Medacta Group SA (MOVE) Earnings Call Transcript & Summary

Dear ladies and gentlemen, welcome to the conference call of Medacta Group SA on the 2020 half year results. At our customer's request, this conference will be recorded. [Operator Instructions] May I now hand you over to Medacta's CEO, Mr. Francesco Siccardi, who will lead you through this conference. Please go ahead.

Thank you. Thank you very much and welcome to H1 results for Medacta. I will go through very quickly on the highlights of this very, in particular, semester we all experienced and then we're going to dive into the full P&L analysis. So in terms of H1 2020, we already discussed the revenues in July at EUR 134.8 million with a negative growth of 11% versus the previous period. This is of course a negative growth, but we were all expecting even more negative impact due to the COVID. We have seen, and that's probably in the first highlight of today, that not only June and July we're registering a double-digit growth, but in August, so we continued in the same -- with the same trend. And this is linked to the rigid demand of orthopedics and the good expansion that some of our product lines were able to deliver even during this period. Of course, we are all exposed to the changes which are associated with this pandemic, and we've seen that the future remains very uncertain with the situation like the Melbourne area in Australia in complete lockdown since a couple of weeks, we've just expanded for another couple of weeks, the situation in France, the situation in the U.S. So we remain very, very cautious for the remaining part of the year. At the same time, we have seen a solid EBITDA margin at around 24%. And this is thanks to the different initiatives that the company was able to put in place and to really reduce a lot of costs mainly associated to travel and marketing which have been completely cut during the lockdown period. We are very proud to say that we were able to retain 100% of our workforce, and this is not only critical for all our employees, but it's critical for the rebound effect that we were expecting. And in fact, with those strong months in June, July and August, we really needed the full support of our people in the different departments. As you have seen with a lot of news associated with the new products introduction, Medacta has had the ability to introduce more than 25 new products in different markets, either in Europe, in U.S. or in Australia. We were able, during the H1, to completely redesign our marketing and especially our education offer, where we shifted a lot of activities from physical to web-based, and as well, we redesigned a lot of the physical meetings. We were able, by doing that, to retain the attention of our existing customers and to gain as well the attention of new customers. We invested -- we continue to invest in our instrumentation, which is very critical to support our growth, more than EUR 20 million have been invested in CapEx. And this, of course, had a negative impact on our free cash flow. We will go a little bit more in details later. But we still can rely on a very strong liquidity position in order to continue to fund our future growth. If we go to the next slide, I wanted to go a little bit more in details about the marketing and the education offer that we were able to redesign for our surgeons. This is of course not critical because of the immediate impact of those activities, but because my main focus and my main concern has been to make sure that our pipeline of new surgeons was not drying up during this period because otherwise, this will come as a big problem in the months ahead of us. So we discussed those 1,800 surgeons attending our online and digital education programs. We completely redesigned the Medacta TV channel. We had those web-based, more in-touch initiatives. And that's more on the online activities, but we really redesigned our physical medical education as well. We moved from big labs to very small labs, even mobile trucks in certain countries, in order to continue our medical education on cadaver courses. And we have converted some of the big events we had planned in the H1 into a worldwide webinar, for example, on the Knee side. We have in the more recent weeks restarted almost completely, although not in all the countries, our classical, more surgeon-to-surgeon medical education. This includes not only the cadaver lab as well the surgeon-to-surgeon support. And we are very close to finalize and announce additional initiatives in this space that will help us to continue to stay aside our customers while we introduce our innovative products. If we go on the next slide, there is a little bit of delay on my slide, I just wanted to point out on the R&D focus. We mentioned more than 25 new products cleared in H1. This was linked to the MDR deadline which was expected to be in May 2020. As we all know, this has been postponed by 1 year, but this was the pipeline we did prepare in order to meet this very critical deadline. We have now a new deadline, which is May 2021, for the introduction of the MDR. And we will see another very long list of new products that will be hopefully cleared in 1 year from now. Nevertheless, if we look at what we have done so far, we had across all the different product lines significant innovation, in the Hip side, in the Knee side, on the Shoulder, on the Spine and in our Sports Medicine. And we have seen as well the most recent clearance for our augmented reality NextAR solution. This is the first FDA-cleared augmented reality total knee surgical navigation system. And we had the pleasure to have a very, very positive -- to have a very positive feedback just last Friday with the first clinical case done in Australia with a very positive feedback. So we -- we're very proud of what we've been able to deliver in those difficult conditions. If we go on the next slide, there is what we have discussed more recently about the NextAR. This unique product that doctor was able to internally develop with a strong collaboration from our surgeons designer group, surgeons that are coming from different backgrounds, different geographies and different philosophies as well. This is the first application of many, the total knee application. As we discussed, the solution will be applied to our Total Hip, Total Shoulder and Spine product line as well. And the goal of this solution is really to change the market of the technology with a very, very low upfront capital investment, very much reduced cost per case. So the ability to attack different segments of the market with something which is appropriate and unique. In particular, we mentioned we have a very precise strategy in entering the ASC market in the U.S. ambulatory surgical center in North America. I believe that was my last slide on the highlights of H1. And I have the pleasure to introduce Mr. Corrado Farsetta, our CFO, to go over the P&L analysis. Thank you, Corrado.

