Elekta AB (OTCPK:EKTAF) Q2 2019 Results Earnings Conference Call November 29, 2018 4:00 AM ET

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Executives

Gunilla Öhman - Interim IR Manager

Gustaf Salford - CFO

Richard Hausmann - CEO

Analysts

Annette Lykke - Handelsbanken

Sebastian Walker - UBS

Michael Jungling - Morgan Stanley

Romain Zana - Exane

Kristofer Liljeberg - Carnegie

Kit Lee - Jefferies

Hans Mähler - Nordea Markets

Johan Unnerus - Pareto Securities

Veronika Dubajova - Goldman Sachs

Operator

Welcome to Elekta Q2 Report. For the first part of this call all participants will be in a listen-only mode and afterwards there will be a question-and-answer session.

I'll now hand you over to Gunilla Öhman.

Gunilla Öhman

Thank you very much, and welcome to Elekta's conference call following the publication of our Q2 report for the fiscal year 2018 and 2019 that we issued this morning. I'm Gunilla Öhman, I'm Interim IR Manager of Elekta and with me is Richard Hausmann, our CEO; and Gustaf Salford, our CFO.

Our agenda today is shown here and Richard will begin by describing the quarter in short and some highlights and events, and after that Gustaf will dig deeper into the financials and we will end with Richard rounding up and invite you all to the Q&A session. Welcome.

Just a reminder some of the information discussed on this call including our projections regarding revenue, operating results, cash flow, as well as product 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 that, I am happy to hand over to CEO, Richard Hausmann.

Richard Hausmann

Thank you very much, Gunilla, and good morning everyone. This is Richard Hausmann, CEO of Elekta.

Before we go into the quarter and our numbers, I would like to share some overarching impressions from the quarter and what I have heard when I have been out meeting with many healthcare professionals, customers and employees. Firstly, there is a strong market out there and we continue to see good order and revenue growth in most markets. I also see a growing interest and a better understanding of the benefits of including radiotherapy in the treatment regimens of more patients.

Our thought leadership in Precision Radiation Medicine positions us very well to capitalize these trends and in the end help more patients. Secondly, the interest in Unity is stronger than ever although we didn't book any orders in this past quarter, the sales funnel continues to grow and we signed two new agreements in November and are in final discussions with two more as we speak.

Finally I see many exciting opportunities out there such as a huge Chinese healthcare development plans and the expected FDA clearance of our Elekta Unity with our broad range of solutions Elekta is very well placed to meet these demands.

I just want to remind you of our Capital Market Day in September. Many of you were present and all in all we had about 200 attendees both in personal and online. I was excited to present our strategy and our focus on thought leadership in precision radiation medicine, as well as announce our midterm financial targets.

Just as a reminder, we plan to grow sales by 8% to 10% annually in the coming years and to reach an EBITA margin of over 20% expanding up to 200 basis points by the end of this period - of this midterm scenario.

Now let's have a look at our numbers. We saw a double-digit order growth for both treatment and software solutions call it our products, whereas service orders behind in some regions which led order intake to grow 12% to 2% in constant currency in the total of the quarter. Our installed base however continues to grow and with a clear focus on improving service order intake, we expect services to pick up again in the second half of the year.

The interest in Elekta Unity's firm and our sales funnel continue to grow in the quarter also no orders were booked. The order process for Elekta Unity is long due to budget cycles and tender processes especially in the European public health sector. Two new agreements were signed in November already now, and we are currently in the final discussions on the second Unity in Utrecht, and one in Turkey where all parties have committed to move forward within days. And we expect more to come in the remaining quarter three as well.

We had a high level of startup installations leading to 15% net sales growth, 6% in constant currencies driven by a steady flow of installations across our markets especially in North America, Europe, Middle East and China. And finally in Q2 we saw a strong cash flow in the quarter.

Summarizing our first half year now, we see there is a robust market out there. Our estimate for global market growth at the moment is around 7%. We see a solid order intake and interest for our products, order intake is up 14%, 6% in constant currencies for the half year.

