ALOG
#Thank you, <UNK>, and I'm going to start on the fifth slide in your deck.
Its title is Q2 FY17 Quarterly Update.
Our Q2 revenue expectations were realized in total, with a substantial uptick in Security, offset by minor deficits in both Medical Imaging and Ultrasound.
Security will obviously have a stellar year.
Ultrasound in total not so much, though the direct business is making progress, and Medical Imaging in between.
<UNK> will quantify those statements for you a little bit later in the talk.
On a more strategic level, our team has been analyzing the future of our Ultrasound business, actually our entire business, so most of my further comments this afternoon will address that and you might want to flip to the sixth slide.
So with Q2 revenue finishing as expected, we will commence the course correction implied three months ago.
Our focus is on restoring the Ultrasound cost structure with Uro Surg at the heart, and adjacent categories competing for resources, as is usual in business.
Rising in priority is supporting both Medical Imaging and Security with sufficient resources to grow.
Before the end of this fiscal year, we will be pruning initiatives that have of recent produced revenue but not commensurate profit.
In fact, some of these initiatives often encourage significant losses at variance to our expectations.
Now as a reminder, three-fourths of our Ultrasound business is strategically advantaged, vested by our customers, featuring brand recognition across the world, profitable and growing.
Yet even this core Ultrasound business should be more profitable.
The remaining 25% of Ultrasound will either promptly improve as a result of the restructuring or find another home.
We believe this is the best long-term strategy for Analogic and our shareholders.
After four or five years of diversification in Ultrasound, sometimes depriving Medical Imaging and Security of resources and attention, we are scrutinizing our portfolio in Ultrasound.
In the portfolio printing process, we have retained those activities that are growing and profitable, those which could be restructured to the same effect, and those that have revenue upside with realizable profit no later than entering FY19.
Importantly, not all of our pruning means discard.
Improve the cost structure and we'll reexamine the Resource allocations.
For example, we are continuing point-of-care initiatives but with a sterner investment and profit criteria.
With the ultimate closure of the Vancouver facility, we will be supporting point-of-care product needs from Denmark.
Notably, part of the heritage of Vancouver will be the transfer of point-of-care product knowledge to Denmark.
Point of care, as well as a few other categories are in the show-me category instead of the promise-me bucket.
We will supply resources to Medical Imaging and Security as warranted, rather than subordinate to Ultrasound.
This back-to-basics approach means some non-productive revenue will disappear, but the losses associated there with will also dissolve.
Signaling that redirection, we are changing leadership in the Ultrasound sector.
We consolidate accountability under the control of a single senior vice president, a measure to both improve communication and execution.
Brooks West, whose background is described in the press release, will be joining on March 13 as Senior Vice President and General Manager of global Ultrasound.
Brooks has both sales and marketing experience in the device sector.
More importantly, Brooks has spent almost a decade listening to corporate strategies and sorting blarney from reality.
During the recent interview process, Brooks challenged our initiatives.
He candidly said we're drinking some of our own bath water concerning the patience of investors.
He's not delicate, diplomatic, or sensitive, but he looks at businesses from your viewpoint with acumen we welcome.
We are in a different course, under different leadership with a different prism for value and decisions and determined to deliver the value for which you invested in Analogic.
So welcome, Brooks, starting one week from today.
The 100-day assessment is over.
We commenced an execution phase that will conclude by the end of FY17.
We enter FY18 with business leaders in Medical Imaging, Security, and Ultrasound, in whom I have faith and who will deliver results that earn your confidence.
In turn, they will have expansive authority to make their businesses successful and a reduced overhead cost to bear.
Q2 was a bit better than we expected, buoyed by Security, which is off to a spectacular start.
Our China and European direct sales teams delivered noteworthy revenues in Q2, in both cases again; however two other key account relationships should be reported which will impact the next few quarters.
First, we continue to experience delays in shipment of our technology product to the Ultrasound general imaging partner.
Accordingly, we have taken steps to provide better technical interchange and work more closely with our partner toward mutual goals.
I too am now involved directly with the progress reports with the partner.
This puts FY17 revenue at risk in favor of a longer-term productive relationship.
We have factored these changes into our FY17 outlook and softened our outlook for 2018, a change which could provide an upside opportunity.
In the second case, we were unable to meet pricing targets for a key customer of our CT components business.
We understand the pressure they were under and wish them success, as they are not just a long-term customer but colleagues in this imaging space.
The loss of this business will be felt entering FY18 and also has been factored into our outlook.
Anticipating the challenges of our component business, part of our strategy has been to work our way up the value chain in CT, which we have demonstrated through our private-label CT activities in China.
We expect this strategy and introduction of additional products in this area will bear fruit in FY18 and will provide further growth in FY19.
I'll now turn the podium over to <UNK> <UNK> who will provide some details behind the aforementioned comments.
Thanks, <UNK>, and good afternoon, evening everyone.
I'll start on slide 7 with our quarterly financial highlights.
Revenue grew 3%, driven by 71% growth in Security, which was a significant recovery from a soft prior-year comparison.
