ConvaTec Group PLC (CTEC) Earnings Call Transcript & Summary

Okay. Good morning, everybody. Are we ready to roll. Welcome to the half year 2025 ConvaTec results presentation. First, let me convey apologies from our CEO, Karim, who is not feeling well today and won't be able to attend. So I am going to present his slides as well as the CFO section, and then I'll be very happy to take questions that anyone has afterwards. So the usual disclaimers apply and the summary message for today is that we delivered a strong performance in the first half, financially and strategically, and we're on track to deliver our guidance. The highlights are on the slide. Revenue growth was again broad-based, further operating margin expansion at the same rate as for the last 3 years. Second year of double-digit EPS growth. Our product launches are progressing well, and so, as I said, we're on track to deliver guidance and that's for 2025 and for the medium term. Now these strong results in the first half demonstrate the resilience of our business model. We're not reliant on any one category or geography or product for our growth. At the core of that resilient business model is: first, that we operate in 4 chronic care categories, growing structurally over time. We have strong market positions with high levels of recurring revenue, and we expect to grow ahead of the markets consistently by virtue of our differentiated products and services; second, we invest to develop those differentiated products and services, focusing in the fastest-growing segments. And innovation is directed towards satisfying unmet customer needs, building customer loyalty and strong IP positions. We now have the richest product pipeline in the country's history, and we achieved the target 30% vitality index 1 year early in 2024; third, our growth is broad-based across diverse categories, geographies and products. Organic growth has accelerated in each of the last 6 years. We're launching 16 new products over the last 3 years and the next 2 years, which will contribute to growth across all categories. So that business model is resilient to external impacts on any individual areas. The FISBE strategy is delivering. We are investing to drive growth and that is leading to improving sales, margin and EPS. This chart shows that in each of those 4 key financial metrics, the first half of this year was ahead of the results of the last 3 years. So momentum is building and the flywheel is turning. So now I'll move on to the financial results in our usual format. And here are the highlights. Organic revenue growth was 6.8% on the basis of our guidance, which is excluding InnovaMatrix, or it was 6%, including InnovaMatrix. Operating margin expanded by 130 basis points or by 140 basis points at constant currency. EPS growth was nearly 20% benefiting from operating profit growth and lower financing costs. Cash conversion was in line with our expectations and similar to last year. We still expect over 80% cash conversion in FY '25. Leverage improved by 0.4 turns of EBITDA to 1.9x, and the dividend will increase by 3%, same as last year towards the full year target payout ratio of 55% to 45%. Now sales growth was broad-based across all 4 categories, as you can see in the columns on the left. As previously reported, Infusion Care benefited from positive order phasing in the first half. And on the right, you can see a small contribution from M&A, an FX headwind and in line with our guidance, we've separated out the impact of InnovaMatrix, which was down by $6 million year-on-year. Now let's look at the sales by category, starting with Advanced Wound Care, where organic growth was 4.3%, excluding InnovaMatrix. Growth was strong in North America and in Global Emerging Markets and it improved in Europe through the first half, supported by new products. AQUACEL AG Extra, our flagship brand continued to grow well. And the launch of ConvaFoam continued to build momentum, winning more than 50% of new hospital evaluations in the U.S. and Europe. InnovaMatrix sales decreased by 13% to $39 million, as the uncertainty around the LCDs continue to weigh. This was in line with the guidance we gave in April when the LCDs were postponed until 2026. And we continue to make progress in generating clinical evidence for the RCTs and in developing sales and indications outside the scope of the LCDs. So then on to Ostomy Care, where organic growth was 4.7%. Growth was good in the U.S. with a continuation of positive new patient starts. It was steady in Europe, and we saw strong growth in GEM. The highlight of the period was the launch of its Esteem Body. Our new one-piece soft Convex product, which had an enthusiastic response from patients and clinicians, is building sales and is now available in all of our focus markets. Growth was also supported by our updated accessories range, Esenta. In Continence Care, organic growth of 6.7% was driven by further volume increases in the U.S.A., backed by our outstanding customer service and the broadening portfolio of products. We saw faster growth in sales of ConvaTec product relative to other manufacturers, which is now over 55% of the mix and faster growth of hydrophilic product, which is over 60%. We grew strongly outside the U.S.A. on a small base, which again contributed over 1 percentage point to the category growth rate. And then Infusion Care, where organic growth was 14.1%. As we guided in February, Infusion Care benefited from positive order phasing in H1. Growth in H2 will be lower. But that said, the start to the year was ahead of expectations and has led us to increase our guidance for 2025 to double-digit growth. There was continued strong demand in diabetes across long-standing and newer customers as the penetration of automated insulin delivery over multiple daily injections is increasing. And outside diabetes, growth was very strong led by infusion sets for AbbVie's Parkinson's treatment. Our other therapies now represent mid-teens of Infusion Care revenue, up from about 10% that we have previously reported and the scope to grow further as a share of the category. We've got a strong position in Infusion Care with increasing diversity across new customers and products gives us confidence