Olympus Corp

TSE:7733

Earnings Call Analysis

Olympus Earnings Affected by Earthquake, Strong NA Growth

Olympus faced a setback when an earthquake damaged a key supplier's factory, halting production and slowing new endoscope sales to ensure supply for service and repair. The incident may lead to a revenue shortfall of approximately JPY 24 billion for fiscal year 2024, yet the impact on 2025 remains uncertain although sales loss is expected to recover in Q1 2025. Olympus is actively engaged in a quality enhancement program, Elevate, incurring expected fiscal 2024 expenses of about JPY 30 billion, which should decrease thereafter. The North American market, accounting for 35% of GI Endoscopy sales, shows strong growth with the successful EVIS X1 launch, expecting over 30% sales growth in Q4 despite supply concerns; the GI EndoTherapy business also reports a robust 15% growth in the first 9 months of the fiscal year.

Solid Revenue Growth Amidst Market Challenges

The company has reported solid revenue growth, with consolidated revenue reaching JPY 675.7 billion. This marks a record high for the Medical business, showing a 5% growth in the third quarter and year-to-date. The growth was widespread, with increases seen in all areas except for China, where performance was affected by macroeconomic factors. Strength was notable in the Medical Services and GI EndoTherapy segments.

Profitability Pressures and Strategic Adjustments

Despite the revenue increases, the company faced pressures on profitability. Gross profit declined slightly due to provisions for a voluntary product recall, and the adjusted operating profit saw a 14% year-on-year decrease to JPY 110.2 billion. This was compounded by a significant loss from discontinuing certain product lines and costs associated with a transformation program aimed at remediation and quality improvement. A bright spot, however, was the gain from the sale of a subsidiary, contributing to a record profit including discontinued operations, and an EPS of JPY 192.

Full Year Forecast: Optimism Tempered by Realism

The company adjusted its full-year forecast to account for the impact of the Noto Peninsula earthquake and changes in foreign exchange rates. Revenue is projected to increase by 5%, although adjusted operating profit is expected to decline by 18%. The anticipated adjusted operating margin is set at 15.7%. Despite these challenges, the company predicts a record profit for the year attributable to owners at JPY 252 billion with an EPS of JPY 208, largely due to gains from strategic asset transfers.

Sector-Specific Concerns and the Path Ahead

By segment, both revenue and operating profit have been revised downwards, particularly in the surgical endoscopy and therapeutic solutions divisions due to the impact of the Noto Peninsula earthquake and market conditions in China. Despite these obstacles and a non-fulfillment of the ambitious 20% operating income margin and 6% compound average growth rate targets for the next fiscal year, management remains positive about the long-term trajectory. Investments in innovation and sustainable growth are ongoing as the company navigates through a transformative phase.

Earnings Call Transcript 2024-Q3

[Stefan Kaufmann, executive]

Hello, everyone. I'm Stefan Kaufmann, CEO of Olympus Corporation. And as you could hear at the beginning, my Japanese has not significantly improved over the last 12 months. Sorry for this. I would like to thank you all for participating in this conference despite your busy schedules.

First of all, I would like to express my deepest condolences to the victims of the Noto Peninsula earthquake, their families and everyone involved. And my heartfelt sympathies to everyone affected by the disaster. No employees of the Olympus Group were seriously affected by the earthquake. Also, the Kanazawa and Niigata branch offices of Olympus Group have not sustained any particular damage and there are no manufacturing facilities of Olympus Group in this region.

You certainly have seen our 2 timely disclosures from last Friday and this afternoon. And I would like to give you now more background information. I'm sure that you may have more questions in the Q&A part of the earnings call, which I will then together with my colleagues try to answer, hopefully, to your satisfaction.

Olympus Group procures endoscope parts from a supplier located in Ishikawa Prefecture. The earthquake has impacted and damaged the factory of the supplier. The production of the supplier is stopped at this moment and the timing for resumption of operations has not yet been determined. We are in very close contact with the supplier and actively support him and his employees to resume production as quickly as possible. We are also working closely with a second supplier, who manufactures the same component to increase production volume as quickly as possible. However, out of an abundance of caution, we decided to slow down the sales of new endoscopes in order to ensure the continuity of patient care and safeguard health care supplies for service and repair, either by keeping spare parts on stock or utilizing new endoscopes to increase our loaner pool.

The likely impact of the earthquake on fiscal year 2024 result is estimated to include shortfalls of revenue of approximately JPY 24 billion and the impact on our business performance for fiscal year '25 is still being confirmed. It is very important to understand that this forecast is based on a scenario for slow recovery of production. Further, not all our scopes are affected by the supply shortage. For example, scopes within TSD, like bronchoscopes and surgical scopes, will be manufactured and delivered to our customers without any timely delay.

Finally, based on the current information available to us, we are confident that the loss of sales occurring in this last quarter will shift to the first quarter of fiscal year 2025 and the months commencing.

