Analogic Corporation (NASDAQ:ALOG)
Bank of America Merrill Lynch 2013 Health Care Conference Call
May 14, 2013 4:00 pm ET
Michael L. Levitz – Senior Vice President and Chief Financial Officer
Mark Namaroff – Director-Investor Relations
Lennox Ketner – Bank of America Merrill Lynch
Lennox Ketner – Bank of America Merrill Lynch
I’m Lennox Ketner one of the medical devices analysts of BOA. Next stop, we will be very happy to have full Analogic event. We have Michael Levitz, Senior Vice President and CFO presenting, and in the audience we’ll have Mark Namaroff and the Investors Relations team. I think Mike is going to speak for about 20 minutes, give a good overview of the company, and then we’ll open it up for Q&A.
Michael L. Levitz
Thank you, Lennox. Hello, everybody, it’s good to be with you today. What I’m going to do is walk you through our multi-year strategy, tell you a little about the history of the company, and what we have been able to do over the last few years and then what we expect to do over the coming three years. Just as a point of reference, we see the Safe Harbor statement. I just want to call your attention to the fact that we are currently in a quiet period. Analogic has a fiscal period that ends one month after the calendar, so we just closed April 30, so I won’t be able to speak about the near-term quarter impact or given that it’s the – we are now in the fourth quarter of our fiscal year, I can’t talk about the year, but yeah, I am really happy to talk about the strategies about our technologies and what we are doing over the coming years.
You’ll hear me make reference to non-GAAP financial statements or non-GAAP operating margin. One of the reasons we do that is Analogic is in many ways still a transformation story. The company has been around for 45 years, and has had a new management team over the last five, six years, so there is still sometimes noise in the numbers whether acquisitions as we use the balance sheet to build the business or restructuring, which I can talk about as well or even stock-based comp where we have been very progressive in being very performance driven, and so we strip those things out, we still see the GAAP financials, but you won’t hear me make reference to non-GAAP and that’s why.
So as I said Analogic has been around for 45 years and been very well known in certain circles in medical imaging as a key subsystem component provider in CT and MR and mammography, ultrasound, and then we’ve taken our products and applied them into other areas outside of medical while match with our security application. So 60% of our business is medical imaging that’s OEM that’s where we are selling to the GE, Siemens, Philips of the world. And the key elements in that segment of our business is our CT and MR, and then to a much smaller extent, digital mammography. Within that line of business, there are some other smaller contributors in there, but the main areas are CT and MR followed by mammography.
Our ultrasound business is roughly 30% of our revenue, most of that is not OEM, 75% of that is actually direct where we have our own quota bearing sales rep selling products most typically under the BK brand name in urology, women’s health and surgery. But we do also have an OEM point of that business that’s roughly at third or maybe now 25% of the business where we sell ultrasound probes and transfusers to big name folks that (inaudible) we use the things for.
And, then lastly we have taken our medical CT technology and instead of scanning people we scan bags at airports. So, there are only two companies in the world that are certified for a checked baggage scanning in the United States, one of which is our product through a defense contractor called L-3. And, that represents about 12% of our revenue this is in the last fiscal year in terms of percentages.
Over the last three years we have seen significant growth in our business. When I joined the company going on four years ago, so coming at the end of fiscal 2009, for the first time the company laid out multi-year goals. We laid out a goal for the three years to fiscal 2012. We wanted to have 10% revenue CAGR and we wanted to drive dramatic improvement in the bottom line where the company has historically been break even, we wanted to get the double-digit operating margin.
We were successful in both of those goals. We had 10% revenue CAGR over those years, 9% in the last fiscal year. We grew operating margin from essentially break even to 12% on a non-GAAP basis, so exceeded our target there with dramatic improvement in earnings per share. How did we do that; really this business has a lot of core value; it has great technology; it’s in good market; it has got very strong customer relationship. So, a lot of the work is around deciding what we're going to do and deciding what we're not going to do and really simplifying the story, not just simplifying it for investors but also providing a key value proposition for our customers, targeting market driven needs.
The company has been very strong in engineering, but we don't want to just invest great things, we want to invent great things that can sell and where there’s a real market opportunity for this.
