Vitrolife AB (publ) (VITR) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Vitrolife Interim Report January to June 2020 Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today on Monday, the 13th of July 2020. I would now like to hand the conference over to your first speaker today, Thomas Axelsson. Please go ahead, sir.

Thank you very much, and welcome to Vitrolife Interim report January to June 2020. The speakers of today will be Mikael Engblom, the CFO of the company; and myself, Thomas Axelsson, that is the CEO. Please change page to #2. Our headline today of the report is an extensive impact of COVID-19. So our ambition today is to try to explain more in details the development during quarter 2 and maybe some projections going forward. But let's see then of quarter 2 first. It was sales of SEK 209 million, and it was equals to minus 45% and that's the same as local currency. So today, when we are talking about SEK, it's the same as local currency in all basis. The EBITDA was SEK 40 million then, corresponding to a margin of 19%. So let's go over then and look into Q2 and change page to #3. It is sales and growth per market region. The ambition today with the sales and growth per market region and later also regarding the product is to try to explain what happened during Q2 and also what are the current status. And what I then will do is that if we're looking into Page #3 then and we are starting in China where the flu started with COVID-19, so we can see that it is a decline in that territory of minus 4% to 6%. What has happened then? Because China was first into this and they are also first out of this situation. As earlier, informed the market, we saw within the first month that it was a decline about 1 -- with 2/3, so the sales was around 1/3. And we are currently up to around 2/3 of normal sales. So in China, we can see that best guess from our side is that the clinic is up running and are doing around 70% of normal procedures, and they have a good intake of new customers. We can see that there is a variation between the regions, the provinces where the south provinces are almost up to 100%. In Wuhan in the Bay Area, it's a little bit more than 50% and Beijing has gone back and forth because they opened up and then were closing down a little bit of some centers, so that may be between 30% to 50%. But it is a trend going up, which means, for us, also more sales. In the rest of that territory that we're calling Asia, we can see a good recovery in Korea, in Taiwan, Hong Kong, while they are still quite behind in India, for instance, then. The recovery in India, Pakistan and those territories are between 30% to 50% of normal intake of customers. The belief, at least right now from talking to the clinics, is that the cycle rate will be normal at the end of the year then. I will then jump into Japan & Pacific, and that region was minus 10%. So that's our best region so far in quarter 2. And why is that? Why have they been able to still keep up the clinics and do their procedures? Mainly due to that it's not been the lockdown in Japan, and the decline in Japan maybe sort of around minus 10%, so it's similar to these numbers. And talking to the clinics, they feel that it is almost recovery at this time. Though in Australia they had a lockdown, so they have been opening up. And what they've been doing is that they have supported the patients with telemedicine. So when they are now opening up the clinics, it is full speed of recovery for the IVF clinics. So far, we have not seen any changes regarding the situation in Victoria where part of Melbourne is also closed. But it is a good pickup of cycles in Japan & Pacific. Going then from Japan & Pacific over to China, Asia into the EMEA region, we can see a dramatic drop with minus 52% and that's due to that -- we all know that COVID-19 has moved west, so it's impacting the territories one by one when we go west. So what's the recovery then? The best recovery is in the northern part of Europe where maybe currently, it's up to 80% to 90% of normal cycle rates. Russia, it's around 50%. What we can see, for instance, in U.K., where it's a big difference between the private clinics and the public clinics because the NIH clinics are not opening up in the same rate as the public -- as the private, I mean, excuse me. The private clinics in U.K. are indicating and are currently having opened 6, 7 days a week by -- so they can pick up and take care of both the customers that were not able to do the transfers or had the treatment in April, May then. Spain, maybe around 75% to 80% pick up right now. Turkey is a little bit below, 65% to 70%. So overall, we can see that it is a recovery. And the recovery in the EMEA region as well as in the U.S., I would like to say, has a couple of considerations. One is that where the IVF clinics do belong to hospitals, there's some fear for the couples to go to the hospital. There has also been, as you know, different regional lockdowns, and that has impacted, of course, the cycle numbers. What we can see in meeting customers and also talking to customers is that the restrictions that they are doing around each patient means that they are working 100%, but they're not able to see as many customers, patients as usual because of the restrictions mainly in the waiting room. So going over to U.S., where they still have had a lot of problems within the clinics. I would like to say that they are -- even if they had the increase of COVID-19, almost 100% of all the clinics are opened. And we can see that they are dealing very professionally with the customers, and the increase of telehealth appointments are helping the customers and the clinics to provide the cycles that are needed. If you go further down in the region of Americas to -- for instance, to Brazil, there's more -- there's a situation that is more troubled. Currently, maybe 30% of the clinics are open, and they're only doing special cases or, for instance, that patients are only being seen certain days of the week. So try to do then a summary of the situation, we go to Page #4 then because the short-term outlook is that we can see from situation more or less where the IVF clinics were locked down in April. We can see it's picking up and as mentioned before, around 2/3 at the end of June. We also see huge differences, large differences in the recovery. Between, for instance, Japan and U.S., there's a huge difference. We can also see a difference between the Northern part of Europe and Southern part. The recovery, to some extent, are also being delayed due to the restrictions. We are also saying that we believe that it's going to be a recovery, but the recovery will take place during quarter 3 and quarter 4 this year. What the clinics are talking about is also the situation that there are customers, there are patients that are in need of IVF treatments. So there are a potential pent-up need for more treatments when this crisis is slowly, hopefully, going away. By that, going to Page #5. And Page #5 is about the growth per division. And the growth per division is also following the trend what currently is happening on the market. The first thing that the customers are doing is that they need to replace and start to have fresh inventory of consumables and then especially the Media of our nutrition solutions. Our nutrition solutions have limited lifetime and shelf life, and that means that we can see when clinics are starting up, they are starting to order Media, so they can do the -- also pickup and also the culturing. Interesting also is the quick and extra demand that we've seen in June on vitrification products and that is due to that the vitrified frozen down a lot of -- all sites that they could not transfer during the period. So consumables are the first one to pick up in sales. And the situation there is for us to have a balance between our inventory and difficulty to predict exact demand on each product. The other large division that we have is the technology, and that's mainly the Time-lapse products, and that's a decline there with minus 50% then. Customers, as we see, they are first trying to get back and get an efficient clinic, and then they will later on continue to further invest into capital goods as time let. So what we first believe is what we can see on this side, consumables declined minus 40%; technology, minus 50%; and Genomics is minus 60%. And while minus 60% on Genomics, even if it is small numbers, is due to the situation that we are only selling Genomics in Americas and in EMEA. And the biggest market there is Americas. And since Americas are down and has not yet started up, even if they're reaching about 100% openness of the clinic, it's going to be a little bit delay on that side. So from sales and growth in different territories and the divisions, I'm handing over to Mikael. Please, Page #6.

