Surgical Innovations Group (LSE:SUN) — Interim Results

0:01 Good afternoon, and welcome to the SURGICAL INNOVATIONS GROUP PLC interim results investor presentation. Throughout this recorded presentation, investors will be in listen only mode. Questions are encouraged and could be submitted at any time by the q and a tab situated in the right corner of your screen. Just simply type in your questions and press send. The company may not be in a position to answer every question it receives during the meeting itself. However, the company will review your questions since today and publish responses to where it's appropriate to do so. Before we begin, I'd like to start the following poll. I'd now like to hand you over to David Marsh, CEO. Good afternoon, sir.

0:30 Good afternoon, everybody. Thank you for joining us today. So I'll start the presentation, go running through the commercial and operational highlights, and then hand you over to Charmaine to run through the financial highlights, and then we'll have a summary and question and answer session.

0:57 Okay. So if we start on the commercial and operational highlights. So the company finished h two with strong sales in key markets, particularly in The UK, APAC, and Europe, which was really pleasing to see because that's now back above pre pandemic levels for the first time. We've also seen sort of the area the new geographical areas beginning to gain traction. So the likes of India, Germany, and very slowly, the trocar business in The US as well. Of course, we've issued a trading update a few weeks back highlighting some of the headwinds that the company has faced both from an operational and supply chain point of view and how that's impacted margin.

1:43 However, we have implemented operational review to improve margins and efficiencies, and we've undertaken a significant review of our supply chain department to to ease some of the pressures that we've got there, and I'll touch on those on the next slide. In addition, we've continued to make a transition towards MDR. There have been some roadblocks in terms of the timeline to progress, but that's more around the bandwidth available at the notified bodies than anything on our part. We do expect that to be concluded. We've just got one final group to pass MDR, and we expect that to be concluded by the year end. We have also obtained UK c CA mark, so that's a that's a good opportunity for us in The UK.

2:34 Sorry. Making a meal of moving this forward.

2:40 So to address those operational headwinds that we found, as I said, we've we've implemented a complete review of all operational functions of the business. And, immediately, we're looking at manufacturing and supply chain. The supply chain challenges that we've had have highlighted the wider challenges in the business. We've seen increasing costs, extended lead times, and increasing minimum order quantities, which have heavily impacted manufacturing planning, and have caused a number of issues throughout the business. So a structural overhaul of the supply chain operations to drive a more proactive engagement with suppliers has been implemented, and that's to give us an understanding of costing, lead times in in greater detail.

3:28 Part of this has also allowed us to renegotiate some supply agreements, which we're in the process of doing to keep costs down, but also to provide commitment to the suppliers to keep them engaged. We've employed new people with more experience and are focused on building supplier relationships than we've had in the past. And we're already seeing some some benefits of this in other areas of the business. So for example, in the in our packaging area, we've had a a number of problems around sealing the packaging before it's sent off for sterilization. And working with our packaging supplier, we've managed to change the type of sealant that we use. And so it's eliminated that problem, which is eliminating scrappage and rework as well. So we're in a much better position from that point of view.

4:19 Also, result of a better control of the supply chain will enable us to manage our inventory levels more effectively and thereby returning cash into the business.

4:31 In terms of manufacturing, we've the the whole review has been aided by an industry expert, and the initial focus on supply chain and manufacturing has already implemented a number of measures to drive down to to sorry, to improve margins. We're renegotiating some key contracts, and that's improving the margins in that area. We have a cost down initiative in all areas of the business, particularly in new product design, but also in manufacturing where new tooling, which we have mentioned previously, is now in place, and that's driving margins too. You may remember that last year to help us with the retention and recruitment challenges that were faced by industries last year, we introduced the four day week.

5:24 We are reversing that now. And from the November 1, we are returning to a normal thirty seven and a half hour week, and that will help improve productivity. I know I've talked a little bit about how we're improving scrappage, and there's an ongoing review around that. So the measures that I've just talked about, we estimate we'll return about 300,000 for the business over a over a year. And they should we should start to see those filtering through in the coming in the coming months and into next year. From a market overview point of view, The UK, which is the elemental distribute the elemental business. So this business is is performing really well, 13% growth over last year. And that's despite the clinical staff industrial action that we're seeing in the NHS and the increasing waiting list,

6:21 which I think at the last estimate was around seven and a half million. So that's that's ten percent of the population is waiting for some form of treatment within the NHS. These, the SI branded products grew really well, nearly 30% up on same period last year. And that's on the back of the sustainability messaging, which continues to drive evaluations and conversions. And we're seeing that business continue into into the new year into the second half of the year. Sorry. We've also introduced an intensive sales and product training for our sales team, our expanded sales team. And this is we're seeing this benefit in terms of the sales team having a greater understanding clinically.