Net sales were up 14%, 7% in constant currencies which is in line with our guidance for the total year. And EBITA margin ended up at 16% for half year, 19.2% on 12-month rolling basis. We see significant further improvement potential in the second half as usual for Elekta. Gustaf will come back to this later in more detail.

Some further color on the regional development. Starting on the left with North and South America, order intake decreased by 41% in the quarter mainly because of an unexpected big service order intake and partially because of a tough comparison from last year where we had a 21 C order booked.

South America continues to be challenging partially related to the political situation, but our new regional management which is in place now since a few months is taking good steps to move our business forward.

Over to Europe, Middle East and Africa where we showed a fantastic growth, 43% I'm truly excited to see how our new leaders in the regions are really making their mark and harvesting the strong market demand and grow our share.

In Asia-Pacific orders were up 18% in the quarter, China where Elekta has substantial production R&D showed good growth in the quarter on a high level. In addition there was solid growth also in Korea and Vietnam. In general, we are optimistic and expect continued favorable market conditions worldwide.

ASTRO in October was one of our customer relation highlight for the quarter. I was really glad to see continued great interest in our solutions with more visitors and sales lead than ever before in our booths at the Congress. Our new software suite, MOSAIQ Plaza in particular, drew a lot of attention with fully booked demos throughout the exhibition, as did Elekta Unity which is pending FDA clearance as we know.

At the end of October, China's Ministry of Health announced its plans for investments in radiation therapy until 2020, with up to 1,400 new linacs to be ordered. This is really exciting opportunity especially since the plan is spear to bottom up with commitments from hospitals and regions in China.

Over the years Elekta has invested heavily in China with both Medicaid and local R&D and manufacturing. As a market leader in China, we are well placed to capture a large share of these orders with our additional services order in terms of education and training and our leading position products.

Around the same time I joined our team at the China International Import Expo, Elekta was the only radiation therapy company invited to this CIIE in Shanghai, and we made a great impact on visitors and the media. We signed around 60 letters of intent with hospitals and organizations all over China for a combined value of over one US$100 million.

It was a great honor to promote and discuss precision radiation medicine with healthcare professionals and politicians and encouraging to see a commitment from the Chinese authorities to improve people's lives and health in China.

After the quarter in early November, we signed a new Memorandum of Understanding with GenesisCare amounting to over US$60 million, strengthening our long and close relationship with the largest private provider of cancer care in Australia and Europe. Building on our partnership, GenesisCare will continue to use our soft in all the clinics. We also agreed to establish a common research program developing low dose radiation therapy for the management of the benign disease such as Arthritis.

Finally an update on Unity. During the quarter three new Unity systems were handed over to customers. The University of Tubingen, The Royal Marsden Hospital in London, and Odense University in Denmark. As I mentioned at the Capital Market Day, it's inspiring to hear the positive feedback from our customers now treating patients with Unity. Our system is doing exactly what we promised the market that it should do.

The number of research papers continues to grow as well as media articles being published, and it was inspiring to see another 11 app sites presented at ESTRO this year. As I said, sales funnel has continued to grow in the quarter. Looking at the total number of systems on order as of today, we are now at 36, 34 if you will or 36 very soon, including the two plus two in November.

Olivia Newton-John in Australia, the PLA Hospital in China reasonably signed, and we are in final negotiations with the second system in Utrecht, and GOP in Turkey where the negotiations are now in a final, final stage.

We are on track for starting installation of one system per month this fiscal year including the five systems we are installing in China this year for the clinical trial. The FDA application is on track. We have answered explanatory questions and expect the FDA clearance during the end of the calendar year.

With that, I hand over to Gustaf.

Gustaf Salford

Thank you, Richard.

This is Gustaf Salford, and I'll take you through the financials of the quarter. As Richard said, our net sales grew 6% in the quarter and 7% year-to-date in constant currency. All our regions contributed positively and Unity installations are now starting to drive net sales.

