Stratec SE (SBS) Earnings Call Transcript

Good morning, everyone. My name is Federica Lussana, and I'm part of the healthcare investment banking team at JPMorgan. It is my pleasure to introduce our next presenting company, STRATEC. You're going to hear from Marcus Wolfinger, CEO of the company. [Operator Instructions] And with that said, let me hand it over to Marcus, and thanks all for joining us today.

Yes. Thanks, Federica, and good morning, everybody. Welcome to the presentation of STRATEC. We'll be providing forward-looking information. I was intending to split this presentation into 4 major segments. Like please allow me for 3 minutes for those ones of you who are new to the story to like either get you up to speed or get you an intro into the story. Then I would like to discuss our strategy and what we are planning to do, followed by some figures. And at the end, obviously, the chance to discuss certain elements of the presentation. We develop and manufacture analyzer systems, plastic consumables and in some cases, even the biological material for our customers. You will never find a static instrument out there. We are a pure OEM player. On the right-hand side of that slide, you see a selection of some of our products. Those instruments are already labeled when they leave our factory under our customers' name. Often, we are getting confused with the contract manufacturer. But like taking an example of the automotive industry, it would be as if you would call [ Buscher Magna ], a contract manufacturer. And we are of the same kind. We develop and manufacture those instruments based upon our own background IP rights. From a contractual perspective, we go through a phase where we customize our background IP rights according to the mutually agree different specifications, and then we deliver a specific product to the customer. At this point, about 50% of though, in the meantime, 1,500 employees or state are allocated into R&D. I think it shows a clear commitment to R&D. And like looking into the budgets of 2023 and 2024, we are intending for both years to grow by about 15% in R&D. I think this is not only a commitment. This is unique, and it actually shows how packed or dense our development pipeline is. We have manufacturing sites in Germany, Switzerland, Hungary and Austria. So, it looks a little bit like a European company. It definitely is a European company. But I think it is important to understand that particularly in our industry, 9 out of 10 decision-makers are actually sitting in the United States even if the companies have European names, the decision makers in the diagnostics or the adjacent markets are actually sitting in the United States. I'll dive into our M&A strategy a little bit later, but I think it is important to understand that besides our existing M&A strategy, certainly getting a stronger footprint in the United States. It's not only something which is requested by our partners. I think it is a must stays, and it's actually part of our development strategy. So, if you look into the number of installed instruments, again, labeled under our customers' names, so you will never find that STRATEC instrument out, you will find a Hologic Panther or a Diasorin LIAISON instrument, which is developed based upon our background IP rights manufactured by STRATEC. You will find those smart consumables, life or bioMerieux and other companies running on those instruments. If you would take that figure dose 14,000-installed base, actually 14,000 instruments mid to high throughput and 30,000 of lower throughput and would actually extrapolate that into a diagnostics company with this rule of thumb that from the value proposition that in an installment of an instrument, about 85% is the biochemistry side. So that's actually that part of the business, which is in the hands of our partners and 15% instrumentation. And if you would extrapolate that figure, it would get us into the size of about EUR 2 billion if we would be a diagnostics player. I think that shows our role in this industry, which would mean that we would be most likely among the top 5 players if we would be a diagnostics company. However, we provide instrumentation, consumables, in some cases, the biochemistry. Sales split last year was about 1/3 our recurring business. I think and I think that's important to get that across from the beginning is we will certainly never get this business into a plane vanilla raise a razor-blade business model. However, -- at this point, we are generating about 1/3 of our revenues with recurring elements at this point, mainly maintenance parts and spare parts. But like with the acquisition back in 2016 of the Sony DADC Bioscience business and with all our other activities regarding plastic consumables and certainly other maintenance parts and deepening our value chain here. It's definitely our goal to extend that proportion with recurring business. I think over the next years, we have the chance to grow by about 1 basis point a year over the next coming years. So, I think there will be a certain saturation at a certain point, but certainly not in the area of 50%. I think we have a good chance to grow over time in that area. Certainly, ESG and allow me to touch base on that is a very important topic for us. Let me pick out 2 examples for almost like 20 years. We have solar panels on our roof. We take that very serious. We are very proud of our products and our processes like we -- although we have regular FDA inspections like at least once a year in one of our sites, we never had a warning letter or anything the like. So, we take that very serious. And this is nothing to do with what we show on that slide, I think sustainability and all the other aspects of ESG are super important to us and has always been. In order to address the segments, our customers are working in -- we have splitted our business into those 3 major segments. -- strata instrumentation. As you can see, we are developing specific products based upon our background IP rights and the customers are getting a specific product. It