Earnings Transcript for DEMANT.CO - Q3 Fiscal Year 2023

Mathias Møller: Good afternoon, everyone. Welcome to our conference call held in connection with the publication of our interim management statement for Q3 2023, which we released this morning. We'll run through a short presentation, and then we'll switch to Q&A. The presentation has been uploaded to our website. You can find it there. And as usual, we plan for this call to last no more than 1 hour, including the Q&A session. We are represented by President and CEO, Søren Nielsen; CFO, René Schneider; and then the IR team, Peter Pudselykke and Mathias Holten Møller.

I'll now hand over to you, Søren. :

Søren Nielsen: Thank you very much, Mathias, and welcome, everybody. The agenda for today is key events during the third quarter and financial key takeaways. A few more details on health care communication walk-through of the outlook and then open the floor for Q&A. If we look at the key events in third quarter, we continue to see very strong growth in the Hearing Aid business with sustained market share gains across markets and channels and normalized hearing aid market. I'll get back to that. Solid performance in hearing care and diagnostic despite that we see a weaker than expected market dynamics in China. Communication continued to see negative growth as the market for both enterprise and gaming has remained challenging and our decision, nothing new on that, but our decision to sharpen the focus in communication on the Enterprise business and with that gradually wind down gaming.

A short update on the CI business. The divestment of the CI business, it continues to do progress, but we now expect it to close in first half of '24. And not as previously stated towards the end of this year. The Bone-anchored business will remain for the group for now, pending a review of our strategic options, which we will initiate once the transfer to Cochlear has been completed. Key financial takeaways for the third quarter, strong organic growth of 13%, driven by sustained market share gains in hearing health care. And the hearing health care part grew 14%, which was driven by very strong performance of hearing aids with 25% growth to. In external revenue communication, organic growth of minus 20%, reflecting a continued weak market development, both for gaming and for enterprise. :

Gross margin in line with expectations and with that, an improvement from first half despite of the sequential decline in communication, the hearing health care business have delivered well on that note. EBIT in line with expectation as we have seen material operating leverage in the hearing health care side of the business that offset larger-than-anticipated negative one-off effects related to the wind down of gaming that I'm going to come back to. Based on this, we have narrowed the outlook for the year. We are following plans, but uncertainty reduced in both ends. And therefore, the organic revenue growth is narrowed from previously 11% to 14% to now 12% to 13% and the EBIT range narrowed with DKK 50 million from both [indiscernible] DKK 4.05 billion to DKK 4.5 billion from previously DKK 4 million to DKK 4.4 billion. :

Hearing Health care, taking a closer look at that, starting with the hearing aid market, which has developed in third quarter, totally in line with what we anticipated in August. When we last spoke to it, we have seen a higher-than-normal growth rates, the normal 4% to 6% has been exceeded and there has been a market growth of 8%. However, this is only due to comp figures last year. We have -- when you compare to pre-pandemic levels seen exactly the same as we have seen in Q1 and Q2, average growth rate of 5%. So again, testament to the assumption of a normalized hearing aid market. :

In Europe, the growth was solid. It was predominantly driven by a very strong growth with NHS, where we have seen an element of catching up. U.K. commercial also grew. Germany was in slightly positive growth after a period with slightly negative growth. And France saw a negative growth in line with expectations and as a consequence of the big demand created immediately after the reform. Growth in North America was strong. It was driven by the commercial part of the market. Unit growth we see continue to mainly be driven by managed care and larger chains, growing faster than the independent private market that, however, has also, of course, benefited in a year-over-year comparison. Rest of the World, growth was solid. We don't have statistics that it remains slightly positive, again, back to last year's partially closed down due to corona. :

Australia, growth was [indiscernible] negative. And as you see here, again, the 8% you see on performance. We have sustained market share gains across channels and geographies. We have a 25% growth to external customers, and it is across geographies and channels. It is broad-based fueled by the introduction of Oticon Real in first quarter of '23. And this is in the quarter, primarily unit-driven, while ASP was slightly positive, but all in all, slightly positive growth in France despite of the negative market development. So clear market share gains in France, good performance in most other European markets. Strong growth and market share gains across general traction with a bigger change in North America. Asia Pacific, Rest of the World, strong growth in Asia, driven by Japan, where we have seen very positive development, negative growth in the Pacific region in many rest of the world countries. :