The gross margin increased from the low level in Q1 to 41.4% in Q2 in isolation. The key drivers were increased share of products in mature markets, as well as better product mix with the Leksell Gamma Knife and Brachy installations with higher margins. This led to an EBITA margin of 18% in the quarter. With a further significant improvement potential in both gross and EBITA margin in the second-half, I'll come back to this topic later in the presentation.

We continue to focus on keeping our operating costs under control and we saw a 3% decline in constant currency compared to the last quarter. If you compare to last year, our expenses were significantly up 11%. The increase is related to high R&D amortization, and lower R&D capitalization following the CE Mark of Elekta Unity in the first quarter.

If you adjust for this effect, you'll see that our gross R&D spend was down with 8% versus last year. We usually measure our gross R&D spend in relation to net sales, and we came in at 11% on a rolling 12 months basis.

Going forward, we expect R&D amortizations for remainder of the year to be at Q2 levels of around SEK180 million and capitalization rates will increase when more R&D projects reach the development phase. In summary, we had a strong focus on cost control during the first quarter of the year, and this will continue in the coming quarters.

So, turning to the EBITA development in the first-half compared to last year's first-half, you'll see three main drivers. Firstly, the positive volume effect from increased installations and service growth amounted to some SEK332 million.

Secondly, price and product mix together with course development had a negative effect of SEK272 million. Thirdly, investments in commercialization phase of Elekta Unity and less R&D capitalization had up to SEK217 million.

During the first half we also got a positive impact from currency on EBITA level of some SEK69 million. All-in-all, EBITA came in at the same level as last year and the EBITA percent was 16% year-to-date. EBITA is expected to improve in the second-half of the year. The largest driver is volume, and we continue to see good growth for the year both in solutions and service. With higher volume we get better leverage on our operating expenses.

We expect the continued increased share mature market installations with higher margins, also we'll start to capitalize on some ongoing research projects during Q3 and Q4. At the same time, we will invest in innovation and geographic expansion to drive further growth. With current exchange rates, we will see a positive impact from currencies of around SEK175 million on EBITDA level for the full year.

All-in-all we are executing on the plan to reach our EBITDA margin target of around 20% this year. Our cash flow improved significantly in Q2, primarily from the growth in EBITDA. Net working capital levels were maintained at minus 13% to net sales. The main moments in the quarter was an increase in accrued income was mainly related to ongoing Unity installations but was offset by higher accounts payable.

DSO was at a negative 64 days, slightly up from negative 75 days last quarter. We continue to focus on achieving a stable and strong cash flow going forward, and our business plans supports negative net working capital levels.

Finally, turning to our cash conversion of financial position. Cash conversion during the rolling 12 month period was 81%. Net debt amounted to SEK1.3 billion at the end of the period represented 0.5x EBITA and 0.2x equity. During the coming quarters we expect our net debt-to-EBITA ratio to continue to decrease.

So with that, I'll hand it back over to Richard.

Richard Hausmann

Thank you, Gustaf.

So some key takeaways for the first-half year. There is a strong market out there and we continue to see good order and revenue growth in major markets. Interest in Unity is stronger than ever and the sales funnel continues to grow and we expect a strong order intake in Q3. Finally, I see many exciting opportunities out there and Elekta is well pleased to capitalize on these.

In essence, we are continuing to do what we say, also in our process improvement activities. We aim to be thought leader in precision radiation medicine also in the future. With our focus on thought leadership in precision radiation medicine, we are increasing addressable market by expanding the role of RT for indications which are covering liver, stomach, pancreas, lung cancer et cetera.

We are focusing on radiation as the tool to treat cancer. The focus on precision both on geometric precision, as well as the necessary personalized data at a fingertip with our software solution, and the focus on the medicine aspect of it because we integrate with our software workflow solutions in different aspects of treatment of cancer like surgery or medical oncology together with radiation therapy.

I received very positive feedback on this when I talk to our customer about this topic of our strategy. It resonates well with them and with our robust product portfolio. Finally, we reiterate our guidance for the full year with around 7% top line growth and we expect to reach an EBITA margin of around 20% for the year as Gustaf explained.

With that, I hand back to Gunilla to start the Q&A session.

