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Elekta AB (publ) (EKTAF) CEO Richard Hausmann on Q3 2019 Results – Earnings Call Transcript

Elekta AB (publ) (OTCPK:EKTAF) Q3 2019 Earnings Conference Call February 20, 2020 4:00 AM ET

Company Participants

Cecilia Ketels – Head of Investor Relations

Richard Hausmann – President & Chief Executive Officer

Gustaf Salford – Chief Financial Officer

Conference Call Participants

Sebastian Walker – UBS

Patrick Wood – Bank of America Merrill Lynch

Sten Gustafsson – Nordea

Carolina Elvind – Danske

Kristofer Liljeberg – Carnegie

Veronika Dubajova – Goldman Sachs

Alex Gibson – Morgan Stanley

Scott Bardo – Berenberg

Cecilia Ketels

Good morning everyone and warm welcome to Elekta’s Third quarter of the Fiscal Year 2019 and 2020. My name is Cecilia Ketels, I’m Head of Investor Relations at Elekta. And with me today in the slide presentation in Stockholm, I have Elekta’s President and CEO, Dr. Richard Hausmann; and CFO, Gustaf Salford.

And on the screen you can see the agenda of today, Richard will start by going through the development and the highlights of the third quarter, then Gustaf would lead us through some more details on the financials and Richard come back and talk — summarize and talk about the highlights of the quarter and give some outlook for the fourth quarter. And then as usual, there will be time for questions both from the audience here in Stockholm, but also from the web conference.

Before we start, I want to remind you that the information that we have here today including our projections on sales, operating profit, cash flow, products, and product development contains forward-looking statements and these contains risk and uncertainties and that may cause that actual figures in the future then materially differ from what’s said in this statement.

And with that I hand over to Richard.

Richard Hausmann

Okay. Thank you, Cecilia. Good morning everybody here and on the video screens or the phones. So, I will update you on our Q3 performance. As you saw in the headline from Cecilia already we call it a soft quarter but we confirm our outlook for the year.

But before I go into the details on the performance, I would like to share with you first of all we are working thoroughly on our — executing on our strategy which we call precision radiation medicine. Everyone around the world should have access to high-performance and really a precise radiotherapy and benefit from it and we made great progress in that one I can tell you.

When it comes to driving innovation and thought leadership towards that goal we are — I would like to highlight three points here; one is our MR-Linac program, the paradigm shift, and really what we see is with our high-field Unity system now 20 systems installed excellent clinical results. And also the collaboration with ViewRay as the other vendor offering the similar technology to drive the market adoption is moving along.

We have acquired Palabra, a software company recently now this week finally closed. It adds applications to our MOSAIQ Plaza to our Oncology Information System software which is called Smart Clinic as well as Voice Automation and mobility of our application on our iPhones or iPads whatever you have in the hospital. That’s quite a strong add-on and we see quite good positive outlook for that into the future in our OIS business.

Another company which we have now — we are integrating already we reported on the purchase in the last quarter already was ProKnow or is ProKnow. This is more related to treatment planning and it adds strongly to our Monaco portfolio and gets it into the cloud and I think that’s another strong point towards this thought leadership in radiation therapy.

When it comes to bringing high-performance cancer treatment to the world, we participated actively in what’s called the World Cancer Day, 4th of February. For example in a symposium in Vienna on — IAEA on women’s cancer and how to be particularly helpful in that area.

We have — thanks to Uppsala University Hospital who promote have our Unity now in clinical — as a clinical system and doing great work with it. Also promoting this system — did promote this system now in Stockholm at Karolinska as far as I understand and showing the benefits of it.

And when it comes to real third world countries, I’m happy to report that we installed our first Linac in Rwanda in Kigali the main — the capital city of Rwanda on — and it was open on World Cancer Day, 4th of February by the President of Rwanda. It shows that we go really the extra mile into these areas and we create more and more momentum in this region in particular.

When it comes to momentum, we saw very positive momentum on Arab Health is of course, in the middle of this what we call TMEA region Turkey, Middle East Asia, India region with — and Africa which had attendance of 140,000 people. So, it was interesting just before the coronavirus hit and there were quite some Chinese companies there. But that’s a different story. And it was exciting meetings and we’ve closed a lot of deals there actually. I’ll come to a few of them later on.

Yes with that, I go to the real numbers. So, Q3 was definitely not the best quarter ever in particular when it comes to order intake, very clearly a miss in orders, mostly driven by the United States missing the order target.

At the same time, we got reasonable sales growth of 5%, but our gross margin also improved significantly actually. And that shows that our cost and COGS measure programs — improvement programs are working. You remember last quarter was a bit — was quite a bit a miss on the profitability, but this quarter really came in strong. And our EBITA margin was close to 18% already in the isolated quarter, showing now a tendency towards the year-end of improving this or regaining EBITA and hitting our final target. Compared to last year of 15% last quarter — Q3 last quarter 15% both EBITA margin, as well as gross margin are increasing.

If we look not only on the Q3, but on the first nine-month, the picture is a bit different, actually a bit more positive. The organic order intake is growing 6%. The organic net sales grew 7%, almost 8%, which you are guiding for. As I said, we’re expecting strong Q4. Gross margin is at 42-ish percent and the EBITA margin at 15.4%, growing as I said towards the end.

Overall, if you look back a few years now, we are on a growth path. We see a bit of an order dip right now because of this quarter, but that’s a temporary one. Overall, we see a good book and bill ratio. We have a good backlog as you can see when comparing net sales with the orders and we are on an EBITA level of 18% with potential to improve.

On the regional distribution, as I said, the main miss on order or actually the strong miss on order in Q3 was from the United States from the North America United States in particular, which drove the whole region down. Good contributions from Brazil, good contributions also from Colombia and we have changed now the head of the U.S. business or U.S. North America business Central America business. We put Larry Biscotti in charge because for personal reasons and also performance reasons, Pete left Elekta.