fulfills the look-and-feel approach they are actually shooting for main markets here are our 2 strongest market segments. We have others as well, and I'll dive into detail. However, rent this part of the product portfolio and strategic instrumentation is definitely dominated with products for molecular diagnostics and Immunoassay. We have market-leading instruments out there, and I cannot get you too many details. We have recently launched a product in the dPCR space. We are working together with 2 out of the 4 players in the dPCR space. We have developed and are manufacturing, the pander instrument for Hologic or the LIAISON family for Diasorin. So those ones of you who are familiar with this industry, this actually shows our strength in this area. The end users are mainly the clinical apps, to a certain degree, the reference labs and blood banks and customers are hospitals. So those ones using bigger instruments, instruments like as an Immunoassay north of 100 tests per hour throughput. This part of the business generates about 70% of the group's revenues. Then certainly from a strategic perspective, a super important part of our business is STRATEC smart consumables. It acts as a door opener. I -- after the acquisition, it became more and more clear for us that like particularly with newer markets with higher sensitivities or point-of-care markets that complexity moves a little bit away from instruments and moves into that plastic piece, several process steps microfluidics are certainly important keywords here. And since then, STRATEC Smart Consumables acts as a door opener. We have some common projects where STRATEC Instruments provides the instrument and STRATEC Smart consumables provides the consumable and smart consumables. There is no necessity to do that, but it definitely helps to bridge those interfacing risks and our partners actually see this as one of the very meaningful points in the cooperation that we reduce the risk of integration of complex consumable on an instrument. Our Diatron division is manufacturing smaller instruments, so typically bench instruments from a manufacturing concept, it's different. We have activities between the 3 business units. So just as an example, some of our molecular products are actually developed within STRATEC instrumentation, but due to the manufacturing skills and the size of the instrument, the manufacturing transfer took place into Diatron and instruments are then supplied from our Diatron business units towards the relevant customers here. Definitely, it's not that play in vanilla OEM business. We have developed certain platforms, which are marketed through distributors or are actually white label products. So, the same platform is sold to a variety of customers under their own brand name. Platform is a very important topic here. Diatron generates about 1/4 of the group's revenue. We are uniquely positioned within the value chain in the cooperation with our customers. As I was already trying to get it across, we see our role as providing the analyzer systems as providing the software running on the instrument. And I think that's an important topic when an instrument get launched, about 50% of the efforts associated with the product development are actually -- is actually software development, and that's only under the launch. If we are getting into the product life cycle where software gets renewed every 18 months, every 2 years towards the end of the product life cycle, the actual efforts for software development are more getting into the 70%. So, this is a super important topic for us. Then certainly, plastic consumables are coming from us, not necessarily, but certainly, we are strengthening our position there. And as mentioned before, in areas like hematology, even the reagents are manufactured STRATEC for our customers. I think it is important to understand that particularly reagent and consumables are at least partly seen by our customers as part of their strength and core expertise, so they will never outsource it, but some actually do. And that's part of our business model to really take over what is perceived by our customers as noncore, ideally combining those businesses from different customers and making really a business out of that. Product life cycles are super long in our industry. So -- and that makes it a little bit difficult to get our forecast, of course, but I will try to do that. So, let's assume we are in touch with a new customer and are discussing specifications. It typically takes us a year to even nail down initial specification and to start the negotiations about a contract. Typically, what happens then is feasibility work. So, before we actually start with the development work it takes us 2 years to already and to only get to that point. In order to mitigate and manage any risk and to make the development process at play in vanilla straightforward development process, we perform those feasibility studies, taking us, as mentioned, 2 years. takes us another 18 months to 2.5 years to get the prototypes over. And like until we are trying to get approval for those products together with our customers, it takes us 4 years. So, we are -- at this point, we are already 6 years in. And then again, even if the products are launched, typically, our customers are launching those products with a limited number of tests called the menu being available on those instruments, and they don't have worldwide approval. So typically, if we see meaningful contribution in our P&L with new instruments, it takes us another 2 years. So, I think this shows how long the product life cycle from the first ideas until the product hits the market is already taking us into like more 7 years than 5 years. And then typically, we are selling those products for a minimum of 12 years. Part of our business model, and I mentioned that before, is that we use our background IP rights, which means typically, this helps our customers to launch a reliable product from the beginning, and we don't have to start development work from the scratch. So that means we are