Gunilla Öhman

So thank you Richard and Gustaf. And we are now happy to try to answer your question.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from line of Annette Lykke from Handelsbanken. Please go ahead. Your line is now open.

Annette Lykke

Thank you very much for taking my questions and first of all some questions on the various approval processes for Unity. Have you at this stage received any, I would say unexpected questions from FDA in respect to your tissue heating et cetera. And also in respect to Unity approval but in China at the time last year I still expected to be second half of a 2019 or towards maybe a year end 2019.

And then in respect to regulatory stuff and you have a previously discussed low spec linac that would for example be interesting for the Chinese markets and all the new systems coming soon. When do you expect that product to for schedule be available in China and then I have a follow-up question?

Richard Hausmann

First for the FDA related question towards Unity, no there were no unexpected questions coming from FDA. We got a series of questions which were more explanatory and to get more to explain our structure of the system et cetera what combined as well and all the work flow. But not so, not related to really underlying basic questions which sometimes I know have been pushed out from our competitor to disturb the market. No, that was not the case. And we answered all of them diligently and that's why I said that we are still confident that it will happen until the end of this calendar year.

Related to China, we are right now on the way to install these five clinical sites in China. They will be probably up and running in the first quarter of next calendar year and it will start. So we expect actually to have a clearance more towards beginning 2020, first half of 2020 typically the study still need a certain time and the evaluation of it, so that's the timeframe for that.

In between I mean there are few more countries around the world for example Canada, Japan, Korea that will all happen - we expect to happen in 2019 in the kind of series of events first starting with Canada then Japan and Korea, and that would cover majority of the main markets.

Now related to what I would call the value linac, I would not call it low spec linac because our ambition is to provide precision radiation therapy also to the developing countries and to emerging countries. That is a timeframe where we expect to see that getting to the market at the end of next calendar year. So towards the second half of next calendar year and it is based on an existing system architecture of our product line. So we don't see a major issue with regulatory topics.

Annette Lykke

Then just a short follow-up on Unity orders Richard. Now that you have finalized two orders in November soon to sign another two, should we expect a Unity order sort of to be accumulated higher like you know maybe 6 or 8 or its for the Q3 or is it just that the Q2 was low?

Richard Hausmann

No, I would go with you on the number you mentioned yes for Q3.

Operator

Our next question comes from the line of Sebastian Walker from UBS. Please go head. Your line is now open.

Sebastian Walker

Hi there, it's Seb Walker, thanks for taking my questions. So if I could one on the Americas order growth, so what exactly is driving the weakness that you seeing in service orders. The second question is on Unity, so zero orders in the quarter and the orders that you booked this month in Australia and China. So maybe why aren't we seeing more new orders coming through given you had the C approval in June.

And then finally on China, so what's your take here on the Ministry of Health's message on the quarters I mean my understanding is the quarters have been sealed in the past so are you more positive this time around and if so why?

Richard Hausmann

So the weakness of the services orders in United States simply a miss on renewing service orders. Yes, so our installed base is actually effectively growing in the United States so we are not worried about that situation service contract coverage is high in the United States, but we just missed in a way and we are analyzing what really was the reason probably mentor or something or change of management on the service side we just missed in this quarter to go after few renewals in time which should have been happening yes.

So that's the major part of it. There were also some a few slippages of linac orders I want to open on that into this quarter, but those already booked now. So that was like a timing aspect so that overall I think was the result was a weak order income in the United States. Yes, that’s one thing.

Now on the Unity side, you’re right. I mean and we are happy actually also that we get orders for Unity also outside Europe that’s number one. And we see this happening more and more so I think the other - on the signing is now in Istanbul in Turkey. And of course the fourth one Utrecht which is showing that second system clinical system Utrecht which shows that they are really excited and as a pioneer of this thing, they are really kind of delivering that thing. The slowness in Europe relates a lot through the complexity in particular in the - let’s say from the lead towards the closing of a deal in the public health segment in Europe.

Like Germany or other university or hospitals which are mostly financed through the government, it just takes in the bureaucracy sometimes longer than we expect, or comparably longer than in a normal linac case.

