GN Store Nord A/S

CSE:GN

Earnings Call Transcript 2018-Q2

[Peter Justesen, Vice President of Investor Relations & Treasury]

Hello all. Welcome to GN's Q2 2018 Conference Call following our release this morning, Danish time, of our Q2 report. Thank you all for dialing in.Participants on today's call on our end is, as always, Anders Hedegaard, CEO of GN Hearing; René Svendsen-Tune, CEO of GN Audio; Marcus Desimoni, CFO of GN Store Nord; and myself, Peter Justesen from investor relations and treasury.Today's call is expected to last in total for about 1 hour. First we will go through the presentation, which we have just, about an hour ago, uploaded to our website gn.com. And the agenda is, as you know, as always, Marcus will start off with group financial highlights. Anders will then take us through updates on GN Hearing, and René will take us through an update on GN Audio, after which we will circle back to Marcus for an update on financial guidance. And after the presentation, we have time for a Q&A.And with that brief introduction, I'm very happy to hand over to Marcus.

[Marcus Desimoni, Chief Financial Officer]

Yes, thanks, Peter. Obviously, good morning, everybody, and thanks for joining our call. I hope you all had a very good holiday season.For us, it was a very good quarter and a very exciting time. Basically you have seen the news flow, and you can assume that we have been all very busy. We have been able to achieve in the second quarter double-digit organic growth rate, and that is super, super strong. That is with the leverage also pushing up our EBITA by 17% in the second quarter. And it was fueling our EPS by 10% in the quarter, 11% in the first half year. Based on the prudence how we're managing the business, we also have seen an increase in ROIC in both businesses.If you take a look on the cash flow. Obviously, cash flow is one of the key areas that we have an eye on it. And obviously, we have been able to achieve positive cash flow, and a strong cash conversion in particular on the audio side. The hearing side underlying was a healthy free cash flow development. However, it was dampened by 2 factors: one, an increase of the seasonality pattern in FSAs, where we've had a cash outflow; and number two, an increase in net working capital, in particular in inventories as a preparation for the launch. In general, I would expect that, going forward, we would see a normalization on the hearing cash flow again, as it was a seasonality in Q2.Happy to answer all the questions you might have around these topics in the Q&A. And now I'm happy to hand over to Anders on GN Hearing.

[Anders Hedegaard, CEO & President]

Thank you, Marcus. And thanks, everybody, for attending our conference call today.Going to Slide #7, I would like to walk you through the key highlights of the second quarter of GN Hearing.In the second quarter, we saw a positive momentum primarily generated by the product ReSound LiNX 3D, and we saw that in Q1 and continuing into Q2. Organic growth in the quarter was 6%, while the revenue growth was 1%, with 5 percent points impacted from FX.Like in Q1, the organic growth in Q2 reflects a very strong performance and particularly among the independent customers, which is very encouraging as our relative underpenetration in this segment is one of the opportunities we highlighted when we launched the strategy 2 years ago, and we've been working on with expanded sales force and numerous of other activities to improve performance in this important area. But our strong performance in the independent market was in Q2 partly offset by the development of certain larger accounts, which I'll come back to in a short while. All in all, after a solid Q2 and our very important ReSound LiNX Quattro launch, which I will take you through a little later today, we can confirm our full year guidance for more than 6% organic growth.The gross margin in Q2 was constant compared to last year, which was driven by an increase by -- which was driven by the launch or the sales of ReSound LiNX 3D but partly offset by a strong growth in lower-ASP countries like China and India. The EBITA margin developed favorably. It increased 1.4 percentage points, reflecting operational execution and channel mix. And free cash flow, as mentioned by Marcus, impacted by, among other, inventory buildup by the anticipated launch of ReSound LiNX Quattro.On Slide 8, we have included some details on the organic growth in the quarter. Overall, we had another strong quarter in the independent segment, which was a clear growth driver in U.S. in the second quarter as it was in the first quarter. This was partly offset by some temporary headwinds that are expected to reverse in the rest of 2018. Most importantly, we in Q2 had a headwind in -- on overall growth from our business in Veteran Affairs, where the new rechargeable category has increased a lot, a category where we are simply not playing. In North America, our growth in Q2 was driven by strong performance in the independent channels. In Costco we had experienced a satisfactory trend, considering that, as you know, in the beginning of the year, we saw the launch of the new Kirkland Signature brand. And as usually, we saw a dip in sales of branded products following the Kirkland Signature launch, but we already have experienced a return to a much more positive trend in branded products.In Europe, we continue to see solid growth in the independent market; however, in Q2, was offset by the development in some of our larger accounts, but to a lesser extent to what we saw in Q1. In the Rest of World, we delivered very strong growth again in Q2; most notably, is it growing very well in China, India, Japan and also in our distributor markets. And in all those markets, we saw a double-digit organic growth in Q2.On Slide 9, you'll -- I will move into some of our innovation steps that we have just recently announced. And as the most recent example was the one we announced on the 13th of August, the launch of ReSound LiNX Quattro. GN has, as you know, delivered multiple industry firsts, and we have been setting the direction for the industry over the last few years. These industry firsts includes the first 2.4-gigahertz wireless technology, the first Made for iPhone, the first Binaural Directionality, the first remote fine-tuning. And now we're introducing a product in a completely new category as the first ones, the product ReSound LiNX Quattro. Our ultimate goal is to perfectly mimic the natural hearing. With ReSound LiNX Quattro and Beltone Amaze, we take one step closer to that goal.Turning to Slide 10. ReSound LiNX Quattro offers a combination of unmatched sound quality and rechargeability, while further we are expanding on our leadership in connectivity, including remote fine-tuning. ReSound LiNX Quattro offers a brilliant sound experience with clearer, fuller, richer layers of sounds, basically powered by a completely new platform, chip platform that is 100% faster and have 100% more memory. This allows us to develop a hearing aid with the highest input dynamic range available and extended high frequencies. And this leads to the point that sounds are processed in increased detail in all input levels, leading to superior sound quality where softer sounds are clearer and louder sounds are fuller and distortion free. In addition to brilliant sound quality, ReSound LiNX Quattro offers the longest rechargeable battery life in the market, with 25% less battery consumption when streaming. ReSound LiNX Quattro is the only hearing aid that offers 24 hours of use even when streaming is 50% and 30 hours without streaming. Also ReSound LiNX Quattro is quick to charge. With, for example, 10 minutes' charging, you will get almost 3 hours' battery life.With our new hearing aid, we are introducing a completely new category we call Premium-Plus. In May of 2017, we introduced ReSound LiNX 3D in the premium segment. This product has been a driver for our growth, and we are now enlarging our family by introducing ReSound LiNX Quattro. It is a product we have designed for people who want the best that technology can offer in terms of brilliant sound quality with great speech intelligibility even in noisy situations. Also ReSound LiNX Quattro further expands our leaderships with remote fine-tuning and, as I will get back to in a short while, extended wireless connectivity. ReSound LiNX Quattro and Beltone Amaze will be rolled out by the start of -- by the ending of August. And the hearing aid will be launched in a "receiver in the ear" form factor with both a rechargeable and a replaceable battery solution. And it will only be offered in the premium price points only. ReSound LiNX Quattro will be available as such both as a rechargeable and a replaceable battery solution, so we will be able to give -- even though it's only one form factor, we give the user a choice, but the choice is also to continue with ReSound LiNX 3D, which we expect to have on the market simultaneously with the new products.On Slide 12, you will see another industry first by GN. On the 16th of August, we announced a very exciting new partnership with Google. Benefiting from the new chip and ReSound LiNX Quattro, we expect to be the first manufacturer to enable full spectrum of direct audio streaming from Android devices. After this, in terms of wireless and -- connectivity, we can do everything with Android smartphones that we already can do with iPhones. And our new solution is based on Bluetooth Low Energy. This ensures maximum streaming ability without compromising the battery life. The Android solution with Google will at a later stage be available in the new ReSound LiNX Quattro and Beltone Amaze.With this, it was a strong final of -- end of Q2 and introducing into our announcement here. And it was also another sign of our innovation machine moving on with full speed in order to secure that we can live up to our ambition of continued organic growth.With that, I would like to hand over to René.

