Surgical Innovations Group plc Chairman's Statement

For the six-month period ended 30 June 2023

Market and Financial Overview

The Group recorded strong revenue growth in 2022 and we have seen this continue, trading in the first half of the year increased 4.4% to £5.65m on the comparable period last year (2022 H1: £5.41m). Sales continue to strengthen in the second half of the year and remain on track to meet management's expectations.

The UK business continues to be strong which is driven by the sustainability messaging, having a positive impact on activity. SI-branded product sales were £0.92m (2022 H1: £0.68m) and UK distribution sales were £2.11m (2022 H1: £2.01m), together up 12.7%. This will continue to grow as the NHS pushes its focus sustainability and the implementation of its 'Net Zero' commitment and implements measures to address the increasing backlog of patients on waiting lists.

In Europe, the increased investment in sales and marketing is starting to gain traction, achieving underlying sales growth of 18.2% which delivered revenue of £0.69m (2022 H1: £0.59m). Despite being hindered by missed opportunities in component delays with the new Optical trocar, this is expected to gain traction with new business wins in the second half.

Revenues from the US are progressing more slowly than planned, marginally lower than the comparable period for SI-branded products as the first half decreased to £0.48m (2022 H1: £0.59m). Progress with YelloPort Elite was slower than anticipated, but increased focus, training and sales support has seen momentum gained through the conversion of a number of smaller accounts in H1. 

The APAC region continued to generate strong revenue growth to £0.54m, an 11.8% increase (2022 H1: £0.48m). The majority of the growth was from our Japanese distributor as they continue to gain market share, despite having delays with product registration with the 5mm Elite launch. The launch is now expected in Q4, and this presents a significant future opportunity. In addition, the initial orders for India were sent out in the first half of the year and we are encouraged by the initial interest from early evaluations.

OEM revenues have endured the majority of challenges with supply chain delays, with reported revenues of £0.68m (2022 H1: £0.92m). Notwithstanding this, the order book remains strong for the remainder of the year and the manufacturing disruption is starting to ease for these product lines.

Commercial or underlying margins remained just within target range at 40.5% (2022 H1: 45.3%, 2022 FY: 42.6 %). At the end of 2022 a review was undertaken to analyse the overhead absorption rate, as operating expenses had continued to increase with inflationary pressures, the overhead rate was uplifted, in addition the pressures from material suppliers continue. A series of planned price increases has been implemented across the period however, some of these will be phased in over time due to the fixed term nature of contractual agreements.

The reported gross margin of just under 33.0% (2022 H1: 34.6%, 2022 FY: 34.6%) includes the net cost of manufacturing, reflecting the operational challenges the business continues to experience. Manufacturing productivity and supply chain disruptions will impact profitability in the second half of the year, as reported in the recent trading update. A complete operational review of both manufacturing operations and supply chain is currently being undertaken, utilising an industry specialist. While measures are already being introduced to improve efficiencies and productivity, we expect the majority of the benefit to flow through to the P&L in the next financial year.

Other operating expenses increased to £2.17m (2022 H1: £1.93), driven by additional investment in Sales and Marketing to enhance revenue and continued investment in regulatory costs due the change in certification to Medical Device Regulation (MDR). In addition, the inflationary pressure in employee remuneration has continued to impact profitability. Excluding the effects of non-recurring items and share based payments, operating expenses increased by £0.26m to £2.14m (2022 H1: 1.88m). The Group is trading at an adjusted EBITDA profit for the period of £0.01m (2022 H1: £0.29m). The full effect of these additional costs will impact the second half of the year, but management expects the Group will continue to be profitable at the adjusted EBITDA level, as a result of the operational review initiatives starting to be implemented.

Adjusted operating loss before tax for the period (before non-recurring items and share based payment charges) was £0.28m (2022 H1: £0.01m). The reported net loss before taxation amounted to £0.37m against a net loss before taxation of £0.11m in the first half last year.

The Group reported a tax credit in the period of £nil (2022 H1: £0.09m) which related to an enhanced research and development ("R&D") claim for 2021. The Group received a tax credit of £0.22m in August 2023, relating to its claim for 2022. In terms of deferred tax, the Group continues to hold substantial corporation tax losses on which management takes a cautious view, and consequently the Group does not recognise a corresponding deferred tax asset.

Adjusted net earnings per share amounted to a loss of 0.037p (2022 H1: £0.004p). The net total comprehensive income for the period amounted to a loss of £0.37m (2022 H1: loss of £0.01m).

