Elekta AB (publ)

STO:EKTA B

Earnings Call Transcript 2018-Q4

[Operator]

Welcome to Elekta Q4 report. [Operator Instructions] I will now hand over to Johan Andersson. Please begin.

[Johan Andersson, Director of Investor Relations]

Thank you very much, and welcome to Elekta's conference call following the publication of our full year report for fiscal year 2017/'18. My name is Johan Andersson, Head of Investor Relations, and I will be the moderator for this call. Here in Stockholm, we have Richard Hausmann, our President and CEO; and Gustaf Salford, CFO. We will start with presentations by Richard and Gustaf and then conclude with a Q&A session. [Operator Instructions]Just a reminder, some of the information discussed on this call, including our projections regarding revenue, operating result, cash flow as well as products and product development, contain forward-looking statements. These statements involve risks and uncertainties that may cause actual results to differ materially from those set forth in the statements.With this, I hand over to Richard.

[Richard Hausmann, President & CEO]

Thank you, Johan. Good morning, and thank you, everyone, for participating. This is Richard Hausmann, President and CEO.From my perspective, I clearly see that we are executing and delivering on our long-term strategy for driving profitable growth in the coming years. To summarize the year, I'm proud of our performance. Today, we have a much stronger organization and we have established sustainable business processes that forms a solid base for future growth. Both orders and sales have a better underlying quality.We have a market-leading product offering and we delivered good order growth and solid sales performance. Our EBITA margin improved to 19%, and at the same time, we maintained a low level of working capital and strengthened our cash flow significantly. The improvement in trend speaks for itself. If you look on the graphs at the bottom of the slide, in particular, on the EBITA one, which shows the true development in the gray line, including the one-off items of the past. Elekta Unity continued its positive development with 8 new orders booked in the quarter, adding up to 16 orders for the full year. The Unity project is achieving all milestones and we are on track for CE Mark now in June, something that I will get back to in a few minutes. We have strengthened our position as a leading innovator in precision radiation medicine, and in total, we have also strengthened our position in the market. Compared with the targets we communicate for the year, we can today report that we have reached them all. We are growing both in orders and sales. Our activities to improve cash flow have been very successful, delivering a level of minus 10% net working capital to the sales. And we have reached a margin target of around 19%.I will get back to the guidance for the current year at the end of the presentation, but with all the operational process improvements that we have done, we now have a much better predictability and stability in the company.Let us turn to the next slide and some further details on the quarter. Order intake was up 10% in the quarter and 5% for the year. We estimate market growth for the past year to be around 4%, meaning that we are growing a bit faster than the market. Importantly, we are also having more equal quarters during the year in terms of net sales, and we saw unchanged revenues in Q4 in isolation. For the full year, net sales was up 8%, a strong volume especially for our linac accelerators, Leksell Gamma Knife, as well as treatment planning software Monaco. At the same time, the EBITA margin in the quarter increased over 4 percentage points to 25%, and even more drastically, our EBIT grew by 8 percentage points.Cash flow for the year is up 30%, and we had the best cash flow year in Elekta's history so far. I currently see a market that is growing at a healthy rate. The underlying demand for cancer care is steadily increasing. With our leadership position in emerging markets as well as the market introduction of Unity where we are the leader with precision radiation medicine, we are well positioned to capture growing share going forward.Some further color on the regional development. Starting with North and South America, order intake increased by 10% in the quarter. Performance in our U.S. operations continued to improve during the quarter. Peter Gaccione and the team are doing a fantastic job in gaining market share. As we previously have discussed, we booked a Unity research system at Memorial Sloan Kettering in New York in the quarter. Our activities in South America have recently also started to gain momentum with orders in Brazil, Peru as well as Bolivia. Over to Europe, Middle East and Africa. We performed nicely and orders were up by 28% in the quarter. We established a partnership with Proton Partners International with a major order of 5 Elekta Unity systems valued at over GBP 25 million. Our Middle East and Africa operation had a good momentum during the period. And in Russia, we began to see growth in the market. The new management in place shows -- in Russia shows positive effect as well.In Asia, our performance was mixed in the quarter. Growth was strong in India, Australia, South Korea and Thailand while market development in Japan is challenging. In China, we booked 2 new Elekta Unity systems and had a good growth for the full year. All in all, order intake in Asia Pacific was up 2% for the year but with a weaker ending. We have a solid position in Asia, and we are optimistic and expect continued good performance in the next year.Let us continue with a few comments on our products. Our installed base of treatment solutions has grown 6% during the year. Isolating the service business, it was also up 6% for the year and it now equals to 41% of our total revenue. It's clear that we have a great potential to improve performance in our life cycle business and we do have an ambitious agenda for it.We had a successful year for our leading [ indiscernible ] system, and I'm also proud that our focused sales efforts in our Gamma Knife business showed strong results with both upgrade sales to Icon as well as sales to new clinics. Also, our treatment planning system, Monaco, has been a success story for the year with strong performance.In April, we had great participation at the ESTRO trade show in Barcelona. We presented new solutions from the Elekta Digital program that confirmed our innovation and thought leadership in the sector. Our partnership with IBM Watson Oncology is a great example for this. This partnership will help clinicians to largely automate the preparation of treatment plans using artificial intelligence to convert big data into customized precision cancer therapy. We are excited about the opportunity this offers and are looking forward to being a pioneer all the way in this field.In addition, Elekta Unity caught much attention from existing and new potential customers and it is clear that it represents the next big development leap within precision radiation medicine. This brings me to an update on our Unity. As I mentioned, we have strong interest from customers around the world and I'm very satisfied with the progress of the project. It's clear that we are breaking into new accounts that expand our global customer footprint. During the quarter, we booked the order from Memorial Sloan Kettering in New York, an order of 5 systems to Proton Partners International in the U.K., as well as orders from top hospitals in China -- Shanghai Fudan University Tumor Hospital and Sichuan Tumor Hospital, 2 very famous cancer centers in China. This means that we are now on a total of 28 systems sold since start and they are well distributed between our 3 major regions.Regarding CE Mark, we are on track for it now in June. In practice, we are currently finalizing the customer validation phase, which is the final step.We have recently completed 3 installations, 2 being at Odense and Uppsala. This year, I expect that we install with a pace of around one system per month. In that plan, we have 5 systems to be installed in China. This is to generate the required data for Chinese registrations. In line with our accounting standards, we will not recognize revenue on those 5 systems prior to the CFDA approval, which is expected after this fiscal year. So no revenues from those systems will be booked this current year.So all in all, I'm convinced that Unity will be a major breakthrough, and we will continue to see good activity this year. And with that, I turn over to Gustaf that will provide some more further context on the financials.