that we can sustain high single-digit growth for years to come. So let's move on to profitability. Operating margin expanded by 130 points or 140 points in constant currency, in line with progress of the last few years. In this period, there were significant mix effects. The faster growth in Infusion Care, which has lower gross margin but lower operating cost ratio, and the sales decline in InnovaMatrix, which has higher gross margin and higher operating cost ratio led to a negative mix in the gross margin and a positive mix in the operating costs highlighted on the chart there, which offset each other and had no impact on operating margin. Gross margin declined by 60 basis points, but without that mix effect it would have increased slightly. Price and productivity combined contributed 40 and 110 basis points, respectively. And inflation was 3%. As expected, a headwind of 110 basis points, and we expect it to continue at that level through the second half of the year. Operating costs. In addition to the mix effect, there were further benefits from our simplification and productivity programs, which also delivered more improvement in the G&A ratio down 50 basis points to 7% of sales. This rate of progress in margin, we'd expect to be roughly the same in the second half of the year. Now on to the bottom of the P&L. EPS increased 19% in the first half, benefiting from an increase in operating profit and a reduction in financing costs. That's shown on the left. This was a reverse of the effect last year when EPS was flat in the first half because of increasing financing costs. But it finished the year in double-digit growth. Finance costs have now stabilized. We're expecting them to be roughly flat in the second half of the year, that's in the middle column. So EPS is on track for double-digit growth for the second year in a row, in line with our guidance. Cash conversion was in line with expectations and similar to last year at 60% operating and 35% equity. The components of cash flow, which you can see on the chart were also a similar shape to last year, and we're on track for equity cash conversion of over 80% for the full year. Net debt increased by $107 million, but leverage reduced to 1.9x. So following the strong first half, we are confident of delivering our full year guidance, which is unchanged on the 4 key metrics set out on the chart. In the detail, the guidance for growth of Infusion Care has increased to double digit, and the guidance for finance costs has reduced by $5 million, with all other items remaining the same. So this is the fifth consecutive year of delivering sales growth within our target range. The fourth consecutive year of operating margin expansion towards the target of mid-20s, and the second consecutive year of double-digit EPS growth. These financial results are starting to compound. So now let's move on to the strategic update. ConvaTec is well positioned to deliver that compound growth in top line, earnings and cash because of our leading positions in attractive and growing markets, the resilient business model that I described at the start of the presentation, and the pivot to sustainable and profitable growth that has been delivered through the FISBE strategy. The growth delivered has been broad-based. This chart shows the progress over the last 3 years with each category contributing. There is strength and resilience in the broad-based portfolio. The individual contributions to growth will change from period to period, but the diversified portfolio keeps delivering. We have been delivering this growth across the 4 categories, which you can see at the top of the chart through changes in the reimbursement landscape. Reimbursement dynamics are an expected part of our business. We plan for them. We focus on delivering value for patients, payors and health care professionals. And we believe that in the end, product efficacy always wins. We've developed strong competencies to work continuously in this area of reimbursement across our centers of excellence at the bottom of the chart, which manage pricing, market access and reimbursement, medical and regulatory. Here in the middle of the chart are some examples of recent or current areas of work. In Wound Care, we're developing ConvaNiox and generating clinical evidence to demonstrate its strong, unique efficacy and to secure reimbursement based on its high value to the health care system. We're also generating clinical evidence for InnovaMatrix to secure long-term coverage and access to the private payor market in the U.S. In Ostomy Care, we're launching Esteem Body, soft convexity, one-piece at a higher reimbursement rate based on improved efficacy, and we're developing the 2-piece equivalent as well. On the other hand, we'll be providing feedback on the recently proposed competitive bidding process, more on that in a moment. And in Continence Care, we're developing the portfolio of ConvaTec manufactured and hydrophilic products to be best positioned to serve customers and to be best positioned for whatever changes there are in reimbursement. In Infusion Care, the recent developments in our product portfolio and extended wear for diabetes, and Neria Guard for Parkinson's, they attract higher pricing, reflecting their improved value to customers and patients. The message is that we are working in an evolving reimbursement landscape all the time. With our resilient business model, a diverse base of growth, we expect to deliver sustainably 5% to 7% organic revenue growth and double-digit EPS growth through the reimbursement dynamics that arise. So let's look at the 2 most recent developments. First, in Wound Care, there is uncertainty about the potential implementation of the LCDs next January. And CMS has just announced a potential price of $125 per square centimeter for all skin substitutes for consultation. This price is much lower than most products are currently reimbursed at, including ours. It would have significant implications for the structure of the segment, especially for the more expensive human tissue products. Exposed to this change is approximately 3% of group revenue. And if it's implemented as drafted, we expect the impact could be a headwind of about 1% to 2% of