Elekta AB (publ)

STO:EKTA B

Earnings Call Transcript 2022-Q3

[Cecilia Ketels, Head of Investor Relations]

Good morning, everyone -- afternoon, I mean, of course. Thank you for joining our third quarter update call at this short notice. I'm here with our CEO, Gustaf Salford, and our new CFO, Tobias Hagglov. And Gustaf will start with a brief opening remarks. And after that, we will open up for your questions. The third quarter will be reported on February 24. So during today's call, we ask you to focus your question on the preliminary updated figures about published in today's press release. And with that, I hand over to you, Gustaf.

[Gustaf Salford, President & CEO]

Thank you, Cecilia, and good afternoon, everyone. I would like to give you a brief update on the preliminary financial results for the first -- third quarter and then open up for your questions, of course. And what we have seen is that the demand for Elekta's precision radiation medicine solutions continued to be strong in the quarter. It was driven by Europe and also a recovery in several emerging markets, such as Egypt, where we went direct for a while ago and India. Orders then grew with 8%, and that was the fifth consecutive quarter with underlying order growth. This is resulting in Elekta's strongest order backlog ever. We continue to see a healthy demand with multiple large tender activities ongoing.Elekta has maintained its strong commitment to customers and their patients by continuing focusing on installing new devices and servicing our installed base. But as stated in the last interim report, supply chain challenges remain, and our total revenue came in at minus 3% in the quarter. Solutions revenue declined by 9% due to the longer supply chain lead times, whereas the service revenue increased by 7%, growing faster than our installed base growth. On a year-to-date basis, revenue has grown with 4%. Then going over to EBIT margin. It came in at 10.4% when excluding the contribution to the Elekta Foundation that was reported in the quarter. And we also saw increased costs for logistics and components continued to put a lot of pressure on margins of additional around 300 basis points compared to last year. And margins were also affected by lower installation volumes compared to our plan. We expect the high component and logistics cost to normalize towards the second half of calendar year 2022. Overall, I remain convinced that the growing need for cancer care globally will support continued growth and investments in precision radiation medicine.And with that, I hand it over to Cecilia.

[Cecilia Ketels, Head of Investor Relations]

Thank you, Gustaf. And then I will ask the operator to please open the line for questions. And the first question will come from Kristofer Liljeberg at Carnegie.

[Kristofer Liljeberg-Svensson]

But just one quick question. Could you comment on the reason for gross margin being down sequentially versus the first -- second quarter? Because you had the same type of negative effect, I think, year-over-year on from supply and logistic costs. And I guess the currency situation should that help you sequentially, so if you could explain that?

[Gustaf Salford, President & CEO]

We heard you loud and clear. So on the sequential gross margin impact from supply chain and logistic cost, that was then 300 basis points if you compare it to last year. But we also saw, you can say, a bit of a worsening situation and higher cost if you compare Q3 versus our Q2. And you also saw a bit of the impact from that installations were behind plan. And we had a bit of a worsening situation here in January compared to the initial plan as well. So I would say that's the main reasons, additional, say, logistics supply chain costs, and also some of the installations that are delayed and going into the next quarter. And that has to do with the longer lead times out there at the moment.

[Kristofer Liljeberg-Svensson]

Is it possible to quantify how much of the sequential decline versus the second quarter is due to the delays? And how much is due to even more logistics and supply situation?

[Gustaf Salford, President & CEO]

I think I don't have the specific numbers. We need to get back to that on the reporting day. But the main effect, I would say, would be the additional supply chain costs. Then, of course, the revenue growth and installation growth with the solution growth being relatively weak, is something we will focus on to get also the volumes, the installation volumes and revenue volumes to get to a better gross margin as well.

[Operator]

The next question comes from the line of Patrick Wood from Bank of America.

[Patrick Andrew Robert Wood]

I'll keep it just 2, please. On the first one, what is the capacity for you guys to increase pricing to help offset and mitigate some of the supply chain costs as we move forward over the next, whatever, 12 months? And is that something that you're looking into doing? So that's question one. And then secondly, obviously, it's always hard to comment on peers, but a bit of a different let's say, narrative that we saw from Varian. And I wonder, did you have particularly difficult time when it came to installations and supply chain costs outside of the U.S. because, obviously, the geographic exposure of you two is very different? Was it worse outside of the U.S. than in the U.S., I'm just curious?

