- excluding the effect of the FX. There was a reduction of about JPY 10 billion during the first half. About 1/2 of that, the actual expense, the accrual would be in the second half of this year.

[Unknown Analyst]

That's a big chunk staggered into the second half. Is it unusual? Anything to do with new product development projects? I cannot think of anything else?

[Yasushi Sakai, executive]

Well, of course, the new product development projects do involve payments which need to be paid to outside parties. Just the exact timings of payments, they were delayed. Or the exact -- the timing set which certain goods would have to be sourced and to be paid, they have been kind of staggered back.

[Unknown Analyst]

So are you implying to the further delay in the new -- the product development projects?

[Yasushi Sakai, executive]

No, no. That's not what I am trying to get at. The NPD, new product development, there was no delay in the end point or the completion, expected completion date or the commercialization of the ongoing new product development. It's just the precise timings have been adjusted back.

[Unknown Analyst]

I see. My second question, I think that the capitalization of the R&D expenses in the Medical Business progressed rather significantly during the second quarter. Am I correct to assume that this was because you have reached a higher level of certainty in product commercialization, and therefore, R&D expenses were capitalized?

[Akihiro Taguchi, executive]

Taguchi speaking. Basically, you can capitalize R&D expenses only when the development effort progresses and product commercialization become certain. So in that sense, you are correct to assume that capitalization means we are nearing a product launch.

[Unknown Analyst]

I see. My last question. At the outset, you said that the reduction in R&D expenses accounted for half of the reduction in SG&A expenses. You said of JPY 10 billion reduction, half or JPY 5 billion was from reduction in R&D expenses. Was this because of the delay in recognizing R&D expenses that you mentioned earlier? Or is it something else?

[Yasushi Sakai, executive]

The reduction that I mentioned earlier, I said 80% to 9% (sic) [ 90% ] was from capitalization of the R&D expenses. That's what I said earlier. So in that case, it's the capitalization rather than the delay in the recognition timing.

[Unknown Executive]

Next person, please.

[Unknown Analyst]

My first question is very simple. The results for the second quarter, how did they compare to your forecast? I think the first quarter profit was slightly higher than the forecast. How about the second quarter? I suppose there was an impact of a surge in demand ahead of the consumption tax hike in the Medical Business. How big was that impact? Was it larger than you had expected? And what about the Scientific Solutions, how did that compare to the forecast?

[Yasushi Sakai, executive]

The second quarter results were higher than the forecast. Factors were endoscopes were strong in China. And in addition, in Medical Business, as was mentioned earlier, there was an impact of the consumption tax hike, a surge in demand ahead of the tax hike. Due to these reasons, the results were stronger than the forecast.

[Unknown Analyst]

I see. My second question is on Imaging Business. As of the end of June, I think the inventory level was about 5.8 months. I doubt it increased since. So can you tell us what the level was as of the end of September?

[Yasushi Sakai, executive]

Your question is on the inventory level for Imaging. As of the end of the first half, compared to the end of March, there was a slight increase. This was because, as was mentioned earlier, in preparation for the scheduled product launches in the second half, we intentionally built up inventory.

[Unknown Analyst]

How about compared to the end of June?

[Yasushi Sakai, executive]

I'm afraid I don't have the data for the end of June, but I don't think it went up significantly.

[Unknown Analyst]

So there was no significant decline from 5.8 months at least, correct?

[Yasushi Sakai, executive]

Yes, that is correct.

[Unknown Analyst]

My last question is on short-term borrowing. To finance the share buyback, I think you resorted to short-term borrowing and commercial paper issuance totaling around JPY 150 billion, which I think is rather sizable for Olympus. What is your plan going forward? And also, when I look at your presentation material for corporate strategy, I find that there is no mention of the policy on shareholder equity ratio unlike in 16CSP. So if you're not going to talk about that in your presentation later, can you comment on your policy on shareholder equity ratio?

