Carl Zeiss Meditec's (CZMWF) CEO Ludwin Monz on Q1 2017 Results - Earnings Call Transcript

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Carl Zeiss Meditec AG (OTCPK:CZMWF) Q1 2017 Earnings Conference Call February 10, 2017 3:30 AM ET

Executives

Sebastian Frericks - Director of IR

Ludwin Monz - President and CEO

Christian Mueller - CFO

Analysts

Scott Bardo - Berenberg Bank

Daniel Wendorff - Commerzbank

Oliver Reinberg - Kepler Cheuvreux

Operator

Dear ladies and gentlemen, welcome to the Conference Call of Carl Zeiss Meditec AG for the First Quarter 2016/2017. At our customer's request this conference will be recorded. As a reminder, all participants will be in a listen-only mode. After the presentation there will be an opportunity to ask questions. [Operator Instructions]

May I now hand you over to Sebastian Frericks, who will lead you for this conference. Please go ahead, sir.

Sebastian Frericks

Good morning, ladies and gentlemen, and thanks for joining our quarterly call for the three months 2016/2017 analyst call of Carl Zeiss Meditec AG. I’m Sebastian Frericks, Director of Investor Relations. And with me as usual are our President and CEO Dr. Ludwin Monz; and our CFO Dr. Christian Mueller.

I would like to hand over to these gentlemen now to give you a short introduction to our quarterly financials of the Q1 ‘16/’17 and afterwards we are open to take your questions. Ludwin please go ahead sir.

Ludwin Monz

Good morning ladies and gentlemen, welcome also from my side [Technical Difficulty] analyst conference on our three month report ‘16/’17. On Slide 3 of our presentation you will find the agenda of this call. And the first agenda item is as always a short overview about our results and as usual the second paragraph, Christian Mueller will give you a more detail on the financials, and number three is our highlights section where I would like to talk about our refractive laser business this time in the US and the market opportunity which we see there. And finally, I will give you an outlook for the fiscal year. So let's start with the overview on Slide 4. In the first quarter of this fiscal year ‘16/’17 Carl Zeiss Meditec grew substantially both in terms of sales and productivity. As always we compare with the first quarter of last fiscal year. In terms of revenue we reached EUR280 million which is almost 7% above last year's result. Topline growth would have been 5.4% at constant currency. My colleague Christian will discuss the growth contributors more in detail, however the overall picture has not changed. We saw the biggest growth contribution from our APAC region, while growth rates in the EMEA varied lightly and Americas showed a stable performance.

EBIT increased to EUR44 million which corresponds to an EBIT margin of 15.8%. It is important to note that the EBIT includes about 8 million one-off gain from the disposal of non- core assets of IOL operations in Ontario in California. Therefore our adjusted EBIT margin which is without the sale and the PPA effect, the adjusted EBIT margin is 13.4% and last year our adjusted EBIT margin was 12.6% so that is the correct comparison here. The positive development in EBITDA was also supported by our favorable product mix. Our net income reached EUR32 million which corresponds to earnings per share of EUR0.38 and prior year we had EUR0.21. The increase of our earnings per share versus prior year was mainly driven by the EBIT development and also by positive currency effects. While last year we had some negative effects. So overall the performance developed nicely in the first quarter.

Christian, please continue with the presentation with some more detail and background information.

Christian Mueller

Thanks Ludwin and good morning everyone. As usual I will now briefly review our first quarter results and I'll start with the strategic business unit Ophthalmic Devices, where we achieved a reported sales growth of 8.5% in the first quarter corresponding to on a constant currency basis a growth of 7.4% which underlines our strong performance in Q1 in this SBU. Again the sub segment of Surgical Ophthalmology, the business with our intraocular lenses and devices for the treatment of cataract performed very well, besides continued very strong growth in our IOL business, also the demand for recruitment so especially ophthalmic surgical microscopes picked up again compared to the last business year. Also the business with laser systems for effective correction continued its strong performance from the past. On top here as you know we are expecting additional growth during further course of the year due to the launch of the minimally invasive SMILE technology in the US after having received the FDA approval last year.

