Haemonetics Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Hemonetics third quarter fiscal year 2020 earnings conference call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Olga Gayette, Investor Relations. Thank you. Please go ahead, ma'am.

Good morning. Thank you for joining us for Humanetics' third quarter fiscal year 20 conference call and webcast. I'm joined today by Chris Simon, our CEO, and Bill Burke, our CFO. Today, we will discuss our third quarter and year-to-date fiscal 20 results. All revenue growth rates are on an organic basis and exclude impacts from currency, product and supply decisions, and divestitures. Our remarks today will include forward-looking statements and our actual results may differ materially from anticipated results. Information concerning factors that could cause results to differ is available in the Form 8PA we filed today and in periodic filings that we make with the SEC. This morning, we posted our third quarter and year-to-date fiscal 20 results to our Investor Relations website. We included updated fiscal 20 guidance and posted analytical tables with the information that we'll refer to on this call. I would like to remind everyone that consistent with our past practices, we have excluded certain charges and income items from the adjusted financial results and guidance. Details on excluded items, including comparisons with the same period as fiscal 19, are provided with the Form NK and posted to Investor Relations website. Additionally, our press release and website include a complete P&L, balance sheet, summary statement of cash flows, as well as reconciliations of our reported and adjusted results. And now, I'd like to turn it over to Chris.

Thanks, Olga. Good morning, everyone, and thank you for joining. Humanetics delivered strong third quarter and year-to-date fiscal 20 performance as our value drivers are powering revenue and earnings growth. Our multi-year turnaround plans are on track, and we are building momentum to create long-term value. We grew revenue 8.2% in the third quarter and 8.3% year-to-date with all three of our business units contributing meaningfully. Third quarter adjusted earnings per share was 94 cents, up 49 percent from the prior year quarter and up 47 percent year-to-date due to revenue growth and margin expansion. Adjusted operating income margin expanded by 570 basis points year-to-date as we continue to achieve productivity benefits, strengthen our product portfolio, and remain disciplined with our spending. Moving to our business units, beginning with plasma. Revenue grew 12.9% in the third quarter and 14.5% in the first nine months. In North America, we grew 13.3% in the third quarter and 15% in the first nine months. The underlying demand for plasma-based medicines remains strong, and we are seeing a second-half rebound in collection growth to the high single digits. The majority of our customers showed good volume gains in the quarter, especially in the U.S., while volumes in Europe have also increased over the course of the year. We also benefit from pricing, software upgrades, and competitive conversions. Nexus continues to deliver across all four dimensions of its value proposition, yield enhancement, collection efficiency, donor safety, and overall satisfaction. We completed an additional 1.5 million yes collections since our last call, bringing the total to approximately 8.3 million procedures, yielding over 190,000 extra liters of plasma. Notably, Nexus customers grew collections at twice the rate of our other customers in the third quarter, and they achieved meaningful improvements in device turn rates and donor satisfactions. We remain confident in Plasma, its underlying market growth, and our ability to help customers safely and efficiently collect more Plasma. We are investing in incremental and transformational innovation across all components of the Nexus platform. Our donor management software is a key enabler of Nexus. NexLink DMS has established itself as the industry standard, and our software market share is rapidly approaching our device market share. Earlier this year, we made a strategic decision to divest our Union South Carolina liquids facility and rationalize our product portfolio to exit the rapidly commoditizing, margin-dilutive liquids business. We expect a negative revenue impact of approximately $2 million in fourth quarter as a result of this decision. Overall, we are encouraged by the uptick in customer collection volumes and our DMS share gains. we are reaffirming plasma full-year revenue guidance for fiscal 20 of 13 to 15% and anticipate growth will be at the lower end of the range. Next up is hospital. Revenue grew 11.4% in the quarter and 9.9% year-to-date. TAG continued to drive our performance, growing 20% in the quarter on improved utilization, market share gains, and new product launches such as the TAG6S platelet mapping cartridge and the U.S. trauma indication. We also benefited from pricing and investments in Salesforce. The U.S., our largest TAG market globally, delivered exceptionally strong results in the third quarter. Year-to-date, TAG grew about 17% with all major markets contributing. We are excited about our recent acquisition of the underlying TAG6S technology and previously licensed from Coramid. This allows us to pursue our new growth channels outside the hospital, such as outpatient clinics, and also helps improve profitability. Transfusion management grew mid-teens in the quarter and year to date, with both BloodTrack and SafeTrace TX contributing. We continue to support the launch of the next generation of SafeTrace TX, and remain optimistic about the growth of our software solutions in the hospital information systems market. Self-saver disposables showed some improvement in the quarter, but self-salvage continues to be a laggard due to vagaries in the capital equipment sales cycle that distort quarterly comparisons. We are continuing to drive improvements in product performance and sales execution in this area. Overall, we are building momentum in our hospital business. we are reaffirming full-year revenue guidance for fiscal 20 of 11% to 13% and expect growth at the lower end of the range. Turning to Blood Center, revenue was up 0.6% in the quarter and declined by 0.5% year-to-date. Apheresis revenue was up 2.8% in the quarter and 2.2% year-to-date. The main growth drivers were order timing in a situation in Japan where our customer faced shortages due to technological difficulties with a competitor's product. Our team was proactive to ensure our customer had product to meet demand. Improved market share from this situation and continued success in the global rollout of our universal platelet protocol were partially offset by higher double dose collection rates, particularly in Japan. Whole blood was down 0.2% in the quarter and down 3.4% year-to-date. Favorable order timing in Japan and EMEA in the quarter were offset by the ongoing decline in whole blood utilization rates in North America. In addition, blood center software was down double digits in the quarter and year-to-date due to previously discontinued customer contracts. we expect higher blood center declines due to unfavorable order timing in the fourth quarter and a competitive loss of apheresis business to lower cost sources of supply. This business was historically higher margin, but the market is compressing and we chose not to compete on price alone. We expect a revenue impact of approximately $2 million in the fourth quarter and $17 million in fiscal 21. Overall, We are taking action to further stabilize blood center performance. Therefore, we are reaffirming full-year revenue guidance for fiscal 20 and expect to be at the better end of the 4% to 6% decline due to strong year-to-date results. Collectively, our business units delivered robust performance, and we remain committed to executing against our customer-centric growth strategies. The launches of Nexus, TagSuccess, SafeTrace TX, and the universal platelet protocol are propelling us. Therefore, we expect total company revenue growth for fiscal 20 to be at the midpoint of our guidance range of 6 to 8 percent. Now I'll turn the call over to Bill.