So, now we’ve laid out three year goals for the next three years. And those goals are to continue what we started over the last three years and again we have targeted upper single-digit revenue growth organically 10% or 10% growth using the balance sheet, so consistent with what we have said three years before from a revenue-CAGR. In terms of a bottom-line, what we're saying now is that we will take from the base line of the double-digit that we reached last year and grow 100 basis points a year over the next three years.
So, what I want to do is go by segment of our business and talk about what we see as the opportunities and drivers to reach those targets. Just background-wise we are located just north of Boston, Massachusetts in a town called Peabody. That headquarters is where we do our design and engineering and manufacturing for our CT and our MR products. We also do automated manufacturing for a number of other product lines
Our ultrasound business, the design for that is centered in Copenhagen, Denmark. Historically, we did manufacturing. Now, over the last few years we have taken manufacturing out of Europe and brought it into United States and our facility in China, that’s the one of the drivers of operating margin improvement in our ultrasound segment. But, we keep the engineering and technology development in Copenhagen, because one of the key elements of our brand, we had been in ultrasound for 30+ years, and people view us as the (inaudible) of the ultrasound segment. That’s a really nice brand to have, and so that’s where we’ve kept the design for ultrasound systems there. And, we do our probe manufacturing, transfuser manufacturing in State College, Pennsylvania. This is a key enabler in ultra sound to be able to drive applications of the ultrasound product, and I will talk a little bit about that.
We do our mammography products in – we have a (inaudible) in Montréal and in Shanghai is where we are standing at the facility there for manufacturing in low cost supply chain and this will be one of the drivers of our operating margin improvement over the next couple of years as we’ve been standing up that facility, we ran a temporary facility. This year or a year ago, we moved into the permanent facility. We’re driving value from that this year and we will see the benefit this year in fiscal ‘13 and also next year in fiscal ’14.
And then, we just closed on an acquisition in March of an ultrasound company based in Vancouver and so I will be talking a little bit about how that fits into our strategy. So now, we have a design center for point-of-care ultrasound systems in Vancouver, Canada. First of all, our medical imaging segment, again, this is roughly 60% of our revenues. The imaging market itself between CT, MR, ultrasound, mammography, and so on, is growing in the low single digit. When you look at it from a geographic standpoint, the developed markets are not growing very quickly at all, if at all, but the driver is the emerging market growth. And so, what we are positioned for is to grow ahead of the market and I'll talk to you about how we are going to do that providing more value content to our OEM customers and having product targeted for the growing areas of the world.
So Analogic has built up over the last number of years very strong relationships with the large OEMs, Phillips, Siemens, GE, and so on. Very good relationships with them, in fact, we’re in roughly 50%, our products are in 50% of the CTs and MRIs around the world. That may be a low level of content and part of our strategy is to increase the level of content, leveraging the strength of the technology and the relationships that we have to provide more for our customers. We are also one of the only independent suppliers of key enabling technology in MR, where we provide power amplifiers that drive the magnet and in mammography, detectors only Hologic and thus have the selenium-based direct digital detectors, we provide those detectors to Siemens and to a number of smaller OEM customers.
So, on CT, when you look at conventional CT, it has opened them up, they’re kind of a mess; there are lot of different components in there. And, in terms of what does Analogic do; you’ll see the black box in the center of that right under where the patient would go. What we do is we take the X-ray images and we turn them into a digital signal, a medical grade digital signal that can be then used for diagnosing a patient with (inaudible) CT.
What we’ve been doing from a strategy standpoint and where we see things over the next few years is where we would have provided a very small component in the past, now we want to provide more. So, Analogic really became known for providing detectors or a data acquisition system which was a small piece of that black box. Now, we’re providing a data management system, which is that entire black box, or even a full gantry system, up to a full system itself.
Why is that relevant from an investor standpoint, the AFP for a data acquisition system when you move up to a DMS, you’re doubling the AFP. So, it’s an opportunity to drive revenue growth in our existing customer relationship with technology that we have today.
One of the new enabling technologies is actually referenced on this slide that comes from our subsidiary business. When I first came to the company I was struggling to understand why you would have a medical and security business together. But, for Analogic all our security business is we’ve taken our medical CT and instead of scanning people, we scan bags.
