Analogic's (ALOG) CEO Fred Parks on Q2 2017 Results - Earnings Call Transcript

| About: Analogic Corporation (ALOG)

Analogic Corporation (NASDAQ:ALOG)

Q2 2017 Earnings Conference Call

March 06, 2017, 04:30 PM ET

Executives

Fred Parks - President and CEO

Mark Frost - SVP, CFO and Treasurer

John Fry - SVP, General Counsel

Mark Namaroff - Director, IR

Analysts

Larry Solow - CJS Securities

Jim Sidoti - Sidoti & Company

Operator

Excuse me everyone, we now have our speakers in conference. I would now like to turn the call over to Mark Namaroff, you may now begin.

Mark Namaroff

Yes, hello everyone. Good afternoon. I’m Mark Namaroff, Director of Investor Relations, and welcome to Analogic Corporations second quarter conference call for fiscal 2017. I’d like to remind everyone that a supplementary presentation will be used for today’s call which can be downloaded from our company’s IR website at investor.analogic.com.

Joining me on the call today is Fred Parks, President and CEO, Mark Frost, Senior Vice President, CFO and Treasurer and John Fry, Senior Vice President and General Counsel.

Earlier today after the market closed we issued a press release describing the financial results for our first quarter. If you have not yet downloaded the press release you can do so via our website at investor.analogic.com.

Before we review the results for the quarter, I’d like to remind everyone that today’s call may include forward-looking statements such as comments about our plans, expectations and projections. For more information on risks and other factors that could cause our actual results to differ significantly from our forward-looking statements, please refer to our most recent Form 10-K and 10-Q reports on file with the SEC.

Also on today’s call, we will be discussing certain financial measures not prepared in accordance with generally accepted accounting principles or GAAP. We believe that using non-GAAP metrics provide investors a more thorough understanding of our business. An explanation and a reconciliation of our non-GAAP financial measures are provided at the end of the presentation materials and in our second quarter press release.

For the agenda today, first I would like to hand the call over to Fred Parks, who will update our FY2017 results and restructuring plan then Mark Frost will cover the financial results for the quarter and then Fred Parks will cover the outlook.

So I now would like to hand the call over to Fred Parks.

Fred Parks

Thank you, Mark. And I’m going to start on the fifth slide in your deck. Its title is Q2 FY2017 quarterly update. Our Q2 revenue expectations were realized in total with the substantial uptick in security offset by minor deficits in both Medical Imaging and Ultrasound.

Security will obviously have a stellar year, ultrasound in total not so much though the direct business is making progress and medical imaging in between. Now Mark will quantify those statements for you a little bit later in the talk.

On a more strategic level, our team has been analyzing the future of our ultrasound business actually our entire business so most of my further comments this afternoon will address that and you might want to flip to the sixth slide.

So with Q2 revenue finishing as expected, we will commence the course correction implied three months ago. Our focus is on restoring the ultrasound cost structure with [euro surge] at the heart and adjacent categories competing for resources as is usual in business.

Rising priority is supporting both medical imaging and security with sufficient resources to grow. Before the end of this fiscal year, we will be pruning initiatives that have of recent produced revenue, but not commensurate profit. In fact, some of these initiatives often encourage significant losses at variance to our expectations.

Now as a reminder, [three ports] of our ultrasound business is strategically advantage vested by our customers, featuring brand recognition across the world, profitable and growing. Yet even this core ultrasound business should be more profitable. The remaining 25% of ultrasound will either promptly improve as a result of the restructuring or find another home.

We believe this is the best long term strategy for analogic and our shareholders. After four or five years of diversification in ultrasound, sometimes depriving medical imaging and security of resources and attention, we are scrutinizing our portfolio in ultrasound. In the portfolio printing process, we have retained those activities that are growing and profitable, those which could be restructured to the same effect and those that have revenue upside with realizeable profit no later than entering FY 2019.