Europe, Middle East and Africa is a stronghold. You see a 9% growth. As I said, a lot of drive in Europe in old Europe so to say as well as in Africa, Middle East Africa — Middle East Asia — Middle East Asia and Africa, good momentum in this region. We won a bundle deal in Belgium Jules Bordet which included an MR-linac as well as linacs won four linac deal in Dresden, Germany, several linac orders in Russia.

You remember that was a weaker point the quarter before where deals which were delayed. A Gamma Knife — first Gamma Knife in Dubai was signed during Arab Health. Strong success in Nigeria, in Uganda and other countries in Africa. Nigeria was for example four linacs. So it’s both growth in the emerged so to say countries like Europe and mature countries as well as in the emerging countries.

In Asia Pacific, overall was a little weaker than expected. But if you look particularly to China was a strong high single-digit order growth in China, continuing taking market share in China, strong market leader in China with independent outside reported numbers. We had a large bundled deal in China also in the private market. Besides of course the standard public market in China, there’s a private market developing strongly. The HEDY Group in China bought 10 linacs from us. And we also had a strong win in Vietnam, a country where we are getting quite good momentum as well big country as well.

So if we look at the nine months now on that same regional distribution, the numbers look still bad in the United States, pretty good in Europe, Middle East and Africa and Asia Pacific also is 15% very good. So — and there’s no way around. There’s a clear miss in the United States on the order side and we’re working on that. But we see that also has a quarterly effect and not a continuous one.

On the Unity, it was a bit disappointing too with only one new order booked this was this Belgium one. But the pipeline is very strong and we saw more or less a handful of systems which delayed — the order delayed now into this quarter. So, we are very optimistic on the Unity side as well. The 75 target we reiterate. Most likely we will hit that already at the end of the fiscal year.

So in total, we have 14 units now in North America, sold 30 in Europe, 21 in Asia Pacific. Just a note on the clinical evaluation in China, it’s ongoing — actually the clinical evaluation is from the patient side done. So, all the study patients are done now for the Unity and it’s now in the evaluation phase and we are optimistic that it is going the right way. We are on a green pass as we were told already so that it’s in the fall we expect the release of the system in China.

The clinical results, I have to say are the most exciting part of the Unity story right now, with our 20 systems installed globally and doing clinical patients. This was a patient which maybe some of you have seen when visiting Tubingen 3 months ago roughly shortly after our last Q call to show a live demonstration of a patient.

This patient is particularly interesting because it shows two things. One is, it shows a difference in treating, how we treat now how we can — our customers can treat patients with metastasis in the future with a precision given by an MR-Linac — hybrid MR-Linac. This is a case where 2 metastasis were present and were treated in the same session with a hyperfractionation treatment of only 5 treatments at high dose. And the high dose is possible because at every point in time at every fraction the — first of all the tumatic situation changes.

As you can see on the left two images same metastasis, but different situation of rectum bladder etcetera. So adaption is necessary not only of the tumor target, but also of the sensitive organs. And it was done.

And then on the other metastasis which was treated in parallel, at the same time the same session the sensitive organs also need to be adjusted. And that whole session took only 40 minutes. So it’s highly efficient, yes and it shows that individual metastasis in this post-op prostate cancer patient can be treated very, very effectively and very, very positively for the patient with minimal side effects.

The same is by the way true in a rather straightforward application where you can see in a breast cancer case — post operative breast cancer where the CT just doesn’t show the details. It just doesn’t show the details. And MR shows the details and the tumor can be highlighted and outlined properly and the treatment can be done. And that is also important because the MR shows the anatomy as is and you don’t have to reregister or something. You can really treat the tumor as you see it and adapt at the patient each session, okay, very important part of it.

As I said, we have 20 clinical systems installed. We hear how more and more they do 10-plus patients a day or fractions a day, yes. And most recently we got the system working in Switzerland close to Geneva and also close to Verona.

One system which is doing extremely interesting results do 10-plus patients in a very short time, UMC Utrecht there’s a second system already, second Unity system for them and is live as well. So overall very good distribution and very positive feedback on Unity.

With that I hand over to you Gustaf for the financial details.

Gustaf Salford

Thank you, Richard. So I will briefly go through the financials and then of course open up for questions in the Q&A session. But as Richard mentioned, if you look at net sales in the quarter, it was up 5%. But as we usually talk about it, we break it down in solutions and service. And you saw solutions or devices growing by 3%. And then service came in with a really strong revenue number of 8% in the quarter.

You saw the same trend here with North South America with minus 23%. It’s really down to delays or slow installation numbers, I would say in both regions. The service number and the software number is strong in Americas as a total when it comes to revenue.

Europe, Middle East, Africa plus 25% really strong number and it comes both from the emerging markets, but also mature markets in Western Europe, like Germany. Asia Pacific 19% up, what really stands out there is China growing by 40% in the isolated quarter with a very big installation number going in.

You also see the gross margin improvement from the 40.7% to 42%. We talked a lot about Gamma Knife’s last quarter that they were delayed into the coming quarters and they’re picking up now and are in normal levels to Gamma, I would say. And then we had a really strong Oncology Information Systems revenue number in the quarter supporting the margin as well.

The COGS reduction program that we have talked about over a couple of quarters are now starting to contributing for the gross margin level and we see that program continuing into the coming quarters as well that will have a positive impact. EBITDA at 17.7%. It’s an improvement versus last year, but also versus last quarter. And net profit growth came in at 45%.

If we take a more detailed look at expenses, you can see we declined versus last quarter, but we grew by 4% in total versus last year, mostly from selling. It is still commercialization of Unity, we also had some ASTRO effects as well in the quarter. You see admin costs growing quite a lot versus last year linked to litigation costs in the quarter, but also in the year and also we’re rolling out a lot of IT system to digitalize Elekta, not just externally, but also internally as a company.

R&D net, minus 1% versus last year. But you have to as usual, look at the capitalization and amortization effect. And what you see here is, it’s been quite stable the last two quarters that capitalization has been around 180 — sorry amortization has been around SEK180 million and capitalization around this SEK130 million to SEK140 million.