Our ophthalmic diagnostics business with its very intense competitive environment remains to be the sub-segment with the softest development in the SBU. Here, we are focusing on innovation and also cost measures but also our new organizational set up and several management hires this year especially in the US. We expect to also see further improvement over the next quarters. The SBU ophthalmic devices from a profitability point of view, so EBIT margin came in with 14% reported, this includes the one-off gain from the sale of the assets at the Ontario site. But Ludwin mentioned but also on an adjusted level, adjusted for this effect the EBIT margin could be around 1% higher than the year before, so around 10%.

Moving on to the next slide, revenues in the Microsurgery business unit grew by 1.6%, adjusted for currency effects by 0.2%. So a rather modest growth providing a very stable performance for the last business year with by the way even stronger order entries development in Microsurgery. As you know we are focusing a lot on innovation in this area and we are on a good track here in our progress in this business unit. Regarding operating profitability, we once again achieved an EBIT margin of above 20%. So the profitability remains on a high level supported by positive currency effects. There will be environment here positive for that business and of course ongoing cost measures, strict cost discipline in this business unit.

Regionally, next slide, our split across the three regions as in general relatively similar share but the APAC region that's the region that mainly drives our topline growth currently is gaining share, is now at a level of close to 38%. If we look into the different regions and we start with the Americas, EUR91 million achieved in the first quarter. The Americas region was largely stable increasing by 1.9%, constant currency 0.7%. Here largest market of course the US, [indiscernible] reported by 1% was more or less flat on the constant currency basis and is slightly here. The intense competitive environment that we have seen here - especially in the area of ophthalmic diagnostics is one driver for that situation here. In Latin America, we've seen a slight decrease, different developments, so Brazil catching up a little bit, Mexico and other countries are a little bit softer. So overall relatively flat development in the Americas region.

EMEA, here we've seen a decline in EMEA in the first quarter of 7%, constant currency 6.6%. Here there is one special effect that you have to keep in mind with the let’s say Aaren business and the disposal of the non-core assets that is the let’s say old hydrophilic business that we discontinued. So there is some effect from dealer business with these old products which was included in last year's figures an effect of around about 2 million that effected - had an effect on the EMEA region. But nevertheless we would have seen a decline in Europe by between 4% and 5% eliminating this effect and while we’ve seen some kind of a softer growth than in the past in some larger countries like in Germany, Benelux or Italy, on the other hand there are certain downturns in Q1 compared to the previous year particularly in Southern Europe, Middle East and also UK was softer than the year before. But also to mention and not to forget that the last year, in the last year we had relatively high increase in the first quarter in EMEA, so the comparison is a certain, let’s say, factor in this region here for Q1.

APAC region I mentioned already before an increase of 27% reported, 23% constant currency. So it continues to be the region with the highest growth contribution and now become our largest region. Here we’ve seen again strong growth in China. But not only in China also the other countries performed very well, Southeast Asia, India and South Korea are all very strong. And also Japan reported an increase. So we see a very positive development here from the Asia Pacific region in the first quarter. Next slide, short look at the P&L items. The gross margin now at 55.4%, an increase of roughly 3 percentage points or 300 basis points compared to last year. Here are some mix effects, so higher share of recurring revenue is one key driver as well as cost management measures that play a role here. We also had some accounting related topics or reclassification of so called sustaining cost from COGS into OpEx so that means a release in the margin here and additional an impact or burden on the OpEx which accounted for around about 3 million.

