Olympus Corporation (7733) Earnings Call Transcript & Summary

Hello, everyone. I'm Chikashi Takeda, the CFO. I would like to give you the review of our consolidated financial results for the third quarter of fiscal 2023 as well as the full year forecast for fiscal 2023. Please note that today's briefing will focus on continuing operations. Please refer to the appendix section for detailed information about the discontinued operation. Now a review of our financial results. Page 2 highlights. These are the highlights of our financial results for the third quarter. During the third quarter, we continued to see the impact of supply shortages of semiconductors and other components together with rising materials costs, but the situation is gradually improving, and we have taken measures to minimize risks as much as possible. Revenue increased 17% on a consolidated basis. We achieved double-digit growth for both ESD and TSD, setting record highs for both the third quarter and the first 9 months in the medical business. Operating profit and operating margin also set record highs for both the third quarter and the first 9 months. As for full year forecast, we have revised our foreign exchange assumption from the previous forecast. Based on the results up to the third quarter, we have slightly lowered revenue on constant currency, but have left adjusted operating profit unchanged. -- we are still on the track to achieve adjusted operating profit margin over 20%, the target set in the corporate strategy. We expect revenue of JPY 871 billion, up 16% year-over-year and the operating profit achieved record highs, both in amount and ratio. Profit as the sum of continuing and discontinued operations expect to reach a record high of JPY 376 billion due to a gain on transfer of Scientific Solutions business evident with EPS of JPY 297, up 229% year-on-year. Let me go over the details of financial results and the business review Page 4, overview of consolidated financial results. Consolidated revenue totaled JPY 641.5 billion in the first 9 months, up 17%. Revenue in Medical represented record highs for the third quarter and the first 9 months, with double-digit growth for both ESD and TSD. Gross profit was JPY 433.7 billion with gross margin improving 0.7 points. Despite the impact of rising material costs and others, gross margin improved due mainly to a change in regional sales mix driven by increased sales in China in Q3 and yen depreciation effects. SG&A expenses were JPY 306.1 billion, with SG&A ratio deteriorating by 0.3 points. In particular, expenses associated with is activities and strengthening of the operational infrastructure, such as QARA increased. In other income and expenses, a gain of JPY 14.9 billion was posted mainly coming from a gain of JPY 16.4 billion on the sale of land in Tokyo in Q1 and the record recording of JPY 1.3 billion from the adjusted acquisition consideration due to a change in the fair value of conditional payment that was part of the acquisition consideration for MeditatiQ3. Operating profit was JPY 142.6 billion, up JPY 4.4 billion or 39% year-on-year. Operating margin improved 3.5 points to 22.2%. Please note that adjusted operating margin, excluding other income and expenses, which is a milestone in our corporate strategy was 20%. Profit from continuing operations was JPY 105.6 billion with EPS of JPY 83, up 29% year-on-year. While total profit, including both continuing and discontinued operations was JPY 108.4 billion with EPS of JPY 85, up 25% year-on-year. We have been operating this fiscal year under conditions of multiple growth inhibitors and rising costs while making investments in growth areas and strengthening operational infrastructure. The environment remains uncertain, but we will continue to struggle to achieve revenue and profit growth and reach the must-hit target of over 20% adjusted operating margin set 3 years ago -- we have revised FX assumptions from the previous forecast. Based on results up to the third quarter, we have a slightly lower revenue, excluding FX, but adjusted operating profit remains unchanged. The focus assumptions for annual average FX, JPY 135 to the dollar and JPY 140 to the euro. For more details, please refer to Page 24 in appendix for FX sensitivity. Revenue is expected to achieve JPY 871 billion, up 16% year-on-year. Operating profit is expected to achieve JPY 198 billion, up 35% year-on-year, with an adjusted operating margin of 21.1% record highs for both amount and ratio. Although multiple risk factors continue to stay in front of us and the outlook remains uncertain, we will proceed with all efforts with the goal of achieving the most target of above 20% adjusted operating margin set in the corporate strategy. Profit is expected to reach a record high of JPY 376 billion, reflecting a gain on transfer of scientific solutions business. EPS is expected to be JPY 297, up 129% year-on-year. Profit of continuing operations is expected to be JPY 149 billion with EPS of JPY 118, up 37% year-on-year. Regarding dividends for fiscal 2023, we plan to pay dividend of JPY 16 unchanged from