SDI Limited (SDI.AX) Earnings Call Transcript & Summary

Thank you for standing by and welcome to the SDI Limited FY '20 Results Conference. [Operator Instructions] I would now like to hand the conference over to Ms. Samantha Cheetham, Chief Executive Officer. Please go ahead.

Thanks, Ashley. Good morning, everyone, and thank you for joining us for our full year results investor conference call for Financial Year 2020. My name is Samantha Cheetham, the Chief Executive Officer; and with me today is John Slaviero, our Chief Financial Officer and Chief Operating Officer. This has been one of the most challenging periods we have experienced as a business. Our immediate concerns were with the health and well-being of our staff around the globe. I have been impressed by their willingness to take on the challenges we faced. And together, we haven't been able to continue to focus on our strategic goals. The final quarter of the year is typically our seasonally strongest period. But unfortunately, the global pandemic has coincided with this critical time for our business. We are of the view that while some sales may be lost, we believe that most are deferred to a time when restrictions allow ordinary operations in dentistry to continue. Gross margins have been particularly pleasing -- have been a particularly pleasing story from the year despite the second half challenges, once again, reflective of a continuing shift towards our higher-margin products, but importantly, highlighting the resilience of our business. The overall result reflects the challenges we faced, but encouragingly, as I will share with you later, we have exited the financial year with good momentum as the dental industry begins to reopen. As I have done previously, I always like to recap on where we have come from particularly for those that are less familiar with our business. Having been established in 1972, we have built this business into a successful manufacturing company, where today, we are exporting to more than 100 countries. Underpinning this success has been our continuing focus on research and development. And through this, we have developed new and innovative products that meet the needs of our customers. Let me now turn to the agenda for today's presentation. I will begin with a summary of the last 12 months, then spend some time talking about the product categories and the key geographies we operate in. I will then turn over to John, who will run through the financials before returning to me to talk about our strategy and the outlook for the coming year. Let's begin with a summary of the last financial year. I am now on Slide 4. As mentioned in my opening remarks, this was a challenging end to the financial year, following on from a record first half. Sales were down 15.4%, with the second half down 35.6% on the prior corresponding period. The restrictions imposed by government in our key markets impacted sales and earnings materially, with dentists limited to emergency procedures only. Given these challenges, we reacted quickly, seeing operating costs falling by 8.2%, including directors and management salaries being reduced by 40%. While incredibly challenging, we were pleased to have seen the gross margins improve again, favored by the product mix shift we continue to see from period-to-period and importantly, the business overall was profitable in the half. With the business operating in 100 countries, currency can impact the reporting outcomes. In this period, the biggest impact was from the Brazilian real, which cannot be hedged, falling 33% in the second half of the financial year and resulting in a $1.4 million unrealized currency loss. We have begun a strategic review, looking at ways of continuing to achieve our objectives in this region, and we'll update the market when this is concluded. Directors have declared a fully franked final dividend for the half year of 0.5% -- sorry, $0.5 per share, representing $0.0185 per share for the full year or approximately a 52% payout ratio. Let's now turn to the product category. I'm now on Slide 6 to talk about the product performance. The global restrictions impacted all product categories, however, the relative trends are telling with slower declines in our key aesthetic and whitening product category. The longer-term trend shown on this slide reflect the shift in our business over the last 5 years, underpinned by the investments made and the successful execution over this period of our strategy. Amalgam has continued its downward trend as seen in recent years, now representing less than 20% of total sales. Before turning to the key geographies, I wanted to share some other comments on the product mix. I'm now on Page -- on Slide 7. Despite this period, where we experienced lower sales, our strategy of pursuing the higher-margin aesthetics and whitening products continues. These 2 product categories combined now represent 72.8% of sales, having grown from 51.7% in 2015. Importantly, the gross margin continues to reflect this product shift, reaching 64.8% for the 12 months to June 2020, up from 62.6% in FY '19. Let's now turn to the key geographies. Slide 9 breaks down the sales by business unit, as disclosed in our accounts, showing local currency sales down in almost all regions, reflecting the comments I made earlier. Brazilian sales were up 6.5% in Australian dollars. However, when adjusted for export sales previously exported from Australia, sales were down 2.6%. Further, as indicated earlier, the devaluation of the Brazilian real significantly impacted earnings. For a more detailed look at what is going on in the regions, let's look at customer behavior by region, shown on Slide 10. As shared earlier, the regions were all weaker with the Asia Pacific region performing relatively better and was least affected by the global pandemic with a decline of only 3.7% in sales. The regional sales performance in the 12 months to June for South America, Europe, Middle East, Africa and North America were down 14.3%, 14%, 20.7% and 23.9%, respectively, in Australian dollar terms. Finally, on Brazil, we have made a substantial investment in this market and with the effect of the pandemic on the current -- country's present and future economy, we have suspended future investments pending a full review of the Brazilian operations. I will now hand over to John to talk through the financials.