So adjusting for these reclassification effect, the gross margin would have been at around 54%. The OpEx in terms of absolute numbers increased also due to this effect of course but also we expanded our sales and marketing activities in some areas and we also had an increase in R&D expenses. The OpEx ratio here is stable at a level of 40% more or less, but here you also have to consider these reclassification effects and of course the one-time gain of Aaren which is a part of that. If you eliminate that you will end up at an OpEx margin of around about 41%. So EBIT is at a level of 44 million, so significant above prior year. EBIT margin of 15.8% reported and as Ludwin already mentioned, so this is, the right comparison basis is the adjusted EBIT and here we improved by around 1 percent point, 13.4% compared to 12.6% in the last year. As you can see on the next slide where we summarized the difference special effects. As explained before our adjusted net margins reached 13.4%, here you can see the increase of around about 1%, so 0.8% exactly and only acquisition related effects here on the one side, the one-off gain of the around about 8 million from the sale of these non-core assets related to the operation of the hydrophilic IOLs at the Ontario site and on the other side purchase price allocations related depreciations. The special again by the way does not change of course our forecast here.

Financial situation, next slide, our cash flow statement, here is some important key ratios. The operating cash flow with EUR0.4 million slightly positive, below previous year due to sales related increase in trade receivables mainly. Last year we've seen a shift between the cash flow from investing and financing activities related to a 110 million fixed term deposit which expired in Q1 ’15, ’16 and had not been extended. Also to mention of course the positive effect of the sale of the Ontario and non-core assets which is here included. So all-in-all again I think we delivered another convincing performance during the first quarter. And the very solid overall financial situation of the company remains unchanged.

So that's it from my side and Ludwin will now provide you with some further information about the refractive laser business and some words on the outlook.

Ludwin Monz

Okay very good, thank you Christian and please turn to Slide 13, which shows you a bit about our SMILE launch in the US. As we disclosed some time ago we got the FDA approval for our minimally invasive laser surgery technology SMILE in September of 2016. Since then we have actively prepared the product launch in the US, in particular we are currently building up sales, service and support infrastructure. Training for example is really critically important in that business. Furthermore we have been focusing on the work with the key opinion leaders. As mentioned previously, we hired a Chief Medical Officer for Carl Zeiss Meditec, his name is Steve Schallhorn and he's well known in the US refractive surgeon community and he will certainly help us to address the specific needs of the key opinion leaders in that market.

The initial sales focus will be on what we call the investigators. These are the clinical trials participants and a group of early adaptors who already own a Visumax. We are starting out with an installed base of around 50 devices in this group, we will subsequently broaden the launch to reach a larger group of surgeons and we are expecting an initial financial impact in the low double-digit million range mostly realized in the second half of our business here. However, I’m very happy to report that the first commercial procedures are now being performed as we speak. They are beginning this month.

Okay, on Slide 14, we have some background information on the refractive laser market. Outside the US we are happy to say that we now estimate our revenue market share at 30% largely owed to the success of SMILE of course. We have overtaken AMO globally and are now actually not far behind Alcon in terms of market share with a strong tailwind from SMILE. So what is the long-term potential of the market. I would like to discuss the opportunity in the US and outside the US separately. In 2015, Market Scope estimated the number of refractive surgery centers to be 4,900 globally. So given the number of devices we have sold, it is certainly fair to say that outside the US at least we are far away from market saturation. And there is still room to grow also outside the US.

According to Market Scope about 20% of the reflective laser clinics are located in the US. The revenue share of the US in the global market is even a bit higher. We estimated to be roughly one-third of global sales, in other words the US are the largest refractive laser market. However, China is actually close and might overtake the lead somewhere near in the future. Currently, the US refractive laser market is firmly in the hands of two firms namely Alcon and AMO. Our big advantage is the unique SMILE procedure which nobody else can offer right now. We believe that there is a significant opportunity as Zeiss has hardly seen any innovation since the introduction of femto-LASIK more than a decade ago. So the installed base of refractive lasers in the US is relatively old which certainly is an advantage for us. We will keep you posted on progress in this field as we move ahead and yeah, that's basically the information I have to share today.