[René Svendsen-Tune]

Thank you, Anders. And good to speak to all of you today. Thanks for attending.So it's now my pleasure to take you through the GN Audio's results of the second quarter of 2018. And we go to Slide 14.So in the second quarter, we continued our strong performance, and we delivered 19% organic growth in the quarter. Revenue growth was 16% after around 4% negative impact from ForEx exchange. There was a small positive contribution from M&A, driven by our recent acquisition of the Indian distributor Innova. The strong growth continues to be driven by our CC&O business, which in second quarter delivered again strong double-digit growth rates, as we have seen over many quarters now. I'm also very pleased to see that our efforts in repositioning our consumer business is beginning to pay back. We achieved our target of returning the consumer business to positive organic growth in the quarter. The growth was driven by the recently launched Jabra Elite family of products, and it was partly offset by the continued decline in the mono Bluetooth business.Gross margin increased by 0.7 percentage points in the quarter, mainly reflecting a favorable product mix. And as a result of the above, our EBITA increased by 23%, which implies an EBITA margin improvement of 1.1 percentage points compared to the second quarter of 2017. The free cash flow continues to be very strong. And we delivered again excellent cash conversion, 140% in the quarter.So all in all, a very strong first half of 2018 in GN Audio across all financial parameters. And based on this strong performance and a more clear outlook, we again increase our financial guidance for the full year to 16% to 19% organic growth, up from earlier communicated guidance of up to 15% organic growth. And Marcus will come back to this a little later.So if you go to Slide 15, where we want to dig a little bit deeper into the development of the CC&O business, which as you know account for roughly 80% of the revenue in GN Audio. So in second quarter '18, CC&O continued to deliver, as said, strong double-digit organic growth across all 3 regions. And we have again further strengthened our position in the CC&O market. In North America, we continue to expand our presence in the market. And we see solid development across all product categories, leading again to double-digit organic growth, solid double-digit organic growth. In our home turf, Europe, we saw again very strong growth during the quarter, and we have again strengthened our position throughout most countries. And in a similar way, in our Rest of World sales region, we delivered strong double-digit growth, and this growth was well balanced across countries across the region.Moving to Slide 16. So I would like to spend a few minutes talking about our newly announced strategic partnership with audEERING. And audEERING is a Munich-based company specializing in artificial intelligence within the field of voice analysis and soundscapes. We have decided to partner with audEERING, as we see them as leading in the field of intelligent audio analysis and emotional artificial intelligence, all something we think is very relevant for GN. We expect joint development in this field of artificial intelligence solutions, and we expect it to bring value to both our professional and our consumer businesses. Imagine, as an example, that you are sitting in a call center and you are talking to an angry customer. Imagine that your headset solution is continuously analyzing and feeding back to the -- you the sentiment of the customer in the call. And such information alone, or perhaps combined with other real-time information, can help you improve the quality and the outcome of such a call. This is one example. We believe that the outcome of this partnership can add to our general innovation and focus -- innovation focus, and it will come across to the market and product road maps over time.So going to Slide 17. Here we have tried to offer a view to our product offering, which is obviously the main reason for our strong performance. With our current portfolio of product categories and price points, we are today serving a wide range of customers, all from large call centers to office workers sitting in the office or at home or the consumer commuting from work or commuting [ to the workout ]. Engage is the franchise for call-intensive purposes. Evolve is for office and productivity. Elite is for the consumer, and BlueParrott for the field worker or the driver or in particular the trucker use in North America. All these product solutions are very intuitive and very easy to work with. The introduction of the Jabra Elite franchise was an important milestone for us in the repositioning of our consumer business and a perfect example on how we can bring new innovations to the market and affect the market right away. These products, the Elite products, address better than most consumer needs for high-quality combination of voice, music and strong wireless connections.So in summary. GN Audio had a very strong first half. We have delivered 18% (sic) [ 19% ] organic growth in the first 6 months. And as a result of that and the recent development, sell through the channel, we are now confident in the full year outlook and ready to upgrade our full year organic growth guidance.And speaking of guidance, with that, I'm very happy to hand back to Marcus for a recap, please.