[Gustaf Salford, CFO & Executive VP]

Thank you, Richard. Everyone, this is Gustaf Salford, CFO of Elekta. I will provide some further detail from the financials and let me start with the quarter. As Richard said, we're striving for more even quarters during the year, and accordingly, net sales in Q4 was flat compared with last year. Q4 gross margin was down 1.1 percentage point, which from my perspective, is lower than expected. The deviation is related to higher third-party revenues with low margin as well as we didn't achieve all of our expected COGS savings before year-end. Expenses were down compared to last year, and EBITA grew 18% to SEK 918 million or a 25.4% margin. Net profit was SEK 544 million, and earnings per share SEK 1.42.Let me move over to our operating expenses. I'm satisfied with our efforts of keeping costs under control and at the same time investing in areas driving future growth like the commercialization of Unity, expansion in growth markets and investments in product development. All in all, operating expenses was flat compared to Q3 and down from last year.In selling expenses, we have the ESTRO trade show and a few other exhibitions adding costs in the quarter. On the other hand, administration costs are down. R&D cost in the P&L is down while capitalization has increased linked to passing of final stages of the Unity development. We usually measure R&D expenditures in relation to net sales and we came in at 12% for the year. For the current year, we plan for 10% to 11% together with lower R&D capitalization levels.So let me move on to some details on the P&L. The results for the year is a clear sign that we're building a stronger company with growth, higher earnings and a solid working capital position. We have continued strong cash conversion and a healthy balance sheet. As Richard said, net sales is up 8% for the year. The growth, combined with cost control, has been the main drivers for 50 basis points gross margin expansion to 41.9%. EBITA grew nicely and we reached a 19% target. Total amortization, including bad debt, came in at SEK 578 million for the year. After the Elekta Unity CE Mark, we will have additional SEK 30 million per quarter in amortization going forward. Net financial items decreased significantly compared to last year. This is mainly related to the refinancing of the convertible bond and a continued low interest rate environment. All in all, net profit was SEK 1.1 billion or SEK 2.88 per share. And now turning to the EBITA bridge for the year. The positive volume effect was some SEK 260 million with the majority from strong linac, Leksell Gamma Knife and Monaco treatment planning volumes. We're gaining SEK 61 million from efficiency and COGS savings mainly through procurement, but we also have some one-off costs for closing and completing outstanding projects. Investments in the commercialization of Elekta Unity, higher R&D and selling costs resulted in a negative SEK 120 million effect. Admin expenses are slightly up for the full year and we'll continue to focus on automation and transferring of processes to our shared service center. Exchange rate differences are positive with SEK 242 million compared with last year. As you can see in the currency table to the right, the year-over-year effect is mainly due to the negative hedging result last year due to the weakening of the British pound. All in all, EBITA is up 27% or SEK 455 million for the year.Turning to cash flow and net working capital. We ended the quarter with a net working capital position of minus 10% to net sales. During the quarter, the main movement has been reduction in inventory. Accounts payable and accrued income increased related to higher volumes than in Q3. We continued to reduce the lead time from start of production to final payment, and we're completing outstanding projects at a faster pace. Cash conversion for the rolling 12 months is strong and at 109%. If we analyze the cash conversion over a few years, I clearly see 2 drivers: firstly, that we have improved our underlying earnings; secondly, we have released around SEK 1.8 billion of working capital during the last 3 years, primarily from reducing our project lead times. DSO ended at 12 days down from 33 days the previous year. Financial [ net ] is down to refinancing and other items is mainly driven by currency effects.All in all, we'll have a continued strong focus on achieving a stable and strong cash flow going forward.Turning to leverage and dividends. Net debt ended at SEK 803 million, representing 0.4x EBITA and 0.1x equity. With regards to dividend, we went to -- we want to see a stable growth in allocation to our shareholders. This year, the board proposes to allocate 49% of the profit, corresponding to SEK 535 million, is an increase of 40% from last year.This ends the financial details of the quarter, and now I would like to go through our change in accounting principles and our restated numbers for the past year. As we mentioned earlier and with start from this current year, we have changed our accounting principles to align with the new accounting standard, IFRS 15. The main change is that the revenue recognition of our devices will happen at start of installation instead of at shipment. Since start of installations are more evenly spread across the quarters, we will have a more stable revenue and EBITA distribution throughout the year. Also, revenue recognition will be better matched with our payment terms and cash flows.If you look at last year, start of installations was approximately the same number as the shipments. The IFRS 15 restated numbers resulted in a small 2% increase in revenue. The increase is explained by the average revenue value for the systems installed was slightly higher than the ones we shipped. In addition, we have a positive margin effect related to lower COGS in the restatement resulted in 2 percentage points higher EBITA margin.It's important to note that the revenue and margin guidance for next year is based on these restated numbers.And now to the main balance sheet effects. On the asset side, accrued income decreased since we get a better match between our revenue recognition and invoicing plans. Inventory will increase with the projects between shipment and start of installation. Cash and cash equivalents as well as accounts receivables are not affected since they are linked to payment terms.On the liability side, customer advances increased both by invoiced and paid projects. The residual is the equity effect from lower retained earnings. And in today's quarterly report, we have presented a restatement of the past year. We have reported the income and balance sheet effects in detail per quarter. So with that, I hand over to Richard to go through the final remarks and guidance for next year.

