Arjo AB (publ)

STO:ARJO B

Earnings Call Transcript 2023-Q1

[Operator]

Welcome to the Arjo Q1 Presentation for 2023. [Operator Instructions] Now I will hand the conference over to CEO, Joacim Lindoff; and CFO, Daniel Faldt. Please go ahead.

[Joacim Lindoff, executive]

Thank you very much, and good morning to everyone, and welcome to this Q1 call 2023. Together with Daniel Faldt, our CFO, I will give you some details on the Q1 report that we released at 7:00 this morning.Next slide, please. Today's agenda includes a summary of activities and results from Q1, Daniel will give some details on balance sheet, and I will then address the outlook for 2023 before we open up for questions. And as always, we intend to keep this call to an hour and finish at around 9:00.Next slide, please. So let's start with a business update and then a look at Q1.Next slide, please. Following the trend that we had coming into the year, we continue to see good demand on most major markets for our solutions, as well as capital sales, service and rental. As expected, our net sales development was held back by the development in U.S. with significantly lower critical care rental volumes, and we continue to see weaker demand for our more long-term patient handling programs. This resulted in an organic growth of 4.3% for the quarter, setting a good base for the rest of 2023.The activity level in U.S. remains on a good level, but it continues to [ beat ] the conversion from lead to order that is slower than usual due to the continued stressed financial situation of many health care providers due to the known staffing shortages and increasing costs. There are some small positive lights in the tunnel when talking to customers, but they are more confirming our current view that we should see a step-by-step improvement on the U.S. capital equipment market from Q3 and onwards.Our critical care rental business is, as expected, seeing a significant drop in the quarter, but this is now the last quarter, where we have high COVID-related comps in this area. As of next quarter, we will be able to see the full effect of our core rental business that continues to develop well. Excluding the critical care rental part, the Group grew with almost 6% organically in the quarter.The postponement of invoicing that we saw in our diagnostics business in Q4 has been addressed in an okay way during the quarter, and we have cleared some of that backlog in the smaller part of our business. Inbound supply of electronics in diagnostics has continued to be volatile in this quarter, and prices has remained on a very high level. But also here, we do have some light in the tunnel in the back end of the quarter.We continue to see good growth on major markets like Canada, France, Germany and Australia, where both capital service and rental developed well. Our gross margin in Q1 came in slightly better than expected at 42.2%. The gross margin continues to be affected by higher material prices, inflation effects on fuel, energy and salaries and negative mix effects from critical care rental and obviously the lower patient handling sales in the U.S.On the positive side, we are now clearly starting to see transportation costs come down, well in line with our previous forecast. The current gross margin level is obviously not a level we are satisfied with going forward, but we did see a trend shift versus the last 2 quarters, and we continue our efforts to drive long-term improvements in this area.We continue to drive efficiencies throughout the value chain. Our U.S. rental efficiency program is now completed and generates forecasted gains. Our U.S. sales reorganization is implemented during the quarter, setting us up for a good strategy alignment going forward. We have consolidated parts of our Nordic sales and rental business and supply chain continues to work on efficiencies in a number of areas.Our price increase focus remains with good traction and customer understanding also during Q1, and we will see both carryover effects from 2022 and effects of new initiatives in Q1 in the quarter to come.OpEx was well under control in the quarter with a reported level reflecting higher activity levels than Q1, 2022, which was still very much impacted by COVID. Adjusted EBITDA for the quarter was SEK474 million, well in line with our expectations. With solid plans in place to further improve profitability over the coming quarters versus 2022, this result sets a stable base for 2023.Cash conversion develops on plan for the quarter, below our [ year end ] targets, but still an okay start to the year. We continue to lower our inventory levels in line with forecast, and the 59% cash conversion is mainly due to larger amounts of invoicing at the end of the quarter with low quarter-end collection, as a result. We continue to keep a very high focus on both AR and inventory and still expect that we will be able to meet our 80% cash conversion target for the full year.In summary, good development on those markets with overall net sales developing well. Our growth in the quarter was held back by significantly lower critical care rental levels in the U.S. and lower patient handling net sales in the U.S. as main reasons. But our service and rental business continues to develop favorably across almost all markets and will be an important