And we expect that to go up a bit with additional projects going into capitalizable level. But amortization we expect to be quite stable. If you take away this effect, we’re looking at gross R&D. And that is at the 10%, as a percentage of sales, that we’ve been talking about, for quite a while.

Now over to the EBITA bridge, for the year-to-date, and if you adjust for the divestments we did previously, last year came in at 15%. So we see this impact from volume and product mix, having a strong support for the margin, Unity, sales expenses.

And now the amortization effect taking it down a bit, admin and other expenses and the FX rates, bring it down to the 15.4%. But overall, we see this underlying positive effect, on our margins. We had a lot of discussions about, the FX effects, last quarter as you remember.

This quarter came in I would say, as expected. We had a positive EBITA effect, if you take through the full P&L of SEK50 million. So year-to-date, we have a negative SEK40 million, FX impact on the EBITA level.

Working capital is at the high level. We’re at minus 2%, as a percentage of revenue, as you see it on the right-hand graph here, from 7% last quarter. And the reason for it is really, the accounts receivable effect that we see in the beginning of the calendar year.

So we do a lot of service invoicing, affecting the accounts receivable, but also the prepaid income, in the quarter. And this is then, invoices that we would collect during Q4. And you’ve seen this effect, over the last years.

Positively, we also saw the inventory going down. So we’ve talked a lot about this Brexit mitigation plan. And the Brexit inventory, we’ve had, and now we see that declining, going out to the customers, in Q3.

And you will see that continuing also, in Q4. Accounts payable decreased, because we didn’t procure so much. Because we have already produced the Linac’s in Q1 and Q2, for Brexit, so that’s why you see the accounts payable, going down.

So the focus there as for Q4 really is, to reduce the Brexit inventory and also collect the high invoice volumes, we have generated now, in Q3.

And from the impact now from the coronavirus and so on globally, it has been quite good for us to have this surplus inventory to be able to secure, the installations and deliveries, we have in Q4 in front of us.

So with that, I leave it back to, Richard. Thank you.

Richard Hausmann

Thank you, Gustaf. Yeah. Outlook, I just showed last time in the meeting, showed our measures to further improve profitability and cash flow. And I just wanted to update you on those, so the same measures are still in place.

COGS improvements, obviously, they kicked in already drives strong installations, which obviously have also improved in the last quarter, get rid of Brexit inventory, which helps us at some point, also right now with the coronavirus.

So we are not totally unhappy about it. But of course it increases our inventory as Gustaf pointed out, and continued improvement in invoicing and collection process where we still have some improvement possibilities. And we’re working on them.

So where are we now? I think, we increased our gross margin. We reported on that. We continue to draw this benefit from the COGS reduction. This is an important aspect of us as Elekta because I felt, for quite some time we have not looked so much on our cost of goods sold, yeah.

And we have potential there in the future. And this is a program which is running. And as Gustaf said, it is bringing results in now, more and more so. And we will do more of those, in the coming quarters as well.

We had strong installation except the U.S. yeah. But especially on our Oncology Information System which is high-margin business. And also we had five Unity installation starts in the quarter, which was strong as well.

So we deliver — further on deliver on plan. And optimize our global resources accordingly. If we invest in manpower, as you saw, we invested into the customer-facing ones.

We worked that inventory down. That’s a clear target for the year. We have a lot to deliver, in this quarter. We are very active – very, very active. The goal is at the end of this quarter, to be at a zero Brexit inventory.

And I think that, we can reach that. And on the invoicing, there’s improvement going on already. There’s more work needed. We have now concrete action points for the end of the quarter, end of the year, regional targets. And we support essentially this project.

A few words about, the coronavirus, I mean everybody talks about. It is of course a very serious topic, for China. There’s no question about. We of course very much are caring about the safety of our own personnel. I’m happy to report that none of our 600 employees is infected despite the fact that they still go into hospitals into service and other things on our systems, yeah. We also supported actually China and some of the regions and hospitals with devices even for protection, because we were asked to help and we gladly did that. And now our local people are very much engaged in the overall situation.

So we see no major or no production issues coming up to us because our main production site is in the U.K. We have a mirror — small and mirror factory. You see a picture of it in Beijing quite far away. Since Monday last week after Chinese New Year they have started to work again and we’re producing systems there as well.

So we are securing the production mostly out of Crawley. And as I said the Brexit inventory helps us a bit. There’s some dependency on Chinese sub-supplier, which however not relevant for us right now because also on the supplier side for Brexit we staffed a little bit more, not only on the finished goods side. So we’re pretty confident on that side.

There are challenges in order flow. You can imagine that hospital directors and finance people are not really eager at the moment to do tendering and those kind of things. So we see — we might see some effect on that one. We are monitoring that and as well as the installation of the clinics. After the first more positive news now this week that infection rate is not growing anymore or not growing as fast as before, I think we are optimistic that towards the end of our quarter normalization will happen again.

As I said public tenders are temporary on hold right now. That’s understandable. There’s a lot of attention to the disease right now in China and needs to be there. So overall, we don’t see — we monitor it. We don’t see too much effect on us looking forward. But, of course, there might be some effect coming up if it’s not developing as we expect maybe going down.

So we keep our guidance clearly and fully confident for this year, 8% to 10% on the net sales, 18% on EBITA. You know us probably from the past and we are quite heavily weighted towards end of the fiscal year, a topic which personally I don’t like and we are working on it smoothening out. We have been successful quite some amount already but we still need to go further. But, nevertheless, we expect a very strong Q4 this year again. We also confirm our mid-term scenario.

But the focus points are Elekta Unity. There will be quite some momentum in this quarter. Harvesting MOSAIQ Plaza platform, recall this acquisition of Palabra but also other topics, which we’ve integrated already into the Plaza executing COGS reduction secure installation pipeline and continue our overall cost consciousness and cost control.