[Richard Hausmann, President & CEO]

Yes, thank you, Gustaf. Once again, I think we are executing on our strategy for profitable growth. Elekta Unity will continue to be in the center of attention. The interest is strong, and we are prepared for commercialization in Europe and we are working on the U.S., China, Japan and additional approval processes.We will continue to strengthen our sales organization and grow our installed base by offering our customers world-leading solutions, including service during the life cycling of the system. We will continue to execute on our R&D strategy and develop our position as thought leader in precision radiation medicine. Meanwhile, we will constantly reduce complexity, improve our processes and keep a strict control on our costs going forward.So based on these developments, what do we now expect for the full fiscal year? We have considered some main factors such as underlying market growth, continued rising demand for advanced health care and higher deliveries of Elekta Unity, and as I said, we will install 5 systems in China but no revenues until we have the CFDA approval. From these factors, we estimate that net sales will grow around 7% based on constant exchange rates and that our EBITA margin will be around 20% this current year.Finally, I would like to welcome you all to our Capital Market Day in Stockholm on September 27 where we will go more detail about our strategy into the future.

[Johan Andersson, Director of Investor Relations]

Thank you very much, Richard and Gustaf. And with that, we will then start the Q&A session. So please, operator, do we have any questions over the phone?

[Operator]

[Operator Instructions] And our first question comes from Annette Lykke from Handelsbanken.

[Annette Lykke, Medtech Analyst]

First of all, my first question is related to Unity and the consortium systems you have installed already. Now you have added the new functionalities, including diffuse-weighted imaging, and how long will it take for you to upgrade those systems that you have in your consortium members? That's my first question. My second question is when -- also when you expect to receive the CE Mark filing, how much of a push will that be in terms of order SKU? Are you aware a lot of the discussions with clients where they are simply waiting you to achieve the CE Mark, should we expect sort of a very nice Q1 in terms of Unity orders, assuming that you are granted the CE Mark by mid-June or so?

[Richard Hausmann, President & CEO]

Yes, thank you, Annette, for the questions. Well, first of all, as we have pointed out, we are -- we have now installed the 3 clinical systems, Uppsala, Odense and Tübingen and they are, of course, the final clinical systems as they are released via CE. And the consortium members are, in parallel, also upgraded, as we speak, to the final CE system in a serial. Why not all at once? Because, of course, there needs to be done some work. But as we speak, we are already upgrading those systems to the final CE labeled version. So that will happen within this month, next month and then they are also at the same level. So yes -- and I agree with you with the diffusion-weighted imaging, possibility is there and can also be used. This -- the CE filing will happen this month, and coming to your question, will that kind of create some additional momentum? Yes, we see there will be some additional momentum, but not instantaneously because what really is important for the customers is to see patient scans. And the CE label is the first step and then sometimes these -- our customers have to do some own physics adjustment and the typical thing for QA, so it will be smoothing out a bit. But moving forward, we will see, of course, the momentum growing in our Unity attention.

[Annette Lykke, Medtech Analyst]

And then just a short follow-up question to Gustaf. Gustaf, if you look at your IFRS 15 adjusted numbers, you have an EBITA margin on the 21%. Can you elaborate a little bit on how you reached to a decrease in your margins of 100 basis points?

[Gustaf Salford, CFO & Executive VP]

Yes, and I think if we look at the guidance on around 20% for EBITA, we have gone through our planning cycle now and we are looking into next year and we see the key thing is to drive future growth. So we are looking into some growth-driving investments on the market side, but also on the product side. Some of those expenses will impact, of course, the EBITA margin. Then you need to consider as well the capitalization effect we have into next year that we have yet to finalize or about to finalize the Unity project and then that would go into amortization and then the capitalization will be a bit lower for those projects we run into next year. So that will also have a negative effect on EBITA.