group revenue in 2026. Now there's a long way to go before this is implemented, a lot of moving parts, and there could very well be changes to the draft proposal as they were to the initial draft LCDs. We're focusing on strengthening our position, and we're confident of the long-term growth opportunity irrespective of any short-term volatility. InnovaMatrix works. Product efficacy is the most important factor leading to market share. Our clinical evidence is good and it's increasing. And ours is an advantageous position for supply and on cost of goods. If this proposal happens as currently drafted, it would have a far greater impact on higher cost players, presenting a volume opportunity for us. So second then, on the right, in Ostomy Care and Continence Care, CMS has just announced the proposal to change rules to enable a competitive bidding process in these areas. This too is in consultation and may face changes before any implementation. 7% of our group revenue is directly exposed to this potential change, being the reimbursement to 180 from Medicare. There is an additional 2% of sales to other distributors, which we estimate are also reimbursed by Medicare. But the impact of any CBP on that indirect revenue would be much less. So if implemented as drafted, which it might not be, we would expect a net headwind of 1% to 2% of revenue in 2027 or later. And you get to that 2% using an average price reduction delivered across previous CBPs of 30% and on the 7% of revenue. And the range down to 1% is because of the volume gain opportunity that there would be. We are in a strong position for whatever changes arise. And therefore, here too, we are confident of the long-term growth opportunity, whatever the short-term volatility. We are an integrated distributor and manufacturer with the leading position of the largest and loyal customer base, a strong and broadening portfolio of products. There are approximately 3,000 distributors, which are reimbursed by Medicare for these products currently. And CMS has indicated that under a competitive bidding process it might expect 7 or 8 for each category, not 3,000. So if this proposal is implemented as drafted, there would be far fewer players, and there will be an opportunity for us to gain volume. So to summarize on reimbursement, these dynamics have always been a feature of the health care market and will continue to be so. These recent consultations are not extraordinary. In 2025, we have a similar headwind from InnovaMatrix of just about 1%, and we will still deliver within our target sales growth and double-digit EPS growth. We set our guidance assuming that such reimbursement dynamics will arise. We'd not expect these recent announcements to knock us off track from delivering our medium-term targets of sustainable growth. Now let's take a quick look at the focus areas for each category, starting with AWC. So on this chart, you see the 4 segments of Wound Care that we focus on and the structural growth rates in each. The middle row shows the key and new products in each segment. On the left, AQUACEL AG Extra is our market-leading flagship brand, which continues to perform well. The other products are all new. This is the richest pipeline of new products we believe of any competitor in Wound Care. Our focus currently in Wound Care is to continue driving the success of AQUACEL, to build on the launch of ConvaFoam, to begin launching ConvaNiox and ConvaFiber this year and ConvaVac next year and to deliver further clinical evidence of the efficacy of these products, especially in other metrics. In Ostomy Care, this chart shows the segments we compete in and their respective growth rates. In the middle of the chart are our main products in each segment, existing and new, and the innovation is focused in the fastest-growing segments. Our focus is on driving the Esteem Body launch, building on the good momentum we have in GEM with our existing product portfolio, further developing the Esenta accessories range, and filling the main remaining gap in our product portfolio with Natura Body in 2027. In Continence Care, here, we're showing the category by geographic region. We've got a strong presence in the U.S., the #1 home care brand, 180 Medical, with over 40% share, but we're small in Europe and GEM. In the middle, you see our existing and new products, in particular, the GCA brand using our hydrophilic FeelClean Technology and the value brand Cure. Our focus is on maintaining our outstanding customer satisfaction and loyalty scores in the U.S. to develop our market-leading position, growing the penetration of ConvaTec and hydrophilic products and building our services and product presence in Europe and GEM to grow quickly from a small base. And then in Infusion Care, we show the Diabetes segment and other therapies. In Diabetes, the number of insulin intensive people using pumps is still very small at about 6% of the potential total. The growth in pump use is accelerating, driven by innovation in pumps and monitors. In therapies outside diabetes, pump usage is growing quickly. For pain management, for immunoglobin deficiency and especially for Parkinson's, led by AbbVie's new VYALEV therapy. Our infusion set technology can support a wide range of different types of pumps. Our focus in this category is working with customers to innovate, meeting the growing demand for our infusion sets with great service and diversifying our customer and product base. So I hope that summary update of our strategic agenda by category is helpful in demonstrating the breadth and diversity of ConvaTec's current and future growth. So let me finish with a recap. We have a resilient business model based on leading positions in growing markets, diversity of growth across our categories, geographies and products, all underpinned by a strong pipeline of new product innovation. The first half saw strong delivery from that business model financially and strategically, including good progress on product pipeline, colleague engagement and customer loyalty. We are on track to deliver our financial guidance for 2025 and for the medium term. Thanks very much. I'll now be happy to take any questions. David, are you going to help compare the questions?