Bill Walsh Good morning, everyone. Our adjusted gross margin in the third quarter was 52.1 percent, improving 480 basis points compared with the prior year. This expansion reflects benefits from productivity savings from both our complexity reduction initiative and operational excellence program, improved product mix, and pricing. We also had higher depreciation costs related to both Nexus device placements and expansion of our plasma production capacity, which were more than offset by the benefits I just highlighted. Adjusted gross margin year to date was 52 percent, improving 440 basis points compared with the prior year, with essentially the same factors influencing results as in the third quarter. Adjusted operating expenses in the third quarter were $73.4 million, a decrease of 1 percent compared with the prior year. As we continued to leverage our operating structure, operating expenses were 28.3 percent as a percentage of revenue, or 170 basis points lower than the prior year. We realized productivity savings from our cost savings initiatives and had lower research and development costs, mainly as a result of project timing. Partially offsetting these items were continued investments in sales and marketing as we expand our hospital sales organization. Adjusted operating expenses year-to-date were $220.1 million, essentially flat when compared with the prior year. As a percentage of revenue, adjusted operating expenses year-to-date were 29.3% of revenue, down 120 basis points versus prior year. Similar to our third quarter, our year-to-date results were favorably impacted by productivity savings and lower research and development costs. Partially offsetting these benefits were investments in sales and marketing. Third quarter adjusted operating income of $61.6 million increased by $18.9 million, or 44% compared with the prior year. Adjusted operating income year-to-date was $170.8 million, an increase of $48.5 million, or 40 percent compared with the first nine months of fiscal 19. Adjusted operating margins were 23.8 percent in the third quarter and 22.7 percent year-to-date, an expansion of 650 and 570 basis points compared with the prior year, respectively. While we remained disciplined with our spending, the majority of our adjusted operating margin expansion came from our improvements in gross margin. We remain confident in our efforts to improve our operating performance and raised our fiscal 20 adjusted operating margin guidance to be approximately 22 percent. Our third quarter adjusted income tax rate was 17 percent compared with 16 percent in the prior year. The third quarter adjusted income tax rate was higher than our first half as the benefits of shared vestings and option exercises were lower in the third quarter compared with the first half of the year. Our year-to-date adjusted income tax rate was 14 percent compared with 17 percent in fiscal 19. This lower tax rate was due to higher share vestings and auction exercises in our first half fiscal 20 results. Our third quarter adjusted earnings per diluted share was 94 cents compared with 63 cents in the prior year. an increase of 31 cents or 49 percent. Adjusted earnings per diluted share year-to-date was $2.61 compared with $1.78 in the prior year, an increase of 83 cents or 47 percent. Our year-to-date adjusted earnings per diluted share included a net benefit of 8 cents from the lower adjusted income tax rate and lower share count, partially offset by higher interest expense. Our year-to-date performance has enabled us to increase our fiscal 20 adjusted earnings per diluted share guidance to a range of $3.30 to $3.40 from our previous guidance range of $3.10 to $3.20. This revised guidance implies 38 to 42 percent growth in our adjusted earnings per diluted share when compared with fiscal 19 and represents the highest growth since we started our turnaround in fiscal 17. Free cash flow before restructuring and turnaround costs was $95 million in the first nine months of fiscal 20, compared with $58 million in the first nine months of fiscal 19, primarily driven by higher income and lower capital expenditures, partially offset by higher working capital in fiscal 20. Our working capital cash outflow was $81 million year-to-date, despite an $11 million cash inflow in the third quarter. the majority of the working capital increase was related to high inventory balances, which included the continued manufacturing of Nexus devices and a build in our disposable safety stock levels. Due to strong cash flow in our year-to-date results, we were able to increase our free cash flow before restructuring and turnaround guidance for fiscal 20 to a new range of $125 to $150 million, compared with the previous guidance of $100 to $125 million. In the third quarter of fiscal 20, we entered into an accelerated share repurchase agreement that resulted in the repurchase of approximately 436,000 shares for $50 million. Coupled with the share repurchases we executed in the first half of fiscal 20, we have repurchased approximately 1.5 million shares for $175 million. at an average price of $118 per share under the current share repurchase authorization. We finished our first nine months of fiscal 20 with $126 million of cash on hand, a decrease of about $43 million from fiscal 19 year-end. Once again, we are pleased with the quarterly and year-to-date results. Our revenue growth, operating margin expansion, and EPS growth reflect strong execution and improved efficiency of our operations. And now, I'd like to turn the call back to Chris.