[Operator]

Our next question comes from the line of Kristofer Liljeberg from Carnegie.

[Kristofer Liljeberg-Svensson]

When it comes to the Unity machines that you have already installed, how much additional revenue will you have from those? With upgrades, I guess, there might be some extra payments after the CE Mark, et cetera. Or have you received everything you will from this?

[Gustaf Salford, CFO & Executive VP]

So if you look at the units we have revenue recognized, it was initially the consortium members and those we took more on the level of completion revenue accounting standard and we'll take parts when they go to post CE Mark. And then -- so that would be the main effect. But it's not a significant effect in the next couple of quarters.

[Richard Hausmann, President & CEO]

And some of them are in the United States consortium members where we have to also [ break down ] to the FDA clearance to do a further step in revenue recognition.

[Gustaf Salford, CFO & Executive VP]

Correct. And for the 3 commercial systems now with Odense, Tübingen and Upsala, we have taken that according to the plan as well. But there would be some additional revenue to be taken there.

[Kristofer Liljeberg-Svensson]

Yes. And what about orders then for -- to take those Chinese machines? What order machines that will go to China for the approval trial? What type of -- what value are you booking for them? Is that total amount or rather limited?

[Richard Hausmann, President & CEO]

The order volume is typical like $8 million to $10 million as we have always communicated. All 5 are part that of the study, there's no other way. And it's actually happening as we speak that we install them and during the -- towards the end of the year, this calendar year, and then the study will start and that's why typically we study the result and the release for CFDA will not happen in this fiscal year.

[Gustaf Salford, CFO & Executive VP]

So to your question just of how they are booked, we will book the full amount according to our order booking policies. So if it's within the 3 years, then we'll book it on the device side and then we have 5 years for service contracts. So it's according to those principles. So to your question, yes, we will book the full amount.

[Kristofer Liljeberg-Svensson]

Okay, okay. And my second question relates to development in Asia in the quarter. It seems adjusted for the Unity machines. Chinese order growth seems to have been weak. Your main competitor seems to have a better momentum lately. And the same in Japan, I think Varian is more positive on the market there. So I don't know if you could give some further explanation why you are not seeing and it cannot pick up in Japan.

[Gustaf Salford, CFO & Executive VP]

Yes, if you look at the Chinese order intake, we see that we are keeping our market share and we're still the market leader in the region. So I agree, it's a lower order number for the APAC region there, but we don't see that as an underlying trend. We foresee continued growth from that market. Japan has been a challenging market for us and it's the total linac volume during the last couple of years has come down dramatically. So we don't think that -- we don't see a quick turnaround in that market, but it's a focused market for us and we are working with it to drive future growth again. But it would take some time.

[Richard Hausmann, President & CEO]

Yes, especially related to the fact that in Japan the average age of the linacs is now reaching 15 years. So I mean, there is -- in a few years to come, there is a phase of replacement, which is unavoidable, I would say. And we are preparing right now our organization as well in Japan to be able to cope with that.

[Operator]

Our next question comes from Michael Jungling from Morgan Stanley.

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

My first question is on Unity orders. Of the 20 orders that you've received so far, how many require a new bunker versus going into existing bunkers? And question number two is further clarification on the EBITA margin guidance for fiscal year '19. It seems to me that -- I mean, is it correct to assume that you've effectively lowered guidance by as much as 300 basis points because you're benefiting 240 basis points from IFRS 15 plus on a like-for-like basis today you slightly lowered your guidance and maybe that's another couple of percentage points. Is that correct? And if it is, effectively, what it means is, is that you're investing $40 million more in fiscal year '19 that you had initially expected. Where is this spend going, please? That would be very helpful.

[Richard Hausmann, President & CEO]

Okay, I'll take the Unity and Gustaf takes the IFRS 15. But first of all, we have 28 Unity orders and -- on the books and not 20. I would say most of them go to new bunkers because these are typically systems -- or modified bunkers, which is unusual, I would say. But there are also a few which go in existing bunkers, I would say. But we would have to come back and count them really for you. I mean, I don't have the real number now in my head.

[Gustaf Salford, CFO & Executive VP]

And on to the IFRS 15 question. To your question is it correct, I will have to say no, because if you look at the IFRS 15 restatement the plus 2% is not the continuing effect. I mean, it's a timing effect, it's the revenue per unit we have. The difference between within that period, the number of shipments versus the number of start of installations. So that's the effect last year. If we then look at the 21% we had last year as EBITA under IFRS 15 and compare it to the around 20% we foresee for next year, there are 2 main effects. It's -- we are investing in areas, but then you need to also factor in this capitalization effect that I described and that has around 1% impact on the EBITA margin.

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

Okay, so when you say it's a onetime impact, but if you look at fiscal year '19, does the restatement that you benefited from in '18, meaning the 240 basis points that you disclosed in your slide -- sorry, in your reconciliation in the results released today, does that 240 basis points, plus/minus, not also benefit you in fiscal year '19?

[Gustaf Salford, CFO & Executive VP]

As I said, we have a higher baseline for next year. And on top of that higher baseline, we guide on around 7% revenue growth.

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

Okay. Maybe I can ask the question in a different way. If there was no IFRS 15, what would the EBITA margin guidance have been?