In summary, overall a good performance except United States. You heard about the action for United States. And I’m also optimistic that this action will have an effect. Strong Elekta Unity sales funnel confidence in the 75 for mid of this year or even at the end of the fiscal year, improved profitability overall in the quarter. And based on really underlying good behaviors like COGS reductions and good mix both on the gross margin side and the EBITA side.

We have good underlying business, strong outlook for our whole portfolio. There’s a good mix. And our new Linac will be launched at ESTRO at the beginning of April in Vienna. And for that, I would like to invite you also for investors meeting at ESTRO on April 4th, which is the birthday of my son as I realized 2020 and it will be I think a breakfast meeting right, something like that yeah. Okay, maybe you tick that in your calendar.

And with that, we are open for question-and-answers. Thank you very much.

Cecilia Ketels

Yeah, I would like to start with questions here in the audience in Stockholm. But while we hand out the microphone, maybe operator you can give instructions how to ask questions on the conference call please.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]

Cecilia Ketels

Okay. And the first question here go to Patrick [ph].

Unidentified Analyst

Yeah. Maybe Richard that — could you give us a little bit more flavor about the U.S. order situation and what is it that has actually driven the situation to the point where we are? And the fact that you’re changing your regional head, what else are you doing to actually rectify the situation in the U.S.?

Richard Hausmann

Yeah. So it was a true miss in the U.S. So it’s not that I blame comparability. Also it was a difficult comparability, but I don’t blame that. I think we have not performed in the aggressiveness, enough aggressiveness towards this market and didn’t bring in enough order. That was one thing.

Second thing is that the market itself is a little softer. We noticed that. And I think our competitors do that too because of a certain uncertainty towards this new payment models, so that’s another thing. And the third topic I would say what disappointed me is no order on Unity in the United States and that is call it also home made because I think we need more people on the street, more specialists on the street to explain a bit more complicated product Unity to this market.

Unidentified Analyst

And given that orders and tenders and that type of business that you’re in, usually it takes some time before it actually materialize. So if you do the changes now and if you have realized that you haven’t been aggressive enough or haven’t sold the systems and products in a correct way, how long do you expect it to take before you actually start to see that materialize in numbers?

Richard Hausmann

Yes. I think that Q4 will show a clear recovery. There were also some delays frankly on bigger orders into this Q4, which we didn’t close aggressively enough I would say. And we have also – was a premier contract which we are a preferred vendor for them. We see also some pickup now. So I think – and Larry is really on top of it. I mean he’s not totally new, he was a sales manager in this thing in the organization. But I think he knows the customers and goes for it. We’ve obviously recovered risk-reward already.

Unidentified Analyst

One more follow-up then I’ll jump back into the queue. And when you’re saying that you have larger orders that you didn’t close because you weren’t aggressive enough is that orders that are still outstanding? Or is it orders that you lost to competition?

Richard Hausmann

Yes. No, no we don’t – orders which are outstanding which we didn’t win yet didn’t sign yet but they’re coming to us.

Unidentified Analyst

Okay. All right. Thank you.

Cecilia Ketels

Please Annette [ph].

Unidentified Analyst

Just one follow-up on U.S. To see more Unity orders in the States I guess also clinical data or maybe clinical experience from MDA and the like how should we see this in the next couple of quarters?

Richard Hausmann

We have – we’re a little bit disappointed about how for example MD Anderson started how many patients they did. But now I hear that they do 10 patients a day, so they have picked really up. Iowa is clinical which is not a consortium member and we use it more and more as a reference side as well in the Midwest. And Milwaukee is also doing quite fine. So there is good momentum and the pipeline is actually strong. We see a lot of deals coming now in this next weeks months.

Unidentified Analyst

Then on the installations it’s not more than I think a month ago or back in Tubingen, you were expecting to install I think 14 systems in the second half. Now you expect that to be around nine. And as I understand it’s the bunker readiness and other things, how can we be sure that this installation pace will pick up and will get to more than once per month?

Richard Hausmann

As I said in the last quarter it was only five. We’re expecting three or four more this quarter so it’s quite a good pace. We have a significant backlog. We also started for example now this Proton Partners five linac. You remember now the first one is going – is installing.

So we are working down our backlog. Yes it’s slower than we expected. I said that things of installations sorting out situations in different hospitals and bunkers so is a challenge and actually not only for us. So we hear that also from our competitor on the MR-linac side. It is another system for radiotherapy which they are not used to. But we will get there. We have now good teams to install and we will move the needle further.

Unidentified Analyst

And just a final question on China. And you mentioned you expect sort of a stabilization or normalization maybe towards the end of April. What if that is not happening? I mean, how much buffer are there in your 8% to 10% top line growth expectations if China is not sort of stabilizing as you hope so?

Gustaf Salford

China is an important market for us it’s sort of 14%. So now we have a plan for the installations. And of course they need to start to happen throughout the quarter to get to the China numbers. So I think that’s what we expect there. And then of course, we’ll look into the rest of the world to drive higher volumes there in Europe and Middle East, Africa and so on to recover if we have a longer coronavirus period. So that’s what we’re doing to recover.

Richard Hausmann

You saw also the strong revenue growth in Q3 in China. So we have done a lot already in this market for this fiscal year, yes. So the sensitivity on that side is not so big.

Cecilia Ketels

Okay. Operator, I would like to take the two questions of two persons that are on the queue from the conference call please.

Operator

Okay. First question comes from the line of Sebastian Walker from UBS. Please go ahead. Your line is now open.

Sebastian Walker

Hi. Thanks for taking the questions. I’ve got two if I could. One, again on the U.S. So one of the things you mentioned was a softer market given some uncertainty around the bundle proposals. Why is that something you think will change already in Q4 and in the next few quarters, if you could give more detail on the market? And then secondly, just on working capital movements. I understand there’s some seasonality but I think a big focus was certainly on the invoicing and the receivables side. So, why is it that we haven’t seen that improvements and what more can you do to drive that? Thanks.