[Marcus Desimoni, Chief Financial Officer]

Thanks, René.As stated here on the page, you can see that GN Hearing is confirming on all levers the guidance that we have given at the beginning of the year and reiterated during the year. And we are fully on track to achieve the guidance for this fiscal year. In audio, based on the strong performance and the momentum we see, we have been able to revise our internal forecast and therefore upgrade the guidance, as René said, to 16% to 19% organic growth with an EBITA margin of more than 18%. And that should obviously drive absolute numbers. And on the Store Nord level, the guidance remain unchanged. We're targeting an [ cost plug ] of roughly DKK 135 million in others driven by headquarter activities. And we have an effective tax rate on the guidance of around 22%. All of this together should drive again a double-digit EPS increase for GN Store Nord for the full year.With this, I hand it over to Peter, please.

[Peter Justesen, Vice President of Investor Relations & Treasury]

Thank you.A bit of housekeeping before we hand it over to the Q&A part. This is just a placeholder to invite you all to participate on our events on the annual EUHA meeting in -- this time in Hanover. It's on 18th of October, at 9:30 a.m., where we will be hosting an event. More on that as we get a little bit closer to it.And thank you much, Anders, René, Marcus, for the first part of the show. Back to the operator for the Q&A.

[Operator]

[Operator Instructions] We do have a first question. The first question comes from the line of Michael Jungling from Morgan Stanley.

[Michael Klaus Jungling, MD, Head of MedTech & Services and Analyst]

I would like to ask 3 questions, please. Firstly, when it comes to the hearing EBITA margin and also the margin for audio, how much of the margin expansion is coming from foreign exchange? I'm talking about the transactional benefit probably from hedging in the quarter. Question number two is also on GN Hearing and audio. Why has the margin guidance not been lifted for both? And the final question is on the Google partnership. Will it be based on Google's own Bluetooth Low Energy language? And how will a Bluetooth standard that we're all waiting for fit into this announcement between you and Google?

[Anders Hedegaard, CEO & President]

Yes, thank you for your question, Michael. While Marcus take the financial-related questions, I will address the Google part. There is still work for a Bluetooth standard, and we and others still have an interest in getting that standard finalized. How it then technically will match into the Google and Apple Bluetooth is to be seen, and that's what I can go into now. I cannot go deeper into the technical part of the Google part, but it will soon be an open source. And everybody will be able to see what it is.

[Marcus Desimoni, Chief Financial Officer]

Okay, Michael, it's me, Marcus. On the margin and the guidance, a couple things. So the first question was around the second quarter and the impact of FX translation and the hedging impact. So the net effect of translation and hedging was margin-wise slightly positive on the audio side. And we said it was also slightly positive in the first quarter, but that will turn around towards the end of the year, so it's a very slim slope from a little bit positive to a little bit negative towards Q4. And on the hearing side, it's for all 4 quarters slightly negative. And slightly means, of course, then less 1 percentage points, so that you just get a feeling. The second one, in regards guidance upgrades on audio, I'll leave it to René.

[René Svendsen-Tune]

Yes. Hopefully, I understand the question. I mean, first of all, more than 18% is more than 18%. Second is that I think we have shown in the second quarter is leverage in the business. We do, however, see constant opportunities on investing in growth. And we are also making some investments into company infrastructure. And we want to reserve the right to do what is best for the business in the months to come basically.

[Michael Klaus Jungling, MD, Head of MedTech & Services and Analyst]

And then for hearing, on the margin? I mean, if I look at your guidance, it seems that you're comfortably, comfortably ahead of the bottom end of what you're guiding for. Why not lift the bottom end of the range to provide more comfort that everything is fine?

[Marcus Desimoni, Chief Financial Officer]

Michael, it's me, Marcus, again. It is a mix question. And you see the revenue composition and the impact then in the gross margin down to the bottom line. If I would have only U.S. business and private pay, the sky is blue and shining, but I also have other countries. And you have seen that, in particular in the second quarter, we had strong business again in India and China. And then I have a mix from other customers as well. And therefore, I am able to drive top line with the guidance that we have, but it's not necessarily 100% then a leverage down to the bottom line, if I would have everything constant. So it is a question of the mix, what kind of trend and what kind of country is driving. And that is giving me the impact that I can't just have a jump in the bottom line there.

[Michael Klaus Jungling, MD, Head of MedTech & Services and Analyst]

Marcus, may I follow up on the transactional EBIT margin for hearing? Given that you've had negative FX on sales for Q1 and Q2 and that you also hedge, and you mentioned sort of in your press release that you hedge pretty much 100%, why would Q1 and Q2, or Q2 in this instance, not benefit from a hedging gain? I mean the margin should be positively impacted by the hedging gain that you would have, given that foreign exchange was a negative for you in the quarter. Why would it be negative? Why would it be negative to margins? What am I missing?

[Marcus Desimoni, Chief Financial Officer]

Because there are swings in FX, as you know. So what we do is we have the net cash exposure from the budget run rate on the EBITA also. And we're hedging this up to 100%, sometimes -- between the range of 80% to 100%, let's put it this way. And therefore then you have some swings. So you'll have transaction costs of the hedging of a forward as well as the mark-to-market valuation of the options, and that is then counterattacking. So therefore, with the hedging, all I can do is minimizing the impact but never 100% offsetting that. If I'm damn lucky in 1 quarter, then I have the swing in the quarters in the mark-to-market valuation and the runout of the forwards, and then I might have a positive impact, but that's not my goal. My goal is to basically minimizing as much as possible the margin and therefore the cash flow impact. And this is why I'll normally be around the 0%. In audio, it's slightly positive in the first half. For hearing, it was slightly negative, based on the composition of the currencies against the DKK.