the announcement in May -- next page shows forecast by segment. We expect both ESD and TSD to continue double-digit growth year-on-year. As a result, the combined revenue of the 2 divisions in the medical field is expected to reach record high. We previously announced that EX1 would be launched in the U.S. within the fiscal 2023. However, we have been revising the schedule to ensure all regulatory requirements are completed prior to the launch of the product. We are now aiming for a launch in the middle of fiscal 2024. We do not expect this postponement to have a material impact on our business performance. In ESD, the impact of supply constraints including semiconductors is improving. We expect continued sales expansion of AV X1 in Japan, Europe and APAC. In China, we expect growth supported by pent-up demand due to delays in tenders and business negotiations caused by the Shanghai lockdown in the first quarter as well as government support such as low interest loan programs for medical equipment. In TSD, we expect continued growth centered on the 3 focus areas. While in Japan and China, the number of procedures is declining due to rapid surge of COVID. In Europe and North America, where the number of procedures like recovering, sales of mainstay products are expected to be strong. We will continue to work on achieving adjusted OPM of above 20% despite the unstable and uncertain environment by controlling SG&A expenses through company-wide efforts such as hiring constraints to review of various projects, limited nonessential overseas trips and review of R&D priorities. Discontinued operations is expected to record a gain on transfer resulting in a significant increase in profit I would like to explain the warning letter that we received from the FDA and our efforts to strengthen quality assurance and regulatory affairs. Olympus received warning letters regarding an inspection of the [indiscernible] facility based in Kusuma Japan and in July and the inspection of the Hachioji factory based in Turkey, Japan in September. The content of the warning letters fights the quality system issues related to process and records for design and manufacturing as well as the rate submission of MDR. We are closely communicating with the FDA through both return and live interaction in order to ensure a met in a timely manner. We have been promoting efforts to strengthen quality assurance and realty affairs, including the globalization of the quality and regulation. We have implemented a global complaint improvement program that is a new process and technology platform to ensure compliance -- we established an independent worldwide quality and realtor organization structure, including hiring many leaders with knowledge and experience of QA/RA at Meditech companies under the Chief Quality Officer, reporting directly to the CEO. We have been implementing global quality system and the governance model for all Olympus sites and businesses and remediating design and manufacturing processes and records. The total amount of investment for these initiatives is currently under review. We will inform our forecast when a reasonable estimate can be made. The latest cost include JPY 1.4 billion in expenses for the current fiscal year. In order to become a leading global medic company, we will further strengthen our quality assurance and realty affairs and globally established quality and compliance to ensure patient safety. Thank you very much for your attention. Before we move to taking your questions, we would like to focus on one question that we received in advance. Regarding the results up to '23 and the projection for Q4. So see if we're on to that question. Yes, I think I've covered a majority of that in my presentation. And although I skipped the oral presentation the longer version that is available from the company website, which includes the scripts, I do answer your question. As for the guidance, compared to the guidance, as for revenue, largely in line with the guidance. But when it comes to specifics, TSD revenue is a bit short. That has been the trend so far. And so that is the reason why we made a very small revision to the full year forecast. And profit is doing better than the guidance to a certain extent. And regarding the SG&A expenses compared to the projection 3 months ago, we are spending more. As is included in the slides, the sales activities are becoming more active, is one reason. And for enhancing the operational infrastructure, we are hiring people and also QA/RA and some other functions to address the specific challenges facing the company, we are making the investments and expanding, which explains an increase in SG&A over the production. That has been the case up to the end of the 9-month period. Regarding Q4, -- the adjusted operating profit number hasn't been changed, meaning that during the last 3 months, we are to catch up, especially regarding the SG&A expenses by implementing further measures we are to catch up and make up for the difference. That's my high-level response. Nacho is close to the field. So I think he can add some more comments.

