Nanosonics Limited (NAN) Earnings Call Transcript

[Audio Gap] again, a very strong recovery was seen across the half. In the first quarter, new units installed were up 17% compared with Q4 of FY '20, when the majority of the COVID impacts were actually felt. Importantly, however, the number of new units installed again in the second quarter of this half, they continued to recover and were up 35% and compared with the first quarter of this half. So a great result emerging in North America. In Europe, as you know, over the last 18 months, we have increased our infrastructure as the fundamentals for adoption of trophon continued to strengthen. And this investment is resulting now in excellent growth in the number of new units installed, which was up 31% in the last 12 months and 18% in the last 6 months and is now 1,320 units in the EMEA region. The number of new units installed in Q1 of the half was actually up 60% compared to Q4, so recovering quite strongly from the major impacts in Q4 of FY '20. And that growth trend continued into Q2 with the number of new units also up 50% compared with Q1. So seeing good recovery and good momentum continuing to emerge in our European operations. And in Asia Pacific, the total installed base was up 6% in the last 12 months and 3% in the last 6 months to 1,660 units. While in Q1 of this year, the number of new units was actually down compared to Q4, that, I think, is a reflection, in some cases, of the strict lockdown measures everybody here in Australia has experienced over that time period. But this recovery was experienced -- or recovery was experienced in the second quarter with new units installed up 50% compared with the Q1 of FY '21. So overall, a very positive growth profile for our new installed base across the half, which we're expecting to continue into the second half. Moving on to revenue. From a total revenue perspective, the half year revenue of $43.1 million, that was down 11% compared to prior corresponding period. Now this lower revenue was primarily driven by the foreshadowed reduction in purchases by GE Healthcare as a result of the impacts of COVID-19 on its ending inventory at June 30, 2020. So in addition, there was the impact of the stronger Australian dollar. Everybody realizes the appreciation of the Aussie dollar in the last half. And in constant currency terms, revenue was $44.6 million versus the $43.1 million reported, so down 8% on prior corresponding period in constant currency terms. But just a brief reminder on the foreshadowed reduction in purchases by GE Healthcare. We brought this up when we reported our FY '20 full year results. And as you remember, Q4 of FY '20 is where we felt the biggest impact of COVID-19. In that quarter, new installed base was down almost 50% due to hospital department lockdowns, which also, in itself, resulted in ultrasound procedural volumes being reduced in that period. Now this had the effect of GE Healthcare's ending inventory at the end of FY '20 being greater than anticipated with the knock-on effect then, of course, of impacting capital and consumable purchases in the first quarter. In the second quarter, however, the global revenue recovered strongly. So it's up 48% compared with the first quarter. So it was up to $25.7 million in the second quarter, and that growth resulted from stronger installed base growth across all regions. As I mentioned, there was 800 million new installed base in that second quarter, which was higher than even the third quarter of last year, which was pre-COVID. But not just the installed base, GE Healthcare have resumed purchases of capital equipment in the second quarter as they've worked through their inventory overhang from COVID as well as an increase in consumables and service revenue. And it's also worth mentioning because back in November, we did announce a major upgrade deal that has been entered into with I-MED for the 200+ trophon upgrades from the EPRs to T2. And thus, it is expect -- that revenue will be -- is expected to be recognized in the second half as the -- those trophon2s are installed across their network. Accordingly, there was no revenue associated with that particular deal in the first half but expect it to be fully recorded in the second half. So if I break the total revenue now down by consumables and capital. First of all, the consumables and service business, which certainly really demonstrates the resilience of the Nanosonics business, I believe, our half year consumables and service revenue was $33.7 million. That was down 1% on pcp but actually up in constant currency terms. And as already explained, there were some temporary impacts on consumable revenue associated with ultrasound procedure volumes being impacted by COVID-19, especially in the fourth quarter of last year and some of it into the first quarter of this year, but also some GE inventory overhang at the end of June 30. But importantly, this was temporary and has since recovered well. In fact, revenue from consumables and service in the second quarter was up 29% compared with Q1 to $19 million. And if I take that in constant currency terms, that's almost close to $20 million, which is the company's highest quarter