Thank you, Francesco. Thank you. So what you see here is what we already discussed, Francesco broadly discussed the revenue. I would like just to refresh some key numbers, and then I need Francesco to give -- provide more color if needed during the Q&A session. So we say sales declined by 12% at constant currency driven by the reduction in revenue in Europe, 17%, U.S., minus 14%. And rest of the world, Asia Pacific registered positive results of plus 6% in terms of revenue. Products, Hip and Knee revenue were down by 17% and 13%, respectively. Extremities and Spine did very well, plus 41% for Extremities, Shoulder and 11% plus for Spine. But let's now have a look at the profit and loss, where we will see -- we can discuss the profitability and the results of the company. The gross profit margin, equal to 69.7%, shows a reduction by 3.9% compared to prior period. This drop is largely explained by higher D&A as a percentage of revenue. And I think that the reason is clear, the revenue declined, but the number of instruments in the market did not disappear and continue to generate the same amount of depreciation. I would say that this amount can be even higher if we consider the investments we did in this semester to prepare for the recovery in demand in the next month. At this level, there was also a minor effect deriving from the negative trends in the market and, I would say, a less favorable composition in terms of revenue, geographic mix, given, let's say, the U.S. part of revenue declining compared to last year. The savings delivered in the first semester, along with EUR 2 million grants obtained by the government for the reduced working hours plan, helped the company to protect the EBITDA margin. And at the end of the semester, the EBITDA was EUR 31.9 million, equal to 23.7%, adjusted to 23.8%. The adjustments are 2 types of adjustments. The first one is an adjustment for legal expenses, extraordinary expenses, which is a positive effect on the P&L. And then we have a negative effect because we released the overaccrual that we did last year for the same lease. So basically, the effect is almost 0 in this semester. Financial results, we see they are in line with prior periods. So nothing to report in this regard. I would spend 1 second to discuss about the tax. You see a positive number in this line, which is strange, but this is due to a one-off effect of about EUR 2 million deriving from the Swiss tax reform, which reduced the company tax rate from 18.6% to 17.3%. This EUR 2 million of positive one-off effect is coming from the release recalculation and the release of deferred tax asset and liabilities in accordance with the new tax rate. As we said -- Francesco said we continue to invest. We invested about EUR 20 million compared to the EUR 26 million last year. And you see that the biggest chunk of investments is composed by instruments, and those instruments are needed to basically both cover the demand coming from customers and the expected recovery demand that we forecast for the next month. Research and development, we continue to invest, which is the vast majority of the line intangible. It is more or less in line with last year. I would say there is a slight decrease due to some savings between consulting expenses and some minor delays due to the COVID effect in the first semester. The timing of the key projects will be -- the timing delay of the key projects will be recovered by the end of the year. The free cash flow came in minus EUR 7.9 million. Let's see, just wait for a second, there's a delay. Yes. The free cash flow came in minus EUR 7.9 million after we discussed the EUR 20 million investments and additional EUR 10 million of new influx of additional stock. This increase in stock was decided to support both the expected increase in demand and the possibility -- possible disruptions coming from shortage in supply chain in case of second wave of COVID or other issues that could occur in the second semester. The free cash flow, adjusted by normal, was equal to 4.7 -- minus EUR 4.7 million, which compares to a positive EUR 3.5 million of the prior period of adjusted cash flow. As you see here, the net debt of the company remains very low, EUR 115 million at the end of the semester starting from EUR 106 million at the end of 2019. As you see, we have EUR 235 million of credit lines, out of which, EUR 179 million are committed. So we think that we have a strong liquidity position and I would say that we are ready to sustain the future growth. This brings me to the end of my section. Francesco now will go through the next session for some conclusive consideration. Thank you, Francesco.