Well, I would like to add some comments on the revenue development in Q3 and along the first 3 quarters of the year. I think at this point of the year, we are completing a solid revenue growth year, having in mind all the different situations that we have experienced in this year, including the lockdown in China in the first quarter, the covered search in China and in Japan in the third quarter and some continuous supply chain tensions that have promoted some delays. I think with having all that in mind, still we have been able to solidly grow our ESD business, especially with a remarkable after FX change impact, 10% growth in our gastrointestinal business in ESD and including as well a recovery of the business in China in ESD for GI that even with a very severe lockdown in the Q1, we are able -- we have been able to show growth in the year-to-date in the China region for ESG. In TSD, the situation has been a little bit more complex because the tensions in the supply chain and the lockdowns has provoked a situation where -- well, the TSD business is mostly run rate. Obviously, when we are not able to fulfill immediately the orders from customers, those orders are lost. -- because the procedures cannot wait. But even though I think that we are, at this point, 2% growth in the TSD business, and our analysis shows that without the situation in China and TSD and without the tensions in the supply chain, we would have been able to be on north of 4.5% growth in the TSD business, which gives us a lot of confidence in terms of when the normality in terms of supply chain, which is where we are now and the China situation is normalized, we can return to the goal that is expected in the TSD business. So altogether, I think it's a healthy situation. EVIS X1 progressing very well in those regions of the world, which has been launched, and we are expecting this to be the case in the United States as soon as it is launched. And in TSD, with the exception of the situation in China and the supply chain -- we believe that both the urology and the IT business, which are the main stage of the business are progressing very well in based on the plan. So these are my comments regarding TSD. Thank you very much.

We would like to open the floor for questions now. Since I can only ask one question, I want to ask about the warning letter from FDA. So 2 letters. One is for eye Olympus, design validation, deficiency and also like a response for earlier findings and design record deficiency and MDR. And the other letter is about -- this is basically URF for medical device as a whole delay in MDR -- so I would like to understand the current status of response for each because if you go back, -- there was an MDA delay for duodenum endoscopy, and I understand that you have to pay a penalty for that in the past. And at first glance, it looks like there has been no improvement since then. For isolympus, I understand that it's something that you could deal with documentation. But for the Erisaendoscopy, this was exposed metal, which could cause penetration. And despite that fact, why was MDR delayed? I think it had to be reported within 30 days. But how much was the actual delay? I would like to know? And how do you intend to respond to this situation? That's my question. Thank you, Mr. Cotai. Pierre Basie is joining us today. So he would like to take this question, Pierre the floor is yours.