[Technical Difficulty]

It's Graham from UBS. Just 2 questions from me. So firstly, on the wound acceleration through the year. Should we expect that to get to mid- to high single digits once you get ConvaNiox? And does ConvaNiox launch a bit differently to ConvaFoam, so maybe faster? And the second question then is on CBP, which is you've given us the revenue potential outlook. I suppose on the cost side, is it feasible that you can switch products -- more products to your own brand, which will presumably help gross margins? And is there much OpEx change in the business model in case studies where you've gone to the CBP elsewhere?

Wound Care, first of all, the acceleration in sales growth, we do expect to build through this year. But we're aiming for mid-single digits growth in 2025 for Wound Care. ConvaNiox won't have a material impact in 2025. You asked if ConvaNiox NOx would launch differently from ConvaFoam. Well, to a certain extent, it will because it's effectively a new category in our minds. In ConvaFoam, we are updating -- replacing existing foams with a superior product. But in ConvaNiox, there's nothing like it out there. ConvaNiox, we wouldn't expect to build quickly. Let's not get carried away. It will build steadily and slowly but for a long time in our mind. Once the new products are all launched because we got 5 of them in Wound Care, we do see Wound Care being a high single-digit business in the medium term, but not this year. And then on CBP. What is the opportunity if that happens? And I do want to emphasize it's early days. Can we replace -- can we sell more of our own product? I think that was one of the questions. Yes, we can. And we already are doing. There's been a steady increase in the proportion of ConvaTec manufactured product because our product portfolio is getting better. Remember, in 180 Medical, the emphasis is what does the customer wants. It's about customer loyalty, driving that retention, driving the growth in volume of customers. And as we get better products and as our portfolio expands, one would expect naturally for more of the products to be ConvaTec that are sold. So I would expect that trend to continue, maybe accelerate a bit. Operating costs are variable as they are in all of our categories. So we will adjust accordingly. But our emphasis will be on driving that growth long term. Do you want to..