[Gustaf Salford, CFO & Executive VP]

For me, that's a hypothetical question. We guide on IFRS 15 standards and that's how we've also done our plan and our budget for next year.

[Operator]

Our next question comes from Thomas Zana (sic) [ Romain Zana ] from Exane.

[Romain Zana, Research Analyst]

The first question regarding the order book, can you please give us an idea of the order book breakdown between Unity and the rest of the business? And also what is your outlook for market growth? And second question is just to clarify something regarding Unity revenue recognition. You said the pace of installation will be one per month. So assuming 12 systems installed in the year and sold around, let's say, $8 million, it would imply a 90% of the group growth will come from Unity. Is that a fair assumption? Or am I missing something here?

[Richard Hausmann, President & CEO]

Let me take the very last one because it's easy to answer. I mean, it's not -- you should never assume 12 because, as we pointed out, the 5 to China are not revenue-recognized. So you have to effectively take 7 for this year, okay, rev rec; when you talk about one per month, okay, so that's number one. The Unity and the rest, we would need to -- I mean...

[Gustaf Salford, CFO & Executive VP]

Yes, I think on the Unity, on the backlog side, you have the numbers for number of Unity in the backlog and you have also the total backlog number we have. And you will see it will be a fairly small number because in our backlog, we of course, we have the linac, Gamma Knife service, brachy volumes as well, you need to consider that.

[Operator]

Our next question comes from Hans Mähler from Nordea.

[Hans Mähler, Director of Healthcare]

Hans Mähler here. First, if we continue to talk about the order book and say if we exclude the incremental increase that comes from Unity in this fiscal, I get to a negative growth number. And at the same time, you talked about the solid demand for linac successfully or for the Gamma Knife growing share for treatment planning and so on. Is it the oncology information system or brachytherapy that is declining significantly? Or how should I do the math? And my second question is also -- or it's regarding Unity. Whether the first version now you would release after the CE Mark, if that will include MR control gating. That's my 2 questions.

[Gustaf Salford, CFO & Executive VP]

So on the order growth question, we see growth in the underlying business, both on the service and the device side. And yes, we also had a good growth from the revenue number. And then if you go down item by item, different product lines grow differently, but overall we see growth in all our main product lines.

[Hans Mähler, Director of Healthcare]

But how do you explain that if you assume a price of $8 million per Unity and if you deduct that from the orders received in this fiscal, I cannot see that underlying orders are really growing.

[Gustaf Salford, CFO & Executive VP]

We see growth in both those 2 items.

[Hans Mähler, Director of Healthcare]

Excluding Unity, okay.

[Richard Hausmann, President & CEO]

And coming to the other question of gating, what we have, of course, on the system is gating from the start, manual gating. And automated gating is foreseen as being released in the first of [ job ] that -- which we're planning for early next year, yes.

[Operator]

Our next question comes from the line of Ian Douglas-Pennant from UBS.

[Ian Douglas-Pennant]

Sorry, I'm going to come back to the 2 questions that we've had on the call. So firstly, the margins, you said one of the headwinds that you're expecting to see is increased R&D amortization. I obviously got something wrong. I thought that in the EBITA adjusted margin R&D amortization was excluded from that metric. So could you just explain again those comments? Order growth at Unity, just going back to the maths there from the last question, you've got 8 machines at a price of $8 million a unit. Let's gives you credit for kroner- U.S. dollar ratio of 8.8, that gives you SEK 560 million in orders just from linac MRs. That is that, I mean, 13% of last year's order numbers. So how is it that your underlying business can't be growing with that math?

[Gustaf Salford, CFO & Executive VP]

Okay, I can start with the capitalization question. So capitalization will have -- if you have a high capitalization, it would have positive effect on your spend in the P&L. So the effect in next year is that we have less of this positive effect. It has nothing to do really with amortization.

[Ian Douglas-Pennant]

Sorry, so the amortization of R&D is excluded in your EBITA definition. So increasing amortization has no impact on that metric?

[Gustaf Salford, CFO & Executive VP]

No, that's part of amortization between EBITA and EBIT.

[Richard Hausmann, President & CEO]

Capitalization, the capitalization effect.

[Gustaf Salford, CFO & Executive VP]

The capitalization effect will be lower next year compared to this year because we have been in the final phase of the Unity project.

[Ian Douglas-Pennant]

So how does that affect your EBITA margin? That doesn't go through the P&L.

[Gustaf Salford, CFO & Executive VP]

Yes, because you have on the expenses, on the R&D expenses. If you do an R&D project, you will capitalize some of that -- those expenses to the balance sheet.

[Ian Douglas-Pennant]

I understand. Just to be clear, I understand basic P&L accounting of R&D. The issue is in the EBITA number that you give, the non-IFRS number that you give, amortization of R&D is ignored in that metric. And you highlighted that one of the headwinds to your EBITA margin this year is increased amortization of R&D.

[Gustaf Salford, CFO & Executive VP]

Next year in '18/'19 guidance.

[Richard Hausmann, President & CEO]

And it had to be both lower capitalizations, not amortization.

[Ian Douglas-Pennant]

That's not a P&L metric.

[Gustaf Salford, CFO & Executive VP]

It will have a P&L impact if you capitalize less of the R&D spend in the projects developing the products.