What’s interesting about the security business is these things, these CTs run 24 hours a day, 7 days a week. And, they need to be reliable, and they need to have a low total cost of ownership. Those are some of the dynamics that we see moving in the medical stage. And so, what we designed in the security space is the ability to transfer power and data from the element of the CT that’s stationary to the elements that’s rotating very quickly around the item being imaged.
And so rather than using brushes which generate dust and which is the standard today, which brings dust and all these components and also the brushes were down themselves, we transfer the power and the data over in a year gap, and so it’s a more reliable system. And as there are pressures on in the medical business, we believe this is something that could be very compelling not only in the security side, but also in the medical side and life spec cedar coming out over the next couple of years.
This is just an example, often our OEM customers don’t, but as share a downward product swing that GE was kind enough to give an example. So when they want to bring a product to market quickly like this particular SPEC/CT, they can come to Analogic and we can provide a CT that you can fit in there relatively quickly and it’s a lower cost of development for them. And that’s basically what we do in our OEM CT business.
Unlike CT in MRI and mammography, we just provide a key component, we will not – we cannot provide a full system. So we do as we provide the power amplifiers that drive the image in a magnet. One of the drivers for us in growing MR is this move from a traditional MR that’s up to a wider bore MR. Why is that happening? In the United States, Americans are getting bigger and need a wider opening. In order to drive in it over a wider opening, you need a dramatic increase in power.
And right now we are the only – we are the company in the world that has the most powerful RF gradient amplifiers on the market and that’s been what’s helping to drive our growth in MR. The other driver there is products for the emerging market as MR growth is happening there.
And lastly in mammography as I mentioned only as Analogic has the selenium digital detector, we provide those for Siemen and number of other OEMs. Our products are used both for 2D imaging and for 3D tomosynthesis. And, so as these options of tomosynthesis occurs, right now, it’s happening outside the United States, but as it moves to the United States that presents a nice opportunity for growth for us over the coming years in our mammography OEM business.
So, where the markets in medical OEM are growing low single-digits we expect to grow faster than the market, so our three year guidance that we expect to grow mid-single digits in this space. But, the primary drivers of growth for us are actually not in medical imaging, that segment they’re in our ultrasound segment and our security segment.
And, our ultrasound segment as I mentioned, most of this business for us is direct sales reps where we saw direct-end customers when most people think about ultrasound, they often think of OB/GYN, or radiology, or cardiology, where Analogic sales are actually in these niche area. We are using ultrasound not primarily for diagnosing things, but primarily for guiding, guiding surgeries, guiding applications for therapies, so in urology, for men’s health with the prostate, and in surgery where you are guiding a procedure either laparoscopically with the laparoscopic ultrasound or now with da Vinci robotic assisted surgery, we are able to take our capability to design high-end transducer application, and that would favor an application for the – for use with the da Vinci robot.
So, in terms of growing our ultrasound business, one of the ways that we are growing is we are growing in our core areas with new products like the robotic assisted surgery. We are also growing our sales coverage, which I will talk about in a second, but we are also growing into adjacent markets where they are procedure based as opposed to diagnostic based, where the ability to design specific transducers and probes guide the procedure and enables an application of ultrasound, which you can see reflected on the far right of the page here in terms of a fully shaded circle. That’s where it’s really a procedure based use of ultrasound, so this has been the strategy that we’ve been talking about.
In terms of the move into point of care anesthesia, we announced a short time ago that we were doing an acquisition; we bought a company called Ultrasonix located in Vancouver, Canada. It was a start-up company; they did about $37 million of revenue last calendar year. And what they had is they had a product that was very well tailored for point of care market that we were moving into organically, they also been building out a sales force that augmented the sales force we were starting to build out in that market, so it was a very nice fit acquisition for us to accelerate our move into the adjacent markets.
So in terms of the Ultrasonix acquisition the cost there was roughly $80 million, the company has been around for over 10 years and I would say that what we’ve seen that made us most interested in the product is over the last couple of years they developed a very nice user interface that makes it very easy to use, touch based and so when you’re talking about a used and anesthesia for a nerve lock or you’re trying to guide the placement of the needle to put the anesthesia around the nerve bundle, we need to make it easy to use, to make it simple and that’s what Ultrasonix has done.
We also have a lower cost product, where our products have historically been premium product which makes sense in surgical applications and make sense in urology but are harder when you get into these lower price point areas like point of care emergency room, the ICU or critical care unit.