[ John Hemeon ] from Barclays. I have 2 questions, both are on InnovaMatrix. In the current environment, the doctor maybe gets reimbursed at like $1,000, ConvaTec maybe gets half of that. So there's a differential there. In a world where the doctor is going reimbursed at $125, what would you expect ConvaTec's realized price to be? And then the second question is on the price cut and the revenue headwind guidance. If your realized prices going from $500 to maybe $125, that feels like a bigger price cut than the 1% to 2% headwind that you're guiding to, which is like a 40% to 60% cut to the 3% revenue. So why is it not a bigger headwind if the price cut is greater?

Yes, good question. Thanks, John. So InnovaMatrix, let's recognize -- this development in InnovaMatrix in the U.S. has been going for some time. We've shared previously that we are developing our sales in other indications as well. So to the question on what will the discount be in the physician's office. Obviously, for -- if the price is as low as $125, this is going to lead to a significant change in the structure of the segment. To our estimation, there could be many of the -- especially higher cost human tissue type operators that just don't continue. And so you'd expect, for sure, there to be some incentives for the physician's office to continue, but it would be much less than currently. So we've made an estimation of what we think it is, but that remains to be proven out. The worst it can be in InnovaMatrix obviously is a 3% headwind because that's all the sales there are. We don't think it's going to be like that because as our product, which is strongly positioned, and we continue to generate clinical evidence to prove that. As that has a volume gain opportunity and as the other indications grow, we think that there is a long-term growth opportunity for InnovaMatrix. And therefore, in a worst case, 2%, we'd like to aim for 1% down even at that low price level, if that's what happens. I mean 3% is the worst case. I don't think 1% to 2% is overly racy in terms of headwind.

Seb Jantet with Panmure Liberum. So just sticking on skin substitutes and CBP. Just the first on the skin substitutes, you talked about revenue, but just help me understand what that happens, what the 1% to 2% hit does to your bottom line because obviously, you're taking big price cuts there, which are going to obviously affect your gross margin and your bottom line, but you've obviously got some OpEx you can move around there. So I'm just trying to understand what that does? And then the other piece is just on the CBP piece. Just trying to understand, I mean, you said 1% to 2%. You talked about 30% price cuts. You talked about 9% of potential sales in -- there must be some volume assumptions that you are making to get to that 1% to 2%, even the top end. So just if I could just get a sense of what you're assuming for volume kind of improvements against that.

Yes. Sure thing. Well, let me do it in reverse. On the CBP 1% to 2%, what we have done there is, first of all, it's 7% of revenue that is directly impacted. The indirect impact on the smaller piece of revenue, we think, is a fraction of that and probably a rounding error. So we've taken very simply 30% price reduction which is the average of the CBPs over time, again, 7% of sales. There's your 2%. And then reducing 2% towards the 1% would rely on volume recovery of some kind. Now we think we'll be successful in that. I quoted the number of distributors currently in the U.S. market as approximately 3,000 if that goes down to under [ 20% ], which is the expressed desire of CMS, we think we'd be in a very good position to gain volume. That's why it might not be as bad as 2% worse case, could be better towards 1%. That's how we've come up with that number. And then on InnovaMatrix dropping to the bottom line, yes, it's a price cut. But do remember what I described in the margin bridge, which is that InnovaMatrix has very high operating costs. It's a complicated sale. And so we would have to adjust accordingly. We've previously said is that although it's a very high gross margin, InnovaMatrix operating margin is not that far from the group's average. So you'd expect a drop-through rate a bit above the group's average operating margin, but not dramatically so.

Ed Ridley-Day from Rothschild and Co. Redburn. Bigger question on the CMS discussions. But to what extent are you speaking to them about the broader benefits of xenograft versus allograft, the safety benefits, the administrative benefits and to what extent are they actually receptive in those conversations? And then I had a quick question on Neria Guard, clearly an interesting product. Can you talk to the contribution from Neria Guard to IC?