growth engine for 2023 and onwards.Next slide, please. And moving into North America, where we saw an organic growth of 0.7% for the quarter. Our U.S. business that has now completed a significant reorganization during the quarter had negative organic growth due to a few main factors. Critical care rental decreased with the expected approximately SEK40 million versus Q1 of 2022, which has an effect not only on net sales comparison, but also as a negative mix effect on gross margin. As stated before, this was now the last quarter with high COVID-related comps and coming quarters invoicing in this area is expected to hover around USD1.5 million that we have seen over the last 4 quarters. Excluding the critical care rental part, our U.S. business had a positive underlying growth versus Q1 of 2022.One driver here is our core rental business that continues to develop well and new contracts are being implemented with continued good pipeline. Here, it should also be noted that we have now finalized the implementation of our U.S. rental efficiency program. And from the end of Q1, we are having the full efficiency savings corresponding to USD5 million on a rolling 12 basis.As forecasted, we also saw lower patient handling sales in U.S. compared to Q1, 2022, mainly coming from the low numbers or low volumes of more long-term outcome programs in this area. As before, this slowdown is related to the fact that the short-term willingness to invest has been limited due to the current financial situation for most U.S. healthcare providers, a situation caused by staff shortages and higher cost to run their business. They need to focus on day-to-day activities instead of changing protocols and way of working, even if it makes clear financial sense for the long run continues to be there. However, customer interest is high, and we continue to work our pipeline in this area.The current drop in patient handling net sales in the U.S. also has a negative product and geographical mix on gross margin. Patient handling continues to be a higher-than-average gross margin category and outcome program sales in U.S. is based on the very clear return on investment for our customers in itself a higher-margin activity.Our DVT business in the U.S. performed well, especially on pricing and compliance initiatives. Volumes are increasing somewhat based on slightly better traction on the elective surgery side, and we expect this trend to continue throughout the year. We continue to see a high interest for our pressure injury prevention programs in U.S. and our overall sales in this area, which is also driving our rental volumes and is trending well aligned with forecasts. The uptick on SEM conversion despite a continued very high interest from our customers, did not reach the expected levels, and it is clear that conversion from positive trials to full-blown commercial usage continues to be more cumbersome than what we would like to see.Finally, a few words on Canada, where we continue to see an impressive performance also comparing to the record year 2022. Our organic growth in Canada in the quarter is above 10% with good development in capital service and rental and with a good mix between long-term care and acute care. As stated before, the Canadian split in segment sales is something that we are trying to build also in other main countries, and it is clearly giving both business stability and a step-by-step improvement on margins.As a summary, on the start of the year in North America, it's well aligned with our forecast going into the year. Customers are indicating smaller beacons of light in the tunnel in -- on the U.S. capital equipment side that confirms our current view that we should be able to see a step-by-step improvement from Q3 and onwards. We have continued good traction on our service and core rental business, and our Canadian market performs a very solid start to the year.Next slide, please. And if we then move over to global sales, where we -- then as always, we'll focus on both Western Europe and Rest of the World, the region in total had an organic growth of 5.6% in the quarter, in my view, a stable performance well in line with our forecast for the year.Starting with Western Europe, where we continue to see good demand for our products and solutions together with a good development of both service and rental in the quarter. The area grew with more than 6% in the quarter with major markets like France, Germany and Austria, showing good growth and are building on long-term plans.In U.K., we have an organic growth just above last year's high level in Q1. We have also here good traction on service and rental, where we, in both areas have managed to implement price adjustment that starts to mitigate the material cost increases that we are seeing, and the organization has done a focused job around this area during Q1. We are deliberately stepping away from low-end bed projects in the U.K., which step by step, will allow us to increase gross margin in this category, but also focus on more profitable segments in -- on this market.In general, our European business continues to confirm positive trends from the second half year of 2022 and we see development in line with our plans in both acute and long-term care.Then on to next slide and some further details on Rest of the World. Our