Thank you, Corrado. I think what matters the most is of course our future. We have seen a very good performance in June, July and August. This double-digit growth is, of course, very positive. And we managed to have this performance, although, as we know, many markets are still not able to work at full speed. So without COVID, the positive effect would have been even bigger. We see and we -- in different markets, different bounces at very, very unpredictable pace. We had countries with extremely high growth over months like August, which are usually very, very slow. At the same time, we have seen new stops in areas where we were hoping that the situation was normalized. So it is, as I said, extremely unpredictable. And given the uncertainties around this COVID-19 development still in H2, we cannot provide a short-term guidance. At the same time, I think we have all experienced how resilient is the orthopedic market in general. I think Medacta was able to show in some of our product lines even positive growth during the pandemic. And if the conditions around us will allow us, we expect a good growing trajectory in the remaining months. Extremely relevant for our future is, of course, the buildup for 2021, so the stronger in the focus not only with the new products we have already cleared but as well with the additional projects we have in our pipeline. Even more relevant is the restart of the Medacta M.O.R.E. education activities, which are the key elements behind our growth together with the continuous expansion of our sales force. We know in many markets, we are just, if you want, scratching the surface in terms of market share. So we have restarted all our hiring plans already in H2 in order to make sure we go back to a very strong momentum in 2021. We have further refocused our activities on our ASC programs in the U.S. This is linked to the acceleration that COVID had on the shift from inpatient to outpatient orthopedic procedure in this market. So this is definitely in line with our previous strategy and even more relevant for the months to come. And all those activities have to be supported by a reacceleration in investments in instruments and inventory to support our growth. This was my last slide. So I would like to ask the operator to open the Q&A session. Thank you very much for your attention, and we are both available for any Q&A.

[Operator Instructions] And the first question is from Alex Gibson, Morgan Stanley.

I have 3 questions. My first 1 is just on the double-digit growth that you talked about in July and August, which are seasonably low months. What sort of level of growth would mean for September to December if the level of revenues that you're seeing today in July and August continued for the rest of the year? Would you still deliver growth for the full second half? Or do the comps get that much harder that you need things to actually improve significantly for the rest of the year to deliver growth? That's my first question. My second question is just on the overall investments you're making to reengage with customers and drive business. The planned investments that you have for sales, marketing and education, are they going to be at or above or below the levels of investment that you would have previously spent to drive sales? Here, I just want to understand if you can generate the same amount of business at less cost or if you think you're actually going to spend more to try to regain lost ground. And then my last question is on the breakdown of the double-digit growth. Could you perhaps be more specific within the divisions, what you're seeing in Hips and Knees, in particular? Are these low-teens type of growth, higher, lower?

Thank you, Alex. May I just ask you to -- I just want to make sure that the first question is clear to me. Are you referring to the H2 growth or the overall yearly growth?

The H2 growth.