Richard Hausmann

Okay. Maybe to the first point, just to clarify, I didn’t mean that this softness, I don’t expect to change now in Q4. But our misses and our performance will change, so that is what I meant. Nevertheless, this softness is based on this new payment models and I think there will be the uncertainty, I think will be relieved during the months to come because obviously there is expectation that this system – new system will be going live in this calendar year.

Gustaf Salford

Yeah. And on the working capital question, I mean, if you saw last year as well we get the big increase of AR in Q3 linked to service invoicing. And also some calendar in January, February you invoice a lot and then you collect it during our Q4. So you see that pattern. What we’re doing about it is really we’re set up to collect this from our different hubs around the world. And then of course, it’s also work with a longer-term AR to collect that as well. And we have an organization for that and the system is set up. So we are set up for a strong cash flow in Q4. And then of course, the burn down of inventory will help and then we’ll start to procure and get higher AP numbers as well throughout the next – coming months here.

Sebastian Walker

Can I follow-up? In terms of working capital as a percentage of sales where would you expect to end the year and then thinking about next year where would you expect the range to be?

Gustaf Salford

Yeah. So nothing has changed from our kind of long-term ambition to be minus 10%. We still see that as achievable. I think it will not happen directly in Q4, but when we would probably approach the 6%, 7% net working capital with the collection of this AR and reduction in inventory. So that’s kind of the first path to get down to the around minus 10% again.

Sebastian Walker

Thank you.

Operator

Thank you. Our next question comes from the line of Patrick Wood from Bank of America Merrill Lynch. Your line is now open.

Patrick Wood

Perfect. Thank you very much for taking my questions. I have two please. The first would be your book-to-bill has obviously been running ahead for quite a long time now. I’d just be curious as to how you guys see over the next year or two that normalizing? And coming back to the room, when you could expect that to happen? And equally on the guidance for this year, I’m just curious and apologies if you already commented on this but the cutting of the installation target, while keeping the guidance range is it that the base business you feel is doing a little bit better and that’s what’s helping you offset those fewer installations in the second half? That would be kind of handy. And then the very final one very, very quickly. On the mid-term guide for the margin being greater than 20%, how should we think about that in the context of a slightly strengthening GDP? I mean, does that matter too much for you guys? Or should that be manageable? Thank you.

Richard Hausmann

Yeah. So the – you’re right the little bit reduced expectation on revenue for Unity, we expect to be compensated with our other portfolio of businesses yes. And overall dynamics is quite good very good. We have quite a significant number of Gamma Knife’s to be installed in this quarter and going being revenue as well as we drive our software business and linacs as well. So yes that’s exactly what happened. And the other question –

Gustaf Salford

And also Oncology Information System, we see strong performance there on both the treatment planning side and Oncology Information Systems. Then to next questions on the book and bill normalization, I think that was the question. I think it’s often important to say that the timing between order and revenue in Elekta for a regular project could be up to a year or longer. Of course, it could be shorter as well. So you have this almost 12 months effect. So often it’s not one to two quarters it’s longer.

We still have a higher order growth number. And we also have a very strong backlog to deliver from more than SEK 30 billion over the next couple of years down here. On the midterm guidance and effect of the pound I don’t see that as when we quantified the model, it is not that of a big, big effect actually it’s more our OpEx in the U.K. that’s impacted. We also have a lot of procurement volumes in dollars and other currency and euros as well. So I don’t foresee that as a big negative effect over the next couple of years here that we’re talking about.

Patrick Wood

Thank you very much for taking my question.

Gustaf Salford

Thank you.

Cecilia Ketels

Okay. We go back here to Stockholm, and Sten Gustafsson from Nordea.

Sten Gustafsson

Good morning. Could you talk a little bit about Unity and what makes you certain that you will meet the target of 75, hopefully already in Q4? It implies 10 Unity orders already now and what sort of visibility do you have on that?

Richard Hausmann

We have – well, as I said, we have a very strong pipeline. We have expected also more to close already in Q3 to be very clear. This one was disappointing for us. We expected more in this quarter. But they are just shifting and the overall pipeline is extremely positive. And my team in the business line basically is very confident on that one. I am too.

The feedback as I said is very positive. Sometimes it takes a little longer to, sort of, say crosses all the dots in the contracts. And especially in some countries where the financing topic is a topic it takes a bit longer. We had one order in Tashkent for example where bigger order — where this was a topic and others could give you similar examples more and more. But 10 in the next few months is absolutely realistic.

Sten Gustafsson

Could you quantify how many delayed unit orders?

Richard Hausmann

A handful.

Sten Gustafsson

A handful. And where do you expect the orders to come from?

Gustaf Salford

Globally.

Richard Hausmann

Very globally. U.S. as I said was also no order yet in the quarter 3 yes but we have a pipeline going on where we expect a few. It is Europe strongly I would say also Eastern Europe as I mentioned before. And I think we have also a few in Asia, yes. So it’s distributed.

Sten Gustafsson

Thank you.

Cecilia Ketels

Okay. Carolina from Danske.

Carolina Elvind

Yes. So you installed five Unity’s in Q3. Could you elaborate on how you view that contribution to gross and EBITA margin?

Gustaf Salford

Yes. So we now see the volume coming where we’ve been talking about to margin accretion from the Unity and we needed the volume to go up. But on these levels they are accretive on the EBITA level. So that’s important. On the gross margin not yet. We need to bring the volumes up a bit more because we have service installers trainers and so on in that between revenue and gross margin but accretive to the EBITA margins let’s say versus last quarter.

Carolina Elvind

Okay. Thank you.

Cecilia Ketels

And operator, we take questions from two persons from the conference call, please.

Operator

Thank you. Our next question comes from Veronika Dubajova from Goldman Sachs. Please go ahead. Your line is now open.

Richard Hausmann

Veronika? Hello?

Operator

Hello, Veronika. Your line is now open. You can go ahead with your question. Okay. In that case I will move to the next question. The next question comes from the line of Kristofer Liljeberg from Carnegie. Please go ahead. Your line is now open.