Next, I would like to talk about the change of executive officers from fiscal year 2025 onwards. Starting from April, we will welcome 3 new executive officers in Gabriela Kaynor, who has been serving as TSD Head to date, will assume the post of Chief Strategy Officer. Nacho Abia, to our regret, has decided to accept an offer from a public-listed pharmaceutical company based in Barcelona and leave Olympus after 23 years of service for the company. I would like to congratulate him to his new role as CEO.

Now I would like to briefly describe 3 new appointments: Tatsuya Izumi, Boris Shkolnik and Seiji Kuramoto. First, I'm excited to introduce Izumi-san, who will be newly appointed as Chief Financial Officer. With his track record in different finance roles of ITOCHU Corporation and its group companies, we expect him to contribute to further strengthening governance in finance and improving efficiency and profitability of Olympus. Chikashi Takeda decided for personal reason to resign. Boris will be newly appointed as Chief Quality Officer. We are currently executing our comprehensive quality transformation program, Elevate, and he has been leading Elevate's ongoing efforts, providing strong leadership and fostering a culture of patient safety with his expertise in quality management.

Meanwhile, Pierre Boisier, who currently serves as Chief Quality Officer, will continue in fiscal year '25 for a defined period of time as Quality Executive Adviser reporting directly to me. By enhancing our quality management capabilities and strengthening our patient safety focus and product quality culture through Elevate, we will build a solid foundation for the prosperity of the quality assurance and regulatory affairs function, which are key capabilities in a global medtech company.

Finally, Seiji Kuramoto, who currently serves as Co-Head of TSD, has extensive experience in research and development, sales and marketing in the medical business along with achievements in forging innovative collaborations with our business partners, including Sony. He will be appointed to Executive Officer while continuing to serve as Co-Head of TSD and will further accelerate the growth of the Therapeutic Solutions business. Seiji will be supported by the new Co-Head of TSD, Gabe McHugh, who is based in Boston and has reported directly to Gabriela before.

I'm happy to say that we have a very robust talent pipeline in our company. And we will continue to strengthen our corporate values and focus on long-term sustainable growth under the new leadership team.

As you are aware, our most important priority is patient safety. The remediation of the findings that resulted into our 3 warning letters and the transformation of the entire company towards a company with the highest level of patient safety focus and a quality-first mindset. I'm happy to report that our remediation efforts are well underway and our relationship with our regulators are constructive and reassuring. We expect the expenses related to Elevate to be approximately JPY 30 billion, SG&A expenses of approximately JPY 7 billion and other expenses of approximately JPY 23 billion in fiscal year '24. But these expenses are expected to decrease after this fiscal year.

Culture plays a pivotal part in any transformation. And on January 31, 2024, our new core values of patient focus, integrity, innovation, impact and empathy were introduced to our employees. Olympus established its first set of core values in 2018 and our core values have served us well until now. However, since then, Olympus has transformed into a medtech company. Our core values were reviewed not only to address the culture of true patient safety focus and customer-centricity but also to align with the expectation of quality and innovation from all stakeholders of the evolving medtech industry landscape.

Our core business remains robust and grows steadily, specifically in the area of GI diseases. But unfortunately, we continue to face some temporary headwinds, which negatively impact the overall growth story. The suspension of shipments of some products in addition to the impact of purchasers' decision to delay tenders as they manage the effects of the anticorruption campaign in China and other regionally located headwinds are few examples of this and the Noto earthquake now comes as an additional growth obstacle to us. However, excluding China, we achieved solid 4% growth after exchange adjustment in the third quarter, October to December. In North America, where our new EVIS X1 was successfully launched, sales performance has been strong from the beginning, and order intake is high. Also, our GI EndoTherapy business grows double digit in North America.

Finally, we also continue to actively pursue M&A opportunities and partnerships with other companies to further maintain our sustainable future growth. Specific examples include the acquisition of Taewoong Medical, a manufacturer of metallic stents for GI, a business alliance with Sony in the field of GI and respiratory endoscopes and an agreement to collaborate with Canon Medical Systems on ultrasound endoscopy systems.

Today, I would like to focus on the gastroenterology area in North America, our growth driver. First, let me start with GI Endoscopy. In October '23, we launched X1 GI Endoscopy system in the U.S. In the U.S., EVIS X1 received 510(k) clearance from FDA at the end of April and has been exhibited and demonstrated at several academic conferences since DDW. In our last earnings call, I outlined that X1 has been well received by endoscopists globally. And after the launch in the U.S., we see this confirmed by our sales numbers. EVIS X1 has been performing very well in the U.S. with 9% growth in the third quarter since its launch. The latest order situation is also favorable. And we would expect growth over 30% in the fourth quarter, putting the supply chain shortage side. As you are aware, the North American market accounts for about 35% of our total sales in the GI Endoscopy segment.

Next, I would like to talk briefly about our GI EndoTherapy devices. North America accounts for about 25% of our total sales in this segment and has been growing at a double-digit year-on-year rate for 6 consecutive quarters since the second quarter of the fiscal '23. And sales in the first 9 months of this fiscal year also grew by 15% and continue to grow strongly. Growth is particularly strong in 3 core clinical areas: colorectal cancer detection, e.g. ENDOCUFF VISION; collateral cancer treatment, product lines for ESD and EMR; hepato-pancreato-biliary, HPB diseases, e.g. stone retrieval baskets, stone extraction balloons, hemostasis powder. We will continue to invest in this portfolio to expand our business.