business in Rest of the World, again, had a healthy net sales development, an organic growth of almost 5% with continued good market demand and higher activity levels. In Australia, we have a good position, both in service and rental and our capital business is growing despite a lower focus on low-end medical beds also here. India, Hong Kong, Singapore also adds to the momentum, and it's now good to see that we are back to pre-COVID activity levels on those markets in the region.Our Chinese sales and service activities have started to pick up speed in the end of the quarter, again, a small part of our current business, but with potential to grow gradually. Japan is performing on plan so far and is expecting higher net sales numbers versus last year starting in the second part of 2023. All in all, Rest of the World has started the year in a solid way, well aligned with our plans, and I feel comfortable that this part of our business will continue to grow in a good way, given the current pipelines and implemented [ plans ].Next slide, please. And moving on and over to some financial details, and next slide, please. For the quarter, we have a gross margin of 42.2%, slightly higher than previous expectations and also higher than the last 2 quarters. We continue to see negative product mix effect due to less patient handling equipment and negative geographical mix, as we are selling less percentage wise in the U.S. also in this quarter. For your information, the drop in critical care rental is having almost a percentage point negative effect on gross margin.Material cost is again significantly higher versus corresponding quarter in 2022 and affecting negative with more than SEK40 million in isolation. This is higher than expected, mainly due to the continued high cost of electronics, especially in our diagnostics business. It should, however, be noted that we continue to see stabilization in the inbound deliveries and we also buy less electronics on the spot market, which is a good sign for the future.Transportation came in almost SEK30 million lower than last year's Q1 on a volume-for-volume like basis. On top of this, we had around SEK10 million in low logistic costs, thanks to the inventory reduction plans, an effect that we do not expect to be as high in the coming quarters. However, transportation in general, is trending better than expected.Increasing inflation and energy costs are affecting the gross margin negatively in the quarter with around SEK15 million versus Q1 of 2022, a value which is in line with our expectations for the full year of 2023. We are as before, working hard to mitigate the negative effects with continued long-term efficiency gains throughout the value chain. The U.S. rental efficiency program is now fully implemented.Our continuous improvement plans in the supply chain continues to perform according to plan, and we are seeing external factors to move both towards stability and in some cases, lower [ cost debt ]. Price adjustments to mitigate for the higher material cost is still a highest focus. We are compensating well for material cost increases in the isolated quarter, but obviously need to continue to work in this area to compensate for the drop seen in 2022.Given the additional adjustments made in many countries and with the majority of our product portfolios, I continue to feel confident that we will perform on or slightly above previously communicated effects for pricing in 2023, adding at least 1.5 percentage points in organic net sales for the full year.Next slide, please. Our OpEx level in the quarter is well aligned with plan and are reflecting a considerably higher activity level in sales and marketing compared to Q1 2022. And again, Q1 2022 was much affected by severe COVID lockdowns across the world with low cost levels, as result. In Q1, 2023, we are up to full speed, and we are working with pipeline, loans, preparations and investments supporting, for example, our pressure injury prevention focus buildup in a good way.Additional inflationary cost in OpEx is approximately [ SEK13 million ] in the quarter versus the same quarter of 2022. Salaries will continue to trend upwards in the coming quarters with energy and fuel, most likely flattening out.Admin cost is also negatively affected by approximately SEK9 million of higher IT costs versus a very low Q1 of 2022. The additional cost comes mainly through the new accounting rules applied and also the higher activity levels that I indicated before.R&D gross investment is at 2.6% for the quarter, well aligned with our portfolio planning and upcoming launches. Our net R&D cost is approximately SEK5 million higher than Q1, 2022, as an effect of this. Adjusted EBITDA in Q1 was SEK474 million with adjusted EBIT ending up at SEK195 million.Here, I would also like to shortly comment on the restructuring cost of SEK19 million in the quarter. Main part of this restructuring is coming from a larger change in our Nordic operations, the final implementation phase of our U.S. rental efficiency program, and also the implementation effect of our U.S. sales reorganization that has been finalized during the quarter. For your information, we forecast approximately [ SEK40 million ] in total restructuring costs for the full year of 2023.Then over to Daniel, and next slide, please.