And that is where Ultrasonix very well complement out traditional BK product line there. Now yesterday we put out an announcement about the restructuring and that restructuring was really in response to the Ultrasonix acquisition, when we did the acquisition we said we expected the number of synergies and so the restructuring is in large part related to that. So we’re taking manufacturing out of the Vancouver facility. We’re going to keep the Vancouver facility for research and development driving these really innovative point-of-care applications, but we can leverage our global footprint for manufacturing as what we did to drive operating margins in our BK business over the last few years and we’ll just do that same thing with Ultrasonix.
In addition, a couple of years ago, we bought a small ultrasound OEM manufacturer in Colorado and so, in conjunction with looking at this acquisition, we also, with the Ultrasonix acquisition, we also decided to streamline our operations on the OEM side and bring that Colorado capability into our State College, Pennsylvania facility and so, we’ll be closing down the Colorado facility and transitioning that over the coming year into say college. So that part of our ongoing effort is to streamline our business and drive operating margin improvement while still positioning for growth of new products.
What you can see here are BK Flex Focus products, which you will notice about them one of the reasons we’re still successful in surgery because these don’t take up a lot of space and there is a lot of competition for space in a surgical suite. Also it has a very nice screen image quality, 19-inch screen, so it’s very easy for the surgeon and also it’s – the keyboard is easy to keep clean.
In terms of robotic assisted surgery, one of the new areas there is the ability to return to the surgeon the ability to use ultrasound with the robot. So before the use of the robot, the surgeons could use a laparoscopic probe and guide where they’re going to use ultrasound real-time to see blood flow and making sure they are cutting in the right places. With the robot, they no longer have that ability and they have to rely on technicians standing over the body to guard the ultrasound. So we did and working with intuitive is, we tailored a 10 millimeter probe that were dropped in through virtual cards for use with the robot where the surgeon now can control with the robotic arms, the placement of the ultrasound, and we pipe the imaging from our high-end surgical system directly into the viewing screen of the da Vinci robot.
And so over the last year that we’ve introduced that we’ve been placing in all the different (inaudible) in all of the key opinion leaders and teaching hospitals and we’re very excited about this product. And it illustrates why analogic an ultrasound, because we have this capability with the some transfusers and ability to drive application.
So the key drivers for us in ultrasound are new products, like robotics assisted surgery moving into adjacent market and then also increasing the size of the sales force. Historically, the sales force was very small in the United States. The new management team has been making a significant investment in growing that sales force, growing from what was ten reps just a couple of years ago to now 30 reps in the United States. You add on the 20 combined reps of our new point-of-care sales force, it’s hard to get some real solid coverage in North America in addition to what we historically had in Europe.
So just in closing, an ultrasound what we expect there is, we expect to build the drive growth in the direct ultrasound business, that’s double digits, the 10% growth in that business leveraging those three opportunities I just described. Security, this is again where we’re scanning check baggage at airport. Historically, Analogic business is one location with one customer in one product that was needing to be units in the United States with one different contractor L3. United States and North America is a very robust market after 9/11 had the highest detection standards in the world.
The two growth drivers for security over the coming years are; one, the replacement of those units placed after 9/11. They are now approaching 10 years old which is the design life. The CSA has said that over the next five years they expect to replace two-thirds of those units that presents a very nice growth opportunity for us. And then outside the United States what's very exciting is the adoption of this higher level of detection that we have in US now being adopted outside the US in converting some traditional X-ray.
So, that opens up a market that is just as big as the EU as just as big as North America in terms of number of sockets and their regulations going into effect next year requiring CT level detection for all new machine. In addition, we opened up a new relationship with Smiths Detection, so historically we just work with L-3, one of the largest defense contractors out there in the space; Smiths is the market leader in Europe, and they came to us to be able to develop a CT that now has European approval and we are excited about the opportunities for both our L-3 products outside the U.S. as well as Smiths, not just in Europe but also the rest of the world.
So with L-3 we have a full suite of products, the medium speed being more targeted for the replacement cycle in the U.S., and then the high speed being targeted for the replacement of X-ray outside the U.S., because the x-ray systems are high speed, and the Smith system is also high speed. It's actually the fastest system out there today at 1,800 bags an hour.