[Michael Klaus Jungling, MD, Head of MedTech & Services and Analyst]

Great. And then please, one follow-up on Google. Is -- the first product coming out, will it be primarily a solution that works with the Pixel phone from Google? Is that the first phone that will be available? Or will it be available amongst a whole bunch of phones that have a BLE chip in it?

[Anders Hedegaard, CEO & President]

It's a bit too early for me to elaborate on, Michael, even though I would like to do it. We have announced the collaboration, the partnership that now allows Google to move on. Now it's Google and their partners that needs to implement, and we're very pleased that we are the first ones. We therefore set the standard in continuation of what we did with Apple. And it clearly shows our customers that, if they want connectivity, this is the products to select. And the ReSound LiNX Quattro and Beltone Amaze will be the first products to take advantage. That's what we can say right now. We would love to come out with more details when we have it.

[Operator]

The next question comes from the line of David Adlington from JPMorgan.

[David James Adlington]

Firstly, just on the audio guidance. Just wondered. Obviously you upgraded guidance during the quarter, on the 14th of June, and upgraded again this morning. I just wondered if the business had materially accelerated since the middle of June and maybe even what sort of visibility you have on the third and into the fourth quarter that's driven a further upgrade. And the second one is just on financials, Marcus. They were a bit higher than we were expecting, certainly after a quarter like Q1 as well actually, so I just wondered if you'd give some further color to that, an explanation on how we should be modeling that line from here.

[Marcus Desimoni, Chief Financial Officer]

David, it's me, Marcus. Let me start with the financial item line. I think you're referring to financial items line on the P&L. We've had a slightly negative number in Q1, slightly negative number in Q2. That ends for the first half year of negative EUR 90 million, and the first half year in '17 was around EUR 60 million. That comes mainly from the revaluation of the balance sheet items from FX. And you have seen that U.S. dollar against DKK was moving up 6% and that giving us the biggest hits in terms of revaluation of balance sheet items. If ceteris paribus, everything, other currencies are staying the same, then I would expect also a negative second half of the year, however, less than the first half year. So it's not the EUR 90 million anymore in the second half year. I would see it more in the run rate then DKK 60 million, DKK 50 million to DKK 70-ish million, in this range. And last year, in the second quarter, we had some positive effects also over there that was -- that's why it was 0, but other than that, it was unfortunately due to the FX movements always somehow negative over the last 6 quarters. I hope that answers. René?

[René Svendsen-Tune]

So on the guidance upgrade and the multiple steps here. So I mean there is a sequence to this. The -- I mean the revenue is composed by an existing portfolio of products, plus a number of launches we did early spring this year. Launches went well. What we could see in second quarter is that the sell into a channel was strong, and the channel acceptance was strong. The marketing programs were kicked off, of course, as they should. So it looked good. We upgraded the guidance. What we couldn't tell was the sell-through. I mean the sell-out through retail on the consumer side and the actual sell-through of new products on the enterprise [ here ], of course, was the impact on existing portfolio. We have seen, as we go forward, that the sell-through is strong and therefore, of course, the follow-on sell-in equally strong, so we have the full effect from the market that we are looking for. And that gives us now the platform from where we can upgrade the guidance further. So -- and of course, one component in all this, of course, is also the supply chain. As we accelerate with the speed we are doing now, we have to be sure that all suppliers and the logistics machinery can follow, and it does very well. In that sense, we are seeing run rates that we were looking for but we didn't have end-to-end back in June. So that's the simple story.

[David James Adlington]

Perfect. That's very clear. And then maybe just one follow-up on hearing. There's no mention in the release this morning of the FalCom tenders. I just wondered if you have any updates there.

[Anders Hedegaard, CEO & President]

Yes. As we have previously informed, we have moved in and put in a request for 2 tenders in U.S. We're moving on. And we also see numerous of other opportunities in the U.S. market in particular, and we are right now in the process. We do see positive traction. Our product is being tested right as we speak. And so things are moving. Will we end up with a final conclusion on one or other purchase orders this year? It's too early to say, but we do expect. So far, it's going very well, and we think it's likely that there will come maybe small test orders during the year and -- but that's where we are right now. It's too early to guide further on it. It is so with when you deal with the U.S. military that you need proven technology. There's no doubt that we are a company with proven technology, but in the military setting we are newcomers. And so we need to build that confidence in products, organizations and support, but we're on the track to do that. So right now we still look at it positively, but no orders of significance right now.

[Operator]

The next question comes from the line of Carsten Lønborg Madsen from SEB.

[Carsten Lønborg Madsen, Research Analyst]

Just when it comes to ASP growth and unit growth, I was wondering whether you could talk a little bit about what you're seeing in market. I'm sure you don't want to be 100% specific on how things contributed in hearing in the quarter, but still if you could give us some sort of feeling on how your development has been. And then number two, when it comes to the consumer part of audio any -- again, I know you will not break it down, but maybe talk a little bit about the market growth in the truly wireless setting, your market share in this rapidly growing market where many, many launches happen almost every month. It's relatively hard from the outside to get a real feeling about the truly wireless consumer headset market, how it's actually moving forward, apart from the fact that it's moving fast.

[Anders Hedegaard, CEO & President]

Thank you for the question. I will start out on the hearing part. And for Q2, as we have announced, the organic growth was in value 6%. It was higher on units, driven by a strong performance in Asia Pacific, but also in general we saw -- also we had a higher growth in volume than we had in value.

[René Svendsen-Tune]

René here. So correct. We don't anymore give splits between growth in enterprise and consumer, as we think it helps mainly our competitors. So we'll refrain from that, but a couple of comments: First of all, it's meaningful growth in consumer, so we are clearly in the positive. On the true wireless side, it's correct that there's a lot happening in that space. We are very well represented with the -- still shipping Elite Sport. We have the 65t true wireless and now the Active in the market and shipping volume as well. And this is a market, as I guess you all know and understand, is driven by Apple, with the AirPod. The growth rates are exceeding anything you have seen in this sector earlier; and therefore it has taken very significant share of the market, especially in North America. And we are a top 3 player in North America and Europe in this segment as we speak. Did that answer your question?