[Gustaf Salford, President & CEO]

Patrick. And capacity as you know, and we mentioned as before in our service contract that is around 40% of revenue. We have CPI, so inflation corrected the clauses , the solutions.then for price increases due to higher logistics costs. That's how I understood the first question. And if I start with that, as you know, and we mentioned that before in our service contracts, that is around 40% of revenue, we have CPI, so inflation corrected clauses in those contracts. But if we focus them more on the solutions, so the devices, the linacs and the Unities and the Gamma Knifes and the brachial and so on. There is more we increase the target prices and so on in quotes. And then that takes between 6 to 12 months to get that into kind of revenue from order to revenue, as you know, we have between for some products, 6 months, and then for a regular linac around 12 months. But that we have been working on now over the last quarters when we saw inflation and logistics costs going up, so that's in motion.To your question around, I mean, geographic mix, I would say, I mean, products with global supply chains and global longer supply chains are more affected so -- , of course, if you have a business in emerging markets, that's more challenging compared to mature markets, in Europe, for example, we also saw a good development in the quarter. So it depends a bit where you send it and how you mitigate that effect.I think for Elekta, we have the benefit of having our production facilities in -- both in Europe, but also in China. So we are able to mitigate that effect by having kind of both those sites to deliver our products from. Compare U.S. with the rest of the market, I don't have any specific view there. However, what I think we have seen throughout COVID is that we have shown, I mean, resilience and also a good revenue growth throughout the COVID situation as well.And that's thanks to our supply chain and all our people in the supply chain that are working extremely hard at the moment to mitigate all the negative effects of the current supply chain challenges we see. So I think that's what I can say about the quarter.And I think I'm very pleased to see also that -- to see the service revenue increasing with the 7% and also higher than installed base growth, and that's an indication that we create a lot of value from our service business as well.

[Operator]

;And the next question comes from the line of Rickard Anderkrans from Handelsbanken.

[Rickard Anderkrans, Research Analyst]

2, if I may. So number one, can you comment if there's been any order cancellations or notable order cancellations here? And secondly, how should we think about catch-up effect into Q4 on the sales side? That would be very helpful.

[Gustaf Salford, President & CEO]

No, what we see now, there is a huge need for cancer care and radiation therapy around the world. So we see the orders growing. We talked about the very large and healthy order backlog we have to deliver from. So it's more about getting the supply chain to be able to do the product management, get to the customer site, install the machines. And as you know take revenue when we start the installation at the customer site. So -- and we haven't seen any major order cancellations and so on. It's, I would say, rather opposite that people are really having the demand for our products when it comes to linacs, but also software and of course, Unity and Gamma Knife and brachytherapy as well. So I think that's the current situation.And we have a lot - as we mentioned, there is a lot of focus from the recovery programs in both Europe, partly U.S. and in other parts of the world to transfer that into investment in cancer care but also radiation therapy. And that's what we're mentioning, there are a couple of really large tenders going out globally and that we, of course, are part of.

[Rickard Anderkrans, Research Analyst]

All right. Also on your comment on the catch-up effect there?

[Gustaf Salford, President & CEO]

Yes. So the catch-up effect. So we have the order backlog. We have seen good order growth over 5 quarters here. So the catch-up is more to manage the current supply chain challenges we see. And of course, they are here in Q4 as well, and we saw it in January, and we see it here as well. So we're doing our utmost to mitigate all those effects and get to the customers with our products and our services as well, and that's what we are driving here in Q4 as well. And we'll give some more flavor on that in the Q4 -- sorry, Q3 report on the 24th of February.

[Operator]

The next question comes from the line of Veronika Dubajova from Goldman Sachs.