We are also very pleased to highlight the recent completion of our acquisition of Taewoong Medical. This acquisition opens new segments, enhances our care pathway strategy and provides additional synergies for Olympus, which we believe will help us grow our entire GI portfolio. Let me explain. As many of you already know, the success with our GI endoscopes has created a complementary growth engine through our GI EndoTherapy business. One place where GI EndoTherapy has done very well is in the treatment of HPB. HPB diseases are a $1 billion-plus opportunity for Olympus and a segment where we have a leading position. Our success in HPB results from our broad portfolio of GI endoscopes where we have a strong market presence and from the frequent innovations that Olympus has made with access and treatment devices such as guidewires.

Metal stents and radio frequency ablation solutions are a great addition to our portfolio as they are very important for HPB procedures and their use is growing rapidly beyond HPB as well. These new solutions open up new geographic areas globally such as China and Japan, as well as additional procedures such as endoscopic soft tissue ablation, which Olympus could not address before. Bringing metal stent technology in-house and having access to radio frequency ablation catheters will both open up new segments for us to address and create greater product pull-through for our leading HPB portfolio.

Now I would like to pass on to CFO, Chikashi Takeda.

[Chikashi Takeda, executive]

[Interpreted] Thank you, Stefan. So once again, hello, everyone. I'm Chikashi Takeda, CFO. Using several slides, I'd like to go over the financial results for the third quarter as well as the full year forecast.

Slide 11. This is the overview of our consolidated financial results. Consolidated revenue amounted to JPY 675.7 billion. The Medical business reached a record high for the third quarter and for the first 9 months, a 5% growth. For all areas, we saw an increase in revenue. By region, all region except for China grew on the backdrop of favorable foreign exchange. By business segment, Medical Services and GI EndoTherapy continued strength.

Gross profit was JPY 451.4 billion with gross margin deteriorating 0.8 points due to a provision of approximately JPY 5 billion associated with the voluntary recall of the small intestine endotherapy -- endoscopy system and others in ESD. SG&A expenses were JPY 340.9 billion with SG&A ratio deteriorating by 2.7 points. Major factors include an increase in expenses related to remediation and quality transformation program, Elevate and expenses for improving efficiency and strengthening of operational infrastructure for innovation and sustainable growth.

Adjusted operating profit declined JPY 18 billion to JPY 110.2 billion, down 14% year-on-year. The adjusted operating margin deteriorated by 3.7 points to 16.3%. Other income and expenses, a loss of JPY 71.5 billion, a loss of about JPY 50.8 billion due to the discontinuation of manufacturing and sales of electromagnetic navigation systems by Veran Medical and expenses of about JPY 17 billion related to the remediation and quality transformation program, Elevate. In the previous fiscal year, we recorded a gain of JPY 14.9 billion, including a gain of approximately JPY 16.4 billion on the sale of a land in Tokyo. Profit was JPY 7.5 billion from continuing operation.

In the meantime, with the completion of the transfer of Evident in April, we recorded a gain on the transfer in the first quarter of this fiscal year. Total profit, including both continuing and discontinued operations, amounted to JPY 235.2 billion with EPS of JPY 192.

Next, I would like to explain our full year forecast of fiscal 2024, utilizing Page 17. So we have revised the forecast to reflect results up until the third quarter in addition to changes to ForEx assumptions from the previous forecast. In addition, revisions have been made to incorporate what we believe will be the impact of the Noto Peninsula earthquake, which amounted to approximately JPY 24 billion in sales. The assumed exchange rates that are the basis for forecast are JPY 143 to the U.S. dollar and JPY 156 to the euro.

We project that revenue will increase 5% year-over-year to JPY 924 billion with adjusted operating profit declining 18% year-over-year to JPY 145 billion with adjusted operating margin of 15.7%. We project the record profit attributable to owners of parent of JPY 252 billion with EPS of JPY 208, reflecting a gain on the transfer of Evident. Also, profit from continuing operations is expected to reach JPY 24 billion with EPS of JPY 20. Regarding dividends for fiscal 2024, we plan to issue a dividend of JPY 18 per share, unchanged from the forecast announced in May.

Going to Slide 18. This is the forecast by segment. In ESD, both revenue and operating profit have been revised down mainly due to the impact of the Noto Peninsula earthquake, suspension of shipments of some products in surgical endoscopy and the impact of purchasers' decision to delay tenders as they manage the effects of the anticorruption campaign in China.

In TSD, we also have revised down both revenue and operating profit due to the impact of the market environment in China and the Noto Peninsula earthquake in addition to supply delays due to the quality issues and part shortages. Expenses related to the remediation and quality transformation program, Elevate, are estimated to be approximately JPY 7 billion in SG&A expenses and approximately JPY 23 billion in other expenses for the full year.