using established technologies and are developing a specific product to be manufactured in serious manufacturing then later on for the customer. As a trade-off, that our customers don't have to pay the entire development work, but are using our background IP. We are asking for a variety of things. But in common is that we are typically asking for a minimum volume commitment, which means after the market launch, there is a phase where our customers for a certain period of time, have to take a certain number of instruments or consumables or anything which is provided by STRATEC. And additionally, we continue to have ownership in the associated background IP rights. -- which means our goal is to guarantee each and every partner freedom to operate, which means we cannot hand over IP rights of a specific product of our background IP rights to those customers, which means we continue to have ownership. This means, in most of the cases, our customers don't even get access to the software source code or to the drawings or the PCBAs, everything, which is associated, which means they are buying those products over the entire product life cycle from us and cannot walk away. This actual long-term contractual setup is leading to 4 major value streams. First of all, we are collecting milestone payments based upon the achievement of technical milestone like supply of prototypes or supply or validation units during the development stage. If we do that with, let me say, early or start-up companies, and I'll dive into detail later on what that means for us, we are not only collecting the milestone payments, but often we do development for equity, which is a value stream for us. But as mentioned before, we have a very hard criteria. If we do that and we are only doing that like in 1 out of 10 projects, first value stream. Second value stream. As soon as we are -- as soon as the product launch is happening, which is a series of regulatory and quality management events. The products are sold in quantities, typically instruments or consumables. And obviously, along with the product, we are sending the invoice, that's the second value stream, third value stream is recurring revenues, like maintenance parts and consumables. Again, as soon as the products are shipped, we are collecting the money. And then certainly, we are providing additional services like I mentioned before, the fairly long product life cycles of our products like north of 12 years. It means that software has to be renewed in some cases, even hardware, which is the fourth almost guaranteed value stream. Talking about the markets. I mentioned before, the manufacturing in Europe and to a certain degree, services in the United States has a necessity to make sure that we are only working in those market segments, which are really providing the multiples and now really like helping us to find our sweet spot from an application perspective. And here, we have a variety of sweet spots. So certainly, it's molecular, here mainly random access, mid- to high throughput. A typical example would be the Panther instrument for Diasorin or the LIAISON MDx instrument for Diasorin then certainly, our strength and that's actually where we are coming from is Immunoassay here more or less. In the meantime, exclusively chemiluminescence Immunoassays, where we are serving a variety of instruments to the market-leading companies, particularly in the Diatron business unit, we are working in the hematological space with the acquisition of Diatron back in 2016, we got access to the veterinary space, which is in the meantime, generating a nice top line and margin profile. Today, we are generating about 10% of our revenues in the veterinary space. further applications, and I'm not intending to read you through that. Another very important aspect is actually that we are doing complex sample processing, which is becoming particularly in those areas which we often call translational research. So, at the border line like between life sciences and diagnostics that often complex automation processes are playing a meaningful role, and that's where we are actually working in a variety of products together with our customers. Certainly, tissue diagnostics is becoming more and more important, particularly considering all the activities of the IVD space and of us in the oncological fields. On the right-hand side, you see those pie charts. So, the darker the blue is the more our involvement. As I mentioned before, immunodiagnostics, -- this is actually where we are coming from. So as you can see from a market perspective, already 50% of the applicable market segments for STRATEC are actually in immunoassay and molecular but certainly, hematology and Clean chem, which is not that important for us but are playing a role for us. I mentioned before when I made that extrapolation of how big would we actually be being a diagnostic company. And you see that breakdown. If we are looking from a perspective of our customers, about 80% are in the hands of our customers. That's a typical equation. So, in some areas, it's actually 90% in other very instrument-heavy market segment, it may only be 70%, but as a rule of thumb, but I think 80% is okay, which means that $100,000 instrument typically generates 3x of its value with the biological sales through our customer, which means over a typical product life cycle and instrument costing $100,000 generates between EUR 1 million and EUR 1.5 million or euros in sales for our customer. And that's actually a good point to start from if we think about market and market development. Outsourcing in -- I mentioned before, our intention to grow over time. And I think you saw that on the first slide that after the IPO in 1998, we grew on a compound annual growth rate level by 15% top line. Our long-term goal is actually to stay in the area of high single digit, low double digit, like on a 5-year rolling horizon, I think the assumption of high single, low double-digit growth is actually a good one. We believe that about -- and that may differ from year-to-year, but we