[Carsten Lønborg Madsen, Research Analyst]

Yes. I guess it's hard to be very precise on that market.

[René Svendsen-Tune]

Yes. I think we -- that's probably as far as we can get. I mean, as you said, there are many players there. 2 American players are leading, Apple one of them. And the third player in the space is us.

[Operator]

The next question comes from Veronika Dubajova from Goldman Sachs.

[Veronika Dubajova, Equity Analyst]

I want to start actually with hearing. And Anders, you made a comment about the European business and some of your large customers. This weighed on your growth in the first quarter. It sounds like it was still a factor in the second quarter. What's your degree of confidence that you see a recovery with those larger customers in Europe? Has that changed at all since -- versus last quarter? That's my first question. My second question is for the Google initiative. I'd like to understand whether you believe, one, that the Android phone manufacturers need to make any hardware changes to be able to adopt this protocol; and two, whether you believe your competitors would need to make any hardware changes to push it through into their hearing aids. So that would be my second question. And then my third question is for René on audio. Can you clarify what proportion of increase in the guidance is related to enterprise versus consumer?

[Anders Hedegaard, CEO & President]

Thank you, Veronika. So the Google part first. I think it's too early for me to step into details of what phone manufacturers and, by the way, also our competitors need to do of changes. It's for sure here that our ReSound LiNX Quattro and Beltone Amaze are prepared for this change, and whereas it will not be the case for some of the other products, so -- in our portfolio. So this is -- requires some new adaptations, but that's how far I can go right now. Then we need to see how things pan out before and when Google is ready to go out with all the details. To the European momentum, we -- Europe is a mixed bag of countries and channels. And it's clear, when we look at the overall growth, we have a higher momentum in certain U.S. segments and Asia Pacific, but in general when it comes to independent, also in Europe, it's going very well. With the larger accounts, we do expect a catch-up during the year, but also driven by ReSound LiNX Quattro and Beltone Amaze. These are products that fulfill a need out there. And we will be now also playing more actively in all categories for rechargeable batteries with these new products, and so we believe that we will be able to deliver based on that.

[René Svendsen-Tune]

So René here. Thanks for that question. As we say, we are not sort of giving the breakdown between the 2 businesses on growth. It's a fact that they both contribute to the guidance upgrade, but as we have 80% of our business in the -- on the enterprise side, it's clear that this has a dominant effect on also the guidance upgrade as such. We would have to have very strong upgrade of the consumer side if that should have any sort of major impact on the overall performance, so...

[Operator]

The next question comes from the line of Martin Parkhøi from Danske Bank.

[Martin Parkhøi, Senior Equity Analyst]

Martin Parkhøi at Danske Bank. I actually think I have a question for all 3 of you. Let's start with Anders. I'm still curious on the LiNX Quattro Premium-Plus category because it's quite evident that products which include a rechargeable battery needs to have a premium, so could you elaborate a bit on the cost that is included in such offering? Do you expect to see improving gross margin rolling out a product like this? Or is it just something which will have a significant impact on your top line but maybe not necessarily so much on your margin side? Then second question is for René. Just now you're upgrading for the third time this year. When you make this decision, are you not taking a look at your long-term financial targets as well? You have a 6% to 9% growth aspiration in the '17 to '19 period. And as I recall, you did 10% last year. And now you are at 16% to 19%, so should we expect a significant deceleration to the growth in '19, which is still within your plans? Or should we just start not looking at this long-term financial guidance anymore for audio? And then final question, for Marcus. You have been successful in many things, but one thing you have not been that successful in is delivering on your aspiration to reduce capitalization of R&D. And as I calculated, R&D capitalization has some positive impact on your margin of 1.9 percentage point on GN Hearing alone in the quarter. So it's very difficult to predict where you will land above the 20% this year if we don't know how much you will capitalize in the last 2 quarters, so how should I expect that? Q2 was maybe impacted by the LiNX Quattro launch, but what kind of level should I expect for the full year, in hearing in particular?

[Anders Hedegaard, CEO & President]

Thank you, Martin, for your question. We'll do it in a way I'll start and then Marcus will take over, as a lot of what you asked for actually related back to Marcus. But just to remind everybody that ReSound LiNX Quattro and Beltone Amaze will be launched in 2 versions. There is a battery version and a rechargeable version. Each of them will have -- will be launched with a premium price to the relevant premium products in the market. That means that ReSound LiNX Quattro versus ReSound LiNX 3D will be more expensive, and the same will be for the rechargeable version. It's obvious that, when you have a rechargeable version, you also have higher costs, but I would hand over the overall margin discussion to Marcus.

[Marcus Desimoni, Chief Financial Officer]

Yes. Martin, the -- as Anders elaborated, depending on what country and what segment we're going to launch it, yes, of course, it's targeted. And we're going to achieve a higher ASP, and that is driving revenue, and therefore, ceteris paribus, it also drives up the gross margin. Then it depends, is it the rechargeable or the nonrechargeable solution that goes out and from what kind of country it comes. And therefore, against our overall gross margin, in some areas it has a positive gross margin impact. In some areas, it will not have a positive gross margin impact. And that is based on some contracts that we have as well as what is the pricing of the different countries, but in general a like-for-like ASP increase is targeted. And therefore, that should fall down. In regards to the capitalization, 100% with you. I don't like this at all, but once you're on the needle, you stay on the needle. And we're not changing our accounting principles, and therefore, depending how we are going to develop our projects, then we have to, by the accounting standards, put these items also on the balance sheet. You see that we have an increase in development projects in audio, hearing and in others. So in others, that is the FalCom project that we have been running. And in hearing and in audio, you have seen, in particular in the second quarter, the increase. Obviously audio did a fantastic job in creating new products and launching it, and that's why you have the buildup. And you can also see it quite for hearing. Going forward, I am shying away to give you a guidance because, with my explanation I've just been giving you, if I would say we go up or we go down, then you will be -- have a read-across how far are we away of new products. So I don't want to give you a guidance on that, but in percentage of sales, that should normally level out. And my principles are still staying in place. We are not getting more aggressive over here. We're trying to ease wherever we can, but we can't change the accounting principles, unfortunately, okay? Then I give it to René.