Again, all in all, 25% growth year-over-year in the hearing aid wholesale business. Hearing Care, continued good momentum in most of our medium-sized markets, markets where we’ve proven of the business through growth. Organic growth in France is slightly negative due to the market development but less negative than the market. So also a good performance there. Positive contribution from acquisitions across the business, but especially in Germany, where we continue to see progress on our decision to enter the retail space in Germany as well. Organic growth, all in own retail, the product mix have benefited from a new high-end product like Oticon Real. :

Diagnostic, we estimate that the market in Q3 grew in line with the estimated 5%, however, probably in the lower end of that due to the current development in China. It is our growth driven by Europe, where we saw good performance in many markets as well as the U.S., Asia due to the weak market dynamics in China. China is bigger for diagnostic relative than for our other businesses. And therefore, you see it more clear. Growth is mainly driven by the service business, et cetera, but also instruments for balance testing as well as audio meters have performed well. And there was also a diagnostic, an element of 2% acquisitive growth. :

Communication follows the path of first half and both gaming headsets and enterprise solutions have continued to develop negatively year-over-year in the third quarter. Enterprise Solutions is now approximately 85% of revenue percent and we continue to be materially impacted by the hesitation among professional buyers to invest in equipment like this. I think it goes way beyond our sector meaning of the second half looking at it from a market perspective. Gaming, now 15% of revenue, we saw a slight positive organic growth driven by effort to sell out of inventory and it has required some significant promotions and therefore, a low gross margin, and we are through the oldest part of inventory and the one that moves the least. So we see this as of making sure we wind down this business and will cover as much cash as possible. :

The sharpened focus on enterprise continues. We are very focused on reshaping the EPOS business to be a one-off EBIT impact of DKK 50 million to DKK 100 million in H2 from the decision to wind down, and this is all related to clearing of inventories and lower-than-anticipated sales prices and to focus our effort in enterprise, this is really centered around strengthening product portfolio. We have just launched the first of a series of new professional headsets that continue to receive but lag sales globally. And therefore, we are happy to announce today that we have entered a strategic agreement with Lenovo, Lenovo, a key provider of PCs, et cetera, globally with a very more than 180 countries. EPOS is now the preferred partner, meaning that there will both be a limited number of SKUs that will carry both the Lenovo and the EPOS brand, but there will also be a listing catalog products that can come along in picking a solution for instance, working from home solutions for your staff when picking among Lenovo's offers and solutions. :

And these things together is, yes, we have seen a significant decline to gross margin here in second half, driven by the wind down of gaming but we expect that to return to the levels of first half '23 in '24 and with vision of further lifting OpEx was and will this year end around DKK 600 million. We are now on target to deliver between DKK 450 million to DKK 500 million and maybe closer to the DKK 450 million than the DKK 500 million in '24. I mean our belief that we can deliver a less negative in '23. We have already assured you can say, DKK 150 million to DKK 250 million of improvements, everything else equal going into next year.:

The outlook for '23, there is a few adjustments. The fundamental outlook for the market is unchanged. The underlying structural growth is still expected to be as we have seen in the first 3 quarters, 4% to 6%. That would imply above that level growth in fourth quarter. We will continue to see a negative ASP development of around 1% to 2% from various mix effects. And we expect a continued weak momentum in the market for enterprise and gaming solutions throughout 23. And based on that, the communication, we previously expected negative organic growth and an EBIT more negative than the levels of 22% for all the reasons explained. But in addition to that, we now, as I said, see an additional negative one-off effect in second half of DKK 50 million to DKK 100 million, all related to the wind down of the gaming activities. :

We expect a slightly higher than normal bolt-on acquisitions, but the number of acquisitions planned for 23’ is going to be slightly lower and some of them are moving into '24 and will be close there. That's purely timing around the end of the year and nothing especially there. We continue to focus on adding to our existing business also through acquisitions. And then the expected delay in the closure of the CI business to first half of 24’, again, all related to making sure that whatever was necessary for Cochlear to uphold the commitment to take good care of our patients, things are taking a little longer than anticipated. Outlook to 13 acquisitive growth of around 3%. FX minus 1% based on the rates as of yesterday, we continue to see improvement of our gearing. And therefore, we may still resume share buyback. However, that's subject to the actual cash generation and the exact timing.:

I’ll leave it now Q&A. :

Operator: [Operator Instructions]. Our first question comes from Martin Parkhøi from SEB.