[Veronika Dubajova, Equity Analyst]

I'm also outside. So I apologize for the poor sound quality. Two questions for me, if I can. One is just on the gross margin. And kind of good to a 2-part question really. I guess, so do you think this is the trough in terms of where the gross margin might come in? And how long until you believe you can return to the sort of low 40s type of gross margins and I see many of us were thinking about for your business earlier, previous to pandemic, are you able to commit to a time frame when you think you might be able to get there?And I guess, maybe just walk us through what part of that is going to be priced versus what part of that's going to be the volume recovery just so we can kind of think through the upside and downside risk to that? And then my second question is obviously, the order momentum continues to be really good, but I think both you and coming to Varian are sitting on this massive backlog. And I'm just kind of curious how you're thinking about investments into your own infrastructure so that you can tackle that backlog faster? Do you need to grow your installer base? Do you need to think about increasing your production capacity? And I guess how would that play into the gross margin dynamic? Or is your view here, look, we're going to just install over 2, 3 years as opposed to 12 months and our customers will wait?

[Gustaf Salford, President & CEO]

Great question. I could also hear you loud and clear. So if we start with the gross margin, and of course, I'm not satisfied with the gross margins in this quarter if I start there. But I'm satisfied that we have managed to install and service our customers and helping cancer patients around the world. However, the costs are high. We see that, as I mentioned, we believe, based on everything we read and all the reports we see internally as well as externally that the supply chain challenges and component prices that are very high at the moment, and you have to buy it to quite a large extent on the spot market will normalize in autumn -- so the second half of 2022. So I think that's an important trigger for improvement and margin expansion on the gross margin side. Of course, we also need growth. We shouldn't be at minus 3% in the quarter and solutions revenue going down. So I continue to see that through transferring the order backlog, of course, the installations and revenue. So coming to that view, how do you then do it and how do you transfer the order backlog? And I think it's a great point you make that it's about installers. So installers are very important for Elekta.And I think what we're doing right now is to regionalize it. So have it more on the local controller, so we are not dependent on global installation teams. That was okay before the pandemic. But today, we need to be more local in the market. And you've also seen us going into many -- quite a few markets like Egypt and then you see the benefits of doing so. So I think that's the key thing.And then coming back a bit to the gross margins again. You mentioned the low 40s or -- and at the Capital Markets Day, we were talking about around 41 that you've seen on the historical development of Elekta. And I say we should get back to those levels, and that's also part of our margin expansion throughout the midterm period. If it's volume, if it's price, of course, it's both. I see new products like the Harmony coming out with better prices, and that's really good because that's new innovation to the market and you get higher prices for that. The customers are willing to pay.And then also volume, absolutely, we saw similar linac volume in this quarter compared to the last year's quarter. And we saw a bit lower volumes on products with global installation teams. And I expect that to come back, and we have it in the backlog. So it is to get these new installers and regional teams to install the linac and also help the customers with product management and so on. So I'm not concerned about that. It's more to get the resources. And I think something that's very positive is that the COVID impact has reduced over the last couple of weeks and months. So many economies, as we all know, are getting back. And so the impact then on delays due to COVID guarantees and so on has reduced a bit. So sorry, a long answer, but just to give you some flavor there Veronika.

[Veronika Dubajova, Equity Analyst]

No, that's really helpful, Gustaf. And I guess, I mean, if we were to assume you get to the 41% gross margin in 2023, I mean are you comfortable with that assumption?

[Gustaf Salford, President & CEO]

Yes, I don't want to validate assumptions. But what we are saying is that we stand firm on our midterm -- in guidance of our midterm outlook of the more than the 7% and the margin expansion on EBIT level. So I think that's what we are driving for at the moment. We're also saying that our resilience and excellence program and the activities we're driving there is important. So we'll continue with activities we're driving. And we learned a lot from COVID when it comes to how to work in a digital way, reduce our travel expenses, reduce our marketing expenses, and that's something we're now working with those activities to do that also going forward. So that's another driver for margin expansion, maybe more on the EBIT level there.

[Veronika Dubajova, Equity Analyst]

Okay. That's helpful. And then if I can just squeeze in a very quick technical question. The 7% growth that you had in services, what contribution to that came from price?

[Gustaf Salford, President & CEO]

I need to check that for the next call, Veronika. I don't have that number. Will follow up at the Q4 call.

[Operator]

The next question comes from the line of Lisa Clive from Bernstein.