believe that about 50% of that growth is actually growing with our existing customers growing with the market, but the other 50% is actually that super strong outsourcing trend. We believe we are sitting in Southern Germany, highly dominated by the automotive supplying industry. We believe that our industry is where the automotive suppliers used to be like in the '70s and '80s. So outsourcing is only beginning. Outsourcing doesn't mean contract manufacturing outsourcing means that somebody assumes full responsibility for the entire product life cycle and for the performance of the product, and that's what we actually do. We cannot be successful if our customers are not successful. And that's actually our motivation to provide them with a quality, reliable product, fulfilling all the requirements of the customers. At this point, and it really depends on which survey you are looking. We believe that about 40% of all instruments hitting the market at this point are outsourced instruments, outsourced by our understanding. So, handing over responsibility for a product to a player, but still 60% of in-house development. In the area of complex microfluidic element, it's actually, let me say, for us, way better from an outside perspective way worth because actually -- and again, it depends on the survey between 90% and 95% of our plastic pieces hitting the market are actually the industry called it foundry. So, products which are actually designed and manufactured under the control of those companies selling the products, but we truly believe and we see those indications already that particularly for the second and third generation products when, let me say, pricing constraints are kicking in technological constraints, ramp-up constraints and everything else are kicking in that those companies are willing to outsource the next-generation product. And here, the actual volume and value contribution is even bigger than on the instrumentation side. So, what I want to get across at this point is we are far away from a saturation effect in outsourcing. We have that -- and I mentioned that we have that strong base of recurring revenues. At this point, about 1/3 of revenues, very much dominated at this point by maintenance part. We are selling some classical consumables, which have been designed over the past 10 years, but what I would like to get across certainly the highest value contribution, and we believe that, that part of the business may become EBIT margin accretive over time is certainly by complex plastic consumables. So, all on one carrier, ideally very few moving parts, several process steps on one cartridge, microfluidic. Those are those elements which are differentiating us from our customers. With that growing installed base, we saw during corona, so some of our instruments had really nice tailwinds during corona with this growing installed base. Certainly, we have a good chance to actually not only grow absolutely, but even nominally with those maintenance and ops spare parts on that area. So, we have some -- we've put some details here. At this point, as mentioned, breaking down revenues in a typical year. And again, that may vary between year-on-year, about 60% of revenues with instruments, about 10% with development and services, which is a little bit lumpy, but not lumpy because of our activities. It's lumpy because of the capitalization aspects of development activities, particularly related to IFRS 15, which is a real challenge for us, particularly as our development projects are long-lasting multiyear projects and again, getting back to the service parts and consumables at this point, about 30% -- but as mentioned before, we think that not only from a growth perspective, but even from a value contribution perspective, this is the area we are focusing into. On that slide, we put the top 20 of the IVD space, which is our main market. I mentioned that before that about 95% of our revenues are in that space, led by Roche, obviously, those ones indicated and you will hardly find the white spots here. Those ones indicated in blue are our core customers, which means we are generating our revenues with 15 out of the top 20 in the IVD space. It looks like a horribly saturated market, but actually, it isn't -- so companies like Roche or Albert or Beckman from Danaher, actually, they have a variety of products, which could theoretically come from us. We do 1 or 2 or 3 of their projects. They may have 20. So obviously, like in any other industry, it's a little bit easier to do project #2 or project #3 with an existing customer rather than checking the box with new customers. But what I want to get across here is that, first of all, we have established a business model, particularly from an IP rights perspective, which allows us to work with companies which are actually competing in the space. And secondly, that we have a very stringent approach of how we want to do business with our customers. So certainly, we are splitting our customer base into 3 major segments. Let me say, the top 10, which is actually super attractive from a volume perspective, but like they typically have overlapping product portfolio, it's a little bit more risky to do business with those companies because we have no influence whatsoever about their strategy, we can only contribute. In very rare cases, we do their core products. Often, we do their niche product, which is super attractive for us, but still a niche product. South of the top -- of the top 10, it's a little bit easier. So typically, we understand the strategy. We know that these companies can only grow using our technology, the likelihood that those products will hit the market is way higher than in the top group. And this is why our sweet spot is definitely to be like south of the top-10. And then only the third group is important as well because typically, we are working with the innovators in that space. Just picking out the example. We started the project about 10 years ago, which was one of the first products where we had combined efforts with our smart consumables