Martin Parkhoi: Parkhøi SEB, 2 questions. Firstly, you say that share buybacks may resume some to cash generation and level of positions completed. But maybe you also talk a little bit of the balance between share programs and the increasing interest rates, the impact on your financials and the impact on potential tax rate. So maybe we will have our balance where it actually makes sense to do shelter where it makes sense to go below your target label for gearing? And then second question, and I have to go back to the OpEx level on the communications business because it's possible for me a bit that you can find the DKK 50 million, DKK 200 million in additional one-off costs, only 2.5 months after you have announced the closure of the gaming activity. So how certain can you actually give you on the DKK 450 million to DKK 500 million in August next year. What are the risks of further one-off costs next year in the case that the enterprise business did not turn around?

Søren Nielsen: I'll take the second, and Renee can comment further on the financial aspects. We are pretty firm on the OpEx for next year. This is predominantly a business with salaries and et cetera and fixed cost, you could say. And we are good in control of that. The one-off element does relate to the price we have managed to achieve for selling out of inventory. And the positive thing to be fully transparent is we have sold the things that either did not move at all or moved very slowly. We are through that. So we still have inventory on gaming, but it's already much more healthy. And we have taken, I would say, a slightly aggressive approach to secure the cash that we can and to avoid exactly what you point to that we would have 2 months carry into next year. So we are really trying to make sure we clean it this year.

René Schneider: On the leverage and buyback and acquisitions and so on. The appropriate gearing level for the demand group is something that we continuously discuss with the Board and also in light of the higher interest rates we have, let's say, the demand is between 2% to 2.5%. So that is still our approach and also our mid- to long-term range to stay in. This also means that as we create a lot of free cash flow, and we will also resume share buyback at some point, whether it will be end of this year or next year, it's a matter of timing, but that's definitely in our plans. Essentially, you can say nothing has changed in our position in this regard.

Operator: The next question comes from Hassan Al-Wakeel from Barclays.

Hassan Al-Wakeel: I have 2. Firstly, following up again on comps. Can you talk about the gross margin impact in the third quarter from selling inventory at lower prices? And to what extent is this likely to persist into Q4 and potentially into Q1? And how should we be thinking about margin headwinds into next year as well? So maybe you can take that first question, and then we can come back in a second.

Søren Nielsen: Definitely, we have a headwind on the Communications gross margin from selling out of gaming inventory. And the gaming products isolated have been sold at very, very low gross margin and in some instances, also at a negative gross margin. But we have been through the majority of the inventory reduction during Q3. So we will see an improvement in Q4 on that parameter. And when is our firm belief that it will be a pure enterprise communication business with a gross margin more similar to what you saw in first half of this year or previous periods.

Hassan Al-Wakeel: The second question is your guidance implies around mid-teens growth in hearing health care, which is a step down from Q3 and a function of comps, but clearly still ahead of the market. How should we be thinking about growth into 2024 and some of the puts and takes here, please?

Søren Nielsen: You're absolutely right. The comps are changing. We did see in the fourth quarter last year. But we are still seeing a good momentum in the business, and we are still seeing all the hearing health care businesses deliver organic growth above the underlying market growth. So that's also our plan and expectations -- [Technical Difficulty].

Hassan Al-Wakeel: Just on the comps piece, I mean you've given us some commentary around OpEx for 2024 as well as gross margin. Is it fair to be landing somewhere in the range of DKK 100 million to DKK 150 million of loss?

Søren Nielsen: What we do say very specifically is that we know we have a strong handle on 2 specific improvements next year versus this year. And one is that this year, we take the full effect of winding down levering. And then, of course, the remaining uncertainty is top line development. But on that parameter, we do also believe that we have a product portfolio and, for example, the new initiative with Lenovo to provide -- [Technical Difficulty].

Hassan Al-Wakeel: The enterprise. Are you close to a trough? Do you see any signs of that market traffic?