7:08 They're understanding the sustainability messaging, and this is developing growth in today's quarter three and the second half of the year.

7:24 The US is remaining a bit of a challenge for us. We're seeing flat scissor growth in that region, and the business overall is down 20% on prior year. So there are a number of factors around this. The Adler, our master dealer for scissors in The US, they have focused primarily in the Southeast, and that business is is being maintained. But where they are overseeing the consortium network, they're struggling to do this, and we're struggling to make impact. And so we're changing focus to work with a fewer number of distributors, but to work more closely with them to deliver the sustainability messaging and to work with the GPOs in those regions.

8:13 So we're working on a sort of a a lot more narrow and deep strategy, and we're we hope that that will give us quicker and sharper growth as we go forward. For the trocars, we go through MicroLine who who share our sustainability messaging. Activity has been a bit slower as they restructure some of their operations in The US, and we sort of the the growth in the first half of the year was a a little bit slower. But we're working with the regional sales managers to implement a an incentive account conversion program, and we're also supporting those regional sales managers to drive sustainability and the nuancing around trocars.

8:58 So we expect to see traction, and we have won a number of small accounts in the last couple of months. So we're we are beginning to see some progress there. In terms of Europe, as I mentioned earlier, that business has returned to pre pandemic levels or above pre pandemic levels. Sales grew 18,

9:19 and this is back this is on the back of improved sales and marketing support to help drive the sustainability messaging. We're seeing key countries like France, Spain, and Benelux now have reduction in single use agendas in their key health care providers, and that's growing sales. And we we continue to see growing sales into the second half of the year. The APAC region grew 12%, again, primarily Japan, but we will see further regional growth. The completion and registration of the elite five millimeter optical trocar will allow, particularly in Japan, allow ongoing growth in the second half of the year. And in the new markets of India, we are seeing a strong pipeline of evaluations where we have worked really closely with them to develop that business, and we expect that to come to fruition probably in quarter four this year and into next year.

10:17 Rest of the world grew 58%, but it's on a small number. That's primarily driven by a change in distributor in Canada. We now go through, the MicroLine distributors, so they understand the sustainability messaging. And we've had a number of new account wins in Israel, which has been really promising too. On the OEM side, so the supply chain challenges that we faced in the first half of the year had significant impact, particularly on our OEM business, and we entered the second half year with a significant back backlog of orders. We've addressed that during July and August, and we have a strong order book for the remaining remainder of the year.

11:04 The changes to our supply chain department have already made progress to address these supply chain challenges, and we see that reducing over the year. Although margins have been impacted as we see some in increasing costs there.

11:23 In terms of compliance update, we continue to make progress to the transition of MDR. Although we are seeing the focus of the notified body shifting to more immediate priorities now that the extension to c the extension c mark has been granted. In addition, the compliance team have successfully navigated UKCA certification and n d r sorry, MD SAP and microbiology audits have successfully been completed this year too. The regulatory environment remains challenging, and investment in this area will continue. But we do foresee a time in the not too distant future when we can start taking some cost out of our our compliance budgets.

12:12 Moving on to new product development. We had the successful launch of the optical five mil truck car in most key markets. Japan registration is pending. We expect that in q four. One of the benefits of MDR has seen the the ability to rapidly develop some new products under line extensions, And we will introduce at the tail end of this year a cutting shielded trocar, which has specifically uses in gynecology, and that will complete the yellow port elite family. We have a number of other projects which have been delayed partly by the supply chain challenges. So the logic dissect and logic grasp are typical of that.

13:00 They were on track for a q four launch, but that's been pushed back until q one twenty four, and that gives us a real opportunity to build it next year. We've continued with a number of cost down projects around the YellowPort Elite and LogiCut. New tooling is now in place, and that will drive cost out of one some of our high volume products. That's now validated, and we'll see that filter through in quarter four or the benefits of that filter through in quarter four. And we've got some further projects around materials, which will take cost out and a more sustainable materials too and some supply chain sorry, some design changes to to follow.

13:47 So I will now pass you over to Charmaine to take you through the financial. Good afternoon, everyone. I'm gonna talk you through the financial highlights, and then I'll go into more detail on the slides further down. In terms of overall revenue, we're 4.4% up on the comparable prior period. That growth really driven from The UK, Europe, and Japan regions, really. Look at the underlying gross margin, we have seen those operational inefficiencies have an impact on those margins. So if you look at the comparable period in the prior year at 45% going down to 4.5%, and I'll talk through that in further detail on on the slide further down.