[René Svendsen-Tune]

Yes, René here. So on the long-term guidance, I mean, we are guiding for next year when we announce the annual report in February. And I understand the question, for sure. Right now, of course, all focus is on increasing the base, and I think we're doing that well. And it's correct that the growth is accelerating, but as regard next year and the years after, we have to come back, as we have stipulated earlier.

[Operator]

The next question comes from the line of Christian Ryom from Nordea Markets.

[Christian Sørup Ryom, Senior Analyst]

This is Christian Ryom from Nordea. I have a couple of questions. My first is to René on the audio business and more specifically on the consumer business and whether you can give us a sense of the development in the mono Bluetooth category and whether this is still a relevant driver of your sales or whether we have now reached a point where your sports audio headsets are the dominant driver of this business segment. And then my second question is to the hearing business and to what's this increase we see in your loan to dispensers. What regions do these pertain to? Is this mainly with U.S.? And how would you expect this development, the development in loan to dispensers going forward? Is this related to increased emphasis on growth with independents?

[Marcus Desimoni, Chief Financial Officer]

Christian, it's me, Marcus. Yes, we have seen this increase in the balance sheet and therefore also reflecting a cash outflow on the cash flow and cash conversion. That was a number up to DKK 100 million in the second quarter, DKK 100 million. The majority was in the U.S. We had 2 bigger loan agreements signed, and this is why the cash outflow was there. It was much higher than the normal quarter, but I would not read too much into that. It's a seasonal pattern. This current quarter, Q3, we don't foresee that, so year-to-date then it's become normalized. It was just a peak in 1 quarter, and no change in our policies as well as in our profile over there.

[René Svendsen-Tune]

And René here. So I mean the answer is quite clear. So there is decline, a significant decline, in the mono business. Still it is now positively compensated by the Elite franchise of consumer products, which is not only sports audio but also these voice and music and true wireless products that we are taking to the market. So the net impact of these 2 phenomena is a positive growth for the business. So you can say this dominant effect of mono is vanishing -- has vanished.

[Operator]

The next question comes from Niels Leth from Carnegie.

[Niels Granholm-Leth]

I have a follow-up question on the R&D capitalization. So as -- Parkhøi, he mentioned the impact of R&D capitalization in the quarter was plus DKK 39 million, but Marcus, you also mentioned that you incurred part of these R&D costs in other, related to GN FalCom, so should this be understood in a way where you actually book the costs related to GN FalCom in other, however you're then going to record the revenue from GN FalCom under GN Hearing?

[Marcus Desimoni, Chief Financial Officer]

Niels, no, what you see over there is, in the disclosure that we have, Note 2.1, segment disclosure second quarter, there you have the line item capitalized development costs. And I assume this is what you all refer to, where we have an increase in the second quarter on a year-on-year base, more on hearing, more on audio. And then we have incurred development costs also. That is also increasing, and therefore we have a small number in others, so -- and this is why I'm saying these are all the project that we are running together. In others, it is [ strat com ] that you know, the costs. And then we have in hearing and in audio the project that is relating to products. So FalCom is in -- is within hearing, to be very, very precise.

[Niels Granholm-Leth]

So just to get it clear. So the cost related to GN FalCom is recorded in GN Hearing.

[Marcus Desimoni, Chief Financial Officer]

Yes.

[Niels Granholm-Leth]

But you mentioned before that the capitalization part related to GN Hearing was recorded in other.

[Marcus Desimoni, Chief Financial Officer]

Yes, I said, "And others, like FalCom." So I was talking maybe a little bit too fast. Sorry for that.

[Operator]

The next question comes from the line of Annette Lykke from Handelsbanken.

[Annette Lykke, Medtech Analyst]

My first question will be for Anders in respect to overall growth in the U.S. We have a positive move for the independent, a negative one from VA and, I assume, maybe a more neutral one from Costco. And what is the [ end growth ] for you in GN Hearing for the U.S.A. market? I wonder if it's above the group average or if it is only Japan and Rest of the World that have delivered the growth above the 6%. And then for René, could you please tell us or share with us what changed for you since you made your upgrade in June 14? Where are the areas where you've seen a better than, at that time, anticipated performance? And should we then expect a sort of acceleration during the remain of 2018?

[Anders Hedegaard, CEO & President]

Thank you, Annette, for your questions. Going into the segmentation. We are as such not communicating specifically on a regional basis, but to put some flavor on the overall: We saw U.S. being very close to the overall growth, but the driver in U.S. was the commercial market that had double-digit growth in the quarter.

[Annette Lykke, Medtech Analyst]

Okay. So then if you have Japan and Rest of the World above group average and U.S. on par, how about Europe? And which markets were you facing lower growth than for the group average? Anything we should be concerned of?

[Anders Hedegaard, CEO & President]

We have been basically through all the different elements saying that in Europe we saw strong growth in the independent market, but we saw a slower development in the larger accounts, although better than in Q1. And so things are trending the right way. And where we have the fundamental important decision making on our products and offerings, we see a very positive growth, which is the larger accounts, as I've described. As you all well know, that has been dragging it somewhat down.

[René Svendsen-Tune]

So René here. On the changes since June, as I tried to comment a little bit earlier here, what we -- the big difference from the middle-of-June situation to now is that we experienced in the second quarter a strong sell-in and pull from the channel. And we have, you can say, a relative higher share of new products in the making, in the composition this year than we have had earlier. So a strong sell-in triggered this guidance upgrade we had to do back in June. What we didn't have by the time was the sell-through, sell-out from the consumer side, sell-through on the [ enterprise ] side, evidence that we needed to see if this was sustainable. We have that now, and that has triggered the -- so the run rate, the pull effect is as strong as we -- the sell-in would indicate. And now we have that. We have both. And in that sense, as I said also, we have the supply chain proving that they could accelerate with the pull. And now we have the -- you can say, the rationale for the next upgrade.