The H2. Yes. So we, of course, have been pleasantly surprised by the acceleration we had already in June, July and August. We were expecting an acceleration, but both the timing and the magnitude were kind of a surprise to us especially if you consider -- and this explains, if you want, or address partially your third question about the breakdown, especially if you consider that some geographies did a restart and re-stop, affecting the overall performance in a negative way, of course. So we do expect in H2 to be able to deliver a solid growth if the conditions around us will not further deteriorate. So this, if you link it to the breakdown of double digit, we had very strange growth. We had, in some of those months, extremely high double-digit growth in certain of our core product lines, in Hips, and the following months, exactly the opposite in Knees. We had regions like Asia Pacific, which was driving our growth or delivering good growth as well in H1 that is now more affected than other markets. You know that both Australia and the Victoria State, the State of Victoria, but as well in Japan, where especially past months in the region of Tokyo, the COVID spread was reaccelerating. This was negatively impacting mainly the psychology of the patients and the concern. And so we have seen delays and postponement again. So it is very, very difficult to predict the future, but what we have seen is that as soon as the condition allow patients to go back to surgery, then we see those extremely high reacceleration. You are right, July and August are usually, in terms of seasonality, less relevant months, but they are usually, in any case, a significant -- significant enough to support or not a semester growth. So I would say we cannot complain, and we should be happy of having July and August with such a very good performance, which will allow us to potentially address some slowdown in the future months if the situation is going to negatively impact. In terms of marketing investments in H2, we plan to go back to our normal level of investments in terms of marketing, medical education. Those are the key activities that Medacta is building to make sure our pipeline is not, as I said before, drying up. The overall marketing investment, though, is probably still below what we spent last year simply because many of the third-party event have been canceled. So we have reallocated some of the resources we usually use for third-party events to Medacta-specific events, which is, for us, the most relevant activity to refill our pipeline. I hope I did address your question in a proper way.

Yes. Yes, that's actually helpful. And just following quickly up on that sales and marketing. I think you said, so the overall level of investment would be less than last year. So you're talking about the EUR 60-odd million in sales and marketing you did last year, that should be what we're thinking would come in the second half this year?

Yes, absolutely. So we are slightly below overall simply because some of the activities are still not possible. D&A is definitely lower than last year. We did reinvest, as you correctly asked in your question, in order to reaccelerate and recover some of the educational activities we could not do, but there's a limit to that reacceleration. So we are going to have a lower marketing cost overall. That's our expectation.

And the next question is from David Adlington, JPMorgan.

Two, please. So just one of your -- one of the orthopedic players has indicated that they ditched an eye on pricing as we come out of the other side of COVID. Actually, maybe a bit early. I just wanted to get your views in terms of what the pricing environment -- what sort of pricing environment you're expecting on the other side of COVID? And then secondly, just again on selling and education costs. Have you learned anything from COVID? Or have it just changed the way you do things in COVID that could be a permanent impact on how you do your sales and marketing and education? And what potential implications does that have for your costs and margin going forward?

Thank you, David. So pricing, I think we are all well aware that orthopedic implants have been under a strong pricing pressure for many years now. We have seen technologies coming in, in the market, trying to protect its price. We have not seen yet a dramatic increase in price pressure. We had some attempts from some hospital administrators, especially in the U.S. market. This pressure, I would say, did disappear when they posted their own results showing a dramatic increase of their profitability. So in terms of short term-pricing, we are not seeing anything new in particular, but it is fair to say that the pricing pressure is already a very strong factor in our market. We did not see a dramatic change. It is possible that in certain markets, this trend will simply continue and that's what we expect. In terms of education cost and potential redesign of activities, I think we showed how quickly we have been able to redesign our marketing and education activities. I think we did understand as an organization that there are alternatives and additional tools that can complement our offering. Some of the offering is here to stay. It will help us to both either simply increase our exposure by adding those activities on top of what we were already doing. But there are definitely some activities that will be replaced by some of the newer activities that we have launched this year. And we are preparing an announcement about an additional web-based activity that will, in my opinion, support a very good level of medical education, while at the same time, hopefully allowing us to do it at much lower cost. So some is already out there. Some other activities will be announced hopefully in a few weeks. And those new activities will help us definitely to further improve our education at a lower cost.