Thanks, Bill. I want to close by reinforcing a few points about our performance and growth trajectory. Third quarter and year-to-date growth are evidence of the strength of our business unit strategies and the value our products bring to the market. Complexity reduction and operational excellence are multi-year restructuring efforts are additional value drivers that are having positive impact on the organization and our P&L to make revenue growth and margin expansion sustainable. We are rationalizing our product portfolio to focus on the products and markets that meet our strategic goals, prioritizing investment and allocating capital to strengthen the core capabilities and technologies that make us distinctive. We are committed to profitable growth, and we act from a position of strength. We are excited about how our people are championing these efforts and about how success is transforming our organization. We have momentum, and we are using it to drive value creation. Accordingly, we are increasing our fiscal 20 adjusted operating margin, adjusted EPS, and free cash flow guidance. We also reaffirm our fiscal 21 aspiration of doubling fiscal 16 adjusted operating income and quadrupling fiscal 16 free cash flow before restructuring and turnaround. Thank you for joining today, and I'll turn the call back to the operator for your questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Anthony Patron with Jeffrey. Your line is open.

Thanks. Good morning, and congratulations on a good quarter here. Maybe Chris and Bill, just to start with just some guidance questions, just the bridge from the first nine months through the end of the year and just the implied guidance for fourth quarter, both on the top line and margin side, it sort of implies... As you mentioned, Chris, a little bit of a slowdown at the top line, but also from a margin standpoint by our math, something in the range of 200 basis points of lower margin versus the third quarter. So just a little bit of color on the bridge there. And I'll have a couple of follow-ups. Thanks.