[Annette Lykke, Medtech Analyst]

Okay. In respect to leverage on and obviously your EBITA guidance, where is your threshold in maybe more established markets like Europe and U.S.? Are you -- do you have leverage when you grow from the 5% leverage? Or where should we expect some leverage to happen? I find, like all the other analysts asking questions about this, hardly to believe that at a 19% -- or 16% to 19% growth, you will not see any material operational leverage, despite the fact, of course, I'm aware that you're reinvesting in growth in the company. But there seems to be a lot of room there for both.

[René Svendsen-Tune]

I mean, first of all, I think, I mean, we are now -- we delivered a strong result in Q2 with 18.3% EBITA margin, so I think we have shown that there is leverage in the business. As we go forward here, we have guided more than 18%, as I said. I don't think I have much more to say than we reserve the right to play our cards best possible throughout the year, as regard both market investments and also upgrade of the machinery. And I don't think I can get it much closer here. There is leverage in the business at this point of time with these growth rates, for sure. I think we also have on these calls discussed earlier what is better: pushing the growth and driving the machinery forward or drop a bit more to the bottom line. And we need to find that balance all the time.

[Operator]

The next questions comes from the line of Kit Lee from Jefferies.

[Nyeok Lee, Equity Associate]

I have 2 questions, please. Just firstly, just on GN Hearing. Did I hear it correctly that you are not going to participate in the rechargeable category in the VA channel? Or is that something you will be addressing, I guess, in the near term? And I'll come back with the second question.

[Anders Hedegaard, CEO & President]

Yes, let me -- on the ReSound LiNX 3D -- or sorry, Quattro, we will -- well, we expect to launch it by the end of August. If you have launched before the 1st of September, you can qualify to get the product in for the next open window at VA. The next open window is the 1st of November. And we will then play -- and we do then expect to get ReSound LiNX Quattro into VA at that time, and then we will play in the integrated rechargeable category.

[Nyeok Lee, Equity Associate]

Okay, that's very clear. And then my second question is just on audio. I guess, if you look at the end market of unified communications, do you still see the growth being mainly driven by the large accounts? Or I guess, have you seen increasing adoption from the small and medium enterprises?

[René Svendsen-Tune]

Right. I think the growth in that segment is very widely sort of based nowadays. I mean, it's all over the world. It is large companies, small companies. We don't -- years back, we were sort of counting the amount of customers and the big deals, and there is nothing like that anymore. So it is -- of course, has been driven and is mobilized by large enterprise, but there are many cloud solutions out there that small, medium companies can hook up to and very -- in a very smooth way without big IT department investments and so forth get access to these services. So the phenomenon is strong, and the penetration is going up all the time. We are trying with, you can say, the ecosystem, the infrastructure providers to bring out market-expanding products, so in that sense it's a broad phenomenon.

[Operator]

The next question comes from the line of Oliver Metzger from Commerzbank.

[Oliver Metzger, Analyst]

It's about your strategy on the Quattro pricing. So for many years, the whole industry described that premium prices have reached a level which cannot be increased further because nobody really would buy the hearing aids and pay a rechargeable hearing aid. And for gamers, they just save money for the batteries and pay a high amount for the device upfront. But now you present Premium-Plus with a price premium, which I generally like as a strategy, but that might be discussed within the industry. So can you share with us here just your view? Has the industry missed an opportunity over the last year? Or is the technological advancement bigger compared to previous launches that you believe that patients at the end are worth to pay even a premium on the premium devices?

[Anders Hedegaard, CEO & President]

Thank you for your question. I think that, at least in the years I've been in the company, when we launched LiNX, ReSound LiNX, back in '14, we also, when we talked in the market and heard that we have reached that level of saturation with -- when it comes to premium pricing. We heard the same before we launched ReSound LiNX2. We heard the same before we launched ReSound LiNX 3D. It -- but anyway, on those 3 launches, we managed to go out with premium prices, in particular with ReSound LiNX and ReSound LiNX2. That doesn't mean that we can do it every time. I fully follow that. So the way we have prepared for this is that, besides, of course, having our R&D to develop a superior product, we have, as we were preparing, getting ready, done extensive market research, willingness-to-pay studies and you name it, where we're basically going out with many customers, and we're talking about more than 200 customers, are analyzing in different markets their willingness to pay depending on the benefit -- features and benefits we are offering. The feedback we have received to this product is that we are bringing a product to the market that has superior features and benefits compared to what is in the market. And we have been receiving signals, clear signals, well documented, that we across countries can actually go out with a premium. That doesn't mean you can do that with every customer, but the product will be priced as premium to reflect the premium, superior quality of the product. Time will, of course, show as we go along how well we are able to master that, but as such, we are going out. And we have pretty well documented that this is a possibility and a reasonable possibility. Otherwise, we wouldn't do it, but time will show whether we are able to drive our ASP. And this is a product mix combined also with a like-to-like price increase.

[Operator]

The next question comes from the line of Maja Pataki from Kepler Cheuvreux.

[Maja Pataki, Head of Med Tech Devices Sector]

I'd like to start with audio. René, could you give us a feeling for what the market growth in consumer is, just to kind of be able to model our own assumptions on growth going forward? Then the second question. You said that the guidance increase also included the positive turn in momentum in consumer. That means that you do expect consumer to end the year in positive territory? Then also on audio, you've had fantastic H1 results. And as we know from experience, Q4 is usually a very strong quarter for audio, so I'm trying to understand how to think about the pattern throughout the year. Is Q3 softer than we've seen Q2? And therefore you expect basically the strong Q4 to get you into the range? Or shall we think about a possibility where Q3 is going to be yet another upgrade quarter? And then I'd like to end my questions with regards to hearing. I'm trying to consolidate everything that you've been saying about growth in the different regions and then unit growth and ASP growth, and maybe you could just elaborate a tiny bit more. You've stated that you had very strong, and I think you said double-digit, growth in the U.S. in the commercial independent market. You said that you had in Europe very strong growth in the independent market, where I would expect that both regions must have benefited from a positive ASP development. Is the growth in the remainder of the world that strong that it actually has resulted in a reversal of the positive ASP? Or how shall we think about that? And that's it.