Yes, actually, we have another slide. This is the last slide. This slide shows the factors behind the increase or decrease in adjusted profit compared to the previous forecast. This is a waterfall chart. As already explained, we continue to face a challenging situation this fiscal year due to various factors. In addition to a decline in sales, adjusted operating profit is expected to be JPY 145 billion due to the impact of the suspension of shipments of some products, a change in sales composition by region due to sales decline in China and a change in the product mix due to the Noto Peninsula earthquake.

So in terms of the operating income waterfall chart, please refer to appendix under IFRS on Page 27. So please refer to that page. Thank you very much. That is all for me.

We will now move to Q&A session.

[Unknown Analyst]

[Interpreted] So I'd like to ask about the momentum of your operating results from this fiscal year to next fiscal year. Downward revision to your forecast is regrettable.

Looking at the reasons for that downward revision, the impairment loss on the R&D assets is included, I understand. And 3 months ago, you posted -- you recorded the impairment loss on Veran transfer. And therefore, if you exclude those, profit actually grows.

So I think this is positive, constructive in that you are building the foundation for growth for next fiscal year. Can you explain the backdrop to these actions? And also, although this was a difficult year because fundamentals improvement and barring unexpected costs, are you being more positive about next fiscal year? High-level response would suffice.

[Unknown Executive]

[Interpreted] Stefan, please.

[Stefan Kaufmann, executive]

I will take these questions and maybe Chikashi, you want to supplement. So first of all, thanks a lot for the question and also for your perception of our performance. And actually, I do agree. This year has been from some aspects a little bit like [indiscernible]. And so while our core business is still having a very good momentum, we have seen a couple of headwinds that have been out of control. And obviously, they have a significant impact on our performance, both top line and bottom line in fiscal year '24.

And as I outlined in the last earnings call, we are still in the process of remediation and transformation. So I don't want to be too optimistic when it comes to sales growth in fiscal year '25. But I'm very reassured that -- and that's in line what I said in the last earnings call that fiscal year '25, you will see better results in terms of sales growth and you also will see better results in terms of margin.

We will most likely not yet achieve the 20% operating income margin in fiscal year '25 and we will most likely not yet achieve 6% compound average growth rate in fiscal year '25. But from my point of view, we are doing at the moment the right things. The momentum is on our side. Maybe in one of the other aspects, we have been missing a little bit of luck, although that doesn't sound very good out of the mouth of a CEO but that's also part of the reality. And I'm very positive and nothing has changed my perspective on this that fiscal year '26, we can return back to growth, to profitable growth and that we can also make all the strategic investments into the future of our company that are necessary to take.

[Unknown Analyst]

[Interpreted] For the Noto Peninsula earthquake, what is the impact? I would like to hear more in detail. Maybe it'd be difficult to disclose. But if possible, what are the parts shortages that is happening? And I think it's the supplier's supplier. What is the -- I think it's the supplier. How far are you aware of the situation? When is the production going to resume? If anything you can share, I'll appreciate it.

Another point is that generally speaking, the medical device components, basically, you tend to hold a high level of inventory. If I'm mistaken, please correct me. But -- so having this impact from this earthquake, maybe that was expected. In terms of the BCP-related prospect, what is your take on inventory? So in terms of the JPY 24 billion, I think basically, is this the worst case scenario or the -- is it a -- if you are able to catch up earlier than possible, maybe the impact will be less than that? Can you enlighten me about this point?

[Stefan Kaufmann, executive]

For the question and this is indeed a very good question and I'm just trying to answer within a limited amount of time available because indeed, it's a little bit complex. So let me start with the nature of the supplier. The supplier is producing components, alloy steel seamless pipes that we use and further process for our medical endoscopes. And this component is a key component basically in the majority -- in the vast majority of all our endoscopes.

The complexity is that this is not only one component but this component has 100 to 130 different varieties. And this component after it is further processed at our side is built into more than 100 scopes in different constellations. So it's not that one component equals one scope. Basically, when we look at the overall situation, we really have to take a perspective SKU by SKU. That made it for us a little bit difficult at the beginning also to estimate the full impact of the impact of the damage that has happened after the earthquake with our supplier. So that's the nature.

And basically, the first 2 weeks and I think you are even more aware than I am, the situation in Noto was really bad and the damage has been huge. Also the mental health of the people is not great. So we have over the last 1.5, 2 years professionalized our procurement department. So we have a pretty good insight on our Tier 2 and Tier 1 suppliers and we also have risk mapped them. So we knew already beginning of January in the first week that one of our critical suppliers is located there. But it took us 2 weeks to reach out to him and it took us another week to go there in person and talk with the supplier, make sure that he is -- he and his family is in a good mental condition and that he is willing and able to resume production. And since then, we provide him with a lot of support. So that's the overall situation.

So then let me now come back to the impact. At the moment, we have different scenarios and all scenarios depend when this supplier can resume production and it depends how quickly the second supplier can increase capacity. So there is a level of uncertainty. So while I'm very optimistic and all the news we have received in the next -- last couple of days are very positive, we don't have certainty yet when production will be resumed.