Søren Nielsen: No. We don't see the market turning, and we also -- not out all around the world. So we would have to…

Operator: Our next question comes from Veronika Dubajova from Citi.

Veronika Dubajova: My question [indiscernible] is impacting your growth rate at TRT. And then related to that, your degree of confidence in your ability to outgrow the market as we move into 2024, given these changes in the competitive environment? That's my first question. I have a follow-up. [Technical Difficulty].

Søren Nielsen: And it's basically one of our key competitors. I must say our business seems very stable, still very strong, delivering good results. So no, we have not seen any significant change, at least not affecting us in always been. And I am also firm that we, of course, want to continue our growth. It is driven by innovation. It is driven by our expansion of our own distribution. It is driven by the global reach. And I'm sure these things are also the 24’. We, of course, also expect to launch products next year and deliver growth. And we always have an ambition of growing above the market. So there's no changes for the long to midterm guidance. [Technical Difficulty].

Veronika Dubajova: Well, is it to prognosticate of what France might return to growth at this point in time? And what your broader thoughts on the retail market heading into next year off?

Søren Nielsen: Well, is it to prognosticate of what France might return to growth at this point in time? And what your broader thoughts on the retail market heading into next year off?

Operator: Our next question comes from Maja Stephanie Pataki from Kepler Chevreux.

Maja Pataki: On the retail side, you mentioned it for the diagnostics business. The slower-than-anticipated dynamics that you're seeing in China, what do you relate them to? Is it just purely still a comparison due to the various effects from COVID? Is it going forward? And then just double checking quickly, did you say that you're launching a product next year? Or did you mean the normal cycle?

Søren Nielsen: Let me start with the last. We always launch new products, and we also expect to launch new products next year. China, I think China is, of course, a little less mature market, and there's no market statistics. So most of it is based on, of course, assessing your own business and what our local people here and see in the marketplace is uncertainty. And when there is uncertainty, people either do nothing, meaning don't start or they postpone repurchase. When a market is growing like China, the majority of people or a lot of them are first-time users. So there is stuff like that, that have meant a significant slowdown to investments in the public sector, government system, and that is what hits the Diagnostic business.

And for the diagnostic business, China is a bigger part of share of business by government-driven hospitals. We have no other reason than to believe these are postponement rather than sales never going to happen. There is no change to the number of we're hearing impairment in China. There's no change to this continuously expanding. So I think there will be a catch-up. I don't know exactly when we don't have the same touch and feel and experience with the development in the Chinese market simply due to the less maturity it has – [Technical Difficulty]. :

Maja Pataki: Overall ASP development. You mentioned for you, ASP development was slightly positive for market slightly negative. So given where you are in the cycle is more than 9 months after launch, you see to say that the price increase you've experienced versus the market, is it really relates to price increases you had? Or have I missed anything in my conception? Can you comment about the competitive dynamics in enterprise? Do you observe that ASP basis for crisis takes longer as initially expected that some players try to defend where market share in volume terms by just becoming more great – [Technical Difficulty]

Søren Nielsen: Involves mix effects. And there's no doubt that, I would say, both our geographies development, our channel mix and also our product mix have all improved during the past 12 months. And that's the rash by price increases. But it is a mix effect that we see. And yes, there are channels where we also see less success and share gain. But in the areas where we see, I would say, the most tremendous and a strong growth. So we both see a very significant unit growth, but also continue to see a positive ASP development in our business. And that is, of course, those elements, a number of them, you could say, have more permanent character especially the channel mix and the geography mix. Of course, product mix have an element of being fueled and spiked by platform introductions, new high-end, et cetera.