So let's move on to the last agenda item, which is the outlook. On page 16, the growth drivers for the medical market in general and for the microsurgery and ophthalmology markets in particular are intact and unchanged. Carl Zeiss Meditec will continue to follow the strategy, which has been successful over the last years. Let me briefly mention some elements of our strategy that are listed here on the slide. We will further drive recurring revenue generation with both our IOLs and our refractive laser business. We will extend our technology leadership in cataract and improve our profitability of Ophthalmic Diagnostics and we will continue to lead neuro/ENT visualization market with application-driven innovations. And finally, particularly in the Ophthalmic Diagnostics business, but also in other fields, we will further build on our strength in data management, which will become more and more important.

Therefore, year 2016/17 and the next years, we confirm our guidance. We want to grow at least as fast as our markets grow and we want to maintain an attractive EBIT margin between 13% and 15%. In the current year, we are going to be in that range, also when corrected for the one-off capital gains of EUR7.7 as discussed before.

Yeah. Ladies and gentlemen, this concludes our presentation and we’re now happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Scott Bardo. Your line is now open.

Scott Bardo

Yeah. Thanks very much for taking my questions. So the first question please and thank you for the disclosure on the refractive correction market. Around 30% of the ex-US share, which I think you’ve built relatively quickly. So I wonder if you can give us some sense of where you see a total addressable market share. What's a realistic market share for Zeiss ex-US? And do you anticipate realizing a similar sort of market share in the North American market as you've achieved outside of the US? So that’s the first question please.

Second question, sort of a bigger picture question, you've had some initial experience now with Jim Mazzo and Andy Chang, can you talk a little bit about some of the things that they're implementing, have they had any impact in the organization, we still have somewhat of a flattish development in North America. I wonder if you can talk a little bit about that please.

And last sort of housekeeping question if you like, I think Christian, you mentioned that you've not renewed your fixed term deposits for your cash. Can you talk a little bit as to why that would be the case and what you're doing with that cash in the interim? Thank you.

Ludwin Monz

Yeah. Thank you, Scott for the questions. I start with the first part and then I might need help here from my colleagues on the market shares, but outside the US, I believe our revenue market share in refractive laser is 30%. Within the US, we're not present right now. So we expect to slowly grow there as well, but that's basically the current situation. Does that answer your question?

Scott Bardo

And well, you mentioned that you, that there is still room to go. So I just wondered if you could, do you have any sort of plans, targets where you think that the group can achieve 40%, 50% market share outside of North America or are we coming up to the buffers of what is achievable? And your expectation that you can replicate this sort of market share success in the US. I mean is the 30% a realistic expectation for the mid-term in North America? Thank you.

Ludwin Monz

Yeah. But it will certainly take some time to get there, but now I understand what you mean. I mean I had in mind when I said, well, there's room to go, it just means we don't see saturation effect yet, right. So we can further grow and we expect our business to grow on also outside the US and do not expect saturation effect soon, which means that our market share will further grow. To be honest, I don't have a number for you, so I don't have a specific market share goal or something like that outside the US. In the US, I mean, for us, it really is key, as I said in the presentation, it is key now to build relationships with the key opinion leaders in that market to establish SMILE also as an alternative to the currently performed procedure of Femto-LASIK that needs the support of the key opinion leaders. Because of that, it’s so important to build that up. That might lead us to a similar market share in the US, but it's hard to predict how long it will take to get us there, because it also depends on the investment cycle and not everybody will immediately exchange the technology, it just takes years to get there. So that was that.

Then you asked about the impact of Jim Mazzo, Andy Chang in the US and what we did there. So our focus in the US clearly is on improving in sales and service, building up infrastructure, improving there. We need that for two reasons. One reason is now the launch of SMILE. Right. And as I explained before, service plays a key role in that field and it is also a market segment where size is not present today, because we’ve not served the refractive laser market in the US in the past. So we need to newly build that up and that is one of the activities.