Thanks, Sam. I'm now on Slide 12, the profit and loss. As was mentioned earlier, sales declined 15.4% in the period, with the second half weakness offsetting a record first half. Gross product margins in Australian dollars increased by 2.2% to 64.8% compared to 62.6% for the prior corresponding period. When adjusted for currency movements, gross margins increased by 1% to 63-point -- sorry, 63.6% compared to the previous corresponding period. The improved margin is reflective of the ongoing shift in product mix, but also the changes experienced in the overall regional performance. Operating expenses in Australian dollars decreased by 8.2% when compared to the previous corresponding period. Approximately 55% of SDI's total operating expenses relate to its offshore subsidiaries. And after adjusting for currency movements, total operating expenses decreased by 9.8%. In response to the pandemic, we reduced expenditure in all areas, apart from research expenditure, with a further increase of $600,000 for the year. Finally, as mentioned earlier, following the devaluation of Brazilian real, we incurred a $1.4 million unrealized currency loss. Turning to the balance sheet on Slide 13. The company's net asset position decreased by $1.8 million after increasing inventories by $3.4 million, planned investment in plant and equipment of $2.5 million and product development expenditure of $1.9 million. Inventories increase was due to the buildup of stock for the expected fourth quarter sales, which was impacted by the pandemic. Finally, the company has ample headroom in its $10 million bank facilities, with only $1.5 million drawn as of the 30th of June, 2020. Turning to the cash flow statement on Slide 13. Decrease in cash was attributable to the lower fourth quarter sales and inventory buildup for the fourth quarter ahead of what -- of what would have normally seen a seasonally strong quarter for the business. We were successfully managing receivables, adding to cash inflows. Finally, we managed our investment carefully, limiting additional investment to product development, with a further $1.9 million spend in the period. I will now hand back to Sam to run through the strategy and the outlook for the coming financial year.

Thanks, John. The company continues to drive its strategic priorities. Firstly, the rationalization of the product portfolio is now complete with a 45% reduction of SKUs expected to drive further production efficiencies. Secondly, the product -- the key product categories of Aesthetics and Whitening products continue to be the focus for product development, manufacturing efficiencies and the sales and marketing teams. Thirdly, ongoing research -- ongoing investment in research and development to release 1 to 2 new products per year is on target. And finally, SDI's Amalgam replacement product is on schedule to be released in 2023. On this slide, you will notice the image of a new exciting product, Pola Light, launching in the U.S. next month. Pola Light is a tooth whitening system a dental office can sell to help them compete with online stores and supermarkets but a much more powerful product. For the outlook, it is expected the 2021 financial results will follow similar trends to previous years, highlighting the strong growth in both the Aesthetic and Whitening products and the continued decline in Amalgam products. In addition, equipment sales are expected to grow with the ongoing rollout to all markets of the new Radii Xpert curing light. We will continue to invest in research and development with the aim of launching at least 1 to 2 new products in the next financial year. Evidence of the recovery is beginning to be seen in our July numbers, having achieved similar -- sorry, having achieved sales similar to those recorded in FY '19 despite almost no contribution from the U.K. region, which is slowly reopening. In regions where government restrictions have started to ease, we are advised that dentists are experiencing a significant backlog of patients. While the outlook remains uncertain and some sales may have -- may be lost, we believe that most have been deferred to a time when restrictions allow ordinary operations in dentistry to continue. Thank you for listening to our presentation. I will now return to the operator to moderate for your questions.

[Operator Instructions] Your first question comes from Mark Topy with Select Equities.

It's obviously a pretty tough period. But just to talk through how quickly the dentists can get back into full operation. And I suppose we're more familiar with Australia, so will it be a 1-month, 2-month period in -- is that going to be a typical sort of time period when dentists can get back into full operation? And you mentioned the backlog, how significant market backlog be as well in terms of all the dentists will be working pretty hard once they get back into operation?

Yes, Mark. We have -- I mean look, the dentists get back pretty quickly. I mean obviously, in Victoria right now, they're not allowed to operate except for the emergency procedures. Once the restrictions are eased, they'll get back quickly into it, it's easy to get the patients back. They all need to go to the dentist. The U.K. is one where we're expecting a huge demand when they come back, hopefully, in September. There's been a flow -- the government is not allowing them to come back yet. But they come back quite quickly, and they certainly work extra hours to catch up with their patients.