So then looking at our position in the market, we enjoy a 70% market share in endoscopy, as you already know. And alongside this market share comes a huge responsibility. So our responsibility is that we can ensure that our customers, the doctors in the hospitals will always be able to run procedures. And in order to do so, our first priority at the moment is to secure, on the one side, spare parts or finished goods for repair and service. And at the same time, we continue production but we have advised and instructed our regions for a few days or 2 weeks to pause delivery to our customers until we have clarity about the situation because those scopes, we can also use to increase our loaner pool in case that a scope cannot be repaired but the hospital depends very much on this scope to run a certain procedure.

From a company perspective, there are 2 ways to deal with the situation. The first way is and for me, that is a little bit gambling, we could assume the best case scenario, continue to produce and sell our endoscopes. And if things go well, most likely we can all congratulate ourselves and be happy that neither there has been any impact on the top line, on the bottom line, also no impact on customer, on customer satisfaction and customer security to run procedures in the hospital.

I personally believe that for a company like Olympus that holds itself in high regards for integrity and has just also launched new core values with a strong focus on patient safety, I don't think that's the right way to deal with the situation. So our assumption at the moment is that most likely during the next 2, maximum 3 weeks, we will have clarity about the exact timing when production can restart.

Until that moment, we want to be on the safe side. We hold back with delivery of new endoscopes and we reserve our capacity for service and repair. So that's a scenario we have applied. And then obviously, we have to be consistent because this is how we communicated with our customers. This is how we communicated with regulators. This is how we communicate with you.

So then this scenario has to find impact into our lending forecast. So we cannot have a more positive lending forecast than our actions are in reality. So -- and that's basically the situation you find. That's what I tried to highlight at the beginning of my presentation. The assumptions you see here are all based on a negative scenario, which we all at the moment don't believe comes true but we cannot completely exclude. There's opportunity to recover already some earlier in -- earlier or -- not earlier but at the end of this fiscal year. And as I mentioned, it's capital goods, it's not consumable goods. We also don't believe that this is lost sales but this is basically a shift from the fourth quarter of this fiscal year into the first quarter or second quarter of the next year.

So that was a little bit longer than I intended to answer your questions but it's complex. And I think it's very important that you understand our rationale and hopefully also agree that we want to apply the highest integrity standards, which are, from my point of view, not only relevant and mandatory for a market leader in endoscopy with a market share of 70%, we have to be responsible in what we do and we have to secure that patients can be treated.

[Unknown Analyst]

[Interpreted] So I have a follow-up question. If I understand correctly, in 3 weeks' time, the supply situation, you guys, you can understand it more clearly, it means that you'll be able to understand the impact on your performance more clearly after 3 weeks. So in 3 weeks' time, the more accurate information is going to be communicated to the equity market. Is that the correct understanding?

[Stefan Kaufmann, executive]

Don't hold me accountable for the 3 weeks. Basically, on all the information available right now, we believe that in the next 2 to 3 weeks, we will have clarity on when production can be resumed. And then obviously, depending on the impact, we would communicate this. I mean that's good news if it happens. So we will not be shy to share it with you.

[Unknown Analyst]

[Interpreted] Understood.

[Stefan Kaufmann, executive]

That question about our inventory and safety stock, so indeed, after the great earthquake in 2011, we have already started to build safety stock for critical components in the average 2.5 months of each. I mean, obviously, now under the impression of the latest event, we will look with a refreshed lens on our risk mapping of suppliers on our safety stock.

And as an immediate action, there's a possibility that over the next couple of months, we will increase safety stock and inventory in order to take even more cautious and preventive measures to be utmost prepared if such an event would happen again.

[Unknown Analyst]

[Interpreted] So looking at Q4 forecast, revenue very strong and SG&A very high as well. And therefore, operating profit is going to be smaller. Most likely top line is going to be smaller and SG&A would be smaller as well. And therefore, the operating profit, as a result, would be the same as the subtraction from your business forecast and the actual for the first 9 months. So for the January, March period, what is the most likely operating profit, is my question.

[Stefan Kaufmann, executive]

This question is not so easy to answer since we have the uncertainty around the impact of the earthquake in Noto and how this will influence our possibilities, to satisfy the order intake we certainly see in many areas. When you look at the lending Chikashi has presented today, taking into consideration how I explained our stance with respect to prioritizing repair and service, is not an unrealistic one.

So I think there might be upside opportunities on the top line but I would not be bold enough to make any commitment at this moment of time. When it comes to SG&A, throughout the entire year, we have taken, independent from the latest events, actions to and measures to reduce SG&A. When you follow our quarterly SG&A development, you see that we started with a peak in the first quarter. And now quarter-by-quarter, we will able to reduce the SG&A. And I think also in the last quarter, we will see a further reduction.

And obviously -- and this is not fully reflected in the lending. We will also ask our colleagues to apply cost cautious management because while we see the impact on the top line, we also have to take preventive measures as much as we can to protect the bottom line. So I hope this answers your question. So all in all, the lending is what we regard realistic and there might be some small upside opportunities on sales growth. There might be some upside opportunities on cost management. But all in all, I would not expect that there will be a huge deviation to what we have presented today.