Kristofer Liljeberg

Yes. Thank you. Sorry, for not being there live but three from me. First you seems to be playing down the risk related to China and corona so just wondering how soon do you need to start doing normal pace of installation there?

Second question coming back to the U.S. So maybe could you explain why or if the problems you have there aggressiveness et cetera is that something that has happened this year because I thought the momentum was pretty good in the previous one to two years?

And a final question on margins. So we’re seeing a nice trend here for the cross –for the gross margin. And that makes me wonder why you don’t — why you’re not able to lift the EBITA volumes despite the positive gross margin trend? Thank you.

Richard Hausmann

Maybe I’ll take the U.S. question first. You’re right in the — I think — when was Pete starting? 2017 I think there was a good momentum because frankly we needed a new leadership at that point in time so urgently because our customer — our existing customers actually got really upset with our own management frankly. And that — and Pete was somebody who was well-known. He had a very good relationship — he has very good relationship with our customers our existing customers. And that helped quite significantly in the first one or two years.

But what was becoming obvious during this fiscal year already maybe earlier but not so visible yet to the top-line was that we were not able really to spread out to other customers and there was a missing systematics in that one and the leadership towards that. We have hired 2 — 1.5 years ago Larry from our competitor. He came from our competitor and — main competitor and of course he brought in now more custom knowledge on that one and he can now act on this one more. And that was something which was missing with the previous management.

Gustaf Salford

Yes. And relating to the installations in China and the coronavirus when they need to pick up. I mean of course it’s a very difficult question. We’re monitoring it. When the customers are ready we are ready to install but I mean of course the sooner the better then you reduce that risk. But as I said previously we tried to mitigate it globally with installations of other linacs around the world but also then software and service.

On the margin side, gross margin I would say versus EBITA margin so to say. You had the effect in Q3 with the FX. We talked a lot about it in sorry, Q2 I meant about the FX effect. Now we see that normalizing. We have also seen the amortization and capitalization, especially capitalization coming up to higher levels. So I think we have a good starting point to get the leverage on the OpEx going forward. On the gross margin side, we do the COGS reductions. That’s positive. But we also see a large growth from emerging markets that has a bit lower margin. So that’s — we have two kind of drivers for the gross margin current development and also going forward. So expect more leverage, let’s say on the OpEx side.

Kristofer Liljeberg

But from here on the gross margin, do you think it’s fair to assume rather flattish development and the leverage is coming on, on the OpEx side?

Gustaf Salford

We’ll come back to more of the details around that for next year after Q4, but we are driving a lot of efficiencies on the OpEx side as well. And then most of our new innovation will then will be capitalized when it gets into development phase.

Kristofer Liljeberg

Okay. Thanks.

Gustaf Salford

Thank you.

Cecilia Ketels

Okay. Operator I heard and understood that Veronika from Goldman Sachs is back in the queue. Can you please try to connect her?

Operator

Next question comes from Veronika.

Veronika Dubajova

Good morning. I hope you can hear me okay now?

Richard Hausmann

Yes. Good morning.

Veronika Dubajova

Perfect. Apologies. Good morning. I’m having some technical issues, so I apologize. Two questions for me please and they’re both bigger picture around the business. One, Richard I know you don’t like to talk about the business ex-Unity. But if I do look at your order cadence this year, excluding Unity, it’s fairly sort of pedestrian 0% growth. I get that Unity is part of your business. But I look at Varian who are growing orders 9%, 10%, 11%, just what do you think you need to change in the organization to close that gap? Is this a question of portfolio, is this a question of execution and how long will that take?

And maybe sort of a brief comment kind of looking at that order exit growth rate being at zero, how do you still — how do you feel about the achievability of the medium-term guidance in particular as it comes to fiscal year 2021? So that’s my first question. My second question is just kind of a follow-up on the Unity question around the installations. What issues are you running into? Is this an external customer problem? Is this an internal problem? And I think you’ve had this fairly ambitious target of getting to two installations per month. When do you think you can get there since you are not getting there right now? Thank you.

Richard Hausmann

Okay. Let me take the first one on the question of we call it core business or something, our base business, which we don’t do differentiate. I think the Unity is our innovation. And it is so to say adding to our portfolio as others innovate in non-so-radical innovations like our competitor and of course discounts to it. But if I take your question, I would call it mostly our not dynamic enough development in United States hinders us to grow our orders in the way how we want to grow it and we are acting on that one. This is an uphill battle, there’s no question. Varian is strong in the United States I would say, it’s very, very strong huge installed base. They can sell a lot of options and upgrades as well where we are a bit more limited because our systems are also more modern, recently installed and recently sold.

So these are topics which of course there is a benefit. And we believe also that it’s not necessary always new systems which are now in the order books of our competitor, but there’s a lot of those options and upgrades which make it up as well. So U.S. is the biggest thing. We are absolutely convinced that our portfolio is extremely competitive. Look at other markets. We are market leader in a highly competitive market like China. And we are very strong in Europe. And with Unity, of course we also have — are innovation leader in a new paradigm-shifting area as well. So it’s not our portfolio. It is more our execution in one of the biggest markets or the biggest markets of — for radiotherapy namely the U.S. And the other one was on…

Gustaf Salford

The impact on next year’s guidance of the order impact this year.

Richard Hausmann

And what are the reasons for the longer installation et cetera. As I said already in last call, it is as it is at the moment that we are in a learning curve for the Unity both on the sales channel. So the time between first contact with the customer and then basically closing it, it takes longer than a Linac much longer than a Linac in my opinion too long. And we’ve taken on us that we might have not have the right arguments et cetera or like models available to sell it easier, but that we are underway and we are investing significantly into that.

The second part is then the installation which you mentioned also when the system is so to say sold and then up to the point that — it’s start of installation, which is in our case revenue taking. That is typically more from — driven from the customer side and readiness of — or evaluation and readiness of locations to put the system.