[Daniel Fäldt, executive]

Thank you very much, Joacim. Coming off a relatively challenging 2022 in terms of operating cash flow and cash conversion, we delivered a solid start to 2023, in line with our plans, as Joacim mentioned earlier. Through continued high focus and improvement of working capital management, we managed to come back to a neutral impact from working cap in Q1 compared to a significant negative impact in the same period last year.We are confident that our cash conversion target for the full year 2023 of 80% is well within reach. The situation with regards to material supply and logistics continued to stabilize during the first quarter, giving us further confidence that our working capital improvement ambitions are achievable. We foresee further progress on inventory levels throughout 2023, and given that, we managed to continue to improve working capital days for the second consecutive quarter. Encouragingly, the main positive effect comes from continued inventory improvement building on the last quarter of 2022.We want to stress that the fact that our inventory continues to be current and not a concern in terms of looking at our stock aging analysis, no additional balance sheet risk in this area to be worried about. We continued our solid work on receivables meanwhile and building on previous quarter, even taking into account significant invoicing late in the quarter, of which collections are expected in Q2. We expect this performance level to continue and to be built on going forward. Important to note here is that we did not see receivables dropping into older buckets in our receivables aging analysis, much like inventory aging analysis, hence, no additional credit risk to be concerned about.Along with a slight increase in current liabilities, we managed to decrease the working capital days level by 1 day in the quarter to a level of 101, building on the 4-day reduction we accomplished in the fourth quarter 2022.The EBIT level in the quarter, along with a flat impact from working cap, overall means that we're posting an operating cash flow number of SEK271 million compared to SEK25 million in the same quarter last year. So a solid start to the year that we will continue to see progress on in the coming quarters and a significant improvement compared to Q1, 2022.Subsequently, cash conversion improved considerably versus the same period last year, where we came in at 5%, and now we achieved 59.2% in the quarter. Cash flow from investing activities was a negative SEK211 million, mainly containing investments in our rental, R&D and fixed assets.Next slide, please. The profit level in combination with the cash flow, including financing and investment activities, along with some negative currency effects resulted in our net debt increasing slightly to SEK5.2 billion, which is SEK0.2 billion higher than the previous quarter. To remember is that financial cost has increased substantially compared to the same period last year and reflects the current interest rate expense and debt levels in Q1. Even so, we expect our reduction journey to resume mainly in the second half of 2023.Meanwhile, our cash position remains strong, and our net debt to adjusted EBITDA came in at 2.7%, a slight deterioration of 0.2% versus Q4, 2022, but a minor setback due to the net debt development described earlier.Finally, the equity ratio came in at 47.7%, which is 0.5 points above the recorded level at year-end 2022.Now back to Joacim.

[Joacim Lindoff, executive]