Okay. Before I start, I would like to go through and introduce myself. So my name is Pierre Bossier. I'm the Global Chief Quality Officer for Olympus. Elysis is committed to becoming a leading global med tech company. Since March of 2021 when I joined the company, we've been focused on support of a global QA/RA globalization effort, which supports the pillars of all of our quality and compliance improvement efforts. This initiative began with my hiring as the Global Chief Quality Officer. In addition, Olympus has hired many new senior executives to lead the quality and regulatory global organization. The new leadership possesses decades of industry experience from top-tier companies, including leading companies going through change initiatives. We are moving from a regionally based managed quality organization to an empowered centrally managed flow organization with oversight of all Olympus facilities, improving quality culture and mindset, strengthening and consolidation of quality systems across Olympus establishing new governance structures and standardizing practices at all Olympus operating sites, most importantly, provide insurance that the compliance issues identified by the FDA are being addressed. Following the FDA inspection and the issuance of the U.S. FDA warning letters, Olympus has accelerated efforts to invest in our globalization initiatives. This is an important and essential investment for Olympus to become a leading global med tech company and achieve sustainable growth. Over the next few years, we will be making significant investments in this area to further strengthen our global assurance and regulatory affair function as well as to establish quality and compliance to ensure patient safety worldwide. Lastly, we are closely communicating with the FDA to ensure actions are timely through written and live interactions and in order to ensure FDA expectations are met in a timely manner. So with that said, I think there is 2 parts to the question. The second question was how late were the MDR reports. The reports are due to the FDA within a 30-day working period. If I remember correctly, the complaints that were cited were between 45 and 60 days old when they were reported -- it is also important to remember that when the FDA came in and audited our files, they were going back over a 3-year time. During the time we had gone through COVID. And for about a year, we are trying to figure out the best way to work. And so things were not always going as required. So that's not an excuse. It's just the reality of -- as we're going through the COVID lockdown, companies had to find new ways of working. Did I answer your question? Or was there additional?

So I think you were talking about at least the addressing the MDR for the URF scope, the failure, I guess, whatever failures that occurred there. So that's -- you said it's 45 to 60 days. So obviously, it's not that far away from 30 days and it's coverage. What about the Izu documentation, I think is that that's something that's going to be resolved very quickly. And while we're on the subject of regulations, if you could comment on any impact on Olympus from the India there is changing the medical regulation, I think it made it very difficult to sell products. And I think a lot of companies have talked about cost increases from that. And on top of that, of course, there's the Italian clawback small that was, I think, winning to effect somewhere later in last year. Some companies have put a lot of write-downs on that it based on this Italian or if there's any impact on meta. Those are my follow-ups.

Okay. Go back. Just to be clear, I am not trying to say it was all COVID as far as late MDRs go. Just to be transparent, part of our problems for MDRs are operationals. As we are working through regionally controlled quality systems, our systems don't always link up to be able to hit the 30-day window. I think that when the FDA went into our facility and found the 15 late MDRs. Some of that was probably caused by COVID, but I don't want to say that everything was always caused by COVID. I would have to say that our systems are -- as we work on globalization and we create one system line quality system to have everything come together, that will fix all the problems. But we're not going to get there until mid next year at the earliest through the end of next year. So hopefully, I've clarified that the MDRs. As far as Izu goes, the issues that were identified in Izu were tied specifically to process validation and to design verification. There were no safety issues found. There were no product issues found. It is not, I believe, like past inspections where they actually found a product issue that had to be resolved. So far, our analysis, and we are still going through a lot of analysis or identifying which processes need to be validated. But as we look at each of the processes, we're also analyzing the product to ensure that there are no safety issues. So we've been working very closely with the FDA on that. As far as India, I am not aware of that is Nacho. Is that something you're aware of?

Yes. I think I can take -- thank you, Pierre. I think I can take the last 2 questions about India and Italy -- in the case of India, I mean, there is -- actually, in India, there are continuous changes in both the regulation but also the reimbursement. So it's a changing environment. Our work in India is quite stable and our market share in our main platform of GI is quite solid there. The market is still not as relevant as the population in India, I would say, but our market share numbers are good, and the product that we have already registered there are working very well and as planned. So there is very limited impact in our business plan and the changes for the Indian emulate changes in the regulation. As per Italy, yes, I can confirm that we have all of the reserves in our books. are related to the Clawback clause that was imposed. So I think in both cases, the situation is in good shape. I hope I answered your question with a...

Could you quantify those reserves? Is it in the couple of hundred million range? Or is it $1 billion?

It -- I mean, the reserve, I mean, I don't want to speak by the finance department, but based on the few millions of euros.

This is Takeda speaking. So as Nacho mentioned, the amount is not that material to our company. And also, I would like from a finance perspective that new regulation in EU and in India. Activities are already taking place and finance does understand that in other words, we are making investment from our side as well. I hope that answers your question. Thank you very much.