[René Svendsen-Tune]

So René here. Thanks for that. On the consumer market, I think I need to say there are many segments in that market, and some of them have very high growth. Some of them have negative growth, and some of them have you -- what you would call, in the old days, moderate growth. Net-net of everything, where we are playing now in these segments, there is significant growth across the segments we play, if we add them all up. And so we are growing in -- we are playing now, on the consumer side, in a -- on the totality of the mix we have, in a well-growing market. So there is a market to play into, but of course, we're also playing with some very sizable players there, like Apple, as we talked about a little bit earlier. I think that's what I can say about that. So we are not market limited in that space.

[Maja Pataki, Head of Med Tech Devices Sector]

But is the market growing itself above 10%?

[René Svendsen-Tune]

I don't want to give clear guidance on how exactly we read the market, but it's growing. Yes, and I can also say, it's growing more -- the market there is growing more than 10%, net-net of everything. On the Q4 question -- I think, on the full year guidance for consumer, yes, we expect to be in the positive growth domain, just to -- without giving a number, but we expect to have full year positive growth on the consumer side. On the Q4, of course, you can say there are 2 issues here. There is a base because we're operating from a large base. And Q4 is a much bigger quarter. It doesn't mean that necessarily we have higher growth in Q4 than in any other quarter, but the -- we had a strong Q4 last year in audio. We have the biggest base to work up against. I think with the guidance we have given, we are trying to signal that, if we are in the upper end, we would need to deliver growth at the ranges we have delivered in the first half; and if we are in the midrange, a little bit softer, from a higher base. I don't have so much more to add here. We still have the bigger part of the year left after second -- after June, but we are well into Q3. And of course, we have a good feeling for how the market works.

[Anders Hedegaard, CEO & President]

Yes. Say -- let me say a little bit few more words on the growth even though it's -- I have to say that the minute you slice and dice deeper in it, the more complexity it comes, because there is channel mix, there is country mix, there's customer and product mix. But the point is that the organic growth of 6% is we saw a very, very nice, positive growth in the commercial market in U.S. You are all aware of the negative growth we experienced in VA. When it comes to outside U.S. and Europe, we had on the independent a good growth, but on some of the larger account, not as good. So clearly Europe versus U.S. and Asia Pacific in total showed a slightly lower growth. And when it come to Asia Pacific, we saw a very nice growth driven by the countries I mentioned earlier, China, India, and distributor markets. But even in a country like China, you -- when you go from 1 quarter to another, you have channel mix and product mix. So there is a lot of granularity in those numbers, so unfortunately I cannot and will not provide you with further details than that.

[Maja Pataki, Head of Med Tech Devices Sector]

I -- understood. Just would it be fair to say that you had a positive ASP impact in Europe and the U.S. but by sheer magnitude of growth in Asia Pacific and the fact that the pricing level is lower there, that will just counterbalance? Or shall we not think about ASP -- positive ASP impact also not in Europe and the U.S.?

[Anders Hedegaard, CEO & President]

I think your question is just another way of phrasing the first question, and it is to -- the point here is that in a market from 1 quarter to another, you have -- you can have -- let me just use China as an example. You can have a tender in 1 quarter. You don't have it in the next one. So private pay versus public pay, that has an impact on ASPs. And so there is a lot of details in that, that can distort, disturb the overall picture. Point being, we have launched ReSound LiNX 3D with our expanded commercial activities. That is giving us a nice development in product mix and pricing on a like-to-like. Then we have all channel mix and larger customers mix that makes a lot of it up. And that's how far I can go right now.

[Operator]

Your last question comes from the line of Michael Jungling from Morgan Stanley.

[Michael Klaus Jungling, MD, Head of MedTech & Services and Analyst]

I have two more. Firstly, on hearing, for the upcoming third quarter, can you sort of provide some indication as to how the growth will be impacted by inventory stocking and restocking to avoid a large modeling error with the launch of Quattro? And secondly, when it comes to hearing cash flow, you've mentioned that the poorer cash flow is a function of inventory but also growth investments. Can you comment on what these growth investments are? Does this include loans to dispensers, et cetera?

[Anders Hedegaard, CEO & President]

Thank you, Michael, for your question. First and foremost, we're not guiding on a quarterly basis. So, and within a few weeks or week, we'll hopefully launch ReSound LiNX Quattro and Beltone Amaze in the first country. That will be U.S. We have a rollout plan, and we have not made that public, and we are working on it right now. So it's -- and in some countries there is, of course, a take-up of it, but usually what we see is -- when we launch new products is that, yes, there is somebody building up on stock, but we see a throughput pretty quickly. So that's how we look at it here. I cannot give you more detailed guidance because that would mean that I should announce our rollout plan, and we are not ready to do that right now.

[Marcus Desimoni, Chief Financial Officer]

Michael, it's me, Marcus. On your question on the cash flows from the second quarter. As I mentioned, they were impacted by 2 factors. One was the increased activity for the preparation of the launch. That means mainly buildup in inventories, of course, and that's where you have seen cash outflow. And that will normalize in Q3 and in Q4 as we come to the normal level. And the second one is dispenser loans or the FSAs. Yes, I mentioned that we've had 2 bigger cash-outs in the quarter, and the activities have been mainly in the U.S., if you see the project. So that was a peak in the quarter, which I would not see as a normalty over the year. And the guidance for the year, plus, minus flattish, still remains, so Q1 and Q3 should have the countereffect than the second quarter of loan agreements.

[Peter Justesen, Vice President of Investor Relations & Treasury]

And with that, this is Peter again from IR. I can see that we have reached the end of the queue. Thank you, everybody, for dialing in. And thank you for Anders, René and Marcus, here in the room today.Thank you all. See you on the road. Thanks.