[Unknown Analyst]

[Interpreted] That would mean that not on each line item, we should look at the operating profit forecast then. That's where we should focus, am I correct, the operating profit?

[Stefan Kaufmann, executive]

Yes. Well, let me just double check because I'm not sure if this has been properly translated. Chikashi, can you confirm or not confirm?

[Chikashi Takeda, executive]

[Interpreted] No, I don't have anything to add. I think the conversation makes sense. Thank you.

[Unknown Analyst]

[Interpreted] So at first, I would like to ask about China. And the outlook for China as of November -- compared to November, it has decreased. So anticorruption campaign impact, you talked about it. So how -- why is this lingering so long? So I would like to ask more in detail the background of this decline in the performance in China. So besides its anticorruption campaign, maybe there is some concern that the economic growth in China is becoming weaker. So is this economic slowdown only due to the anticorruption campaign in China?

[Stefan Kaufmann, executive]

Let me give a very general answer to your question and then I would ask Frank and Gabriela to specifically talk about our ESD business and our TSD business because the situation is quite different depending on the therapeutic area where you look at. So in general and I think that's also something I said in the last earnings call, we see also this anticorruption campaign as an opportunity for us in the future. But obviously, at the moment, there's a strong restriction from purchasing departments to buy capital goods. And this does not only apply to Olympus. That also applies to other companies.

According to the information we have, this will continue until June. And there might be even risk or however you want to -- whatever terminology you want to choose, that this anticorruption campaign might be even expanded to other fields more in the regulatory environment and not so much in the hospital environment. So this is the situation. Nevertheless, long term, we remain bullish on China. As you know, we are in the process to open a manufacturing site in order to comply with the Buy China policy. And we also are committed to make necessary investments into the markets.

But the length of the negative impact of the anticorruption campaign goes beyond what we thought at the beginning of the year. So -- and then maybe, Frank, you want to start with ESD and then hand over to Gabriela to give a bit more insight on TSD because, as you know, there the business situation is maybe a little bit ambiguous.

[Frank Drewalowski, executive]

Yes. Can you hear me well?

[Stefan Kaufmann, executive]

Yes.

[Frank Drewalowski, executive]

Great. And this is obviously one of our key focus areas to understand and work for -- towards improvements. Especially for the capital goods in China, we were sharing with you last time that the X1 regulatory approval was making us optimistic together with the typical year-end rally that would happen in December. We must admit that the X1 has been received, so our core processor product, very positively by all users. But we and many other companies have not seen the typical December peak in orders.

And as Stefan Kaufmann just explained, we have been all more optimistic that the impacts of the anticorruption campaign would slow down more quickly. That doesn't seem to be the case. And we also have in comparison to the sales 1 year earlier in December, we have the so-called loan stimulus program, which has been stopped by now. So we have at least those 2 impacts and obviously also the Buy China situation that has had more impact on our SE, so surgical business. The GI Endoscopy business, we feel, is very solid. And we are basically debating on how and when we will recover.

We don't feel like, especially with the X1 launch having been successful that we are actually losing market share. But we are just not seeing the numbers which we were predicting together with our Chinese colleagues. And with that, I would hand over to Gabriela to talk a bit more about the, I don't know, gastrointestinal and capital goods outlook and [indiscernible].

[Gabriela Kaynor, executive]

And I think for our TSD business, about half or 50% of our business in China is also capital good sales. So nothing else to add than what Frank has already explained. But on our consumables side of the business, we were still nevertheless impacted. And from a short to midterm perspective, we've seen some continued impact from some of our supply shortages that are also affecting our portfolio there, particularly in the respiratory side.

However, as Stefan mentioned, from the long-term perspective, we are still seeing a lot of opportunity as we see procedure volumes continuing to steadily increase and in particular, have a very strong, differentiated portfolio in our EndoTherapy business and Respiratory business, which are a key area of focus for us and where we will continue to, hopefully, in the long term see our growth come from in China.

[Unknown Analyst]

[Interpreted] During the presentation, you didn't talk much about this but looking at your materials, the career support program, career support program is what I'd like to ask about. I think this is euphemism for restructuring. Am I correct in assuming that, that's the case?

And for the third quarter, JPY 2 billion was expenses. For Q4, I think JPY 800 million is projected. Would this continue into the next fiscal year? The expenses related to this career support program, will you continue to see expenses in the next fiscal year?

[Stefan Kaufmann, executive]

Thank you so much for the question and your sharp observation. Let me see how I can answer that question in the best possible way. So I think I told you that a couple of areas for improvement in our company is the budgeting process and also taking accountability of the budget of the functional heads and I mean global budget accountability.

So what we have done this year differently is that we did not wait until the end of the budgeting cycle in May to conclude on the targets. Basically, we have given all functions global budget targets already in the month of September in order to give them the opportunity to use the second half of this fiscal year to prepare the ground that they can achieve their budget target in fiscal year '25. This is not only related to Japan. This is a global initiative. And I think this will help us in fiscal year '25, not only to create a culture of budget accountability but also to start to reduce SG&A and move them in the right direction.