Okay. We have a very close and extensive dialogue with CMS, as you would expect. Like many others in the industry, the discussion, the debate, the lobbying is flowing freely. We talk to them about all sorts of things. I won't get into the details of what they are. But that's why we want to be cautious about these 2 announcements are initial draft proposals, and they are under discussion. And that discussion is genuine. And there are pros and cons and there are lots of people for and lots of people against, and we saw how that played out with the LCDs. They were extended, they changed. We wouldn't be surprised if a similar thing happens in the case of these announcements, too. Your other question, sorry.

On Neria Guard.

Neria Guard, yes. Look, Neria Guard and in particular, for Parkinson's and AbbVie, look, it's growing really well, growing really strongly. We've said it's not that other therapies area has grown from 10% of the category to now being over 15% of the category. And we won't get into specifics, but I said in the presentation that the pricing reflects the value to the health care system. So it does come at a higher margin. Yes.

Richard Felton from Goldman Sachs. Two questions for me, please. First one is just a clarification. But the 1% to 2% headwind from InnovaMatrix, is that including both the reimbursement changes announced this month and LCD? That's the first question. And then the second question is on the midterm guide for mid-20s margin by 2026, 2027. Obviously, you've reiterated that guidance this morning. Is it fair to assume that the path to achieve that is maybe a little bit different now versus what it was 6, 12 months ago? And if that is the case, what gives you confidence that the other parts of your business can pick up some of the slack to compensate for the reimbursement headwinds.

Yes. Okay. Let me do that in reverse as well. One of the points we're trying to make in the presentation was that we plan for something to happen. And it's the nature of the health care industry, reimbursement dynamics. And so are we still expecting to hit our medium-term margin target? Yes, we are. Is the shape of it going to be different from how we originally planned it? Well, I'd say no, not really because we had planned to be delivering on the levers which are within our control. It is simplification and productivity across operations, commercial and G&A. It's pricing, which we saw another 40 basis points of price improvement in the first half. Operating leverage is helping us as our top line growth picks up. All of those levers within our control are still contributing to the mix improvement -- to margin improvement, excuse me. And then we've got some things going on in reimbursement, but we always have had and we always will have. So I don't think these most recent announcements knock us off track from the trajectory that we were on. And what was the first one?

Does the 1% to 2% for InnovaMatrix headwind, is that LCD and the...

That's right, excuse me. So no, it doesn't because we think that if the price goes to $125, that achieves the objective that the LCD was seeking to achieve, which is reducing excess cost and removing bad actors from the sector. So if the price were to stick at $125, no guarantees, but we don't expect the LCD would carry on in its current form. Yes.

Jack from RBC. First, on Infusion Care manufacturing. You mentioned in the release that you're kind of looking to expand manufacturing in Infusion Care. Is that a change given the strength you've had kind of the back into this half? Or is that kind of -- was that already in the plan? And then how much opportunity is there to kind of really automate this is kind of processes within that manufacturing, kind of I guess a footprint there to improve gross margin over the medium term? And then just following up on the ex U.S. InnovaMatrix and the other indications you spoke about, could you give a bit of a bit more detail there. So kind of what the time lines are and what your expectations are over the next couple of years?

Yes. InnovaMatrix capacity, I think what I said in the presentation was we have a focus on growing -- on meeting the growing demand with great service. It's not a new plan, no. We've always said Infusion Care is going to be growing high single digits. It's a long-standing plan of ours to be expanding our capacity to meet that demand. Sure, this year, we think it's going to be double digit, not high single digit. But in the grand scheme of things, that doesn't make much difference to the manufacturing plan. These automation projects, capacity projects. They take years to bring to fruition. So we've been planning this a long time. And then InnovaMatrix outside the U.S.A. Look, we are launching in Latin America now. We have ambitions to launch in other markets, too. But honestly, the market opportunity is currently much smaller outside the U.S.A. So it's the U.S.A. that's going to move the needle most when it comes to InnovaMatrix and Biologics.