14:34 Overall, we've got an adjusted EBITDA profit, a small profit, still profitable at that that level, and we continue to do so aiming for the second half of this year being in a positive position. The change, I suppose, from the price period as well is mostly the majority of that is investment in sales and marketing, which has been driving the revenue growth.

15:04 In terms of looking at the revenue analysis from a segment point of view, and David's talked about the how that geographical split looks. So the SI branded portfolio and the distribution showing 10% growth. I'm really pleased with that. Distribute distribution in particular has actually started to grow in in terms of a larger percentage of revenue. The OEM has been hindered by those supply chain delays, which David's talked about, but we've got strong second half. Looking at the margin analysis, and we we break this down into two areas really. At that commercial margin and the underlying gross margin, we can see that we are still within our target range of 40 to 45%.

15:52 But you can see from last year at the beginning of the year, we've gone from 45 to 42 to 40.5. We can see that decline, basically from continued pressure with those inflationary increases. We have done a series of planned price increases to mitigate less where possible, albeit some of those have been delayed because we've got fixed term contracts in particular with supply chain framework. In terms of those reported margins at the bottom levels, we've gone from 34.6% down to 33. And those operational inefficiencies, in particular manufacturing productivity and supply chain challenges continue into the second half of the year that are causing that reduction in margin. And obviously, David's talked about the ways that we're gonna look at improving those efficiencies and plans are underway as we speak.

16:46 Looking at the adjusted operating expenses, you can see that from beginning of last year, we have increased those. We have additional investment in sales and marketing, which has been driving that growth. We have continued to invest in our regulatory, and they continue to be at higher levels so we can push through with our MDR certification. Those overall inflation pressures continue though into the second half of the year. We will look to review these as we go into this into the q four and look towards the second half of the year as well sorry, beginning of next year as a as part of our operational review. We would expect those operating expenses to be at similar level for the full year.

17:37 Moving on to the the financial position. So we continue to invest in capital expenditure, and we have got plans in place at the beginning of the year for further investment. We might need to shift that focus as we look at these challenges that we're facing at the moment, but the plans still remain in place. Our inventory levels have been higher, so the 3,500,000 at the end of June, and we've we've kept that at a higher level to mitigate some of the supply chain issues. But we have started planned reduction and to try and get those back to normalized levels, and that will release cash back into the business. We're going to get those around about 3,000,000 at the end of the year. In terms of overall cash, we still maintain cash headroom of 2,410,000, And included in that, we've still got a 1,000,000 undrawn invoice discount facility that we can use for further investment if needed.

18:30 I'm gonna hand you back over to David to go through the summary and outlook. Thank you, Shammy. So in look. As we look to the outlook, the strong sales in h one, especially in SI brand, are continuing into the second half of the year, and we expect that to continue to year end and beyond. There are a lot of evaluations and a lot of activity going on, not just in The UK, but across Europe and into The US as well and India. So we we see a real positive opportunity to grow us continue to grow our sales. MDR transition remains on track. We expect that to be concluded this year, and we've we've just got the one remaining product group to complete the technical file review. So we're we're well on track for that.

19:26 The company having sort of sort of suffered the headwinds of supply chain and manufacturing issues, We've responded effectively to these operational challenges, and we expect the benefits of actions that we've put in place and continue to to review and change to filter through to the p and l in quarter four and into 2024. And, you know, we anticipate that we'll be back to normal levels of of margin towards the end of twenty twenty four. We continue to invest in new product development to drive costs down and to deliver new products to the market. You know, that is something which we we strongly believe in. And, you know, sort of part of that is to take some cost out of our high volume products so we can improve margins from that perspective.

20:18 So we we finish with positive sales to con continuing into the second half of the year, and we're confident that we will hit management expectations from a revenue perspective. And we continue to address the challenges that we have in the business, And we're already seeing sort of nominal improvements that will accelerate as we we move to the year end and into next year. So that concludes our presentation. I'm happy to start taking questions. Perfect. David, Charmaine, thank you very much for presentation. What I'll do now is I'll just bring your cameras back up. Ladies and gentlemen, please do continue to submit your questions just by using the q and a tab, which is situated on the top right hand corner of your screen. But just while the company take a few moments for you those questions that have been submitted today, I'd like to remind you that recording of this presentation along with a copy of the slides and the published q and a can be accessed via your investor dashboard.