And as you know, with respect to my 3 strategic priorities, it's patient safety, innovation for growth and productivity. And obviously, we need more productivity to invest into innovation for growth. And that's a matter of fact. And we are very, very committed, the whole executive officer team, to make this happen.

The other and that's part of the [indiscernible] project initiative we will start next year is that we really will look at the global operating model from the perspective of a pure medtech company. So you know the story of Olympus. On the one side, we have been a Japanese manufacturing company with affiliates around the world with a low level of harmonization. On the other side, we have been a conglomerate of different businesses with a holding organization on top of it. And obviously, now that we have verticalized our business by moving into a pure medtech direction, we still have not yet achieved the optimal operating model for our company and that's on the list of projects for fiscal year '25 to look at this.

[Unknown Analyst]

[Interpreted] Also, the SG&A expenses have been reduced and you said that you are seeing the results, the effect of that. And I think you have made a downward revision to the SG&A expenses for this fiscal year. So what are the success areas in reducing the SG&A expenses? Where have you been successfully reducing the SG&A expenses?

[Stefan Kaufmann, executive]

I mean, first of all, thank you for your question just because -- just to make sure that we do not misunderstand. So the idea was that in fiscal year '24, by assigning early budget targets to all functions, we can use fiscal year '24 in order to execute already the measures to achieve the budget for fiscal year '25. So the full impact of all of this, you will see in fiscal year '25.

Nevertheless, also fiscal year '24, we have not been lazy on managing our SG&A. Basically, we had a couple of initiatives in order to freeze vacancies in the company in order to -- either to renegotiate contracts with suppliers and outsourcing partners or consultancy firms. And that's still an area where we can progress more but we're doing already much, much better than previously. We are much more dedicated in the way we prioritize our projects and stage them over longer period of time. I think in the past, we had quite a lot of projects going on in parallel with all the related costs. And obviously, we'd rather take a long-term view, prioritize projects and sequence them over the next couple of years in order to avoid that they all peak at the same moment of time.

And again, as I said at the beginning, I think in the first quarter, we did not pay enough attention. So we saw quite an increase in the SG&A. But now in quarter 2, quarter 3 and you will see more of that in quarter 4, I think we get a much, much better grip on cost control and expense management.

[Unknown Analyst]

[Interpreted] So the CEO, Stefan, you talked about the -- you talked about seamless pipes, that the supplier was making a seamless pipe. So I think it's more on the -- one of the components that is used for the body of the endoscopes. Is that correct?

So if you can -- I want to know how the probability of this is going to be -- come back to production for the first quarter, second quarter in the next fiscal year. This specific, the first supplier is going to resume the production, is there a different supplier? But this will be a small component in terms of the components. I think we have to do a calibration and I think basically, you have to conduct audits but you don't have to do so. And you said -- talked that this component will be used in 100 types of SKUs but you are aligned to 1 supplier for this key component. That's a kind of surprise.

And so I would like -- maybe there's some lessons that you have learned in terms of supply management. Well, this is the kind of vague question. But in terms of the probability of the production going back in line, the first quarter to the second quarter next fiscal year, what is the reasoning behind that?

[Stefan Kaufmann, executive]

Thanks, Kohtani-san, for the question. And let me ask -- let me answer first your second question about the learning. So first of all, the supplier is not a single-source supplier. There's a second supplier but this supplier is covering 80% of our demand. So it's covering the vast majority of this component, we need for further processing as a mechanical component that is used in the tubes of our endoscopes.

And I think in medtech, maybe different than in other industries like automotive, to have a single-source supplier or a supplier who is covering the majority of the demand is not so uncommon because when you look at our products, the specification of these components is very unique. And on the other side, the quantities we need is very small. So it's not so easy to transfer these kind of components to a larger corporation because usually you need a specialized manufacturer in place that is really focusing on these components. And we have benchmarked our single source or majority single-source supply with other medtech companies.

And obviously, we're a little bit higher than others. So there is a learning that we have to improve our BCP but it's not that we are in a unique position. So what are the learnings? I would categorize the learnings in short term, midterm and long term. Short term, as I said, we have to take a refreshed look at our supplier risk mapping. And if we find suppliers where we do see an exposure, which is as critical as it is now for the production of our endoscopes, we have to increase our inventory and our safety stock.

The second is short to midterm. We have to improve BCP. So there are areas where we can do certainly better than we have done at this moment, not in the situation itself but in order to be prepared for such a situation. And the last point is -- but that's really mid- to long term and that's a bit more complicated is, obviously, this is root cause in the way we design our endoscopes. So I think mid and long term, we have to rethink if our endoscopes cannot be more modular than they are today and not as unique by securing still the same quality and superiority they have today and by this being able to drive a better sourcing strategy for the company. But that's nothing we can realize overnight.

That's a bit of a larger project, as you can imagine. But obviously -- and you heard me saying this, when we were receiving the warning letters. Every crisis is an opportunity for change and we are also very much committed to use this as an opportunity for change in our company.