Security growth was largely offset though by declines in Medical Imaging and Ultrasound.
[Non-GAAP GAAP] gross margin declined about 2% because of both product and customer mix.
We turn to non-GAAP EPS; it was $0.99 per share, while GAAP EPS increased $0.83 to $0.59 per share, as we recorded a contingent gain of $8.2 million, or $0.41 per share, due to a drop in the Oncura revenue forecast, as well as in 2016 we incurred charges for both the BK distributor matter and restructuring.
In addition, in the quarter, we recorded an impairment charge of $10.4 million, or $0.52 per share, primarily related to the change in fair value of the Oncura reporting unit.
It should be noted that we passed on all other goodwill, intangible, and annual impairment tests, but our cushion on the Ultrasound reporting unit has fallen to 25%.
Now pertinent to this point, we announced a restructuring primarily focused on our Ultrasound business.
<UNK> has communicated the selling and operational points, so it will not repeat.
The financial impact of these actions is we anticipate reducing our cost structure by $12 million to $15 million on a run-rate basis in FY18.
No run-rate savings are built into our FY17 forecast, but are in upside if we're able to implement actions (technical difficulty).
The restructuring cash charges anticipated are upwards of $5 million, with $0.5 million incurred within quarter two and the remaining amounts expected across quarters three and four.
We may incur additional non-cash charges in the second half of FY17, as we finalize the restructuring plan and determine its impact on our business.
So I'll move to slide 8 and quarter two results.
Non-GAAP operating margin was down about 2% as well, reflecting primarily gross margin results, as well as some higher OpEx because of the addition of Oncura sales marketing costs offset partially by lower R&D and G&A.
A couple of GAAP expense points.
GAAP expenses are significantly lower, reflecting the Oncura contingent gain and the BK matter settlement cost in the prior year within the G&A line, offset in part by the impairment charge.
The BK matter interest charge from FY16 also explains lower costs within the other income expense line.
The non-GAAP tax rate increased to 24.7% from 20.9%, reflecting a lower contribution from foreign earnings.
We still estimate though our FY17 non-GAAP tax rate to be in the range of 27% to 29%.
Non-GAAP operating income dropped 13% and non-GAAP EPS dropped close to 16%, reflecting primarily the impact of lower gross margin for mix, as well as the higher tax rate.
Turn to slide 9 and our quarterly performance trends.
We've already touched on revenue and operating income margin.
One additional point on gross margins is we do continue to expect some improvement in gross margin from the current first-half levels, reflecting enhanced product customer mix.
But lower expectations for both Medical Imaging and Ultrasound revenue will lead to an overall full-year drop of about 100 basis points versus prior year because of the mix impact.
Now I'll turn to our operating performance by segment on slide 10.
Medical Imaging revenue fell 2% caused by lower CT and Mammography, partially offset by favorable timing in MRI.
We now expect Medical Imaging to be down 2% to 4% for the year, reflecting primarily an insourcing decision by one of our large CT OEM customers, which we believe will not be offset as we thought when we entered the year.
Non-GAAP operating margin dropped about 50 basis points, reflecting gross margin impact in the product mix.
Ultrasound dropped 7%, primarily because of lower general imaging, partner revenue, and OEM probes.
Strong results in China and Europe were the bright spots.
We have further lowered our Ultrasound forecast to be down 3% to 5%, as we now anticipate general imaging revenue will push out to FY18, as well as an expectation of the restructuring activities potentially dampening our sales performance.
Lower revenue and a higher run rate cost base primarily from the Oncura acquisition, led to operating margin falling by 9%.
As earlier discussed, we have initiated a plan to address our Ultrasound cost structure, which will drive a benefit in full-year 2018.
Turning to Security.
Security delivered another strong quarter of growth, primarily from higher revenue from international high speed, as well as some rapid D&A shipments.
Confidence in our backlog supports our view that growth should reach the 20% level for the year versus prior year.
Non-GAAP operating margin increased 6%, driven by the revenue benefit, partially offset by product mix.
Move to slide 11 and year-to-date results.
Revenue was up 4%, driven by strong Security performance.
Gross margin is down 2 points, reflecting negative product customer mix within the Medical Imaging and Security segments, as well as a lower Ultrasound contribution.
Non-GAAP operating expenses increased about $4 million because of the addition of $3.6 million in Oncura sales market expense and $1.8 million of CEO transition costs, offset in part by lower R&D.
A note on GAAP expenses is they follow a similar trend of being down as quarter two, reflecting same points related to the contingency gain, impairment, and BK matter charges.
I'll move to my final slide, slide 12, and discuss working capital and cash flow.
We again generated strong cash flow in the second quarter, with $14 million of operating cash and delivered $12 million of free cash flow.
Capital expenditure is still expected to be in the $13 million to $15 million range for the year.
Drivers for the enhanced performance were DSO improvement of 3 days to 53 days, and inventory days on hand reduction of 5 days to 183 days.