Thank you very much, Daniel, and some business highlights. And next slide, please. As stated earlier in the telco, we continue to see high interest for our programs and solutions around pressure injury prevention. We can see a clear interest from caregivers around the world to address this huge cost market, especially as a lot of this cost is preventable with the solutions that we provide.We also continue to experience a high customer interest in our SEM scanner, as a part of these programs with a significant pipeline building. However, the conversion progress from positive trials and customer discussions to fully fledged commercial usage continues to be slower than expected. We are behind our own forecast in SEM sales for Q1 and expect this lower trend to be present also for the coming quarters. We, therefore, now believe that we -- based on a reassessed position, we'll see around SEK150 million in SEM scanner and scanner head sales in 2023 versus the previously communicated around SEK200 million, still with the majority tilted mainly to the second half of the year.Next slide, please. An update on WoundExpress, and unfortunately, we are experiencing a slow recruitment pace to our randomized controlled trial for WoundExpress. And as we described at our Capital Markets Day, we have changed the previous protocol to allow a quicker uptick, while obviously not jeopardizing the quality of the study, but recruitment continues to be slow.Feedback that we are getting is that our targeted sites, especially in U.K. are still suffering from very volatile patient inflow based on post-COVID effects and recently a very severe flu season, with strong focus from caregivers on just [ fixing here and now ]. Randomized controlled trials outside of areas like vaccine and cancer treatment seems to be, at least in the U.K. delayed throughout.We are trying to speed up, where we can influence but must conclude that we most likely will experience additional delays probably until summer 2024 until we can see published data. This is obviously not the wanted position, but it will not have a material effect on our short to midterm financial performance, as we already for the last financial target communication have included only moderate sales numbers for WoundExpress based on sales not directly related to the RCT.Next slide, please. And moving over to the outlook and our current view on organic net sales performance for the year, where we, based on our current visibility of the market expect that the organic net sales growth for 2023 will be within the Group's target interval of 3% to 5%. As previously communicated, we expect the year to be tilted more to the back end, especially when it comes to the expected important improvements in our U.S. patient handling sale and our SEM scanner sales as discussed before.We still expect the overall capital sales volume to grow slightly for the full year with a forecasted positive development in patient handling and pressure injury prevention, while capital sales of medical beds will decline given the focus on gross margin and instead of volumes in the low-end segment. We expect our service and core rental business to continue to develop well during the year, core rental, especially driven by the current implementation of new contracts in the U.S. and serviced by a mix of volume and price effects globally. Price increases are still expected to add at least 1.5% organic growth across the Group for the full year.From a gross profit and margin perspective, the message is as before. We expect material prices to continue to increase with FX visible, especially in the first half of the year and in total, now would be slightly higher than previously expected for the full year. The positive trend on transportation is at the same time expected to continue. And based on our current trends, we believe that the slightly increased material cost will be well compensated by the lower cost for transportation during the year.We expect energy and fuel to remain on today's high level, which means that the effect versus Q2 and Q4 will be more or less neutral. Inflation effects on salaries will be clearly visible in [ COGS ] both in manufacturing, but also in service and rental. Our continued focus on price adjustments and internal efficiency work will continue to mitigate factors to this increase.We expect OpEx as a percentage to net sales to increase for the full year of 2023 and they start to decrease -- and it will start to decrease again from 2024 and onwards. This, as before, mainly based on a higher activity level, but also much from the added inflationary pressure on salaries that will come into effect from Q2 and onwards.In summary, we expect 2023 to be a year, where with net sales and profitability improvements versus the full year of 2022, however, continue to think that this will be tilted towards the back end. Based on the stable start to the year, we feel confident that we can meet our guidance of 3% to 5% organic growth and make sure that we start the journey to improve our profitability in current year.Next slide, please, and some short key takeaways. We have started 2023 in a solid way with a return to organic growth more precisely 4.3% organically. Our underlying business is developing well in most areas, and we are following our plans and forecast well.We are starting to see good effects of our initiatives around price increases and internal efficiencies, areas that will contribute to a positive development of our gross margin and overall profitability for the full year of 2023. Despite continued volatility on several markets, we feel comfortable with achieving our outlook of 3% to 5% organic growth based on the solid start, and we look forward to continue to develop [ Arjo ] in 2023 on both top line and profitability versus 2022 full year.With that, I would like to open up for questions. So moderator, please go ahead.

[Operator]

[Operator Instructions] The next question comes from Erik Cassel from ABG Sundal Collier.

[Erik Cassel, analyst]

[ I has had ] 2 questions. I'll start with the first one. The strong organic growth here in Q1 seems to me to be largely driven by the component access than we maybe expected. Is this correct? And then also, could this be seen as some sort of pull forward of Q2 and H2 deliveries in that case, as you know, it churns out the backlog somewhat rather than the good Q1 growth adding to full year? That's the first one.

[Joacim Lindoff, executive]

I think that in the only area, where better access to material -- has material net sales is in the work with the backlog in our smaller diagnostics business, where we have probably been able to get out, well, a little bit more than SEK10 million from what was postponed from Q4. And that would be the only area, where I would like -- where I would say that the net sales growth is related to better access to material.The better access to material is more in the back end and more, I'll say, gross margin or profitability related. We have a more stable situation when it comes to inflow of components to our production sites, which means that we are step-by-step getting a better production situation. We are also not forced to airfreight as much as we had to do before, and we can into a significantly better extent, meet customer expectations. I wouldn't say that we have dragged forward any net sales. It's based on a good development on the markets that I mentioned, with a solid development on both service and core rental for the quarter.

[Erik Cassel, analyst]

Thank you, Joacim. The second one, yes, SEM scanner not living up to expectations really. Could you quantify in some more detail, where the SEM scanner is tracking now compared to your previous guidance? And also if you think that this has any longer-term implications for where it should have been in 2025?