And then in other times, it can flatten or go down. And then, of course, if a channel like NHS is growing, yes, then it can take down the ASP. On the other hand, in the comps we have seen and continue to see relatively weaker performance in what we call our export too well. So it is mix effects. And again, putting it all together, we have seen very significant unit growth development, but also a slightly positive ASP development comparing to last year. And the competitor tens. And I think there is, of course, an element of EFS being a smaller player. And therefore, as we have spoken to before, have more difficulties getting into new markets where the position is not established and not very strong. That's, of course, is in market and a headwind market. But I feel we do well in the markets we are already established and where we have a decent market share, Scandinavia, U.K., Germany, France, whereas U.S. and parts of Asia, collaboration and partnership with a global player like Lenovo is expected to support the growth of the business. :

Operator: Our next question…

Unknown Analyst: You mentioned preferred partner for EPOS. Is there an exclusivity here along? Will it last and are you expecting sales to accelerate in a couple of weeks and months as Lenovo could build – [Technical Difficulty]

Søren Nielsen: The Lenovo is an exclusive agreement, and it is a strategic partnership that that Lenovo wants to get a lot out of and have a good high ambitions for this kind of equipment. It is a close partnership. They call on it, they buy products, they distribute them. So we sell into Lenovo. And there is, of course, all kind of practical details on how we avoid having tumor stating again that, of course, we have good ambitious plans of continue our -- over the past 3 or 4 years, a very strong launch of platforms and new product extensions based on – [Technical Difficulty]

Unknown Analyst: And maybe, sorry, just to push you on that one, but do you feel the need, like some of your competitors to shorten the product launch pace? Or do you feel comfortable with what you have delivered in the past?

Søren Nielsen: No, I think we have, over the past years, you own to have a good consistent flow of new products a hearing aid, and that's what we expect to continue.

Operator: The next question comes from Martin Brenoe of Nordea.

Martin Brenoe: Quite significantly in the last couple of months. Have you seen any weakness in that regard? That's the first question.

Søren Nielsen: Yes. First of all, I don't know exactly what statistics you look at. We can just see what they buy. So this is the ambition to lower the waiting list that have been built up in AHS across many categories is a big focus to lower, including hearing aids. So all in all, we see a pretty good…

Martin Brenoe: If you could get a little bit of flavor on -- of course, you have this new exciting partnership, and you are on a trajectory to improve your EBIT drag on the group, but could you maybe help me understand at what level you might look to spin it out or do something else with it? If you don't see the EBIT improving over the next couple of years? How long can the road be to profitability before you look at other options, so to speak?

Søren Nielsen: I’ll have caution but it is very important for us to come back to profitability, and we do everything we can to get there as fast as possible. And I think you can see that we do take necessary steps, as you say, to reduce a stronger opportunity for global distribution. And I think that all together is what we currently believe is the best way forward for the Communications business.

Unknown Analyst: And is it correct that sequentially, it's slowed from sort of the low to mid-single-digit tailwind seen in H1? And then are you considering any further retail price increases in 2024?

Søren Nielsen: DA’s profit are [indiscernible]. When China is growing less than the rest of the world, you see tailwind. ASP in retail, apart from price increases is relatively stable market by market, and we don't see any fundamental of course, following uplift to ASP and profitability which was a key focus with that exercise. And then we have added to pricing during the past period to cover up for base. What we will do into next year is an assessment we do when we get into next year. But if necessary, we would, of course, again, revisit pricing to see if that's necessary to cover for inflation. [Technical Difficulty]

Unknown Analyst: And just a quick follow-up on Veronika's question on France. Are you able to confirm what percent of your retail and what percent of your wholesale business France currently represents?

Søren Nielsen: I'm careful to spit it out here live I can't remember – [indiscernible] the total hearing care business and wholesale less -- We can come back to you on that.

Unknown Analyst: Just in terms of the outlook for the Diagnostics business going to next year. I’m curious, given your comments around China and some of the anticorruption and lockdown measures, what are your views today going into 2024, whether we should expect in line in the hearing health care or hearing aid business, which has driven hearing health care. Looking into 2024, is there any reason to believe we wouldn't see normal 4% to 6% type of growth that year? Or are we going to a factor in the very tough comps in 2021 thinking about next year…

Søren Nielsen: It could change but as we see things now, a 4% to 6% growth next year. Again, the market has normalized. So the higher than normal growth rate this year is purely due to low comps from last year. The run rate is quite –Commenting on the diagnostic [indiscernible].

René Schneider: Well, no one knows exactly what will happen in China next year. But some of the things that we see now, in particular, when it comes to public spending, we do believe has a temporary character. We are also confident that we will continue to gain market share and grow above the 3% to 5%. That's our view that the market growth fundamentally is. So nothing changed there.