So but that's understandable sometimes. We are trying to set up processes which help them with arguments to make that faster, but it just takes a little bit time for it. We have a lot of those projects running, it’s not that they are not existing or that we have most of them it's more a timing issue.

And the last question is about China. Well usually I have to say one can believe public announcements in China are more than in many other countries and this is my experience, living six years there was quite positive on that one. If you just look at high-speed train development or anything else, they are quite amazing while they implement this they want to do something. We are quite confident on that plan and we also have seen with our network in China that they are not only doing it centrally but also they are already discussing with the provinces and with individual hospitals even and we feel strongly that with our connection in the country and our presence there that we can help and facilitate that even a bit and we will do so.

It’s not only that the linacs are important, it's also the education program, the training and this kind of topic which we are really differentiating ourselves in this country. And so from that point of view, yes we believe in it and yes we are preparing ourselves to execute on this.

Sebastian Walker

And just a follow-up so on the service orders. So when you say missed, just to confirm those contracts have gone now to competitors or…

Richard Hausmann

No, no, I mean - no, no we do our service ourselves because it's a renewal of it - it's just a miss of the timing to renew them some of them. We renew just to get a little bit advance and for whatever reason we are analyzing it still, there was not enough emphasis on it in this quarter and there was also a change in the service management in United States maybe that was something related to that but we are working it up right now and we see that happening coming back also from a volume point of view.

Operator

Our next question comes from Michael Jungling from Morgan Stanley. Please go ahead. Your line is now open.

Michael Jungling

I have three questions please. Firstly, when it comes to Unity in the United States, once you receive approval, do you expect the orders to come in quicker than what we've seen in Europe to-date.

Secondly, a question on Unity Europe, I think from memory in the past you sort of suggested that the reason you haven't received any Unity approvals before the CE mark which I think is legal in Europe, was that bodes also at hospitals we’re just waiting for the CE mark approval for the formal stamp. Why is it that since then we hardly received any orders – we had UK we had Switzerland but none in Germany, none in France, none in Italy et cetera why has it now changed a little bit.

And thirdly on the China large medical equipment purchase plans, can I just please understand whether the development will result in acceleration in Asia Pac order growth closer to next 12 months. Should we expect a material improvement in order growth in Asia Pac? Thank you.

Richard Hausmann

U.S. orders we expect to come in rather quick after the FDA clearance because there is quite an interest in many sides. And there are discussions as far as they are possible on this technology. You know that we are installing already a few systems for example Memorial Sloan Kettering is on installation right now. So there is quite some interest. So yes, I see that happening in this what I would call less public sector market U.S. and more private initiative and big, big funding happening faster. So that's number one.

So Europe, yeah I mean there are few aspects. One is this rather long I would say phase between lead and really close through to closing. There were aspects of, and I mentioned them also earlier that we need to show a real clinical system which can happen with the final CE installations that you remember in June, July, August on the systems. Now we have five Unity's now running on clinical complete clinical patients and growing that installed base now. So to see - the reference that there was another aspect just takes time to then scale these things et cetera et cetera.

But the major aspect is certainly that there are simply complexities in these projects but mostly from building sides, not particularly to our solution, but related to the fact that this is a larger equipment, this is a big equipment, a big budget. It has to go through different levels of approvals because it's larger than the normal one and that leads typically than to even with C level to – still some delays in the process, that's it.

We see a good dynamic actually in Europe. For example, on more private projects being in [France], Italy or others and also for example Proton Partners yeah, that is faster. And we will definitely also focus a bit more on this one also because we see quite significant level of patients being done on the private side. And then the China thing – sorry I forgot another question.

Gustaf Salford

I am just trying - the question when will the impact on our order intake come? And I think reviewing it with China sales organization we don't expect a major impact this fiscal year. It will primarily come into next year, but it could be also some impact in Q4, that's the visibility we have at this moment.