I'll now turn the call back over to <UNK> to discuss our outlook.
Thank you, <UNK>.
We have not been swayed from a course correction flagged 90 days ago simply because Q2 had a significant lift in the year-to-date growth is noteworthy.
We will be deploying resources more carefully.
We will complete the restructuring before the end of this fiscal year.
We will be pruning marginal activities in favor of those that have more favorable economic structure.
We will build a cost structure that can sustain value creation, even in the challenging years ahead.
Our revenue growth must follow affordable paths.
FY18 will produce increased earnings as a result of the restructuring.
FY19 will reflect an acceleration of both revenue and earnings.
And one quarter ago, we talked about examining our portfolio.
To be clear, that diagnosis was focused on Ultrasound, and we feel like we have accomplished that goal.
Analogic is not a safe harbor for concepts that require too much capital runway.
Welcome to Brooks West who will remind us of the impatience of our owners and rest assured that the technology on which Analogic was based will be deployed in increasingly meaningful ways.
Analogic has amazing talent, evidenced by the products and security that lift this year.
Medical Imaging will be a similar catalyst in FY19.
We will find a more efficient course to bring products to market.
Analogic has always been able to imagine, design engineer, and manufacture, and now we have to find the best course to bring these products to market.
And with that, we can invite some questions.
I don't know that I'll get all your questions let me start from the few.
We are interested in businesses that grow; otherwise we can't create value.
I start from the standpoint that 80% ---+ 75%, 80% of this business in Ultrasound is in a segment that is growing and we are advantaged, so I think they're not high growth.
There will probably be 3%, 4%, maybe 5% in that area.
But more than we have been experienced in the past, because I think we lost a little bit of focus on the heart of that business.
As far as depriving the sales resources, if you would look at our documents over the last four or five years, you would see sales and marketing expense, extraordinary growth in those categories.
And supporting initiatives, perhaps, maybe even support them well.
But it hasn't produced results and it's been ongoing for a long time.
So I do feel like we have a focused sales team.
I think we see evidence now in the direct side that they can still grow the business.
But for the ---+ I'm going to call the perimeter initiatives, those that are not inside that 80%, we are going to test those.
I think some of them will prove successful.
You asked also about Oncura.
I think Oncura is at the edge actually.
I think there's some potential there.
The one thing that we are doing is Oncura is when acquired, they were both a vet Ultrasound business, and they were imagined to be the catalyst of a human telemedicine business.
We are now focused on the former of that rather than the latter.
So I wouldn't want you to think that we had any imagination of cutting our way to success.
That's not what we're doing, but we are going to be careful where we put the resources and we're going to look at them on shorter intervals, and they need to produce results.
<UNK>, comment.
Well, we've been discussing that, and I think there's an ebb and flow here in this customer set.
Product development cycles could be three to five years, so I think customers come into that.
We're grateful for the business, and occasionally like this one, they go out from that.
I couldn't guarantee that there wouldn't be both in the future.
I think this particular customer was in an extremely cost competitive situation.
And when ---+ I wasn't here when this happened, but I believe that when we discussed this pricing with the customer, they were just going for targets that didn't make economic sense for us.
Sometimes that works.
This is a customer we've long had a regard for, and part of us says we hope it works for their benefit.
But if not and it doesn't work, we'll be here for the rebound.
Thank you for the question.
Yes, we can, <UNK>.
Yes, <UNK>.
That's about right, and you could just ---+ that's about the usual level we run at each quarter.
You can have $0.01 or $0.02 either way sometimes, but that's about the level we run at.
Oh, 2018.
Yes, I can answer that.
I think we continue to expect, as we've seen in the last couple of years, roughly flat growth, up 1%, down 1%, depending on the modality.
And continued strong gross margins and operating margins, so similar to what you've seen in the last few years.
So as <UNK> said, we have ebbs and flows, and, unfortunately, we've had a flow out, which will impact us in 2018.
But as <UNK> discussed, we have a number of products we're working on where we hope certainly by 2019, you can start seeing an improvement in Medical Imaging growth as we move forward.
By the way, <UNK>, I was in Tokyo when this final decision was made, and so when I heard about that, I also heard that there was a three-year contract signed with the same customer in another modality.
So this is a very specific situation that even doesn't go across all the modalities with the same customer.
So we wish we had the business.
Maybe we'll get it again, but I wouldn't read too much into it from a trend basis.
No.
We think they will go outside to another supplier.
I think that supplier will be new to this segment.
And in one sense, I said I hope it goes well for them, but this is a very complicated product.
We'll just have to wait and see.
We've seen experience in the past that sometimes these transitions have gone well, and other times, the customer has come back to us because it did not go well.
I think we will continue to have good growth.
We have a whole bunch of growth drivers in Security.
Will it be at the 20%, 25% level.
I don't think we're guiding to that level of growth, but we do continue to expect to have positive growth in security.
No, we do not.
We think we're on a track with the various growth drivers of our high speed, our checkpoint, and then rapid D&A as a upside that will continue to have growth in that segment.