business and a product very successful outcome, nice growth rates. I don't want to touch dive too much into the details. But as you can see, long term, I cannot promise that we are growing on a quarter-to-quarter basis on a year-over-year basis. What I can promise is that if you take a rolling 5 years forward, that we are growing in this area of, let me say, high single digit, low double digit, same thing applies actually for EBIT margin. As you can see that we are growing in this area nicely as well. Net income is like in line with EBITDA. You see that we are not doing any strange things. And then finally, so we are certainly not really a dividend title, but we are -- which is fairly uncommon in Germany for companies or for our sites. We are a company for -- help me out the 15th consecutive year with growing dividends, which is actually like a nice side effect. Discussing our financial guidance. So, we guided on a constant currently basis with a decrease of around 5%. So, we have tough comps come -- obviously, this will certainly become way better in 2023 and 2024. But here, we are comparing our data to 2021 and 2022, where we had those nice tailwinds coming from Corona with some of our product lines, which means a nominal sales reduction of about 1% to 4%, which is actually like for our industry meaningful as particularly 2 of our most important projects had those tailwinds during corona, like we could offset that nicely with new product launches or with already replacements with instruments which have been worn down during corona, and we see a nice replacement rate of those instruments, which were sold during corona with instruments now being new. EBIT margin on an adjusted level of between 16.5% to 18.5% in 2021, again, taking the positive effects for our business from Corona into consideration with 18.9%. I think that's actually meaningful. Long term, and I mentioned that before, we are planning, like I said, on a 5-year rolling basis for a compound annual top line growth rate of about, like I said, high single digit, low double digit. And like with all those projects we have in our development pipeline and what we call deal pipeline, which means pre-contractually but still a discussion in depth with our customers about the specification about performance and feasibility work. That is what makes us positive that we can transfer those deal pipeline into project pipeline, and that allows us to predict that growth. As mentioned before, all those projects in all those products, which will contribute to the growth of the next 5 years are either already contracted or already launched. Those products which will then contribute to the growth in 6, 7 80s, these are actually the products which we are discussing today with our customers. So please bear with me, the clocks in our industry are ticking a little bit slower than somewhere else. I think I -- am I still good with time? Okay. So Federica, please. I get that into Q&A. Do we have anything?

Yes. Maybe I can start with... Get ready with the mic. So, you opened with observations around the pipeline, and that was also your closing remarks. So maybe we can start from there. What is the in the time line for the pipeline? Is there something that we should expect in terms of announcements for this year already? And are you working on new partnerships, new partners besides the ones that you have shown on your slide?

Absolutely. Let me try to kind of get you some background about how the mechanics work in this industry, particularly for us because I think as a supplier to the IVD space, we are in a little with the special situation. First of all, we can assume that there is a certain number of products being outsourced by our customers. There is a low end of threshold, which is required in terms of number of placements per year to justify all the regulatory processes associated. So even without selling one product, there are associated costs to maintain regulatory compliance and all those other aspects. So, there is a minimum of, let's say, EUR 500,000 per rotor, which means those $500,000 have to be rolled over into the products, which only makes sense, let me say, north of a certain point, let's say, generating about EUR 3 million to EUR 5 million in sales per product. From those products, we believe that about 10 of those projects are outsourced. We are doing good when getting like 2 or 3. And this is like business as usual. We do that. We make proposals, some we get, some we don't. Besides that, there is a very limited number of projects, which have the potential. And I would say, let me say, 3 in 5 years, which has the potential to grow, let's say, north of those $35 million to $50 million annual sales. And that's actually -- let me pick out the example, everybody knows the Panther definitely one of those projects. And here, we definitely have some ongoing projects, new ones, particularly a product we launched in the dPCR space with the market-leading company where we are providing not only the analyzer, but the smart consumables, so the plastic consumable for dPCR as well. It has the potential, certainly, no company in this world is willing to commit to those revenues. But depending on the market development in dPCR and we shouldn't assume that DPC takes over PC. It's a new additional market, which partly cannibalizes the expectations everyone had like particularly in oncology, derived from sequencing. I think that's something which will develop over time. So, we see huge potential there. So, this project definitely has the potential to grow in this area. And we have some other projects out of that order of magnitude in the pipeline, but definitely too early to talk about that. But we are really actively working on that. And I think I mentioned that we are intending to grow development-wise by 15% this year and next year, it shows how strong our pipeline actually is.

Yes, that makes sense. And then -- so you just touched upon new technologies such as sequencing. So, you do have projects ongoing and like interest in those, let's say, upcoming areas.