on record for consumables. So a very positive recovery happening in the consumables. From a capital revenue, again, I think I've said enough. The impact on the capital revenue, which was $9.4 million for the half, was down 35% compared to prior corresponding period. But that was primarily felt in the first quarter where despite new installed base recovering, because there was no capital units sold to GE Healthcare, for the reasons already explained, well, then there was a major impact in capital. In actual fact, in the first quarter, it actually resulted in a reduction in capital revenue of 64% between Q4 of FY '20 and the first quarter of FY '21. But as GE Healthcare resumes capital purchases in the second quarter, coupled with increasing sales by our direct operations in North America as well as positive performance of both Europe and Asia Pacific, the capital revenue grew 148% over Q1 to $6.7 million in Q2. So again, a great recovery happening and underway on the capital side of things. In terms of the other financials for the business. Well, during the half, we continued to make significant investments in our broader growth strategy across our global infrastructure, capacity and capabilities as well as geographical expansion with particular focus on Japan and China. In addition, we continue to invest in our product expansion strategy through our internal R&D program as well as our new business development function that's being set up to identify and assess potential strategic acquisition opportunities. And overall, operating expenses for the half were $33 million, which was up 8% on the prior corresponding period. The operating profit before tax was $0.2 million for the half, and that's compared to $6.7 million in the prior corresponding period. And the operating profit really is a tale of 2 quarters being quite negative in the first quarter reflecting the impact of the COVID-19 on the overall Q1 revenue but much more positive in the second quarter. Our free cash flow for the half year was a net outflow of $2.4 million compared with the net cash inflow of $10 million in the prior corresponding period, and that's due to the amount and timing of customer receipts and the timing of supplier payments. And as at the 31st of December, cash and cash equivalents totaled just under $88 million, so $87.9 million, compared with the $91.8 million at June 30. And this cash balance, coupled with negative debt, really does continue to provide ongoing strong foundation for the continued investment and growth of the company. Briefly from a product expansion perspective. As reported at the FY '20 AGM, we continue to invest in a number of exciting innovations aimed at addressing a broader range of infection prevention requirements. Our primary interests span a number of areas across instrument cleaning, instrument disinfection, storage solutions, environmental decontamination and compliance and traceability. And in the first half, $7.6 million was invested in R&D. That's up 12% on prior corresponding period. And the R&D team continued to make significant progress across our late-stage development projects, including a new platform technology as well as a new solution for superior digital traceability and reporting. And in addition, the company is exploring a number of other product opportunities through our own internal R&D capabilities as well as through ongoing investigations into potential strategic acquisitions and our product licensing or collaboration opportunities and all of that through our newly established business development function. So regarding our expectations for the second half. But first and foremost, the positive growth trend and improving market conditions experienced across the half, they are expected to continue, subject, of course, I think as everybody says, to the acknowledged inherent risks and uncertainties associated with the COVID-19 pandemic. But as such, based on all the current indicators and market improvements, the company is anticipating ongoing growth in total revenue and profitability into the second half. And that will be driven by installed base continuing to grow, increased usage of consumables across all regions. GE Healthcare are now purchasing capital equipment again and back to normal levels of purchases for consumables also. And of course, there is the revenue from the I-MED upgrade program here in Australia. And with the COVID-19 vaccination programs underway, the company is certainly optimistic that the overall market conditions, in particular, access to hospitals, are likely to improve. The underlying fundamentals for the business, they do remain strong. And the company certainly remains optimistic about the future for both the trophon ecosystem but also broader opportunities across infection prevention. As such, we do maintain our commitment to continue to invest in the strategic growth priorities of the business through market expansion, R&D and infrastructure and capability growth. And our total operating expenses for the year are now expected to be at the lower end of the $75 million to $78 million range that we had indicated previously. So with that, I'll now hand over to any questions. Thank you.