[Richard Hausmann, President & CEO]

So basically, we still do development work but of projects which are in earlier phases which we don't capitalize. So the cost is existing, so to say. People are there and working, but they are not being capitalized because you can only capitalize R&D from a certain point in the development cycle onward, more towards the -- when you exactly know what you do and that basically is, I sort of say, effective here. And if you are before that in, for example, pre-development phases where you're thinking about the next linac and this kind of topics which we of course are doing, these are not capitalizable and that is the difference which Gustaf means which is a negative P&L effect.

[Ian Douglas-Pennant]

Okay, clear. So you're still selling -- the cash is still going out, you just kind of expense it. Okay, fine.

[Richard Hausmann, President & CEO]

Exactly, exactly, yes.

[Ian Douglas-Pennant]

Okay, great. And on the order growth, please?

[Gustaf Salford, CFO & Executive VP]

Sorry, yes, can we get back -- the order growth on Unity and this year's number. So if you look at the underlying business or the base business, and the Unity on top of that, we see growth in both those categories.

[Operator]

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

[Veronika Dubajova, Equity Analyst]

I'm going to sort of slightly ask about the same topics, but in a maybe slightly different way. Gustaf, can you talk about how we should be thinking about the margin profile of Unity? I'm a little surprised -- I know you're not booking a huge amount of revenues there, but if I look -- half of the incremental growth that you're guiding to in the business is coming from the 7 Unity orders that you will install this year, and I would have thought that Unity should be pretty accretive to the margin profile of the business. I'm surprised that we see margin contraction in spite of the fact that you're starting to book these very high-margin revenues. So can you maybe help us think through what the P&L profile of Unity is beyond the technical things like amortization and capitalization of R&D, more in the gross margin level, that would be helpful. My second question is on the leverage. And as I look at your balance sheet now, it seems pretty inefficient. So Richard, maybe you can elaborate on as you think about cash deployment from here, what are the priorities for the business? And should we be expecting any M&A from you over the next 12 months or rather you keep your powder dry as you go through this pretty important time period for the business?

[Gustaf Salford, CFO & Executive VP]

Okay, so let me start with the margin profile on Unity. And here, it's important to see Unity as a life cycle because most of our P&L is the life cycle of a project. You both have the initial sales of the product, but then you also have the service revenues over the 10 years, 12 years. So I am saying that is that the service margins are a bit higher and the product margins are a bit lower. And when you get this initial project margin, and that's what we get now on Unity, that is accretive compared to our overall project margins. But then it will take a couple of years to build up the installed base and the relating service revenue to even get the better margin level there as well. So that's the main dynamics there.

[Richard Hausmann, President & CEO]

And related to the cash, I'm happy to take this question because, first of all, I'm happy because we first fixed our cash flow issues. And now we have, of course, we're getting cash on the books, and we are an innovation company. We are a company moving forward in ideas and realizing ideas. And yes, of course, we will spend our money in a way to move our products in a stronger way, in R&D, as well as we're looking out for an organic growth, yes. And we have a process on that one. I don't -- I cannot and I don't want to go into more details about it, but especially in our Elekta Digital program, we, of course, are scanning potential targets and see a potential also there, too, for organic growth, yes.

[Veronika Dubajova, Equity Analyst]

Okay. Can I just follow up, Gustaf, on your comment on the Unity hardware margin being accretive versus the hardware margin for the group. I mean, I'm struggling to understand why Unity shouldn't be, even the hardware sale, accretive to the margin of the entire group. I mean, you're selling a device for $8 million that I presume costs you $3 million or $4 million to make an install. Why is the gross margin not better on the hardware sale?

[Gustaf Salford, CFO & Executive VP]

No, it is better. But I think the total revenue numbers for it this time in commercialization is not that large compared to the total revenue number of Elekta. So when you look at the model, you will not get a very high accretive effect on the gross margin number yet. That will come over the coming years here.

[Operator]

Our next question comes from Johan Unnerus from Pareto Securities.

[Johan Unnerus, Analyst]

Congratulations to the Unity support and the improved stability, quite a difference compared with some time ago. And the first one is installation capacity. Great that you gave some indication for the current year. You probably need to double that capacity to 2 per month or something or even higher rather soon, after this year. Is that something you are comfortable in achieving, is the first question.

[Richard Hausmann, President & CEO]

We are comfortable to achieve that. And our supply chain and our whole way of how we install -- produce and install the Unity, is completely supporting that so we are not worried about that.

[Johan Unnerus, Analyst]

Okay, and the China approval, clearly not to be expected this year, but how soon after? Can you provide some visibility on that?

[Richard Hausmann, President & CEO]

Yes, I mean, the -- as I said, the installation of the 5 systems will happen now this month, next few months like -- until fall, late fall this year. And then the study will start, I would say, probably December timeframe this year. And typically, takes 6 months and then the evaluation happens. So I envision the CFDA release toward the second half of 2019.

[Johan Unnerus, Analyst]

Great, that's helpful. And a smaller point, third-party revenue, the project revenues, was at higher level and put pressure on the COGS this -- gross margin this quarter at this stage of the installation of Unity. Can we expect that you will have a period of slightly gross margin pressure and high project revenues also in the beginning of this year?

[Gustaf Salford, CFO & Executive VP]

From third-party revenues you mean, Johan?

[Johan Unnerus, Analyst]

Yes, exactly.