For the first half of 2023, cash used in operations was £0.07m (FY 2022: £0.23m generated, 2022 H1: £0.22m generated). After continued investment into R&D of £0.12m (FY 2022: £0.42m, 2022 H1: £0.17m), capital expenditure of £0.18m (FY 2022: £0.66m, 2022 H1: £0.19m) and the refinancing of the existing bank loan and lease liabilities, the Company had available cash balances, including the unused invoice discounting facility of £1.0m, totalling £2.41m (31 Dec 2022: £3.20m). The covenant test (EBITDA to debt service) for the period ending 30 June 2023 was waived by the lender, they remain fully supportive with approval obtained to waive the next two debt service covenant tests dated 30 September 2023 and 31 December 2023.

Market outlook

The UK continues to demonstrate strong growth underpinned by the sustainability messaging, highlighted by the growth in SI-branded products, and has opened opportunities in both the NHS and private sectors where the drive to 'Net Zero' is gaining momentum. Whilst industrial action by clinical staff has impacted both the volume of surgery and pace of evaluations, the UK business has proved to be resilient and continues to show growth into Q3. The UK sales team is at full strength and has benefited from a new enhanced training programme, which will also be rolled out to support all of our international partners over the coming months.

Sustainability messaging initiatives continue to drive sales in many key markets and the ongoing investment in sales support, marketing, training and development of the financial & environmental calculator have proved to be powerful tools in driving growth. APAC has continued to demonstrate growth and the delayed launch of Elite 5mm and Optical, now expected in late Q4, provides further opportunity before the year-end. Progress in Europe has quickened, with sales in H1 above pre-Covid levels for the first time, with sustainability a key driver and continuing to provide opportunities in H2.

Revised targeting and incentive plans for the US sales team have already seen an increase in the number of active evaluations with the potential to drive sales from Q4 and beyond. Long-term partner, Adler Instruments, continues to have a strong business opportunities, however outside of the Southeast the consortium of distributors has proven to be disappointing. The Company continues to review the most effective routes to market for its scissor sales.

Investment in new product development has continued and a number of projects remain close to fruition. The YelloPort Elite family was enhanced with the launch of the 5mm Optical and, whilst some registration delays have slowed the launch in key markets, it is expected these registrations will be completed to allow a Q4 launch in the majority of  key markets feedback from important markets has identified the opportunity for a further line extension in the form of a shielded cutting trocar specifically in Gynaecology. Under the new MDR approved quality management system we have been able to accelerate the development of this device and anticipate a launch in late Q4. Some supply chain delays have slowed progress on the Logi Dissect and Grasp instruments for which launch is now planned in the earlier part of 2024. Investment in new product development continues to build on the sustainability message.

Underlying revenues in the OEM segment continued throughout H1 to be suppressed, not by demand, but due to supply chain constraints. Alternate suppliers of some key components to address delays have taken substantially longer to come online. These challenges slowed sales in the first half of the year, but a significant improvement has been seen since the end of the first half. Collaborations with CMR have moved to a new phase, and take sales out of the OEM segment, leveraging the relationship with CMR to open opportunity for SI's global partners to introduce YelloPort Elite for both robotic and conventional laparoscopic cases. This has substantially sped up the number and volume of evaluations in two new markets, India and Germany.

Operational and Regulatory activities

The reduction in the Supply chain disruptions has not been as fast as anticipated, leading to a delay to some sales orders into the second half as a result. This has also led to higher levels of inventory being held, though this is now reducing and is expected to return to more normalised volumes over the coming months, returning cash into the business.

The regulatory pathway continues to be on track for the EU Medical Device Regulation (MDR), although the delay in implementing the transition to MDR has seen the focus of the notified body move to other, more current priorities. The Company's Quality Management System, technical files and microbiology data have been made compliant with MDR, audited by BSI and fully approved. Progress on the product technical files continues with 2 out of 3 approved for MDR, and the final file has clinical review in progress.  UKCA mark has been achieved and a further Medical Device Single Audit Program  (MDSAP) audit successfully completed.

Current trading and outlook

Group revenues have continued to grow in H2 in line with the Board's expectations, with key markets and OEM in particular performing strongly. Manufacturing challenges continue to be addressed, to manage the impact of increased supply chain lead times and the increasing cost base. An operational plan to improve productivity and margins  continues to be implemented with the help of an industry operational expert. 

The momentum in sales has continued into H2 and the order book remains positive, leaving management confident of the H2 revenue forecast. A robust operational plan will begin to drive efficiencies and margins, the majority of the impact of which will be seen from 2024 onwards.

Jonathan Glenn

Chairman

19 September 2023