And the next question is from Chris Gretler, Crédit Suisse.

I have now 2 questions left. The first, just on gross margin going into the second half. Could you provide maybe some of the order puts and takes that we should think of and also kind of how that develops in the second half now with the kind of relatively solid growth you have now seen so far in the second half? And also maybe comments on kind of how mix will impact gross margin. And then the second question is just kind of in your remarks, you mentioned that some of the markets have not been back at full speed. Could you maybe indicate what those markets are, and where you basically see still kind of the biggest backlogs, so to say?

So Chris, thank you for your question. If you shouldn't mind, I will take on the last question, and I will let Corrado elaborate on the gross margin and mix. So while I'm on the phone, I will answer on the country-specific situation. So there are some markets which have less of an impact on Medacta, which are still heavily affected. I would say probably the U.K., Spain, are example of markets still affected by COVID heavily as a market. At the same time, there are regions within many markets which are temporarily affected. Australia is a good example. But I think it will help you to understand what's the reality we live on a daily basis, what I'm going to tell you about the U.S. In the U.S., there are states, like Florida states, which is almost homogeneously, or at least the southern part, affected by COVID, but we are facing situations where maybe a surgeon is affected by COVID, and so he's -- or a friend of a surgeon or a son of a surgeon is a factor. And so he's quarantined for 2 weeks. And this has a huge effect if those surgeons are some of our key accounts in the U.S. market. So that creates, of course, a lot of complexity and impossibility on our side to forecast because those are situations which are really surgeons-related, but we know how relevant single accounts can be on a monthly performance of a company like Medacta. So that's a little bit the situation we are facing. It's not only the geography, the country, it's the region and within certain regions is our single people. And that's the difficulty and the complexity. I'm going to just -- if you're fine with that, I will ask maybe Corrado to elaborate on the margins.

Chris, thanks for your question. This is Corrado. So I would say that about the gross margin of the company, we discussed it before, that the biggest impact on the gross profit margin in this semester is generated by the higher D&A due to underutilization of the existing set of instruments in the market, plus the additional investment that we had to do to sustain, to prepare for the growth and to be able to feed the base of new customers. So this was a negative effect that we expect for sure to be absorbed by the additional revenue per instrument that we expect to see in the next few months. Now how fast this will happen, it's hard to say because we have a lack of visibility in the next month, but it is, for sure, expected the positive effect in this regard. In terms of magnitude, I can tell you that, I would say, more than 2/3 of this drop is attributable to the D&A effect of underutilization of instruments. The second component is a more standard, let's say, effect in the market, which is the negative trends in pricing. As you know, we normally -- we are well positioned in terms of geographies because of the mix and the increase in revenue coming from the highest price market, it is normally helping to offset the biggest part of this negative trend. In this specific semester, we have seen U.S. declining. We have seen Europe declining. But within Europe, we have also seen increasing Shoulder and Spine. The growth in this product line was, say, in country with the pricing less favorable. So what we have observed in this semester is a geographic mix which didn't offset, as we expected, due to the change in mix. Now again, is this going to change? We expect this will happen. How fast and how big will be the recovery is hard to say because of lacking visibility. But as we have seen, the increasing, let's say, contribution from the U.S. and the continued contribution from the Asia Pacific countries should bring the company to a level of profitability more in line with the last results. Overall, we do not expect to recover entirely the gap, but we expect for sure to be more in line with last year. Going down to the profit and loss, of course, this reduction at the gross profit margin level should be at least partially offset by, I wouldn't call savings, but let's say, an efficient and volume effect at the EBITDA level. So the profitability at that level, the EBITDA margin is expected to improve as well.

And there are currently no further questions on the conference call. [Operator Instructions] And we received another question from [ Ruben Boyajian, Finance Investor ].