Thank you. So I'll take you through the key financials during the second quarter. So the gross margin during the second quarter was 53% compared to 64% in the same quarter last year, and the drop in margins was due to high scrapping costs of SEK 7 million related to Media primarily, and that's due to the variations in sales and the shelf life that Thomas mentioned earlier. The other major factor behind the drop in margin is negative economies of scale. As sales declined with 45% during the quarter, we had the fixed cost to be shared with fewer products and thereby, reducing the average margin. The EBITDA margin was 19% compared to 38% last year, so the variation is due to the decline in gross margin that I just mentioned and then the other major reason is a negative effect of economies of scale in the operating expenses. So even though operating expenses in absolute terms declined, in percentage of sales they increased due to the drop in sales. Net debt in relation to EBITDA was minus 1.6, and we had positive cash flow adding on to the cash in the end of the quarter. And of course, the decline in EBITDA makes this metric to increase. With that, move to Page #7 for the long-term outlook. So the long-term outlook, after the corona crisis, we believe, is unchanged. And we believe the market will grow with 5% to 10% in the foreseeable future. As before, we believe this will be driven by the demographics that people wait long time with having children, the growth in income and then increased social acceptance for IVF. When it comes to Vitrolife, we will continue to focus on sales expansion and expanding the product offering, and that will be done both through in-house development and through acquisitions. With that, operator, we are ready to take questions.

[Operator Instructions] Your first question comes from the line of Ulrik Trattner.