Yes, of course. So on the Brazilian situation, going through the review, is one of the possibilities pricing product there in U.S. dollars, given that currency volatility would be hitting a lot of businesses in the U.S.? Is there any trend towards adopting a more stable currency in Brazil? Is that part of the -- or is there any mechanism to stabilize pricing from that point of view?

Well, no, that -- I mean it's -- the dentist buy in Brazilian real, and we sell to the distributors in Brazilian real. So you've kind of got to operate in their market in their currency. And yes, I would love it to be in U.S. dollars, it's much easier.

Yes. Just to try and understand, obviously, that volatility would have impacted the whole range of industry there. So there's no -- and how -- what's the sort of latest trend in terms of the currency there in terms of the Brazilian currency?

Yes. Mark, yes, look, the currency lately has gone slightly worse than where it was at the end of June. The forecasts for the currency is not good as what we've said. And also their economic situation is not flash either. So -- and just reconfirming Sam's comments, from our knowledge, the dentists will -- and distributors will not buy in U.S. dollars or Australian dollars or euros. So they buy in Brazilian real. There's no change in their habits there.

Right. And I'm presuming because the COVID numbers still look pretty severe there. There's no -- probably the markets are down in terms of demand as well. Is that fair to assume?

Actually, no, they're operating quite similar to the way the U.S. is sort of -- it's a bit like business as usual. It's -- they certainly are operating because they have to get on with life.

The -- there has been a slight effect on -- well, for some effect on demand, no doubt, yes.

Not as significant as other areas.

Okay. And in terms of the inventory in your production plant, have you taken any slowdown in terms of production? Or how have you managed -- or how are you managing that inventory situation like have you perhaps had a week off for the plant or something like that in terms of the overall production?

Regarding our production, our plant as of the middle of July, I believe, we're back at full swing. Everybody was back on board. We, unfortunately, were left with a lot of inventory back in March, early March when sales almost collapsed and demand collapsed. We don't expect to have any stock that's looking close to expiring. It's very immaterial. We have no concerns there. So we are now starting to see some of that inventory being absorbed. So we are back at full capacity as we speak now.

So in terms of your inventory position as at the moment, then you're starting to move some of that backlog, but you still...

Yes, yes, we are. Yes.

Okay. And where would you think it'd be maybe by the end of calendar year or -- in terms of inventory.

Our target on inventories is depending because also exchange rates affect our inventory valuations. We're expecting somewhere between $17 million and $18 million.

Right. And just lastly, on the Whitening, is there -- has there been any lessening of demand out of the Whitening product with it covered and people wearing masks or other sort of factors in the market? Or is it -- are you still taking that the demand is going to be pretty stable?

Yes, it seems to be okay. Yes, absolutely. I have -- we haven't seen any evidence yet of demand going down. And it's one thing -- a great way to make yourself feel good by getting [ teeth] and you can do that at home. So the new Light we have coming out will be pretty exciting because the dentist doesn't even need to see the patient, they can just ship it to them. So no. Demand seems to be quite strong.

Okay. Great. And lastly, just on the currency. Your thoughts -- obviously, [ your ] been strengthening now. So just in terms of that managing that currency situation now going forward, doing some forward cover or what are you thinking now?

We mainly want to try and building as much natural hedging as we can.

Your next question comes from Daniel Ireland with CCZ.

Just looking at the presentation, you gave a really good breakdown on the revenue contribution from the different products. I was just wondering whether the company discloses the margin contribution from Aesthetics, Whitening equipment and Amalgam?

No, we don't. Sorry.

And so -- okay. Is there any sort of like significant weighting that would be possible to talk about? Or are they sort of all in a reasonable range?

Look, generally, the Amalgam product, it attracts a lower margin, depending on the region and depending if it's a tender, government tender. The range from Amalgam, to say, to the Whitening and Aesthetics can be anywhere between 20% -- 10%, 20%, 15%. That's about all we give out.

Your next question comes from [ Peter Storrow ], a private investor.

Yes. My question relates to the operating expenses, which have been brought down by 9.8% this year. How much of that carries through into FY '21? Is there now a reduced cost base? Or is this just a temporary measure?

It's just a temporary measure. Now that we're full back to normal business, our cost base will go back to normal scenarios. However, here in Australia, it's about the only place that the JobKeeper is still going through to September. So we'll get a little bit of benefit there. But generally speaking, we're -- all staff are now fully back on board.

There are no further questions at this time. I'll now hand back to Ms. Cheetham for closing remarks.

Thanks, Ashley. Look, I think it's been an incredible period for us showing -- it's really just showing the resilience of the company and really the essential nature of the dental industry. I'm very, very proud of our team and what they've achieved during this really difficult time. We're coming out of this stronger than ever before, and we're well prepared for the future growth. So thank you very much, everybody.

That does conclude our conference for today. Thank you for participating. You may now disconnect.