Importantly, not all of our pruning these discard improve the cost structure and we’ll re-examine the resource allocations. For example, we are continuing point of care initiatives but with a sterner investment and profit criteria. With the ultimate closure of the Vancouver facility, we will be supporting point of care product needs from Denmark. Notably part of the heritage of Vancouver will be the transfer of point of care product knowledge to Denmark.

Point of care as well as a few other categories are in the show me category instead of the promise me bucket. We will supply resources to medical imaging and security as warranted greater than subordinate to ultrasound. This back to basics approach means some non productive revenue will disappear but the losses associated there with will also dissolve.

Signaling that redirection we are changing leadership in the ultrasound sector. We consolidate accountability under the control of the single senior vice president in measure to both improve communication and execution. Brooks West, whose background is described in the press release, will be joining on March 13th as Senior Vice President and General Manager of Global Ultrasound. Brooks has both sales and marketing experience in the device sector. More importantly, Brooks has spent almost a decade listening to corporate strategies and sorting blinding from reality.

During the recent interview process, Brooks challenged our initiatives. He candidly said, we are drinking some of our own bathwater concerning the patience of investors. He is not delicate, diplomatic or sensitive but he looks at businesses from your view point with acumen we welcome.

We are in a different course under different leadership with a different prism for value and decisions and determined to deliver the value for which you invested in Analogic. So welcome Brooks, starting one week from today.

The 100-day assessment is over. We commence an execution phase that will conclude by the end of fiscal 2017. We enter FY 2018 with business leaders and medical imaging, security and ultrasound and whom I have faith will deliver results that earn your confidence.

In turn, they will have expensive authority to make their business successful and a reduced overhead cost to bear. Q2 was a bit better than we expected void by security which is off to a spectacular start. Our China and European direct sales teams delivered noteworthy revenues in Q2, in both cases again; however two other key account relationships should be reported which will impact the next few quarters.

First, we continue to experience delays in shipment of our technology product to the ultrasound general imaging partner. Accordingly, we have taken steps to provide better technical interchange and work more closely with our partner towards mutual goals. I too am not involved directly with the progress reports with the partner.

This puts fiscal 2017 revenue at risk in favor of a longer-term productive relationship. We have factored these changes into our fiscal 2017 outlook and softened our outlook for 2018, a change which could provide an upside opportunity.

In the second case, we were unable to meet pricing targets for a key customer of our CT Components business. We understand the pressure they were under and wish them success as they are not just a long term customer but colleagues in this imaging space. The loss of this business will be felt entering fiscal 2018 and also has been factored into our outlook.

Anticipating the challenges of our component business, part of our strategy has been to work our way up the value chain in CT, which we have demonstrated to our private-label CT activities in China. We expect this strategy and introduction of additional products in this area will bear fruit in fiscal 2018 and will provide further growth in fiscal 2019.

I now turn the podium over to Mark Frost, who will provide some details behind the aforementioned comments.

Mark Frost

Thanks, Fred, and good afternoon evening everyone. I’ll start on slide seven with our quarterly financial highlights. Revenue grew 3% driven by 71% growth in security, which was a significant recovery from a soft prior year comparison.

Security growth was largely offset though by declines in medical imaging and ultrasound. Non-GAAP, GAAP gross margin declined about 2% because of the bulk product and customer mix.

Return to non-GAAP EPS it was $0.90, $0.99 per share, or GAAP EPS increased $0.83 to$0.59 per share as we recorded a contingent gain of $8.2 million or $0.41 per share, due to a drop in the Oncura revenue forecast as well as in 2016 we incurred charges for both, the BK Distributor Matter and restructuring.

In addition, in the quarter we recorded an impairment charge of $10.4 million or $0.52 per share primarily related to the change in fair value of the Oncura reporting unit.

It should be noted that we passed on all other goodwill, intangible and annual impairment test of our cushion on the ultrasound reporting unit has found to 25%. Now pertinent to this point, we announced a restructuring primarily focused on own ultrasound business. Fred has communicated to selling an operational point, so I will not repeat.