[Elisabeth Decou Bedell Clive, Senior Analyst]

Just another question on the service growth. Could you maybe just talk us through a little bit where that's coming from? I mean you obviously have the service contracts, which will largely grow with your installed base and then the move towards more sort of software-as-a-service. But what specifically are you sort of gaining traction in? Is it around sort of treatment planning or quality assurance? Or just curious as to what's really the drivers behind that? And also if you could potentially quantify sort of what proportion of your service business is now sort of Software as-a-Service as a separate business line?

[Gustaf Salford, President & CEO]

Thank you, Lisa. So if you take the drivers, we have for quite a why now focused on service. You saw Paul Bergstrom talking about it at the Capital Markets Day. We are adding value to our customers when it comes to value-added services. So we have multiple initiatives across the company to add more value around service and services. So that's the journey we are on right now. And then you also see higher growth linked to that in many different areas. So it's not just about the technical services, and we shared kind of this vision, how we move from technical service, more to value-added services and you can find material on that in the Capital Markets Day and so on. So I think that's the key reason.We also look into going indirect in many markets, Lisa. So if you take Egypt, if you take the Philippines, if you take Indonesia, we go indirect. And then you also get the service revenue from those markets that before the distributor had. And we think it's the right thing to do as well to become closer to the customer, but it often has a very positive impact on the service revenue. Sorry, what was your second question is it was more on the price or...

[Elisabeth Decou Bedell Clive, Senior Analyst]

No, it's more on the sort of Software-as-a-Service sort of value-add business lines as a proportion of your total service business today?

[Gustaf Salford, President & CEO]

I think that's the area with a strong opportunity. So if you take for overall of Elekta, around 25% across Elekta is software, that's our software business. But if you take the service component, that's actually a bit higher than the 25% overall. And I think that's the reason software is sticky. We grow in software. We're focused. That's another big program for us, of course, as well. Software, informatics, and that's also an area I think we can show good growth going forward.

[Operator]

The next question comes from the line of Victor Forssell from Nordea.

[Victor Forssell, Analyst]

I'll start off with one regarding you're mentioning that January was a bit tougher, if I recall it correctly. When we held the pre-close earlier in January, I think it's the second time in 3 quarters that we get -- that we sort of call off guard by how the quarter really ends. So I'm just trying to understand what's happened in the last couple of -- sorry, weeks that you didn't foresee at that time, please?

[Gustaf Salford, President & CEO]

Yes, Victor, absolutely. I understand that. And I think it's a difficult time to predict, especially these lead times. And if you think about January and the last quarter, there's been a lot of these quarantines back and forth. So it's been difficult to predict project management and when you can start the installation around the world when it comes to linacs, Unities, and Gamma Knifes, sort of devices. And that is what has been then a bit below plan in January. So that's the reason. I believe that with COVID restrictions being reduced a bit is what we currently see. We don't know about the future, but that's what we see right now and quarantines are lifted, it will be easier to predict plan for the installation starts in many markets. So I think that's the reason for the delta, so to say.

[Victor Forssell, Analyst]

Right. And if you could be a bit more specific about the cost on your cost of goods sold. I mean what was the largest impact regarding to these logistics and supply chain issues? Was it still the year-over-year impact in freight rates? Or is it more on the component side, as you mentioned on spot markets? What's the largest delta there?

[Gustaf Salford, President & CEO]

I don't have a specific bridge. We can look into that. But I think it's both. Because right now, in order to service the installed base in order to get all the products out for installations we have that's more expensive. And it could sometimes be air freight, for example, that's very expensive, just in order to make sure that our customers can continue to treat patients. So we think that still is the right thing to do.On the component area, it depends, of course, if you need to buy the component on the spot market or according to the contracts you had with the regular suppliers. And we've seen in the current market condition as with many other companies, you need to buy some of your components on the spot market. So I mean if I think about and summarize what I know today is that I would say that the freight prices are the increases and longer lead times, that will be the biggest impact.

[Victor Forssell, Analyst]

Great. And just a final one then. You talked about your efforts on the price side here in this call. But I guess that your backlog does not reflect -- still not reflect the elevated rates that we see here and the component prices, et cetera. So when you talk about the normalization for your supply chain by the second half of this calendar year. What do you compare that to? Is that expecting a flat year-over-year impact? Is that coming closer to -- sorry, the pre-pandemic levels? Just some color there would be interesting to hear.