[Joacim Lindoff, executive]

No. I mean we obviously would like to be slightly higher for the quarter than we were. The frustrating thing again, is that we have a pipeline that is as big as the City of [ Malmo ] on interesting customers on the SEM scanner, and the overall interest for our pressure injury prevention side is increasing by the day. Our customers are seeing the need to prevent something that is truly preventable.In our view, this is just a move in terms of time this year. We are still confident that we -- with our pressure injury prevention solutions have something that should be considered as a game changer. For the more long-term targets in '23, '24 or rather than '24 and '25, I wouldn't be looking at this as a problem because obviously, even if we have a very significant pipeline, we are always kind of careful when we are putting the targets on '24 and '25. So a delay here in 2023 will not have a material impact when we go forward in '24 and '25.

[Operator]

The next question comes from Kristofer Liljeberg from Carnegie Investment Bank.

[Kristofer Liljeberg-Svensson, analyst]

I also have 2 questions. Coming back to the SEM scanner. Could you please explain a little bit why you think -- what do you think is the reason for the slower conversion to commercial contracts? And also would you see any risk that you don't reach some sort of minimal sales level stipulated in the distribution agreement you have? And...

[Joacim Lindoff, executive]

Go on.

[Kristofer Liljeberg-Svensson, analyst]

Yes, maybe take this one first.

[Joacim Lindoff, executive]

Yes. On the contractual side, I believe that we -- it's difficult to comment on that one given that it is a cooperation between 2 companies, but we are working very tightly with BBI, and I feel comfortable that we are going to make sure that we have a long-standing relationship. What is hindering the [indiscernible] or rather the conversion to a large extent is the smaller factors in my view. It is the -- to some extent, the short-term focus that, that healthcare providers in the U.S. still has given the problems that they are seeing. But then we can also see a significant workload when it comes to tying our SEM scanner solutions to different hospitals, EMR systems connecting them in a digital way into patient journals, et cetera, which is a very cumbersome process with IT departments of different hospitals and different solutions, and that is taking more time than what we had expected.Again, it's a little bit like the [indiscernible] those things just needs to be fixed. And when they are fixed, the customer starts using the product and get these usage into their protocols, which is very good when we have done that, but those type of things take longer time than expected. So that's one example of things that are more cumbersome in the conversion process than what we had believed initially. Kristofer?

[Kristofer Liljeberg-Svensson, analyst]

Sorry, I was muted. So my second question is, if you could comment on the seasonal pattern for the EBIT margin, and also given your comment that earnings improvement this year will be back-end loaded, does that mean you expect the EBIT or adjusted EBIT to be down year-over-year in Q2 as well?

[Joacim Lindoff, executive]

No, I -- hopefully, I didn't say that for Q2. You should probably put it like this, we have had a stable start to 2023. We would like to point out that we still see a volatile market. We still see instability on supply chain. So we would like to keep and stay realistic for the quarters to come. And I think that, that is an important message to bring with you.But we have no intention of letting off steam when it comes to developing our business on top line or on profitability for the full year. And we remain with what we have said before that 2023 is going to be a year, where we improve on organic net sales, where we meet our interval target of 3% to 5%, and where we for the full year of 2023, we'll see a higher profitability than what we had in 2022.

[Kristofer Liljeberg-Svensson, analyst]

And on that topic, I think Q1 was the most difficult comparison for sales, as you had the high critical care volumes in Q1 last year. With this in mind, do you see any reason why sales growth should be slower in the coming quarters year-over-year than the positive surprise you had here in Q1?

[Joacim Lindoff, executive]

Again, I would like to remain realistic and say that for the full year, I feel comfortable that we will do the 3% to 5% organic growth, Kristofer.

[Operator]

The next question comes from Rickard Anderkrans from Handelsbanken.

[Rickard Anderkrans, analyst]

So first one, could you elaborate a little bit on the beacons of light that you described it in U.S. clients in terms of patient handling and the overall capital equipment demand in the U.S. elaborate a bit more on the discussions and what you're hearing and what signals you're picking up for that H2 recovery?