[Gustaf Salford, CFO & Executive VP]

No. I think, if you look at third-party revenue, they are really on a case-by-case business. It's not something we drive, but sometimes they are part of tenders for more turnkey solutions and so on and then we have to supply it from other vendors. So it's not a trend. It's more on a case-by-case basis. And here, we've had some of it here in Q4.

[Johan Unnerus, Analyst]

Yes. And what about the COGS savings that you were not completely happy with in Q4? Is that something you can mitigate coming quarter or...

[Gustaf Salford, CFO & Executive VP]

Yes. So we have been previously talking about SEK 150 million in the year. And if you look at our total targets over the last couple of years, we had SEK 200 million. And now if you compare to that level, we are -- over the period, we are over SEK 230 million. But if you look at this year, you will see that we had a gap of around SEK 50 million. And that gap is primarily due to some delays and some -- with some activities we pushed forward. So we foresee that, that will happen in next year. And then of course, it's linked to the volume as well for the different product categories.

[Richard Hausmann, President & CEO]

And these savings are not the simple procurement COGS savings typically anymore. We had more projects running and still running, where engineering is required to make a significant change, which reduces in the COGS for a certain component. That was a little bit deeper [ ties ] in last few months because of the Unity release, but we will come back.

[Operator]

Our next question comes from Scott Bardo from Berenberg.

[Scott Bardo, Analyst]

Yes, so there obviously seems to be a lot of focus on what everyone's calling a declining margin for you, if you like, in the upcoming year, but it seems to me that your guidance is broadly aligned at an absolute level with consensus forecast for this upcoming year. So I just wondered if you could clarify, given that for the first time you collect consensus forecast, would you agree with that assessment? That would be helpful just to put an underlying for these questions. And also, on that, Richard, I think historically, you've mentioned an environment of continued improvement for operating profitability. So can you give us some sense, if this 20% margin or so you guide for, is that something you'd expect to continue to improve upon? And can we expect some sort of clarity in this regard at the upcoming Capital Markets Day? So that's question number one, please. Also, on revenue guidance, pleased to see that you're actually providing some revenue guidance for the first time in a long time. Again, is this something we can expect at the upcoming Capital Markets Day on a midterm basis now? And in your opinion, at this point, can you share thoughts that revenues' growth could accelerate, remain similar or give some sort of feeling for how you're envisaging the development of the business? So they're the first two, please.

[Gustaf Salford, CFO & Executive VP]

Okay. I'll try to break down a couple of points on the margin side and I will let Richard talk more about the long-term view. But if you look at the guidance that you mentioned, I don't think it's our role to act -- or discuss some guidance, but if you look at the 7% guidance we give, I think that is in line with the market growth we see of 4% and then our additional growth on top of that. So that's the 7%. And then on the EBITA margin, I think it's the driving forces that we have been discussing previously in call, so nothing more there. And then on the Capital Markets Day, we are working with a longer-term target linked to the strategy that we will discuss in that meeting as well. So you can expect a more forward-looking and long-term view of our business.

[Richard Hausmann, President & CEO]

Maybe one comment on the margin also. I mean, we are focusing at the moment also to go into a few additional growth regions where we need a few more order fulfillment and service personnel to move this -- actually the projects which we have won over to reality and to satisfying the customers. So that's an investment which we do on purpose because we see ourselves really on a growth path, market share growth, against the main competitor.

[Scott Bardo, Analyst]

Okay. And just, lastly, then, please. Obviously, some pretty significant Unity orders from one customer, in particular, the Proton Partners. Can you share some thoughts then as to the coexistence of Proton and MR linac, along with your discussions with this customer? And also share thoughts on how unusual such a large order is. Is this something that we could expect from other large institutions or chains? Or is this a very isolated large order that is not likely to be reproduced in the future?

[Richard Hausmann, President & CEO]

Okay. Yes, since I was personally very much involved in this Proton Partners discussion and the final deal, I think the idea of the customers is, I think, very good, to combine proton therapy, which has particular applications in some cases, with precision radiation medicine based on MR linacs. So to offer insight basically to both precision technologies at the same time, which are still, of course, different applications to focus on. So I think this is a good idea and we like that and the whole discussion, which is high-quality treatment solutions to be available at the place. Do we have more of those kind of ideas of more than one bigger deals? I can tell you we have discussions. We're going in that direction not so much combined with Proton systems, but with existing customers of us, which have large chains and want to go into this direction as well with the MR linac as being an offer, so to say, of highest-quality cancer care with radiation therapy, yes.

[Scott Bardo, Analyst]

All right. Just perhaps one last question, if I may. You mentioned that your service revenues and your installed base grew by 6%, which was a little bit lower, if you like, than the 8% constant currency revenue growth for the group. So I'm just trying to understand, were there other factors there that were pulling down? Or why wasn't that service growth and installed base slightly higher?

[Gustaf Salford, CFO & Executive VP]

That's a good question, but you need to factor in last year's produce-to-order impact on this year, so to say. But the underlying growth on the service business, what we see on the revenue side, is often around the 6% to 7%. It's quite stable revenue stream.

[Operator]

We have another question from the line of Richard Koch from SEB.Okay, then. We'll move to the next question and that's from the line of Björn Olander from Murgata Equity Research.