Michael Jungling

Maybe a brief follow-up on U.S. approval for Unity, and you mentioned I think that the order intake should be faster. Can I just ask why for instance the level of complexity headwinds that you have in Europe getting things signed-off. Why would the U.S. market treat those complexities et cetera in a faster way than in Europe. I'm trying to understand the difference in perhaps customer behavior why the U.S. would be faster than Europe in terms of the order intake?

Richard Hausmann

I think that, I would say two aspects to it. One is with that ourselves, we are learning also. We are learning how to do the things quicker, evaluating the MAGNET and positioning on the main, those kinds of stuff so and all the preparing side right et cetera. I think we are learning also with installation, so that is one thing and if it's January, February or so coming and we have learned quite a bit already.

Secondly, I have seen various sites where they independent of FDA clearance or not but they were already preparing in new cancer centers bunkers which – basically were prepared for Unity's. So from that point of view I think it is a little bit more advanced than in other situations in Europe.

Operator

Our next question comes from Romain Zana from Exane. Please go ahead. Your line is now open.

Romain Zana

Thanks for taking my question I have three. The first one would be on the order growth regarding the two percentage points in constant currency. Could you give us the breakdown, the breakdown of the contribution from Unity versus the rest of the business? Second question – yeah?

Richard Hausmann

So we’ll start with the first one?

Romain Zana

Yes.

Gustaf Salford

So it quite easy in quarter, it's nothing really. So, but year-to-date it’s what the four orders were booked in the first quarter, but was that really your question Romain?

Romain Zana

Yes.

Richard Hausmann

I understood it more like what should we have expected normally right from the Unity in the quarter. Is that what your question was?

Romain Zana

No, I was actually referring to the – if you look at the incremental sales on the orders and you assume and average price for Unity, you would add to a contribution of growth which according to my estimate would be like five percentage points. And you would have the legacy business declining and this would come to at least two percentage point of growth on the order side, in constant currency?

Gustaf Salford

So yes I understand I mean in the quarter we didn't have any Unity orders. We will then have more Unity orders in Q3 absolutely I agree with that. But the 2% order growth is in the isolated Q2. Year-to-date we are on 6% and there we see some contribution from the Unity orders we booked in the first quarter.

Going forward in the year it is what Richard talked about, we see good start of Q3, we see more opportunities in Q3 on top of that and then Q4 is strong – should be a strong Unity order because we should have FDA clearance. And we have then gone to even more European tender processes and focusing also on private customers around the globe.

Romain Zana

Second question is on China. Can you remind us what have been the gross run rate over the past 12 months for Elekta and what kind of acceleration you would expect related to the new Ministry of Health investment plan?

Gustaf Salford

We have seen double-digit growth rates in China for a long time. This impact of the program is significant. So even if you have conservative views on how many of the 1,400 systems that were actually booked, it will be a significant order growth impact on our APAC numbers starting then primarily in the next year.

Romain Zana

And would you expect a tougher pricing pressure on such a bigger tenders or I mean the existing pricing should be sustainable?

Richard Hausmann

We don't foresee - expect such a pressure. What we would expect a bit is of course that maybe local manufacturers are being a bit preferred - not preferred but at least brought into the game now more than in the past. But with our strength in China and our network and presence there, I think we have a good opportunity to cater to this program. But we also have to prepare ourselves because that means really that we need to add people also to cater to this in order fulfillment in service and training. And we are preparing right now a program for that.

Romain Zana

And last question if I may, because I think you alluded to the skew and the significant profitability catch-up you need to deliver to match your guidance. Can you detail what proportion should come from the gross margin versus the order expenses optimization?

Gustaf Salford

It's primarily leverage on gross margin I would say. From volume best product mix and that’s the key driver some of them leverage on expenses we have in gross margin such as service, manufacturing, order fulfillment that's the key driver. We will get this R&D capitalization effect that I mentioned but that’s smaller and then it's these investments we’re talking about in key markets and Richard mentioned one example in China for example. And then we’ll have this positive currency effects that primarily hits the top line of around SEK100 million in the second half.

Operator

Our next question comes from the line of Kristofer Liljeberg from Carnegie. Please go ahead your line is now open.