[Operator Instructions] Your first question today comes from Josh Kannourakis with UBS.

Michael and McGregor, can you hear me okay?

Yes, Josh.

First question, just with regard to the outlook statement. Obviously, you're talking around growth into this period. I just wanted to clarify. When we're thinking about the base of growth to look at, should we be looking at the sort of -- the Q2 FY '21 run rates? Or are you just talking to the broader first half?

Yes. Look, I think it's the -- we're not giving specific guidance as to the rate and whether you can use the blended across the first half or the Q1 to Q2. But what we can say is we expect the installed base will continue to grow and on a quarterly basis, greater than what we saw in Q2. From that -- and we would certainly expect more purchases from GE in the second half than we saw in the first half. And with that growing installed base and procedure volumes continuing to recover quite strongly, consumables will continue to be -- to grow. And of course, then you've also got the I-MED upgrade that will come through in the second half. So we're expecting to see a -- subject, of course, to what I said, the inherent risks associated with COVID, that we're expecting to see a much stronger second half.

Got it. And just in terms of the consumable side of things as well, obviously, it's picked back up quite strongly. But in terms of the ultrasound volumes and what you're seeing in terms of end market cycles and trends, there were a few data points that sort of showed -- probably from November, there was a little bit of a rollover and potentially a bit of a pickup year-to-date. I'm just interested in what you're seeing in terms of maybe the trends you're seeing in market as of today.

Yes. That's a great question, Josh. And I think I would just remind everybody that when we came out with our update in November, what we -- the consumables that we were talking about there were the in market, so end user use of consumables as opposed to just total consumable purchases, which would include what we sell to the distributors. And we -- there's a national tracker on various medical procedure volumes that we're tracking in the United States, in particular. And it has shown that there has been a good strong recovery in the -- overall in ultrasound and imaging procedures, in general. I think other companies that have reported have come out and said that. The other part that we track is we look at the -- our installed base, our direct installed base pre-COVID, and we looked at what the average daily shipments of consumables were just to that cohort and has that now recovered back to the pre-COVID levels. And it's back over 90%. So we're seeing good strong recovery in that procedural volume and don't really see any reason why that would reduce moving into the second half.

And just following on from that very quickly, last question. In terms of the inventories, therefore, in the channel for both capital goods and also on consumables, could you just give us a bit of an update on that?

Yes. I think the inventory overhang that GE had going into the first quarter, by and large, has worked its way out. It's -- we would not consider now to be any major inventory overhang.

Your next question comes from Shane Storey with Wilsons.

Perhaps I'll just start with -- maybe I'll start with a more strategic question around the U.S. capital sales situation. I'm sort of interested in whether there's been any difference in how GE's team or your team are approaching the back half of that market with the product sort of past 50% penetrated now. And I guess specifically there, I'm interested in anything you can share on CapEx versus OpEx acquisition models developing in the U.S. And then finally, an observation on any EPR replenishment activity that you've observed, that would be very interesting.

Yes. So in terms of the first part of your question, really, the uptake in T2, we've got a lot of existing hospitals who originally purchased a number of trophons, who are now purchasing more as we're expanding into more and more departments within those hospitals. In terms of the model, it still seems to be primarily driven by a capital purchase model as opposed to a fundamental shift over to rentals or leasing. So the model really has not changed. Likewise, in the U.K., it's still primarily an MES model. On the upgrades side of things, as you can imagine, the -- with limited hospital access, especially in -- over this first half, and we have adapted quite well in terms of being able to interact remotely with our customers, which resulted in a really good result, in particular, in Q2. And that is despite the fact that hospital access was still only at about 40%. And -- but as you can imagine, our main focus has been on new installed base. And so the trophon upgrades have not been outside of the I-MED deal that you saw in November, and that revenue will come through in the second half. The upgrade has not been a major focus for us in this first half. As the markets open up and hospital access now improves and vaccinations coming through, et cetera, well, then it will come back very much on to the agenda. And there's a significant number of units now that have reached 5, 6, 7 years of age that we believe are very much ripe for upgrade. And we'll certainly be talking to those customers.

The last question I had was really on Europe, where you'd beat our numbers, notwithstanding sort of matching us there on volume. So I'm interested to know what the sort of principal moving components of that was in Europe for [indiscernible] quite nicely.

Yes. I mean, Europe is -- really is a reflection of the investments that we have made over there and the fact that we've geographically expanded a little bit. But putting the right people on, increasing sales force and infrastructure in the U.K. and in Germany, putting clinical resources on, marketing resources on, all of that timed when the fundamentals for adoption are strengthening and continue to strengthen, I think we're all very pleased with the direction that Europe is going.

Your next question comes from Peiting Liang with JPMorgan.

I just wanted to ask quickly on these kind of ordering patterns from here. I mean, going forward, do you expect to see any sort of more lumpiness in the sales or demand going forward? Is there any reason why we can't use installed base as more of a normalized proxy for capital revenues now?