[Björn Olander]

The first one was related to the EBITA margin guidance, and that's been asked from several additional points of view. When it comes to the gross margin, it seems that the gross margin it included the further SEK 50 million, its 2.2 percentage points positive impact from the accounting changes. How sustainable is that? Is that a reasonable level to -- going forward or...

[Johan Andersson, Director of Investor Relations]

There's a little bit of a distortion here on the line. Can you just quickly repeat the question on the volume, that is?

[Björn Olander]

Yes, yes. It's on the gross margin. If we make the changes of the IFRS 15 and then add further SEK 50 million in COGS reduction, we have a 2.2 percentage points increase. Is that a sort of fair level to assume going forward?

[Gustaf Salford, CFO & Executive VP]

You mean on COGS savings of around 2% on the addressable spend?

[Björn Olander]

No, the additional COGS spend that you have indicated and the accounting changes.

[Gustaf Salford, CFO & Executive VP]

No, the accounting changes, I don't see it has some impact there. There, we drive a lot of COGS savings initiatives and we are targeting a number there. But we don't guide on the gross margin number, but we will continue to drive COGS programs and COGS reductions.

[Richard Hausmann, President & CEO]

But then you refer -- if you refer to this 2% between '19 and '21, which we had in the restatement last year, you cannot take that forward as we have explained before.

[Björn Olander]

No, okay. You also mentioned the R&D in relation to sales. Could you repeat what that statement was for the coming year and if that included the capitalization as well.

[Gustaf Salford, CFO & Executive VP]

Okay. So for this year, what we focus on with that metric is gross R&D, so as we call it, that's excluding amortization, capitalization and then we compare that to net sales. And for this year, it's 12%. It's high compared to historic -- or sorry, last year, last year, 12%. And looking forward, we see around 10% to 11% in relation to sales.

[Björn Olander]

Okay. But that should also drive the EBITA margin further up. So it appears -- and admin expenses, I suppose, is going down in relation to sales. So it means a quite dramatic increase in marketing expenses, selling expenses. Could you quantify what you mean by that?

[Gustaf Salford, CFO & Executive VP]

I think a couple of factors. I think you need to include capitalization effect from the gross spend to the -- what you see in the P&L. That's important factor. For admin, yes, we are continuing to focus on driving down admin expenses, but there are also new regulations and so on driving increases in admin spend as well. So that's 2 factors. And then we have continued to look at customer-focused investments in the key markets to drive future top line. So that's an area we're looking and investing in. And that will primarily hit sales, marketing and actually some COGS numbers because it's about the service organization and the order fulfillment organization as well.

[Björn Olander]

Okay. And the second question is just a minor thing. I mean, you seem very happy with your balance sheet and your cash flow and you distribute almost 50% of the EPS in the dividend. You also have authorization of buybacks for up to 10% of the shares. What is your intention? Will you use that? Or is it something that you just would like to have just in case?

[Gustaf Salford, CFO & Executive VP]

The 10% share buyback mandate that we presented to the board and we'll present to the AGM as well is something we've had in there during the last couple of years.

[Björn Olander]

Yes, I know but...

[Gustaf Salford, CFO & Executive VP]

There's nothing new in that we don't have any specific intentions there and it's more a board decision to the AGM. It's not an operational decision.

[Operator]

Yes, we have a question from the line of Richard Koch from SEB.

[Richard Koch, Analyst]

One year ago, you said that you expected to return EBITA margin exceeding 20% and now you reached 18.7%. So I wonder why do you claim to have reached the target? I realized that you recently lowered the target, but when you look back, do you really consider that you've reached the target that you state in the report?

[Gustaf Salford, CFO & Executive VP]

I think if you compare to the beginning of the year, I agree, we had a different target there. And then due to all the events that we had between Q1 and Q3, we've had a new target -- we guided a new target for the full year and that was the 19%. And when we refer to this in the material in the call, we relate it to the communicated targets and that is what we said in Q3 for the full year EBITA margin.

[Richard Hausmann, President & CEO]

Let me answer that. I mean, the difference -- the main difference as we had communicated when we changed the target from 20% to 19% was also that we had some cleanup activities done, which were effectively having an effect of 1 percentage point of EBITA, so which made us as a company stronger for the future. And that is something which we need also to consider. So it's a positive thing which we had done on purpose. A part of it wasn't and then basically we got stronger moving forward.

[Richard Koch, Analyst]

So now looking at the margin guidance for next year, how good is your visibility on what you will actually be reporting 1 year from now?

[Gustaf Salford, CFO & Executive VP]

I think the visibility has improved because we have better processes, better base. We have done a lot of efforts during the year to increase transparency and visibility. And then looking ahead, under IFRS 15, it's actually easier to forecast start of installations compared to shipments -- the demand from the customer side. So that will actually improve our visibility of the future. So that's 2 main drivers. And we will get more evenly distributed revenue flows throughout the quarters and that will also facilitate better forecasting.

[Johan Andersson, Director of Investor Relations]

Okay, thank you very much. And I think that was the final question we had time with for today. So we would like to thank everyone listening to this and participating in this call. And then we report Q1 in the end of August. So let's talk there as well. So thank you very much for today.

[Richard Hausmann, President & CEO]

Thank you.

[Gustaf Salford, CFO & Executive VP]

Thank you.