One question. As so as I explained, EVIS X1 launch in U.S. is going to be pushed back further. You said to meet all the regulatory requirements. What do you mean by that? And this was sort of a last-minute decision to the ton. What is the backdrop of that -- thank you for your question...

Is, can you repeat? I couldn't hear you.

No, no, just -- first question is about what the old requirement inventory regard means to make us launch in the United States one. I just was asking if Izu can answer to the questions.

I can take a first shot, and I think Pierre wants to comment additionally he can do it. The current situation and the current thoughts on the approval and the BSX is that we are working with the FDA to submit all the necessary documentation and we expect that that the approval -- the FDA regulatory approval, if I think clear approval for the platform, we are expecting -- and obviously, this is -- this never can be consumed 100%, but we are expecting to have it around [ DDW ]. This is our current thought. After that, we will be able to initiate the on the promotional activity in the United States, but we still would require a few months in order to prepare all the sign validation and product validation, which is required in Izu. So with altogether, we believe that around the mid of fiscal year '24, we will be able to make a complete launch of the product in the market. But the promotion activity. So at the time we kind of speak with customers about B61, we are hoping and expecting that we'll be right at I don't know if, Per, you want to add something or I thought I did an accurate representation.

I think you did really good note. When we go through and get a 510(k), a lot of times, we have to work with the regulatory agencies in this case, the FDA and understand what they're approving. So if there's a change in labeling or there's a change in anything on the product, I have to make sure that we have the processes validated and gone through all the factories, make sure everything is ready for mass production. So it will take a little bit after the approval of the 510(k)...

Thank you. I am aware of the screening process by FDA. But -- so what specifically were the issues that prohibited the launch as originally scheduled. And why is it that you are finding that out right now? And a follow-up question. If this is going to be in the middle of FY '24, I understand that in the U.S., many of the business is on the lease basis. So I'm afraid the EVIS X! profit contribution for FY '24 is going to be limited. That is as far as the U.S. is concerned. So can you talk about that? Thank you. Regarding your first point, I think Nacho partly referred to that, but let me repeat...

Yes. I think -- I mean the -- I think I can comment on the business impact of the vision. As you -- and the question you referred very well, the nature of the U.S. business is mostly related to leasing, which means that essentially, every time we launch a new platform is a smooth transition because those lease contracts are still in place until they have to be renewed, and this is where we normally do the technology update, meaning that in energy given year when we launch a new platform, it has smooth ramp-up of the penetration of the VG1 platform. So I think that the current situation in the launching of the platform, it's not going to impact our business results or business expectations for fiscal year -- and in any case, we were expecting a smooth move between the core and reciting platform. We know it's going to take always a few years to penetrate the existing 190 platform that there is a market. And so it's not like a spike in the first months of the launch. It never happened because precisely of the lease deals characteristic of the business. So I think the COVID situation is not going to impact our business plan for fiscal year '24. I think that's the most important message. As to why is further delay, I think I think probably pierre it's better to comment on me. I think that from one side, obviously, we need to fulfill the obligation is 10-K approval, from the other side, we need to make sure that the product validation and design validations that happen in the factories are accordingly with what the FDA is expecting as well from us. And this is where we will take a little bit more of time after the -- even after the 10-K approval will be awarded. So that's the current situation... Pierre, you want to something, please?

So as we are going through putting the product on the market to try and get approval. There was negotiations with the FDA and how certain things should be tested. And if I remember correctly, with the FDA on the EVIS One, we came through and we debated on how to test certain modules. We finally came to an agreement, and we're working full force now on our agreements at what we've had. But we've gone back and forth with negotiating the best way to prove the devices. And so we finally got to that point with the FDA where we have full understanding of what they're looking for, and we're going to be able to meet it. But my belief is that the slowdown in between was us trying to figure out exactly how do we best provide this, and the FDA has been working very closely with us on this.