Kristofer Liljeberg

I had three questions, the first one is would be it be possible to give the size of those missed renewed orders in the U.S. Second question coming back to Unity in the U.S., would you expect some orders in January i.e. to be included in the third quarter this fiscal.

And finally on China it seems visibility here for this new massive program might be better than I thought. So do you expect the 1,400 machines to be evenly split between the U.S. up until 2020, do you think it will maybe take a little bit longer. And also what's your view here on the bottlenecks when it comes to skilled employees to handle these products because it will lead to rapid increase of the installed base while the number of skilled employees, I think it's growing more like 10% per year? Thank you.

Richard Hausmann

Yes, so on the miss service in U.S. it was the miss of renewals, we also have the capital on multiyear service orders in the previous quarter last year that impacted us that’s the two key factors. We had quite a difficult comparison as well in the U.S. as Richard said on the solution side.

So we would have shown significantly best number of calls if we wouldn’t have had flat service orders. But it wouldn't have been a great quarter even if we exclude that effect in the U.S. But we will continue to drive top line orders in U.S. in the second half.

Kristofer Liljeberg

But on the U.S. orders would U.S. orders have been flat if you had done what you should have done when comes to the service orders in the quarter?

Richard Hausmann

No, we had reported orders there as well. So it's not only relating to service orders. But we see an uptick in Q3 and then we see improvement in the second half as well.

Gustaf Salford

The second question Kristofer for the Unity in January we have probably it’s a little bit too tight, we don't have - as far as I see now list we have not planned right now from the United States in January already okay. But if I never so no, maybe we can accelerate one or so but at the moment will plan.

So without any U.S. orders in January we still expect them or at least we sell six to eight Unity orders and took them in the third quarter is not done really realistic.

Richard Hausmann

Yes, and then the 1,400 linacs in China, I think it will not be evenly split because as you correctly mentioned they need to prepare themselves in terms of not even the training and education but even designing the tenders et cetera because everything has to still go through tenders locally then is just a burden where we try to help as much as we can in the early phase. But I would say it's more towards the end of 2020 then this happens.

As Gustaf also said, I mean we don't see a big effect in this fiscal year yet, we don’t expect that but maybe a little bit and then 2019 and 2020 especially will be a big. And yes we will - the training aspect and education of the people are very important one and that’s also why I think our launch of this value linac will be very positive. We’ve seen the simplicity, and ease of use, ease of installation will be a major either major part of that. So from that point of view I think we will - we have to care for that.

Kristofer Liljeberg

But if you don't expect much for this fiscal is it really realistic assume that you may be able to do this until 2020?

Richard Hausmann

Delivery is a different question, but I would say orders yes.

Gustaf Salford

It’s one big other factor and it’s the breakdown by region and province and historically we haven't seen so deep breakdowns. And also a clear transparency on what the actual installed base, - or by all city and all region. So that’s an indication to us that it is lot of work have been going into this plan to look at the underlying need and that’s indication that it will execute on it as well.

Operator

Our next question comes from the line of Kit Lee from Jefferies. Please go ahead. Your line is now open.

Kit Lee

I have two questions please, firstly just to come back here Unity or the pipeline I think you mentioned that you have two contract now that you are in the final stages. But can you just talk about customer's got in advanced stage of negotiation for Unity orders and how should we think about that in terms of that funnel coming through to the closing for the next two quarters and I’ll come back to the second question?

Richard Hausmann

As I said these two orders which are basically closing any day is Utrecht, the second system and GOP. We have as I pointed out before but I cannot disclose the names now there are more projects which are very close to closure and will contribute to this quarter. The funnel overall is increasing and particular also after the ASTRO, lots of interest.

Clear I mean - you probably also saw also the changes in order feedback from customers which was published yesterday in one of the reports that also what we hear, what I hear when I go around that it is more and more seen as being at some point in the future standard of care for cancer treatment when it comes through precision - higher precision to also high perfectination, enablement et cetera.

So the result of first installation shows - these patients show definitely that it does what it's supposed to do, and I would say we were not even talking about linac - I am not talking about Unity, I am talking about MR-linac as a technology is definitely something which is perfecting itself, yes.