[Unknown Analyst]

[Interpreted] I'm looking at Slide 27. I have a question on Slide 27, your revision to the forecast compared to the previous forecast. So dividing between Q3 and Q4, what -- how would they break up?

[Stefan Kaufmann, executive]

When you say dividing, what is...

[Unknown Analyst]

[Interpreted] Okay. In Q3, what has been realized and what's the projection for Q4, so the forecast and the actual.

[Stefan Kaufmann, executive]

Okay. Then let me hand this over to Chikashi.

[Chikashi Takeda, executive]

[Interpreted] Okay. It's very difficult to explain precisely. Easy ones, sales revenue in Q4. And there are 3 elements for revenues towards the bottom of the slide, 3 items. We can't say one quarter is larger than the other quarter or I don't think it's appropriate to say which is a bigger factor. That's for the revenue.

Cost. Cost of sales here, the expenses related to compensation for some products in surgical endoscopy. That's for Q4. And product mix, Q3 and Q4, both. And Noto earthquake, of course, Q4. SG&A expenses. In Q4, in the last quarter, we are going to do the optimization with further momentum. So I wouldn't say majority but a lot is more on Q4. I think -- I hope that answers your question.

[Unknown Analyst]

[Interpreted] In other words, Q3 actual compared to your internal projection, what was the downside shortfall for Q3?

[Chikashi Takeda, executive]

[Interpreted] Revenue, again, it's very difficult to explain this clearly because there are many factors involved here. So I can't really generalize. Our progress rate is one thing I'd like to talk about. Approximately, at the end of Q3, over 70%. That's the average every year. Whereas this year, it was about 70%. Usually, it's above 70% but this year, it was 70%.

More ESD, delay more prominent in ESD. And as a result, if I can generalize what we said 3 months ago, year-on-year growth rates, revenue 3% was our projection. That's what we said 3 months ago, whereas this time around, looking at the progress as of the end of Q3 and the impact of Noto earthquake, minus 0.7% excluding the impact of foreign exchange.

[Unknown Analyst]

[Interpreted] So expenses related to compensation for some products in surgical endoscopy, can you elaborate on that UHI photo?

[Chikashi Takeda, executive]

[Interpreted] During the surgery, the CO2 is injected to make space for surgery. And we made a release in October of last year but we -- in the U.S., this has been suspended. And we had to take actions for that. And that is included in the forecast for the cost of sales for Q4.

[Unknown Analyst]

[Interpreted] So this is one question, a quick question from me. So when is China going to recover? I want to know that. When I look at this material, so the anticorruption campaign led to the delay in tenders. And I thought that this would recover quickly.

But according to your presentation, it seems that there's some real estate issues, the rents being unpaid and there's -- some of them in bank loans situation, Buy China policies. And I don't know whether the equipment order situation from Fukushima is going to have an impact. It will be a more lengthy recovery. It's not simply a delay in tender, more a long-standing situation for the China recovery?

[Stefan Kaufmann, executive]

Thank you for the question. And I wish I could give you the answer. The reality is that uncertainty in the Chinese market and the volatility at the moment is pretty high. And first, we thought that the anticorruption campaign would end, end of March. Now it seems there will be a prolongation. Obviously, we also see that value-based purchasing is increasing, plus Buy China.

So at the moment, we are in intense discussions with our region with respect to fiscal year '25. And I want to be transparent and honest with you. We are not sure yet if we can already next year regain momentum for high single-digit growth. So at the moment, we are not sure about this.

Frank, anything you want to add from an ESD perspective, which is the driver of our business in China?

[Frank Drewalowski, executive]

Only 1 confirmation, which was already included in the question, as this is more multi-factorial than we maybe portrayed before or anticipated. As you mentioned there, this is; a, the anticorruption campaign is prolonged beyond our expectation; but b, the other factors and the overall situation in China are contributing to our expectation that we will not see like a V-shaped recovery in the moment when the anticorruption campaign stops but more a slower and steady recovery.

But we are, as Gabriela mentioned earlier, absolutely convinced that the growth of the overall need for good endoscopy in China will drive us back to this level of high single digit. And the big question will be how quickly can we -- how can we achieve that again.

[Unknown Analyst]

[Interpreted] But on the other hand, so I think basically for the third tier, Tier 3 hospitals is going to increase. So in terms of the -- basically, this means that's going to be taking long?

[Stefan Kaufmann, executive]

Basically, let me repeat what I said when we talked about headwinds. So the unmet needs in China are significant. When you look at all KPIs, number of endoscopists per capita, when you look at mortality rates of colon cancer, I mean, there's a huge unmet need.

That's the reason why we remain and maybe that's a wrong expression but we remain bullish. So we believe in the growth potential and we believe that we have a rightful place there. We have a 50-, 60-year-old long history. Basically, together with Japanese HCPs. We went to China and trained doctors and nurses in endoscopy. So we have a very strong footprint there.

But we also have to accept that the volatility and the unpredictability is higher than it has been the last years. And that's the reason why you see Frank and myself being a little bit careful to raise very high expectations on the V-shaped recovery in fiscal year '25, which does not mean that mid and long term, we believe that high single-digit growth is possible for us in China.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]