The financial impact of these actions as we anticipate reducing our cost structure by $12 million to $15 million on a run rate basis in fiscal year 2018. No run rate savings are built into our fiscal year 2017 forecast but are an upside if we are able to implement actions sooner.

The restructuring cash charges anticipate are upwards of $5 million with 0.5 million incurred within quarter two and the remaining amounts expected across quarters three and four. We may incur additional non-cash charges in the second half of fiscal year 2017 as we finalize the restructuring plan and determine its impact on our business.

So I’ll move to slide eight and quarter two results. Non GAAP operating margin was down about 2% as well, reflecting primarily gross margin results as well as some higher OpEx because of the addition of Oncura sales marketing costs offset partially by lower R&D and G&A.

A couple of GAAP expense points. GAAP expenses are significantly lower, reflecting the Oncura contingent gain and the BK Matter settlement costs in the prior year within the G&A line offset in part by the impairment charge. The BK Matter Interest charge from fiscal year 2016 also explains lower cost within the other income expense line.

The Non-GAAP tax rate increased to 24.7% from 20.9%, reflecting a lower contribution from foreign earnings. We still estimate though our fiscal year 2017 non-GAAP tax rate to be in the range of 27% to 29%.

Non-GAAP operating income dropped 13% and non-GAAP EPS dropped close to 16% affecting primarily the impact of lower gross margin for mix as well as the higher tax rate.

Turn to slide nine, in our quarterly performance trends. We’ve already touched on revenue and operating margin. One additional point on gross margins, is we do continue to expect some improvement in gross margin from the current first half levels, reflecting enhanced product customer mix, but lower expectations for both medical imaging and ultrasound revenue will lead to an overall full year drop of about 100 basis points versus prior year because of the mix impact.

Now I’ll turn to our operating performance by segment on slide 10. Medical imaging fell -- revenue fell 2% caused by lower CT and mammography, partially offset by favorable timing in MRI. We now expect medical imaging to be down 2% to 4% for the year, reflecting primarily in sourcing decision by one of our large CT OEM customers, which we believe will not be offset as we thought when we enter the year. Non-GAAP operating margin dropped about 50 basis points, reflecting gross margin impact because of product mix.

Ultrasound dropped 7% primarily because of lower general imaging partner revenue and OEM probes. Strong results in China and Europe were the bright spots. We have further lowered our ultrasound forecast to be down 3% to 5% as we now anticipate general imaging revenue will push out the fiscal year 2018 as well as an expectation of the restructuring activities potentially dampening our sales performance.

Lower revenue and a higher run rate costs cost base primarily from the Oncura acquisition led to operating margin falling by 9%. As earlier discussed, we have initiated a plan to address our ultrasound cost structure which will drive a benefit in full year 2018.

Turning to security, security delivered another strong quarter of growth primarily from higher revenue from international high-speed as well as some rapid DNA shipments. Confidence in our backlog supports our view that growth should reach the 20% level for the year versus prior year.

Non-GAAP operating margin increased 6%, driven by the revenue benefit, partially offset product mix. Move to slide 11 and year-to-date results revenue was up 4% driven by strong security performance.

Gross margin was down two points reflecting negative product customer mix within the medical imaging and security segments as well as a lower ultrasound contribution. Non-GAAP operating expenses increased about $4 million because of the addition of $3.6 million in Oncura sales marketing expense and $1.8 million CEO transition costs offset in part by lower R&D.

A note on GAAP expenses is they follow a similar trend of being down as quarter two reflecting the same points related to the contingency gain, impairment and BK Matter charges.

I’ll move to my final slide 12 and discuss working capital and cash flow. We again generated strong cash flow in the second quarter with $14 million of operating cash and delivered $12 million of free cash flow.

Capital expenditure is still expected to be in the $13 million to $15 million range for the year. Drivers for the enhanced performance were DSO improvement of three days to 53 days and inventory days on hand reduction of five days to 183 days.

I’ll now turn the call back over to Fred to discuss our outlook.