Yes. I think installed base, that might not be a bad proxy moving forward. We don't necessarily see lumpiness. Sometimes things happen at the end of our quarters or at the end of our halves, which coincide with GE's end of half or end of year, that there may be a little bit of lumpiness there. But fundamentally, I think the most important thing here is the overhang associated with the impact of COVID in Q4 and the subsequent impacts that had on Q1. We believe that based on their growth of installed base that, that has been fundamentally worked through. And of course, GE, when we -- as access improves as well, remember, a lot of the units that are out there that are aged are GE -- existing GE customers. So there's an opportunity moving forward from -- in this second half but more so even further into FY -- into the next year that the upgrade opportunity for GE is quite significant, which obviously then has a very positive impact on the number of units they would be ordering from us.

And just following on that, you mentioned number of units that are aged and are ripe for upgrading. Are you able to give the percentage of your installed base, an update on that, that's the units that are eligible for upgrade now.

It's really -- what I'd be able to provide, I don't have the numbers off the top of my head. But it's an age distribution. But for example, units -- there would be units, well over 5,000, 6,000 units, that we would consider to be targets for upgrades. I mean, if you look at the I-MED opportunity, where there's over 200 units going into I-MED, those units in I-MED were approximately 7 years old or so. So we think it's -- the big issue for us on upgrade at the moment is just hospital access and where we're -- because I think it's more important, where we're spending our time to drive the installed base growth. But the value proposition associated with the trophon2, in particular, with the superior traceability element of trophon2, which now is becoming more and more important, and also the fact that we're now selling a lot, like 100% of our sales now are trophon2, and the fact that we're selling a lot of trophon2s now into hospitals that already have EPR, but we're selling them into different departments, we believe moving forward, the hospitals will actually standardize their SOPs across their departments, which again further supports the upgrade of the T2.

And I just wanted to also ask on the pattern of hospital CapEx going forward. Are you hearing anything or seeing any sort of impacts from potentially lower level of hospital CapEx given the reduced surgical procedures that we've seen kind of over the last 9 months as a result of COVID?

Yes. Look, we've not -- certainly, that hasn't been explicit for us as we've been talking to the hospitals. I think it's more a question of the hospital's understanding even better the importance of infection prevention. And on the CapEx side of things, we're not a $40,000, $50,000, $100,000 piece of equipment. We're down at the $8,000. So it's not a huge overhang on their CapEx, albeit it has to go through the appropriate approval processes. But at the moment, we're not seeing CapEx constraints being a limiting factor for ongoing adoption.

And then just one more, if I could. I noticed that there's no mentioning about kind of the targeted time frame of launch for the second product. I think previously, you were saying FY '22. So just wondering if you've stepped away from this sort of time line or it's still applicable? And has COVID changed your strategy with regards to launching new products, whether that be the product itself or the timing?

No. Look, we're still aiming for FY '22, subject to all the usual caveats put around that. And in addition to the new platform technology that anticipate this, we also have a new traceability and compliance solution. That could, in actual fact, over time have very important implications beyond trophon and really is potentially our entry into the IoT space. And we also aim to have that in FY '22 as well. So there is a lot of activity happening, as you can appreciate, in the R&D area of the business. And of course, with our business development group, they actually have been very active in the last 6 months and have identified a number of potential opportunities and review those in that time frame. But none of those have ultimately come to fruition after we've done the appropriate diligence. But that continues to be an activity as well. So no, nothing really has changed, nothing to read into the announcement here with respect to new products.

Your next question comes from Joshua Ting with Bank of America.

I just wanted to talk a little bit about GE Healthcare and the dependence of some of the sales from Nanosonics on that. Are you able to give us some color on what sort of proportion of revenue is coming from GE Healthcare? And if you could sort of split that between the capitals and the consumables line, that would be really helpful.

Yes. We don't break it down to the capital and consumables. But overall, the proportion of revenue on GE Healthcare is decreasing. It accounts now for approximately 45% of the revenue in that first half compared to the prior corresponding period, where it would have been about 54%. So they still remain a very important partner for Nanosonics, still very engaged, and we look forward to continuing with our partnership for them for years to come.

Okay. Terrific. And if I could just ask a couple of questions around the sales team engagement and what the current access to hospitals has been like? I know you sort of referenced that it had been improving in your prepared remarks. But are you able to give us any idea of how the engagement has been and whether hospitals are a bit more used to dealing with the sales teams coming in now that they're a bit more under control with COVID?