Hi, Anthony. It's Chris. Thanks for that. Let me start with the revenue breakdown, and then I'll turn it over to Bill to talk through the margin implications. As you know, we typically don't guide quarterly, preferring instead to focus on longer-term value creation. However, we do aspire to give the markets full transparency. You know, our year-to-date number of 8.3%, we think, is obviously robust and speaks to the underlying value of the products. If we've guided it to the midpoint of our six- to eight-point range, you can back-solve for that pretty straightforwardly. What's driving the difference in the fourth quarter? Really all three businesses have a role. So for Plasma, we have benefited meaningfully from the annualization, from the Nexus contracts, which will annualize at this point in the year. We have gone through a process to help upgrade and convert customers to our NextLink software platform. which is a one-time benefit that in some cases will not repeat. And then as we called out on our prepared remarks, we made a choice not to compete going forward in the commoditizing liquids play. So we've taken that out and we called out that $2 million implication for fourth quarter. In the blood center business, by and large, the number one factor is order timing. It's the nature of the business. It's contractual. It's lumpy. And that continues. We've seen that previously. We also have a specific challenge associated with a customer loss where we chose not to compete on price alone, as we call that out in our prepared remarks. That's a $2 million hit. Hospital is a positive, and they continue to show robust growth and momentum, which will help us get them back into the range. But they're really the factors on revenue, and obviously revenue first and foremost has the implication for margin, but I'll let Bill talk about the details of that.

Hi, Anthony. It's Bill. So our adjusted operating margins in the quarter were 23.8%, which for humanetics is an all-time high. And for the year, we're at 22.7%. And that 22.7% is almost a 600 basis point improvement versus the prior year. Now, if you look back to FY17, we're up almost like 1,000 basis points in our operating margins over the course of this three- or four-year period. We did up the guidance to about 22%. And when you really look at the margin, you know, you're talking about like $2 million matters a point on the operating margin. So if we have some investments in a particular quarter that, you know, the timing is off and slide into the next quarter, it could be a swap of, you know, upwards of 2% just on that $2 million when you look at quarter to quarter. So, yeah, it is implied that there's a slight margin move down in Q4, but Longer term, we're not concerned that that's reflective of where our operating margin is going to be.

That's helpful. And maybe the follow-ups here would be one on plasma. Just anything you're seeing there on IG shortages, we pulled out the latest FDA notices on drug shortages. So any update there you can share. And then just to clarify, Bill, on margins, how much of the benefit – that we've seen year-to-date is from the second restructuring program where the growth savings, I believe, are $80 million to $90 million. That's the target over the next few years. Just how much of that has been realized to date? Thanks again.

Anthony, it's Chris. Thanks. We're encouraged by what we see on organic growth and plasma collection volume, as we had suspected would happen. We see a rebound more towards what we believe is the long-term historical average, which is now in the 8% to 10% range. We'll see high single digits in the second half, which gets us fully back into our forecasted range. We feel great about that. There's lots of puts and takes from one customer to the next, given variability that exists there and contracts and tenders, et cetera, that they compete for. With 80% share, that tends to normalize out, not entirely, but mostly and quarter to quarter. But we feel very good both short and long term about that, and we feel great about the role that Nexus is playing in helping enable those connections. Thank you.

And, Anthony, on the 570 basis point operating margin improvement, you could say that two-thirds of that improvement is due to the combination of both the complexity reduction initiative and the operational excellence program savings. Thank you so much.

Thank you. Our next question comes from Larry Cush with Raymond James. Your line is open. Thank you.

Thanks. Good morning, everyone. Just starting off on plasma, could you just help us understand the difference between the 9% in disposals growth and the 13% for the category?

Yeah, Larry, it's Chris. So good growth on the organic side in terms of collection volume. At any point in time, we also participate in liquids, which we're backing away from now. We still have contracts in place. We're not going to leave any customers in the lurch, but we don't have a proprietary advantage there, and customers understand that, and we'll seek sources accordingly. We also have software. Software is really lumpy. As you know, the accounting standards there have evolved, and we have challenges in terms of quarter over quarter and when we recognize things. In addition, we are involved in services and support. It looks different in the U.S. than it does elsewhere in the world, but the combination of those things will contribute, and along with some annualization effects, make up for the relative difference that you see, and we'll continue to include that in our overall forecasting.