The second reason why this is so important is that we believe there's more potential also in the, on the diagnostics side in the US. So we, that's the other reason why we strengthen our presence in the US and that is, I would say, the most important focus of the organization right now. Other than that, I believe there's still potential for Meditec -- Carl Zeiss Meditec to better communicate the benefits of our products. We have a unique set up in the sense that we offer a solution and this is one of the reasons why we merged all our ophthalmology activities into one unit because we want to market all our products out of one hand if you like and that departmentalization, which we had in the past does not help there. So that was one of the ideas and that’s the other direction which is being worked on.

Christian Mueller

Christian, third one, the housekeeping question, we have not prolonged the 110 million fixed term deposit simply because of the market conditions here. So the interest rates have gone down so significantly so that this was not really attractive to prolong this. So we have this, I’d say, now very flexible, can we use this extremely flexible, but this might change if the interest rate of course changes and perhaps increases over time. What we have avoided just to mention this also, we are not paying negative interest rates. So at least, this case did not occur in our case.

Operator

The next question is from Daniel Wendorff of Commerzbank. Please go ahead.

Daniel Wendorff

Daniel Wendorff from Commerzbank. Thanks for taking my questions. Three if I may. First question would be a more broader question. And so when you look back to your Q1, and what would you say was the market growth you’re referring to, also in your full year guidance. I just want to understand a little bit of the dynamics of what might eventually lie behind the market growth eventually for the full year?

And second question would be, given that APAC was really strong again and you, in particular, also mentioned China, India and Southeast Asia and how long can this continue and what is driving this? I guess the question boils down to my question how long can this prevail?

And lastly, and you mentioned the positive order entry in microsurgery and what is driving this. Is it the new product launch and any market recovering, so any more color there would also be helpful? Thank you.

Ludwin Monz

I’ll start with the first two and Christian might take the third one. So the first one what were the growth drivers behind the, in terms of products behind the first quarter. And I would like to mention too that one is certainly refractive lasers and SMILE, I mean that has really helped us to further grow. There remains to be a big demand in Asia for this and because of that, that's also one of the growth drivers in Asia. But it's not the only one and the other one I would like to mention is really our surgical ophthalmology business, while other companies are losing in that market, we are growing nicely and so surgical ophthalmology in general and that includes both [indiscernible] also the equipment has contributed nicely here to the first quarter. Both trends I would expect to persist and then go on and that would be the expectation for the rest of the year.

The second question is a little bit long the same lines. In APAC, which you asked, can this go on? Well, I hope so. I mean, it depends on many factors of course. It depends on the economic development, which we cannot predict and the world’s economic climate. But I believe the drivers in Asia and that is both in China, also India, Southeast Asia, the drivers will be the same. We have a strong portfolio, which fits the needs of these markets. It's really about to refractive surgery. It is about surgical ophthalmology. So as I said before, it's the same things and I believe we have a very strong set up, both in China and India, Southeast Asia, we're building up. So I believe it can go on, if nothing happens in the markets, that's very difficult to predict in these markets, right. So as you all know, China to some extent is fragile and it's very difficult to predict how it will further develop, but our market position and that is the good news here, our market position is really good and that is why size has been growing faster than markets in countries now for quite some time. So I believe it can go on, but it's fragile of course in these markets.

Christian Mueller

Yeah. Order entry in microsurgery. The order entry in microsurgery was a little bit higher than the sales. It was not exceptionally high I would say, but nothing special that we see here. So we have not introduced new products over the last quarter in microsurgery. This is normal typical order behavior what we've seen in the first quarter.

Operator

The next question is from Oliver Reinberg of Kepler Cheuvreux. Please go ahead.

Oliver Reinberg

Oh, yeah. Hi, good afternoon. Three questions if I may. Firstly just to understand the underlying margin improvement a bit better. That was actually up 80 basis points. Can you just give us an indication, what amount of costs have you booked in terms of building up the US VisuMax business? And then secondly, can you give us some kind of color, what kind of currency support was reflected in this kind of margin, I guess, the yen probably supported a bit. That’s question number one.