Thomas, Mikael, and first off, I have a few questions. But if we can just start off with, obviously, the demand is down due to COVID-19 for all specific regions and it seems like you're talking about a little bit softer recovery in each respective markets with this year being heavily affected. But if we were to look into 2021, do you see any limitation in capacity through these IVF clinics that could limit your growth even if there is a significant pent-up demand next year?

It was a good question. You know that what -- it's difficult to say what's going to happen. But if you're asking about the demand inside the clinics and if they have the capacity in the same situation, if we have the capacity, if we are then looking on consumable products, yes, I don't think that will be any major challenge for us on our biggest product assortment, the nutrition solutions, the Media. The challenge there would be for us, as Mikael also said, to be able to cope with the variances on the demand. And we can see the situation right now where it was -- where it is picking up quickly, that we have to react and do some extra lots in the same situation when it was going down in March, April, it took some time to coordinate the production. If we are then going into the clinics, it is an interesting situation right now that many of the clinics are having demand. And there are couples, patients that are a little bit frustrated, let me put it that way, that they had frozen embryos that they want to transfer. So therefore, there's an extra demand right now in some regions to do the transfer, of course, because they've been frozen. And we can also see that clinics in many territories in the EMEA region that are private -- not public, private, are opening up and having the clinics open 6, 7 days a week, so they can deal with the demand then. So if your question is if we see that there is any restrictions within the clinics if it gets back to a normal situation? No, not really, not really. If there is any problem for Vitrolife, it could be if it is exploding the demand, but I think we are following this quite closely, so we will be able to manage it.

Okay. That's great. Perfect. And as you mentioned, you're selling to private clinics. And you, obviously, made some provisions on bad debt during the quarter. Do you see any sort of major change closing down IVF clinics? And obviously, especially for the private ones, one would assume that they were to wait buying into your technology equipment until sort of the turnaround has already -- the patients have already come back. Is that something that you're seeing right now or expecting to see some sort of pent-up demand being -- initially, the consumables, but -- especially for the private clinics?

For the private clinics, yes, there are some clinics that has a cash flow problem. I don't think it's going to be any major problem if what's going on will continue. If there's going to be a new lockdown, then I don't know. But the route that we are on right now, I don't see any major challenges. The concern that private clinics has is how quickly to invest, how quickly will the demand come back. And they will, of course, as every other private industry owner are doing, manage their cash and being on the safe side before they go into any investments. So the technology will be behind the consumable growth initially, yes.

Okay. Good. And just one last question before I get back into the queue. You have a very strong balance sheet. And obviously, there is M&A opportunities out there. Do you see any limitation from COVID-19 of you finding suitable targets to acquire or have these become more approachable based on this pandemic?

I would like to say there are 2 sides on this coin. One is that companies that has considered -- and especially family companies are in a situation that should they continue with all the regulatory changes going forward, et cetera, et cetera. So I do feel and I can say that there are a flow on some potential opportunities with companies that are considering if they would continue themselves. Another thing that is a challenge and that is to do the due diligence process. So I do think it's going to be similar to what's going on within the clinics. There is going to be a lot to do when we are finally being able to travel.

[Operator Instructions] Your next question comes from the line of Patrik Ling.

I think it was when you talked about China or Asia that you said that you expected or that the clinics expected the cycle rate back to normal by the end of the year. Was that the correct interpretation that it was only for China and Asia or was it for everything?

I could say, almost for all countries, where it's going to be quickest back to normal are Japan, Australia as we do believe. China is picking up, but they are quite careful also, as you know, within the Beijing area, for instance. And if we see on the Beijing clinics and they have a couple of big ones there, around 60% of all patients going to the Beijing clinics are from outside the city center, which means that when they're locking down, they're also doing some restrictions. But you are asking for a long term -- let's say, long term, but 2 quarters, we -- the only thing we can foresee and what we believe in is that the pickup will take place during Q3 and Q4. And we can see how quickly it's getting back in some territories like in the Nordic and Germany, et cetera.

Okay. But you do not expect to have positive growth numbers until we come into Q1? Is that the right way to see it?