Okay. So the message is, however, the underlying demand of 8% to 10%. you still feel good about and, you know, obviously you're looking for high single digits in those disposals growth in the second half. Is that right?

That's exactly right, Larry. We actually feel excellent about it. We feel excellent about the role that Nexus is playing making that happen. Our Nexus customers grew at twice the rate of our other customers in the quarter in their collection volume. Okay, perfect. And then two other quick ones.

Chris, you alluded to in your prepared comments Again, a pipeline against Nexus. Sounds like it could be software-driven. But any comments around that and the timing there? And I guess I'll just ask for Bill quickly. Again, on the inventory and the working cap issue, it looks like inventory increases did decelerate, if my math is right, in the third quarter. But again, I'm just trying to understand Again, what's behind the inventory? I think, again, as you mentioned, it's really Nexus Capital builds, but how should we think about that inventory number going forward?

Larry, it's Chris. On the innovation front, we have a robust innovation agenda. It's one of our core value drivers for the company. We have product roadmaps across all of our products. For Nexus, we think about that across four dimensions – There's the device itself. There is the software, which is not – the device includes the embedded software. Separately, we have our donor management software offering, NextLink. In addition, we have our kits, which is bowl, bottle, and harness, the plastic disposables that are at the core of this. And then we have services, which includes data and analytics and tech support and customer service. We are challenging ourselves to innovate across all of those, I do think that software, as we called out in our prepared remarks, software is having the most immediate and positive effect. Our software share, we now have 12 of our 14 customers in North America on our software, all of whom are upgrading to NextLink, and we're in the process of further innovating there. That gets us 75 share of the procedure volume on our software, and we are committed to continuing to innovate small and large, to make that the standard for the industry.

And Larry, on the inventory, yes, we've continued to have an increase. I think most of the increase in that inventory balance happened in the first six months of this year, so you did see a flattening out of the build and inventory. And again, the build and the inventory was a combination of both Nexus devices and a build in our safety stock levels. We were at a very low safety stock level, and we've built that up to a reasonable level now. Now that we've hit that level of disposable inventory that we're comfortable with, we obviously don't see an increase in the balance there. Now, going forward, I think you can consider us to be reverting back to what we have seen historical in inventory. You're not going to see the same type of build that we've seen over the last nine months.

Okay, perfect. Thanks, guys. Appreciate it.

Yeah. Thank you. Thank you. Our next question comes from Dave Turkley with JMP Security. Show mine is open.

Great. Thanks. The comment that the Nexus customers grew at twice the rate of others, I guess I'd love to get your thoughts on if that surprises you at all and sort of what that implies as you look at sort of your market share as some of these other customers convert. You know, could we see – you know, disposables growth, you know, I don't know, at double the rate you're seeing today if you continue to convert folks.

Dave, thanks. I appreciate the question. I think what we're observing is, again, another aspect of the adoption cycle of the annualization, right? We work very hard with our early adopters to make this seamless and as positive experience as possible. We're confident in our ability to help customers do that. That said, it's a meaningful change, particularly when they change the device and the DMS software as they have. In doing so, there's a complete new set of standard operating procedures and a learning curve that comes with it. The comment is more about the customers who have converted and the learning curve benefits that they are experiencing. To extrapolate that to the entire customer base would be a bit of a reach and probably not something that I'd be comfortable doing from where we sit today. That said, when we look at those 8.3 million collections, the 190,000 additional leaders collected, the 20% plus reduction in cycle time, the 90% improvement in compliance for under and over draws, and the spike in donor satisfaction, It gives us confidence that the nexus value proposition is real.

Great. And as a quick follow-up, I noticed that you bought some IP, I think, around the TAG on the hospital side. And there was a comment about maybe moving it beyond the hospital setting. I was just curious if you might add any additional color on that. Thanks.