How much of the growth you have seen from June is a catch-up? And how much is going back to normal? And if there is a major catch-up effect, is it already over? Or will it continue for a couple of months more?

Yes. That is a very good question. And we did dive into this analysis in order to understand how much of this growth was here to stay and how much was just a temporary catch-up. The analysis did reveal that we had a significant amount of sales coming from accounts that were not Medacta accounts in 2019. So there is definitely a contribution of both. There is, as usual, the contribution coming from 3 different factors. The growth of our base of customers, there is the growth of our new customers of 2019 that did contribute at a higher level in -- at least in the good months of 2020 and then there are sales coming from the surgeons that just started in 2020. So I can tell you the contribution is from all those elements. And when you read those double-digit growth, you have to understand that it is coming from countries which are maybe delivering at 30%, 35%, 40% or even 50% growth rate, and it's easy to imagine that those countries have a huge portion of this growth which is a recovery. And so for us, this analysis has to be done country by country, line by line. It's even more associated to new accounts in those lines, which are -- were already delivering a very solid growth such as Spine and Shoulder. So we did dive. We are relatively fine with the fact that this growth is not only a recovery but it is coming from new accounts that have been activated in the last semester, which is, for me, very important because it means they will continue to grow in the second half and more importantly in 2021.

And we have a follow-up question from Alex Gibson, Morgan Stanley.

Just a couple more. And you kind of answered it, but given the backlog that you've seen, are you finding surgeons and hospitals more or less receptive to switching to Medacta if they're spending a lot of their time just trying to get through surgeries? How hard is it to actually get those new surgeon accounts on board?

Yes. I would say this is, of course, a very important aspect. Surgeons which are playing catch-up at 50% plus because they've been blocked for 2, 3, 4 months, they will definitely not take time to go to cadaver courses because they have to do their work. At the same time, we have seen many that were close to switch. They took advantage of the break to fully gain exposure and knowledge about Medacta product. And when they switched immediately after the release of the lockdown, they really started at very high pace. So this played in both direction. And I would say that those which have been busy working in the last 2, 3 months, they are the one which are in our pipeline for the September, October and November activities. So the interest has been potentially, let's say, was still part of their mindset, interest in switching to Medacta. They might have postponed by a quarter because of very, very busy period in recovering their activity.

Okay. Great. And the very last one from me is, I'm just trying to understand if this is a rebasing of your sales or not at the end of the year because of the need to get new surgeons on board. And I know you don't want to give guidance for 2021, let alone this year, but should we be thinking about 2021 being able to show almost growth over a 2-year basis over 2019? Or is the fact that you haven't got these surgeons on board over the last 6 months make that unreasonable? I'm just looking at my estimate, consensus estimates, and we basically expect 2021 to be a recovery back to your prior trajectory. In your guidance, you specifically said the growth trajectory shouldn't change. But do you think the absolute level of sales we should think about 2020 being a rebasing?

I think it is very important to see what's the level of education activity we're going to be able to actually deliver in this second part of the year because we all know that the growth of 2021 will be based, at least partially, on surgeons that are expected to start in the second half of this year. I would say some of the lines did show a very strong trajectory, which incorporates a lot of new customers that will -- did not participate in 2019 and 2020 H1 top line revenues, which means their activity in 2021 will come for 12 months at a decent level of their ramp generation. So I would say that without COVID in a normal year, 2021, we should see a good trajectory of growth. The only major question mark we have is how much of educational activity are we able to deliver in these 4 months, which are hopefully back to normal. If we are not able to engage as many surgeons as planned, this might potentially affect our trajectory in 2021.

And we haven't received any further questions on the conference call.

Thank you. Thank you all for your participation then. I would like, once again, to thank as well all Medacta's employees for the support they gave to the company's performance in H1 and the commitment they have continued to deliver in H2 in those more challenging conditions. But I have to say, I've been very, very proud of the overall reaction of the company. So if there are no additional questions, I would like to thank you all and look forward to speak to you soon next time we have important news to deliver.

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