[Joacim Lindoff, executive]

Yes. And again, I would like to underline that the beacon of lights are small, but still there and confirming our view that we should see a step-by-step improvement from Q3 and onwards. The beacons of lights is more customers speaking about that they are seeing a way back to a more normal situation. They're not there yet, but they're starting to see things easing up. They are starting to see that they can produce more elective surgery than they've done before. They see a path to that. So it's more discussions like that.But also then adding to the customers' views is what our competitors on the U.S. market are speaking about and what market players in general are talking about. And our impression when it comes to our line of products and solutions is that these indications is confirming our view that we should see this return to a step-by-step growth in Q3 and onwards. So it's more a message around that the situation has not deteriorated. It has rather stabilized in the right direction to confirm what we have said before.

[Rickard Anderkrans, analyst]

And could you elaborate a little bit more on the development in Canada? Should we extrapolate and expect similar performance in the next few quarters here? Or any flavor? I mean, it's a relatively big market, right? So it would be helpful to get some more commentary there?

[Joacim Lindoff, executive]

Yes. I'm very impressed by the development of our Canadian market. We have a good mix between acute care and long-term care. We have a cultural setup in that country that always aim at improving more and more and more. So I feel comfortable that Canada, as a country will continue to develop well. And if I look at North America, as a region, Canada, obviously, even if it's a significantly smaller market than our U.S. business, Canada with the current traction has a possibility to continue to compensate if we would continue to see a very volatile market in the U.S. also in Q2. So more looking upon Canada, as a -- with the traction that they have as a mitigating factor if we will continue to see some volatility on the U.S. market higher than what we expect.

[Rickard Anderkrans, analyst]

And would you say that Canada is above or below gross margin contribution for Group?

[Joacim Lindoff, executive]

Above.

[Operator]

The next question comes from Mattias Vadsten from SEB.

[Mattias Vadsten, analyst]

My first question maybe another way of asking the same question as before, But anyway, I guess, we're seeing clearly an uplift for [ Arjo ] this quarter, no matter how we look at it compared to last year. So if you could just single out the effect, more important for this than maybe the others and some further elaboration, what happened Q-on-Q because it seems U.S. is still quite volatile and uncertain, and so -- so just the more important factors?

[Joacim Lindoff, executive]

The more important factors for me is -- and again, there has been a lot of good work going into -- already in the second half year in making sure that we set ourselves up for a better performance in 2023. But if I would single out 3 that has stood out is a continued good development of our core rental business across the globe, our service development across the globe, and obviously, especially in the service, pricing has performed slightly better than expected. And I am really happy to go through and work through the initiatives that we have around pricing, the initiatives that we introduced already in 2022, where we are now starting to see the effects, where we have the effects that we have introduced in Q1, which obviously don't have that much of effect in the Q1, but [ they ] will continue to trend well. So yes, pricing, service and core rental, I would point out, as the 3 main factors for a better-than-expected performance in Q1.

[Mattias Vadsten, analyst]

That's very clear. And then if you could just try to talk a bit about the product mix in the quarter within product service and maybe how we should expect this to develop in the following quarters. And I guess, for the second half with U.S. expected to lift its performance that should help, too, but just some thoughts around this matter as well, would be helpful.

[Joacim Lindoff, executive]

As I said during the telco, we are experiencing a negative product mix from less patient handling sales. It is down in absolute numbers versus last year in Q1, which obviously has a negative product mix effect for us. As I also said during the telco is that we do expect patient handling from a volume perspective for the full year to grow, which means that we should be able to see, especially in the second half year, a more positive product mix from patient handling in the second half of the year. So that is really on the positive side.On the medical bed side, we do see a decrease in capital sales in sales of medical beds capital in the quarter, and that is something that will continue probably at a higher pace in Q2, Q3 and Q4. And I think that -- it's important to mention from a few aspects, I mean we are actively stepping away from business in low-end medical beds -- in the low-end medical beds area. So if we would have done what we have done in previous years, our organic growth might have been slightly higher than what it actually is right now.But we also believe -- we do believe that this is the right way of doing it and focusing more on the high end of medical beds and staying true to that message. But I do think that sales of medical beds in the capital area will continue to go down, which in itself, then will have a positive product mix if we compare it to previous quarters or quarters in 2022.Then there is the geographical mix, as you mentioned in your question as well, and that is when we are selling in the U.S. when we are selling patient handling in the U.S. that is giving us a better geographical mix, especially when we are selling that in our outcome programs. So we do expect both geographical and product mix to improve, especially in the second half of the year.