Yep. Happy to, Dave. Yeah, we're excited about TAG. We're seeing growth rates approximating 20% here. a really nice acceleration, particularly at this stage in the product's lifecycle. The transaction that we announced in the quarter was we bought out the remaining rights from Coramed, the originator of the product. We've had a really positive long-term relationship with Coramed, but the buyout helps improve our profitability in the near term because we've eliminated the royalty and payments therein. But really what it does for us is it opens up the potential scope of use. We can take this now to outpatient clinics. We can take it to mobile settings. So think, you know, emergency care. Think mobile stroke units, et cetera. All of where we're seeing demand for, you know, our form of the TAG diagnostic and visceral elastic testing, which we think, over time has the potential to expand the total market opportunity associated with that product. Thank you.

Thank you. Our next question comes from David Lewis with Morgan Stanley. Your line is open.

Hi, this is Mason on for David. Thanks for taking my question. So we're starting to see some of the OEP savings as expected. Can you just talk about how you're feeling about the trajectory of those savings over the next couple of years? Are they still looking ratable or more back half loaded? And I guess as a quick follow-up, margins inflected pretty meaningfully in fiscal 20. Should that tamper down a bit in fiscal 21, or should we think about margin expansion as kind of a similar cadence?

So in operational excellence, we are seeing – early savings. We started the program and we announced the program in August or so. I'm not going to talk specifically about the ramp by year, but when we issue guidance for FY21 in May, we'll be more specific in our May earnings call on what the OEP savings are in our guidance. And, you know, you mentioned the comment about it being more back-end loaded. We haven't said that specifically. What we've said is that a lot of these savings are related to the manufacturing and supply chain portion of our business, and those savings may take a little bit longer to get to just because of the nature of what has to be done to attain those savings. But, again, we'll be more clear in May. And then on the margin improvement, you know, I'll speak operating margins specifically. You know, we're really confident in where we are at the 22% for this year. And given the operational excellence program that is out there, we should continue to see improvement, all else being equal in the business.

Great. And then just as a quick follow-up, can we just confirm that the two largest fractionators customers are now using NextLink?

No. We're not going to talk about individual customers just out of respect of privacy for those customers, Mason. I appreciate the question. I know it's important to the investment thesis, but we're just not going to go there. Thanks. Great. Thank you.

Thank you. Once again, ladies and gentlemen, if you wish to ask a question at this time, please press star then 1. Our next question comes from Mike Madsen with Needham & Company. Your line is open.

Thanks for taking my questions. Just want to ask about fiscal 21. I know you're not giving guidance at this point, but streets modeling about 250 basis points of operating margin improvement, it looks like. It seems to me that you could probably get there just with the restructuring and some underlying leverage without any benefit of any additional large contracts or nexus. Can you give me your thoughts on that?

Yeah, Mike, it won't be a surprise, right? This is our third quarter earnings call. We are focused on delivering what's right in front of us and finishing this year with all the appropriate intensity and velocity that's implied by our guidance. The only thing we're prepared to say about FY21 is that the original five-year aspiration of doubling operating income and quadrupling free cash flow as it related back to fiscal 16 is an aspiration that we intend to meet and deliver on beyond that. We'll talk in May.

Okay, that's fine. And then just on the hospital sales channel, can you maybe talk about the latest investments you're making there and whether or not you've been adding reps?

Yeah, so we've made a series of investments there. It relates back to our innovation agenda. We're really excited by what we're seeing in the trauma setting. We got that indication yesterday. approved from FDA earlier in the year for U.S., and the U.S. team has really embraced that. We have the platelet mapping cartridge, which is available now globally and has helped close some competitive product gaps, particularly outside the U.S. The combination of those two things and essentially a 50% expansion in our commercial capacity. We have both your traditional sales representatives, account managers, and and we have clinical specialists that are quota-carrying but really focused on education and helping drive utilization. And what we're seeing more so than in any prior period is a meaningful uptick in that utilization, which gives us confidence that we're building the right capabilities commercially for hospital and we're building the relevance of our product base, which I think helps us get – get comfortable with the acceleration and growth rate that we see even at this stage in the product cycle. So more to come, and I think there candidly is more we can do outside the U.S. as we refine this. We have a new head of that business unit globally, and I think we're just now beginning to see the full potential of that customer-centric global model. Great. Thank you.

Thank you. And I'm currently showing no further questions at this time. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.