Quite a few of those Unitys go into new bunkers, but also existing bunkers or locations at least need to be highly evaluated in terms of the magnet compatibility, et cetera. That takes a bit longer. And that process we have to optimize and do optimize already. It’s a learning curve right now for us as well. We, as a company, have not too much experience with MRI systems. We, of course, get the help of our partner Philips on that one, but it needs to be just more streamlined.

And then the last thing is when the start of installation happen, how long does it take out until we get clinical? That’s by the way a big effect on our inventory as well, yeah. Because then it’s basically revenue taken and then we need to execute on it. And that is I would call it between 16 to 18 weeks, which of course is significantly longer than a Linac and needs also to be run down.

And these are those three topics which we are working on, on that one. It’s a learning curve. We might have a little bit underestimated the newness of this system towards our customer base. But at the same time, we are so much confirmed by the feedback on the system, and it’s clinical that it’s such a difference and creates new opportunities that we are very optimistic on that one.

Veronika Dubajova

So, can I ask the question differently, Richard? Do you think when you look at fiscal year 2021, you can get to two installations a month and will that be as of May? Or will it take you longer than that to hit the run rate of the two systems a month?

Richard Hausmann

We’re right now in the budgeting phase for next year, and we are evaluating all the details right now, but there is a goal to come to this number next year.

Gustaf Salford

And I think Q3 also — Veronika, Q3 also shows that our supply chain can deliver 5 in a quarter and I think it could deliver 6 as well. So the supply chain is set up for it. Now it’s more to take the backlog and translate it into start of installations and help the customers to be ready to take on the machines let’s say.

Veronika Dubajova

Okay. Understood. Thank you both very much.

Cecilia Ketels

Okay. Operator, we’ll go back to questions here in Stockholm. Patrick, yeah.

Unidentified Analyst

Yes. Can I first have a short question? When it comes to number of Unitys installed you’re talking to report about 20 Unitys going clinical.

A – Richard Hausmann

Yeah, clinical.

Unidentified Analyst

How many are installed as of now?

Richard Hausmann

A few more.

Cecilia Ketels

21.

Richard Hausmann

21, one more.

Cecilia Ketels

21 installed and eight under installation. So, in total 29 then.

Unidentified Analyst

29, yeah. Okay, good. Then a follow-up question on the U.S. market. I mean this — when you changed leadership now a couple of weeks ago. I mean this wasn’t the first time when you have changed leaderships and you have had issues on the U.S. market before. What is it today that makes you think that it’s going to be different now? I mean could it be something more than just a leadership issue? Or is it more maybe a cultural issue?

Richard Hausmann

What do you mean cultural?

Unidentified Analyst

Yeah. I mean maybe you’re a little bit too timid as a company I don’t know. I mean this isn’t the first time.

Richard Hausmann

Yes. Well as I said, it is — as I said it is — we have to realize that. I mean U.S. installed base of Varian is probably, I don’t know 80% or something. So it’s an uphill battle. We are the challenger and we challenged. And we grew now in the United States even longer already before. But when you change management of course there is not only that manager which changes.

There might have been — and there have been topics where I would say previous management have maybe not worked out well enough and created some in marketing in one or the other groups, which didn’t function well enough because of some personal issues et cetera. So, different topics of course are there.

I wouldn’t call it cultural, because all our people over there are Americans. So, we are not having delegates or something in the United States. We have good products. Of course, the competitor has introduced new Linacs, and we are not totally ignorant on that one and they are not too bad. I mean, but I would say our system is highly competitive as well.

We see opportunities. On top of it by the way, for example this TMEA, as I talked about, you probably heard also about the negotiation on a closure and closing of GenesisCare buying 21st century where we had a success two years ago with a deal of 17 Linacs. Part of it is installed already, but GenesisCare is a strong customer of us. And we see there are quite some opportunity to get an inroad into this market with this vehicle, but that has to be of course worked out.

Unidentified Analyst

Okay. Thank you.

Cecilia Ketels

Okay. We have three more persons that want to ask questions on the conference call, and we try to squeeze that in. So please try to make it short. Operator?

Operator

Okay. Yeah. Our next question comes from Alex Gibson from Morgan Stanley. Please go ahead. Your line is now open.

Alex Gibson

Hi. Thanks for taking my questions. My first one is just looking to the mid-term targets over the next two fiscal years, 8% to 10% sales growth EBITA margins of up to 22%. What market expectations for the U.S. were embedded in that guidance? And how does the weakness in the U.S. that you’re seeing change your thoughts there?

My second question is on Unity approval in China and your latest expectations for revenue recognition of the five Unity systems. Is this potentially going to fall in Q4? Or can you confirm it’s excluded from your guidance and will fall in the next fiscal year? And, hopefully, I can squeeze in just, if you have any thoughts or views on Varian’s Ethos system, the orders the company has had in six months after launch, seems to be relatively good. Do you think that technology you will need to develop?

Richard Hausmann

Okay. So let me take the China thing first and maybe also the Ethos and then maybe you take the number question. So the China topic, it will not come in Q4, that’s for sure. It was not planned for Q4, our numbers are — our guidance number are not including them.

So the five systems which are installed in China and doing the study, as I said before, they are not revenue recognized. They will be revenue recognized as soon as we have the clearance. The clearance we expect, of course, always depending a bit on development of the coronavirus now, if it’s getting crazy or what, but we don’t expect that to the fall of this year like September, towards that time frame.

As I said the study itself is done. The evaluation is ongoing. There’s now a point where the patients will be, so to say again, not examined by or not treated but examined or questionnaired and then it can be completely finalized. And then, this will be a five — an upside for next year on revenue of five Unitys at once.

On the Ethos side, I think, we don’t have to learn something. But there’s one thing which I always say when I hear this topic Ethos is — and I’m not criticizing this. It’s a good idea to have an adaptive workflow, also for a CT a cone-beam CT-based Linac.

However, we’re still very convinced that adaptive workflows make much more sense with the necessary image quality based on an MRI, because there is really the adaption than possible. It’s a little bit of a bad image quality in, bad repositioning out. I mean, this is what it is. And I’m not criticizing, but they did and we can also do an adaption on our Linacs as well, on the net adaption and software versions, so in the future we’ll come with that.