[Yasushi Sakai, executive]

You are correct. We are financing the share buyback with a short-term borrowing. And going forward, as the financial strategy, we will look at the duration and the cost and other factors to keep the appropriate level.

[Unknown Executive]

Next person, please.

[Unknown Analyst]

I also have a question on Imaging. The results for the first half, you said that the operating loss was within the plan, in line with the plan. Full year forecast is operating loss of JPY 7 billion and for the first half, it was JPY 5.6 billion. Even with the year-end peak demand season and new products scheduled to be launched in the second half, this looks to be rather challenging. And I'm wondering whether you are seeing the benefit of consolidating production capacity to Vietnam. At least, that didn't seem to be the case for the first half. And looking at your corporate strategy presentation, I don't see much reference to the Imaging. So I'm wondering if there are any comments you can make regarding the Imaging, if you're not going to talk about that in your later presentation.

[Yasushi Sakai, executive]

For the second half, as you have correctly described, we will be launching new products through which we want to improve the gross profit. And we will strongly appeal to our customers the value of our products so as to achieve the sales level that we target. As for the transfer of production capability to Vietnam and the cost reduction effect as a result of that, you are correct. We are not yet seeing the true effect through the integration, further integration of the production processes. Going forward, we want to realize the production cost reduction as planned. So in that sense, for a full year target, we want to achieve the target for the Imaging Business. And we will continue to work so as to enable the generation of profit from Imaging.

[Unknown Analyst]

Any comments over a medium term?

[Yasushi Sakai, executive]

As we have been saying for Imaging Business, Imaging Business is positioned as a driver for our technology and various operation. So that significance remains unchanged. But as was mentioned earlier, we want to make sure that it will be transformed to be profitable.

[Unknown Analyst]

My next question is on something entirely different, about the sale of the land use rights in China. Can you give us an update on that?

[Yasushi Sakai, executive]

Well, the process is underway, I think, is the best way to describe it. It is taking time, true. There are many things that need to be done. So the progress or the process is underway.

[Unknown Executive]

In the interest of time, we will take questions from only one more person.

[Unknown Analyst]

At the very outset, you said that China was very strong. For the second quarter, on the local currency basis, I see that endoscope, surgical endoscopes grew very rapidly. Can we expect this to continue?

[Akihiro Taguchi, executive]

As you have correctly described, endoscopes were very strong in China. Not just endoscopes, therapeutic systems and surgical were strong as well, but GI grew particularly strong. This is thanks to a policy promoted by the Chinese government. The Chinese government is trying to promote the endoscope-based therapy to -- from the Tier 1 hospitals to Tier 2 hospitals as well, so the market itself is expanding. And we have been working on the various sales strategies to capture this, and they are proving to be effective. How long will this continue? Of course, we hope that this will continue as long as possible. But our competitors are trying to capture this momentum as well. Especially in China, as we go down from Tier 1 to Tier 2 hospitals, we need to compete with the local players as well. So we have to make sure we have the right strategies.

[Unknown Analyst]

So you're saying that as there are many hospitals, this will continue for some time?

[Akihiro Taguchi, executive]

We're hoping so. But as I mentioned earlier, as we go down to the Tier 2 hospitals as well, the price range would go down as well, and we will be competing not only against the Japanese manufacturers but local companies as well. So we need the right strategy for that.

[Unknown Analyst]

My next question. I'm wondering if sales dropped since the beginning of October following a surge demand in reaction to the consumption tax hike. Or is it not that serious?

[Akihiro Taguchi, executive]

What do you mean a reaction?

[Unknown Analyst]

I'm wondering if the sales are coming down as a reaction to the last-minute surge in demand before the tax hike.

[Akihiro Taguchi, executive]

Well, as indicated earlier, we can't say exactly how much, but that effect is being felt. We are trying to figure that out through simulation and others. But it's very hard to say exactly how much was the impact, so we can't say that there is no reaction. But it's not serious enough to affect the full-year results.

[Statements in English on this transcript were spoken by an interpreter present on the

Live call.]