Fred Parks

Thank you, Mark. We have not been swayed from a course correction flagged 90 days ago simply because Q2 had a significant left and the year-to-date growth is noteworthy. We will be deploying resources more carefully. We will complete the restructuring before the end of this fiscal year. We will be pruning marginal activities in favor of those that have more favorable economic structure. We will bear the cost structure that can sustain value creation even in the challenging years of ahead.

Our revenue growth must follow a portable pass. FY 2018 will produce increased earnings as a result of the restructuring. FY 2019 will reflect an acceleration of both revenue and earnings and one quarter ago we talked about examining our portfolio to be clear that diagnosis was focused on ultrasound and we feel like we have accomplished that goal.

Analogic is not a safe harbor for concepts that require too much capital runway. Welcome to Brooks West, who will remind us of the impatience of our owners, and rest assured that the technology in which analogic was based will be deployed in increasingly meaningful ways. Analogic has amazing talent, evidenced by the products and security that lift this year. Medical imaging will be a similar catalyst in FY 2019. We will find a more efficient course to bring products to markets, analogic has always been able to imagine, design, engineer and manufacture and now we have to find the best course to bring these products to market.

And with that we can invite some questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, the floor is now open for your questions [Operator Instructions] Our first question comes from Larry Solow with CJS Securities.

Larry Solow

Good afternoon. Thanks for that was a lot of content there. Appreciate it. I was wondering Brooks, I mean, excuse me, Fred. You could maybe just peel back the onion a little. I’ll jump in the gun little bit of that. If you could just peel back the onion little bit though on your assessment of ultrasound. It certainly sounds like you've identified a lot of cost-cutting opportunities. It seems like Oncura probably at the heart of that.

Could you may be elaborate on how you expect to may I could see a path that takes you from where you are today till this mid single digit operating margin just by cutting expenses? How do you expect to sort of invigorate profitable growth? And does all this cost-cutting, does that include less focus on sales or more just the pinpoint focus on certain areas of sales, if you could kind of elaborate on that, because I know, over the last – maybe not last, couple of years but historically that we thought the sales force was always underrepresented? Thanks.

Fred Parks

I don’t know that I get all your questions, let me start from the few. We are innocent in businesses that grow otherwise we can create value. I start from the standpoint that 80%, 75%, 80% of this business in ultrasound is in a segment that is growing and we are advantaged, so, I think they're not high growth. There probably be three or four maybe 5% in that area, but more then we have been experienced in the past because I think we lost a little bit of focus on the heart of that business. As far as depriving the sales resources if you would look at our documents over the last four or five years, you would see sales and marketing expense extraordinary growth in those categories, and supporting initiatives perhaps maybe even support them well, but it hasn't produced results and it’s been ongoing for a long time.

So, I do feel like we have a focused sales team. I think we see evidence now in the direct side, if they can still grow the business. But for the – I’m going to called the perimeter initiatives, those that are not inside that 80% we are going to test those. I think some of them will prove to accept, they are successful. You asked also about on Oncura. I think Oncura is at the edge actually. I think there is some potential there. The one thing that we are doing in Oncura, is when acquired they were both a vet Ultrasound business and they were imagined to be the catalyst of a human telemedicine business.

We are now focused on the former of that rather than the latter. So, I wouldn’t want you think that we had any imagination of cutting our way to success. It’s not what we’re doing, but we are going to be careful where we put the resources and we’re going to look at them on shorter intervals and they need to produce results. Mark, come in?

Larry Solow

Okay. Fair enough. And then just one quickly on the Medical Imaging side, obviously the loss of the customer, is there something extraordinary about this customer that makes it easier for them to may be in source or might could this happen with other potential customers down the road?

Mark Frost

Well, we we've been discussing that and I think there is an ebb and flow here in this customer set. Product development cycles to be three to five years. So I think customers come into that. We're grateful for the business and occasionally like this when they go out from that. I couldn't guarantee that they wouldn't be both in the future. I think this particular customer was in an extremely cost competitive situation. And when I wasn't here when this happened but I believe that when we discuss this pricing with a customer they were just going for targets that didn't make economic sense for us, sometimes that works. This is a customer we've long had a regard for and part of it says, we hope it works for their benefit. But if not and it doesn't work we’ll be here for the rebound.