Now the priority for us was more on the image side that we really see the sensitive nerves and the sensitive organs and avoid them or target them, or kind of put protection on them in a consistent line. For that, you need to see them. That’s our opinion on this one. So good thing and then no criticism on the product. But I would say, our premises is better images and then an adaption.

Gustaf Salford

Yes. So on the mid-term guidance period and the impact of U.S., if I understood your question correct Alex. When we set the mid-term guidance that was September 2018. I mean, the underlying view on the U.S. market hasn’t changed. It’s the same kind of replacement cycle. We see a good opportunity to grow and take share and with Unity in the lead as well. However, it’s been a bit delayed now with APM, but we still see this pent-up demand that will come as soon as we get the clarification there. So that’s our current view. But the underlying long-term view has not changed.

Alex Gibson

And how do you think that the clarification on the bundle reform is going to change people’s expectations here in putting forward an order?

Richard Hausmann

I think, the bundle permit is in principle a promotion of precision radiation medicine. You need to have better images, you have to have certain types of treatments more and more. So as I pointed out in the last calls already, we see that as extremely positive. We see that as an opportunity for us, even because there will be exchanges of system necessary. And maybe yes there might be also some shutdowns of some smaller image treatment centers. That probably will come to, but on a minor basis.

Alex Gibson

Thank you.

Cecilia Ketels

Operator, I think we’ll have two more.

Operator

Yes, we do. Our next question is from Scott Bardo from Berenberg. Please go ahead. Your line is now open.

Scott Bardo

Yes. Thanks very much for talking my questions. Just on the U.S., can you confirm please whether your installed base in North America is contracting or whether it is stable? And maybe extend comments as to your views on the competitiveness of Versa HD, is it time for a refresh?

Second question, following on, can you talk a little bit about this new Linac that you look to launch at ESTRO? What are the main differences here? And what do you think the opportunities for this system, are geographically please?

And my last question, again, a little bit on the U.S. pulling in Unity. U.S. remains the weakest region for Unity demand. And I think that’s slightly different from the picture that you saw several years ago in that market and perhaps surprising given the MR-Linacs are the most established in that market with your competitor.

So what is in your opinion the hesitation of that region to adopt the system? And when do you think you may see some sort of halo effect in leveraging the rest of your portfolio into customers that don’t currently exist today?

Richard Hausmann

Let me take these two products related questions, first. The Unity in the U.S. you’re right, I agree with you, that the pickup in the United States is not as good as we have expected, by the way, it includes also our competitor there, I mean, our MR-linac competitor.

And I think, this is mostly related with the nature of the U.S. market maybe, because of — it’s very financially-driven.

And we have obviously not been able yet to convince that — or to show that with the Unity, you can make more patients per year, you can do more patients per year than you could do on a normal linac, by using hypofractionation and by using the system how it should be used. And we need to work more on that one.

And in that sense the U.S. market needs a bit more the clinical outcome. Ideally of course a reimbursement change, but that will take a bit more time but to show more and more outcomes and the publications that will certainly help in the United States.

I’m happy to report, that there will be a very significant publication on even the consortium sites in the media result at ASTRO, ASTRO in the fall. And that will already show quite a significant result yeah. So that’s important for the U.S. market.

Coming to the linacs the linac system which means — which we will introduce at ESTRO in Vienna in April, so that’s what we call a high-performance linac with a small footprint. So, it has certain aspects of a high flexibility with a design which people are used to, like different energies et cetera.

But at the same time, reduces installation space to get into bunkers, which for example come close to or are of the size of a cobalt system bunker. At the same time, we have invested significant effort.

And I think, successfully also in, how the workflow goes, and not only on the console but also in the treatment room. And there are some very nice and forward-looking concepts realized. So it’s really around, a new design overall.

So it’s really around system. And we are very proud to introduce at the ESTRO. But give me the freedom to not say too much more because our marketing people will kill me otherwise yeah. They want to make a splash at the show.

And from that point of view, you can expect that — when you talked about Versa that similar ideas will of course make its way into the Versa HD as well. Okay. And the other one was installed base, I think?

Gustaf Salford

Yeah. So installed base, Scott, I mean, we have quite a young installed base in the U.S. So we’re primarily adding. So we see growth. And then the replacement cycle will come over the next couple of years, because the replacement cycle is around 10 to 12 years. So that will help our growth going forward.

Richard Hausmann

And globally our installed base is also growing, percentage-wise faster than our competitors.

Scott Bardo

Okay. Thanks guys.

Operator

And the final question comes from Sebastian Walker from UBS. Please go ahead. Your line is now open.

Sebastian Walker

Hi. Thanks for taking my follow-up. Just one on — thinking about margin progression in Q4 and next year, I mean you mentioned that you need more people on the street more education efforts around Unity. How should we be thinking about sales and marketing spend? Thanks.

Richard Hausmann

I see that as more a focusing on — not adding too many, but as focusing competence on this what we call smaller business lines, yeah. We have huge sales force on linacs basically because all our account managers, direct customer account managers are more or less excellent linac sales persons.

We need specialists to do a Gamma Knife to do, the software to do, a Brachy or to do a MR-linac, in a most efficient way. And so it is not hundreds of people, it’s more of a specialist supporting so to say, the sales of this dedicated system so to say that is necessary. So we are not having a huge impact on margin by doing that. We’re refocusing quite a few people there.

Sebastian Walker

Understood, thank you.

Richard Hausmann

Okay.

Cecilia Ketels

Okay. And with that, I am so sorry that we didn’t stop on time. But there were lots of questions and of course very interesting, as such. Thank you for participating both here in Stockholm and those of you who are watching us over the web. Thank you and have a good day. Bye-bye.

Richard Hausmann

Thank you.

Gustaf Salford

Thank you.

Richard Hausmann

Thank you. Bye.

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