Operator: The next question comes from Daniel Jelovcan from Stifel.

Daniel Jelovcan: First question is to Germany. Is it fair to say that you probably have -- and that's actually the retail isn't that strong, like wholesale, first question?

Søren Nielsen: I think we actually do very well in both businesses. Wholesale have clearly seen a very strong momentum also our retail entities have done well and grown also organically. So Germany, a very good performance.

Daniel Jelovcan: But wholesale is much bigger than retail, right, in Germany?

Søren Nielsen: Yes.

Daniel Jelovcan: And the last question regarding managed care, which you mentioned as a key growth driver in the U.S. market. question is are you totally out there? A lot of companies are going out there. So I wonder what the impact is. Somebody has to do that business a bit puzzled, if you can give us an update on that?

Søren Nielsen: Yes. We are not out of managed care. Our hearing care business in U.S. have just decided to leave to other very big players network because, yes, the share of demand products that could be fixed. So we still do managed care, but in another mix. On wholesale, we, of course, still fight for getting a decent share of managed care business, but we are also focused on -- make sure we force wholesale and retail.

Daniel Jelovcan: But the ASP in wholesale is much lower than in large chains or in VA or the – Is that correct? Or?

Søren Nielsen: That's a product mix issue. But in general, the product mix reflects the general market and therefore, is better than you would find -- you mentioned VA or some of the big players. It's better on the wholesale side. A number of them are very interested. They're not the same or the main -- some have a big focus on price, some have a big focus on quality. The product mix are very different, but a number of the players want to make sure they have what you could call the latest – [Technical Difficulty]

Operator: Our next question comes from Christian Ryom from Danske Bank.

Christian Ryom: I have just a single one for you. [Technical Difficulty]. And compare that to the statutory Danish rate of about 22%. How much of the difference there is explained by interest costs this year exceeding the deductibility cap in Denmark? Doesn't the cap works such that the cap is basically adjusted for each new tax year depending on, say, an average interest rate for the day – [Technical Difficulty]

Operator: The next question comes from Niels Granholm-Leth from Carnegie.

Niels Granholm-Leth: On your last CMD, you introduced your long-term organic growth -- [Technical Difficulty]

René Schneider: We have recently refinanced a significant part of our debt, and that will translate into next year where you will see not dramatically, but increasing interest cost.

Niels Granholm-Leth: And on your interest cost, could you elaborate on how much is the average increase in your interest rate on your net debt for next year compared to this year?

Søren Nielsen: Relatively small -- [Technical Difficulty]

Unknown Analyst: [indiscernible] question is what is the growth momentum you're seeing in Germany? And what percent of your total sales in Germany? And also, are you seeing any reimbursement changes there? And my second question is on hearing aid side for the product -- [Technical Difficulty]

Søren Nielsen: And in between, there are many form factors in a complete portfolio, there's many price points. So it typically takes 1 to 2 years to get through a total renewal. The industry has a very high replacement meaning during the year, both in our hearing aid wholesale business as well as our hearing care business. In wholesale, Germany is our second biggest market. And I can't remember the exact share of that, but it's significant, of course, being the second biggest. On the retail side, it's quite low still. It is a market we have just entered and therefore, it still only have a small representation relative to the size of the market and relative to our global here – [Technical Difficulty]

Unknown Analyst: Just a follow-up question. Even on the viewing rates on the public side, can they be subject to reimbursement every couple of years.

Søren Nielsen: I simply couldn't get the question. Sorry, could you repeat the question, please?

Unknown Analyst: On the hearing aid side even from, like the national health insurance and other insurance agencies and developed markets. Are the hearing aids replaceable or subject to reimbursement every couple of years because you just mentioned that the product cycle is like 2 years for hearing it.

Søren Nielsen: I get you right then when there is reimbursement, whether the cycle for reimbursement is changing. And yes, there has been some extension in Germany of it from some sick fund state. It's not like one sick fund. There's a number of sick funds and some have extended the replacement cycle in -- globally speaking, they are relatively stable these replacement cycles.

René Schneider: In small, a little outside [indiscernible]. This is just a save the date basically. So you all know it. But we'll, of course, share more details on a formal invite in due course. But thanks very much for participating. And as always, let us know if you have any…