[Gustaf Salford, President & CEO]

On the component side, so I guess more components than all components on contract rather because of the normalization of our procurement and so on. You've seen many other companies having challenges with logistics costs and procurement costs. But for us, I think that's what we mean when we say the second half that we will get more regular prices on our components, and then we can start to focus much more on COGS reduction again in our supply chain. Currently, the main focus is just to get the supply. And I think we'll have opportunities going forward to work a lot with our COGS as well.

[Operator]

And we have one more question from the line of David Adlington from JPMorgan.

[David James Adlington]

So 2, please. So Q4 is obviously normally your strongest quarter for deliveries. I'm just wondering how you're thinking about supply chain for the quarter and your ability to install and whether you'll actually be able to grow revenues in the fourth quarter versus last year? And then secondly, just in terms of your order growth of 8%, I just wondered how much of that was price versus volume?

[Gustaf Salford, President & CEO]

Thank you, David. So if we start with the first one, Q4, I think what we managed in Q3 is that we didn't stop any production or so on for component shortages. And that's, of course, the ambition here going into Q4 as well. We have a strong backlog. We have opportunities for growth, so to say, and we also need to manage the supply chain throughout the quarter. So that's what we are focusing on. And I think from that we achieved in the Q3. But it is a challenging situation. When it comes to the -- sorry, the second question, David, that was?

[David James Adlington]

How much was price of the ...

[Gustaf Salford, President & CEO]

How much was much of the ? I think I need to get back to that specific -- let us get back to that in the Q4. We need to do that analysis as well. And we are still kind of early in the reporting.

[Cecilia Ketels, Head of Investor Relations]

You mean on February 24.

[Gustaf Salford, President & CEO]

Yes, on February 24.

[David James Adlington]

And just to come back on that fourth quarter point. Obviously, normally, your fourth quarter revenues are substantially ahead of where it would be on Q3. I'm just wondering if you've got a pinch point, which means we shouldn't really be thinking about growth in the fourth quarter?

[Gustaf Salford, President & CEO]

No, I haven't said that. I mean...

[David James Adlington]

You still think you can grow fourth quarter Q4 over Q4.

[Gustaf Salford, President & CEO]

Yes. So let us come back on our view on the fourth quarter in the quarterly quarter.

[Cecilia Ketels, Head of Investor Relations]

Yes. And we -- I think we have one more question there, do we? We have to make it really quick.

[Operator]

Yes. One from Erik Cassel from ABG.

[Erik Cassel, Analyst]

Yes, I'll make it quick. Just one question relating back to the previous call and COVID. Back then, you highlighted, weakness for Unity and Gamma Knife, and you mentioned it briefly now when answering Veronika's questions as well. But is it possible to comment on the magnitude of those to [indiscernible] Q3 results and how they're performing versus last year to get some sort of reference points.

[Gustaf Salford, President & CEO]

Yes. As we said in previous call and as we said throughout COVID, I would say, it is more challenging to install products -- dependent on global installation teams. And 2 examples -- the main examples are Unity and the Gamma Knife. So we have some of that in this quarter because the linac came in more or less on the same volumes as last year, but it was more impact than from Unity and Gamma Knive's and I think when you look at the solution revenue impact from last year, then you get down a bit of a feeling for that effect. So that's the main reason.Going forward, I think we -- as I mentioned before, in Veronika's question, we are installing in these local teams out in the regions. So we're not vulnerable then for this kind of global teams kind of traveling in from quarantine and so on. And we also see that this is improving globally. It's easier to get our products -- sorry, our installation teams to the different geographies.

[Cecilia Ketels, Head of Investor Relations]

I hope that helps. Yes, because we are at the hour and need to stop. But thank you all once again for participating on such a short notice. And let us come back again on February 24 and pick up of some of the questions you didn't get the answer to today. That's when we have published our full report for the third quarter. So this concludes today's call. Thank you very much. Bye-bye.

[Gustaf Salford, President & CEO]

Thank you.