Secondly, when you talked about the US and this is still being challenged in terms of the diagnostic photographing, you mentioned that there will be innovations coming in that hopefully will turn around the situation next quarter. Can you just provide more color on that, what you have in mind? Is this the major product launches that have faced us, any color on that would be appreciated?

And then third question, the R&D costs were probably significantly up, I think 13.3% compared to below 12% the year before. And I'm not sure if the restatement that you alluded to had something to do with that, but if you can provide any color here that would be helpful. Thanks.

Christian Mueller

Yes. So starting with your last question, exactly that was the point is sustaining costs, so product maintenance costs more or less which are project costs are now shown on the R&D costs. So this has an effect on the R&D costs of the 13.2% that you mentioned before and it's more than, I think, it's around about 1.5 percent point [ph] something like that, the effect right here.

Regarding your other question, the first question gross margin, US costs that or US infrastructure that we have built up, I don't have the exact number now here in front of me, but we’ve -- I’d say we've hired people already regarding the build-up of safety and service for refractive in the US. So we have quite a number of people already on board. And this had an effect, yes, but it was over compensated by, on the one side, the positive effects that we’ve seen from the mix effects I mentioned before. So higher share of intraocular lenses, higher share of consumables also in the refractive area and also, if you look at our IOL sales, I mentioned before that we had, I’d say, this comparison effect from the dealer business.

This was a very low margin business. So this also has a positive effect now in Q1 and by the way, besides that of course, microsurgery continues to contribute a high margin EBIT wise, but also gross wise. Currency, yes, currency also had a role, I’d say, some positive, some tailwinds here from the currency. You've seen that on the top line, which was around about 1% and I would guess that the gross margin effect was somehow similar in that range, a little bit lower, but the main effect was really from the mix and I’d say the different contribution the different products had.

Ludwin Monz

Yeah. I can take the second question, which was on products in the US. You might be aware that we just introduced a new modality in OCT. We call it OCT angiography. That's already in the market and Zeiss is very strong here compared to competition. I believe, it's fair to say that we have the best product in the market in that category. We have introduced a new product already with new OCT technology, it's called Swept Source Technology, probably not the time here to explain what that means, but it's a entirely new technology, which I would call the future technology. We have a first product with that technology in the market and so this is what is already out. These products have more potential.

The difficulty when we print something entirely new and that refers to OCT angiography, the difficulty is that the application needs to be developed. In other words, the doctors do not know how to read the data or how to read the images we can now generate. They need to learn this. They need to learn how to interpret this. And that just takes time and this is why, when we introduce such a product, the growth is relatively slow, but I firmly believe in the potential. There's more to come, also in diagnostics in terms of innovation. But please understand I cannot announce this year. I cannot say what it's about, because this would weaken our market position. So I have to be careful here, although I would love to talk about it.

Oliver Reinberg

Okay. And if I may, just try a bit here, is it a completely new product or more a facelift and the thing that you have mind, is that something that we may see this year.

Ludwin Monz

Okay. The only thing I’d say, yes, it's something new, but that’s it.

Oliver Reinberg

Okay, fine. And last follow-up, is there so far any kind of change visible in terms of the sentiment for investment in the US, given the kind of forward transition, independent from your product launches?

Ludwin Monz

No I believe that our investment decisions are long term decisions, right and so it's other factors we look at. I believe, I personally believe our company believes in globalization. I believe that will go on. I hope and also believe that the discussions we have might have a short term impact, but long term, I believe we will, the globalization will continue. It's just our time and I simply cannot imagine that this will go backwards. So we look at long term developments and they’re now, right now, no decisions, which would be immediately impacted by the discussions. Nobody knows what actually will be implemented, what is just being said. So we need to wait and see.

Operator

[Operator Instructions] There are no further questions. I hand back to the speakers.

Ludwin Monz

Okay. Ladies and gentlemen, so thank you very much for your interest in Carl Zeiss Meditec. Thank you very much for your questions. We will talk back and talk with you after the second quarter. I'm sure there will be lot of new things to discuss then. Thanks again and bye-bye.

Operator

Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect now.

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