[Mattias Vadsten, analyst]

I think that's very clear. My last one, just on the balance sheet and inventory. Could you comment approximately how much excess inventory you have now? I guess, there is a price component, of course, but the volume part. And is there anything else that we should think of for the remainder of the year?

[Joacim Lindoff, executive]

I think that we saw quite steep progress from the all-time high level that we had in October last year, and we saw quite significant improvement in November and December. And then typically, from a seasonal point of view, we have a slight inventory buildup in the beginning of each year. So in January, February, which was also true this year. That trend in 2023, we broke substantially in March, but we still see quite good room for additional improvement during 2023. And so I think we have reduced inventory since October by [ SEK0.25 billion ] roughly, and we have somewhere not as much as that left in the tank for 2023, but perhaps half of that at least.

[Operator]

The next question comes from Victor Forssell from Nordea.

[Victor Forssell, analyst]

Two questions from my side. Firstly, starting off with the comments regarding the supply chain, I think you highlighted it as quite volatile still. But we're still hearing from some of your peers that it's actually improving and now that you delivered solid sales growth during this quarter, wasn't it anything that you've seen as an improvement for which you actually could deliver better already now in Q1 and that this will be supportive further on.

[Joacim Lindoff, executive]

I hope I expressed myself in the way that we are seeing better stability throughout our supply chains. I mean in many areas, it is not necessarily fully back to where it was, but significantly more stable. The area of concern still continues to be electronics, which continues to be volatile, but again, light in the tunnel around stability also in electronics. And we are buying less and less components on the spot market, which has an effect on stability, but it also has an effect on price levels.So the only area as I said in the beginning of the Q&A that where we could see that higher access to components gave a possibility to clear backlog was in our smaller diagnostics business, where we, I believe, they are a little bit north of half -- sorry, of [ SEK10 million ] of that full amount that we said was postponed from 2022 was delivered out in Q1. So that could then be specified, as an invoicing that has come through better access to components.But apart from that, as I said before, the stability on the insourcing -- or the sourcing side is rather giving us a possibility to now step-by-step start manufacturing in the way that we should in a more stable way, and then hopefully, step-by-step, starting to see improvements on the material side after probably a very high level in the first half year and then step-by-step starting to see stabilization also on the pricing side -- on [ prices ] side.

[Victor Forssell, analyst]

My final question is on the margin bridge for this fiscal year. Now that with somewhat lower SEM sales here for this year, what is your visibility of improving it in the latter part of this year? Do you think that this could be positive on the gross margin side already by Q2? And also, what -- has anything changed do you still expect it to be somewhere closer to 1 percentage point after this fiscal year?

[Joacim Lindoff, executive]

Yes. From a SEM scanner perspective, I mean, we are talking about around [ SEK15 million ] of reduction, and so it will -- yes, it's obviously not where we want to be, and we hope to have a better traction going forward, but it's not hugely material to the overall expectations for 2023. I won't be able to comment on exact details on the gross margin. But again, just reiterating the work that we are doing on internal efficiencies that we are doing on product mix, what we hope to achieve with the improved geographical mix and what we believe that a higher stability in our supply chain will mean especially in the second half of the year.We stay confident that we are able to grow the Group with 3% to 5% organically and that we should see some improvement on profitability also during 2023, as we stated after the Q4 as well. So the stable start in Q1 is kind of just, yes, again, confirm that we are on the right track to meet those targets.

[Operator]

There are no more questions at this time. So I hand the conference back to the speakers for any closing comments.

[Joacim Lindoff, executive]

Great, and thanks for listening in everyone. We are, as I said, reporting a good organic growth in Q1, and we continue a relentless work to improve 2023 versus 2022 and make sure that those improvements and efficiency gains are there for the long term. So with that, thank you, and have a very good day.