Yes. I mean we are guiding that we believe that the third and the fourth quarter will have a negative impact of COVID-19. So that is the guidance that we have done. And we cannot make assessments that is a longer period than that at the moment given the uncertainty, but we believe a gradual increase in sales. And therefore, we will have a gradual growth from the level that we had in the second quarter.

Okay. Can I also ask you about the gross margin? I mean you said that you had SEK 7 million in scrapping costs. And if we adjust for that, you would have had a gross margin of 56.5, I think. Is the rest of the decline, is that completely due to negative economies of scales or are there any other items in the gross margin that we should be aware of?

No. That is the big factor in the gross margin variation. If you look on the scrapping cost, we had SEK 7 million in scrapping cost. Even in a normal situation, we have some scrapping costs. So in a normal situation, we probably have between SEK 1 million and SEK 2 million in scrapping costs in a quarter. So the scrapping cost, that's out of the ordinary is probably in the range of SEK 5 million to SEK 6 million.

Okay. And what level of sales would you say that you need to reach to be able to start to see positive economies of scale? Because when I look at your numbers and go back maybe 4 years or something like that, I mean, you had sales at the same level as you saw this quarter, but significantly higher gross margin, even if you adjust for the Genomics operation and the dilution that you get there.

Yes. But we have also, of course, invested in our operations in those years and we added products and changed the product mix. So there has been a lot of variations. But of course, as we increase our sales, we will get closer and closer to the previous gross margin. And then it's just a matter of how big decline compared to the previous situation that would be the factor.

Okay. You also took SEK 6 million in bad debt reserves this quarter. Is that what you think will be needed? I mean because when I listen to you, it sounds very much like we have a recovery situation in almost all markets. So have you -- in that number, have you made an assessment for the second half as well or is that only for the second quarter?

No. But that is the added provisions that we added during the second quarter, and that is based on an individual assessment clinic by clinic. And of course, that's on a base of close to SEK 200 million of total accounts receivables. So if you look in that context, it's not a huge provision, but it's our best estimate in terms of potential bad debt.

Okay. And do you have had any clients that have gone out of business due to the pandemic?

Yes. We had 1 client in the U.S.

They didn't go out of business really, but it was a bankruptcy of a clinic chain, and then the clinic has popped up in a new identity.

Your next question comes from the line of Björn Olander.

Björn Olander, Murgata Equity Research. Of course, the recovery is the most important thing here. And I think you have been as clear as you can be. So I will continue along Patrik's questions on the expenses and so on. You participated in the support program that generated SEK 5 million in the quarter. Where has that been booked in the P&L?

It's booked under other operating revenues.

Okay. So it's almost the entire other operating revenues then. How is that -- right now, what is the situation with those programs and participations? And also more importantly, your own organization, are you doing any sort of long-term changes there or long term -- some changes that, I mean, not only related to these programs that you speak?

I can answer first on the first question. And -- so we use these programs during the second quarter. And then as we saw demand increasing in the end of the quarter, we closed this state support programs and then staff returning then to normal working hours. When it comes to the long-term effects, Thomas, do you want to say anything about that?

Yes. We are not doing any changes because we believe that it's going to come back. And also that the things that we are working with on, for instance, the development, all the activities that we are doing, we have been able to do those from -- to a large extent, through the digitalized world that we're working in. And all this with new software programs, the development within the Genomics, for instance, is something that -- no, that's about the future. So we still believe in the future. And also the regulatory thing. There are opportunities with this, too. We have been able to focus and -- for instance, on the regulatory side, when you are not having as much people inside the office, it's an interesting thing that with the digitalization and this kind of work, you can also be more affected. So there isn't always bad things with this life.

Yes. That sounds very good. I noticed that there are exactly 418 employees at the end of this quarter, and it was expected the same number after Q1. So that's very encouraging for the organization, I think. Are they -- speaking about this -- sort of this new world and with digitalization and so on, do you expect any sort of change in that -- in the way you work? Or -- I mean as they work remote from this year and so on, will there be any changes in your sort of sales process or -- I've also heard some companies in other medtech industries that have been -- sort of this period has been a period of sort of education and the clinics are thinking more about how they will change their way of working and so on, so they could be sort of more open to new ways of thinking in terms of that. So any thoughts on that?