Larry Solow

Fair enough. Thanks.

Fred Parks

Thank you for the questions.

Operator

Thank you. [Operator Instructions] Our next question comes from Jim Sidoti with Sidoti & Company.

Jim Sidoti

Good afternoon. Can you hear me?

Fred Parks

We can, Jim.

Jim Sidoti

Great. Just starting out with the bookkeeping question. I just want to confirm looks like stock-based expense was about $0.14 in the quarter. Can you just confirm that's correct and what you think that'll be for the year?

Mark Frost

Yes, Jim. That’s about right and you could just -- that's about the usual level we run at each quarter. You can have a center to either way sometimes, but that's about the level we run at.

Jim Sidoti

Okay, right. When you look at the Medical Imaging business, if you factor out the loss of that one customer, can you give us a sense on how the rest of that business is growing or how the rest of that business is doing? And would you expect for the remaining portion of that business to fiscal 2018?

Mark Frost

2018, Yes, I can answer that. I think we continue to expect as we’ve seen in the last couple of years roughly flat growth up a percent, down a percent depending on the modality and continued strong gross margins and operating margin. So, similar to what you've seen in the last few years. As Fred said we have ebbs and flows and unfortunately we’ve had a flow out which will impact us in 2018. But as Fred discussed, we have a number of products we’re working on where we hope certainly by 2019 you can start seeing an improvement in Medical Imaging growth as we move forward.

Yes, by the way, Jim, I was in Tokyo when this final decision was made. And so when I when I heard about that -- I also heard that there was a three-year contract sign with the same customer in another modality. So this is a very specific situation that even doesn't go across all the modalities with the same customer. So, we wish we had the business, maybe we'll get it again, but I wouldn't read too much into it from a trend basis.

Jim Sidoti

Okay. And was Larry correct when you assumed that they are going to bring that business in-house?

Fred Parks

No. We think they would go outside to another supplier. I think that supply will be new to this segment. And I would -- in one sense, so I’d said, hope it goes well for them, that this is a very complicated product. We’ll just have to wait and see.

Mark Frost

Yes. We’ve seen experience in the past that sometimes these transitions have gone well and other times the customer has come back to us because it did not go well.

Jim Sidoti

Okay. And then my last question on the security business. You set up for a very strong year as you indicated, do you use see this trend continuing for the next couple years or do you think that this is an unusually strong year and you may slow down a little in 2018 and 2019?

Fred Parks

I think we will continue to have good growth. We have a whole bunch of growth drivers and security. Will it be at the 20%, 25% level? I don't think we’re guiding for that level of growth, but we do continue to expect to have positive growth and security.

Jim Sidoti

Okay. You don't expect to have revenue declines to that business in the next couple of years?

Fred Parks

No, we do that. We think we’re on a track with the various growth drivers of our high speed or checkpoints and then Rapid DNA as a upside that will continue to have growth in that segment.

Jim Sidoti

Okay. Thank you.

Operator

There are no further questions at this time. I would now turn the call back over to Mark Namaroff for closing comments.

Mark Namaroff

Great. Thank you. Thank you all for your interest in Analogic. We invite you to call again in June when we will review our third quarter results for 2017. Thank you. And have a good evening.

Operator

For listeners who may have come in late, this call has been recorded. You can access the telephone replay by dialing 1-877-919-4059 or for international callers 1-334-323-0140 and entering passcode of 52494425. A telephone replay will be available at the number beginning two hours from now and running through midnight Eastern Time, Thursday, April 6, 2017. Webcast replay will be available on the Investor Relations page of our website at www.analogic.com the beginning about three hours from now and will be available till Tuesday April 6, 2017. Thank you for joining Analogic Corporation second quarter final fiscal 2017 conference call. You may now disconnect.

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