In terms of our financial performance as I mentioned before we have seen significant revenue growth over the last three years, and dramatic improvement in operating margin, and we expect to continue to improve that over the coming years leveraging our plant in Shanghai to be able to drive savings there, and also a favorable mix. One of the things which you’ll see as you look at our segment is with the growth that’s coming from ultrasound and security at a faster pace than the medical imaging, medical imaging is a really good business for us, and we’ll get some real benefit there from Shanghai and some of these other opportunities, but ultrasound has a highest gross margin as we saw further direct sales force and therefore as we grow the scale of that business has a very nice drop down.
Our Security business, we talked about growing 20% a year in that business just based upon the outside U.S. and the inside U.S. opportunity, at the 20% non-GAAP operating margin business, so it’s a very nice operating margin compared to other businesses and as we grow that, that will provide nice leverage to the bottom line.
And Analogic has had a strong balance sheet. We continued to – this data here is before the acquisition of Ultrasonix, so we had a $175 million of cash, if you take out at roughly $80 million that we spent in cash flow Ultrasonix. We don’t have solid cash on the balance sheet with positive operating cash flows and we have $100 million line of credit that we have not drawing down on. So we have a number of opportunities to attract growth in terms of where we are going to grow. Number one is, we are continuing to reinvest in our existing business.
We’re spending ahead with the sales force expansion, where we’ve been investing the plants in Shanghai and in our ultrasound business. But we are also looking at strategic M&A like what we did with Ultrasonix. It’s accelerating our already our organic growth plans that we already had in place. And then lastly, we also use the cash to return cash to shareholders in a form – we have a small dividend that we’ve had for a number of years and we have a buyback in place.
So in summary, I think the next three years have some really interesting opportunities. We expect as I said to drive solid revenue growth over those three years for single-digit revenue growth CAGR over the three years at targeting 10% rather the use of the balance sheet, and at the same time improving operating margins at 100 basis points a year as we execute our strategy across our segment. Thank you very much.
Now, there is a few minutes left for questions
Good afternoon, in the audience have any questions? Yes, there are a couple. One, in the security business, you talked about the opportunity in Europe there switching over to requiring the CT, I’m still a bit confused, are there any competitors as far as you guys or especially you are the only one cleared with the CT technology over there?
Michael L. Levitz
So, right now, there are three companies that have a product that meets the specs in the marketplace that are certified in the EU. One is Morpho, the second is L-3, and third is Smiths. And OSI Rapiscan just got a product approved, but it doesn’t necessarily meet the spec for that particular market outside the U.S. We provide the CT for both Smiths and L-3. In terms of PSA approval, which in Europe certain places still look for the PSA because it’s the gold standard and so both the L-3 product and Morpho product has TSA approval and Smiths is currently in the process of getting that approved.
Okay. And then, could you maybe speak a little bit more about the opportunity on the ultrasound side with robotic surgery. It sounds like there are products that are being used in discectomy cases right now, do you see the potential – the standard there maybe general surgery or gynecology or some other areas?
Michael L. Levitz
Yeah. So one of the opportunities for growth in that space is right now partial discectomy is that where you would use ultrasound traditionally and what we provided is very nice solution for that. The key opportunity is to continue to find other applications where a surgeon can use ultrasound to guide procedures. So, one of the things that Intuitive want to do is they want to guide as many procedures as they can as quickly as they can which drives the sales for the robotic arms.
So, if we can demonstrate the ability to speed up procedures and improve outcomes I think there are some really nice opportunities. So, that’s one of the things that we are working on with the key opinion leaders. As I said, over the last year since we introduced the product the focus on marketing standpoint has been to sell those units into the key opinion leaders at the key chain hospitals and so, that’s what they are looking at is what other opportunities are there, and we were able to develop the – our capability with the da Vinci robot fairly quickly because we have somewhat unique capabilities in designing ultrasound probes. So we can also come out with new ones as well for different tail of applications and so right now, we’re doing a market assessment there and I feel like we can react fairly quickly to that.
Lennox Ketner – Bank of America Merrill Lynch
Great. Thanks for that. Any other questions from audience? Okay, we’ll leave with that. Thanks very much.
Michael L. Levitz
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