21:13 As you can see we received a number of questions throughout today's presentation. And, David, Charmaine, if I could just ask you to read out those questions and give responses where it is appropriate to do so, I'll pick up from you at the end. Of course. So question number one, how reliant are are you on third party sales team, and how do you maintain their focus on your products? It's a really good question, and it's one of the challenges of working with a distribution network. So we it it will vary from distributor to distributor and how much access you get to them, but there is a very definite link between the the more the greater the access we have, the greater the result we have as well. And so we produce a a number of marketing tools around sustainability for countries to drive that messaging to health care providers.

22:06 We have a sales team that work very closely, firstly, with the sales managers of each company, and then they go out and they co travel with their sales team. And we find that that, by helping them and showing them how to do conduct evaluations properly, to understand the nuances of products, and to show them how to convert to an evaluation to a sale, that works very effectively for us. So there are, you know, a number of measures that we do to to ensure that we have focus on our products rather than other products they have in their portfolios. Next question is why has your expansion into new geographies been slower than anticipated, and how can you change the rate of change? So very, very similar to the previous answer in many ways. So so if we take India, for example, so there are structural issues within the business in India where they haven't had the right sales network for us to link into.

23:17 We've now worked with them to put that in place. We they have a new sales director who is working very closely with our international team. They have new salespeople that are properly trained, and one of our team members will be out there next week conducting a full training program. And it's providing the the incentive to drive evaluations in those hospitals. The beauty about India, for example, is that, you know, a typical hospital in The UK will do about a thousand laparoscopic cases a year. In India, it's about six thousand cases a year. So you make a conversion there, and the impact is significantly greater. But we have seen, for example, in our trocar business in America through MicroLine where we anticipated that to be much faster.

24:10 They have been going through some structural changes, and we are now beginning to find our route through the regional sales managers to the sales team. And that sort of we we are seeing activity increase. So next question. What is your marketing spend for this year, and how is it split geographically? So we we we don't necessarily split the the marketing spend geographically. We we split it to on to to develop the tools around sustainability, around product information, around product training. And so it that is spread right across all regions because product training applies to all markets.

24:59 Sustainability is a key unique selling point for us, and we drive that through our distribution channels. And we have things like a financial and environmental calculator that allows hospitals to understand their current spend using a competitive product, the equivalent spend using SI branded product, and the reduction in c o two and plastic waste. And so it's a very effective tool. And so it's measures like that that we spend our money on and then roll out to the team. It's not broken down by geographical region, but it's it's broken into developing the sustainability messaging, product training, and things like that. The next question is, you engaged a specialist to investigate manufacturing and supply chain disruptions.

25:51 What are their findings what are their findings been and recommendations? So we're still we're still in that process, and we're still working with them. There have been some very quick fixes that we've talked about around renegotiating contracts, around tooling, and a number of different initiatives that we've got in place that we will see driving the bottom line throughout this year and going into next. We continue to work with the with the specialist, and we're developing data to help us understand some of the areas that we can improve faster. So it's a it's a question that the the person came on board at the tail end of the first half of the year, and we're working with them and through different initiatives. So rather than, you know, sort of we don't have definitive findings per se at the moment, but we are putting measures in place to improve the to improve the business as as we speak.

26:56 So I think that concludes all question. Perfect. David, thank you very much. I think you've addressed all of those questions from investors. And, of course, the company will review all the questions submitted today, and we'll publish those responses on the Investor Meet company platform. But just before redirecting investors to provide you with their feedback, which I know is particularly important to the company, David, could I just ask you for a few closing comments? Of course. So I I think we leave you with the the messaging that's from a revenue point of view, you know, sort of the the business remains very strong, very outlook for the rest of the year. You know, sort of our own SI branded products are continuing to grow well across the globe, and that's very encouraging. We have responded effectively to the operational challenges that we faced and continue to do so, and you will start to see those benefits filter through to the p and l in quarter four and throughout next year.

27:51 So sort of we we have a positive message around sales and the order book, and we are putting right some of the challenges that we faced in the first half of the year. And the the business will be in good shape as we enter into 2024 and beyond. David, Charmaine, thank you once again for updating investors today. Could I please ask investors not to close this session as you'll now be automatically redirected to provide your feedback in order that the management team can better understand your views and expectations? This will only take a few moments to complete, but I'm sure it'll be greatly valued by the company. On behalf of the management team of SURGICAL INNOVATIONS GROUP PLC, we'd like to thank you for attending today's presentation, and good afternoon to you all. Thank you. Thank you.