Kit Lee

And I guess and on the increase quota in China I guess that’s positive news. Have you had any specific discussions with your customers in China which points ramp-up of order for next year? Just wondering whether they have already secured funding or they have already come out with detail plan to soak up the increase quota because as far as I understand the last round of quota wasn’t completed filled. And just wondering what are you seeing on the ground now that points to order ramp up next year?

Richard Hausmann

Well I think I mean yes we have - we have strong contacts - I personally have also strong contacts from own history in China with relevant people. And we hear that from all sources, I mean that it is serious there is a clear commitment of China towards increasing healthcare - quality of healthcare in the totality of the country that's what Gustaf said before there is a detail plan of rolling out those number of Unity - of units not Unities but units, linac to the different regions and also with remote regions of the country.

And I think that shows a bit more that there is a commitment of the country. We had recently a Board meeting in China. I had the pleasure to meet one of our former friend from Minister of Science and Technology of China until early this year. And he also made it very clear that there is a momentum going forward to improve healthcare, in particular cancer care in the country. So from that point of view comments we’re very convinced about this program being a major impact.

Operator

Our next question comes from Hans from Nordea Markets. Please go ahead. Your line is now open.

Hans Mähler

It's Hans Mähler here. First, the question on the gross margin. Would you say that your graphical mix has normalized now or should we expect any change to that impact in the gross margin for the second half? And also maybe you can discuss the letters of intent you signed in China, are they a result of the new licenses or how should we see it and what kind of products do they include? Thank you.

Richard Hausmann

If I start with the gross margin, yes, it's down. So in Q1 we had two negative effects in way gross margin wise and it was lot of emerging market installations, little bit lower margins. And we had lower specific margin deals in U.S. and Western Europe impacting the gross margin.

If you look in Q2, I think that's the first indication on how it will look in the remainder of the year, and we saw a debt to ratio of mature market products versus the debt product mix with more Gamma Knife on Brachy and we also see an opportunity on the software side based on the new launches et cetera to drive margin in the second half of the year. I say that's a trend that will continue.

Gustaf Salford

And I take the second question on LOI's in China because I was personally there and witnessing a few of those signing ceremonies myself. It's interesting for us to see, it was actually covering quite a lot of different provinces, in that sense it was already a bit related to this program already, but we have to see now because these are intents and similar things and we're looking forward.

It was all products actually, Brachy and everything signed in this memorandum of understanding and you should also not underestimate the Icon is now released in China as well with a big - quite a good momentum there.

I personally gave a presentation, it was more a TV kind of thing which combined Icon and Unity as proposal for precision radiation medicine. It was very well received and actually there were already some Icon deals in this LOI's also included. So it was a very broad approach, very broad in regions, very broad in products.

Operator

Our next question comes from Johan Unnerus from Pareto Securities. Please go ahead. Your line is now open.

Johan Unnerus

Johan Unnerus from Pareto Securities. Yes, a few questions. First one will be looking at the 12-month order growth organic, constant currency and back out the Unity order support even if it wasn't anything. This particular quarter, you seem to be - the order growth is distinctly below the market growth. You pointed - alluded to that you expect Brachy, Gamma Knife and software to improve, but maybe you can expand on that. Will we see a change when you come up with new versions for planning and workflow for a start?

Richard Hausmann

So in order growth I clearly want to state it again, that was disappointing 2% in the quarter but if you look at our rolling 12 months average, we are in 8% already. So that's already the kind of bigger than the market growth what we see right now, a little bit bigger than a market gross.

So in that point of view, yes, it was not a great quarter but we know the reasons behind that and has not lost these or something. So it is - it's basically coming back, and with the 8% in the last 12 months, it's a good starting point and a good basis.

And there's also quite a pipeline of Gamma Knife, Elekta Gamma Knife, which we expect growth in the second-half of the year and then Brachy is doing actually quite well, so we also gross in Brachy again which was also little bit low.

And then last but not least, really very strong momentum we feel and see right now on our software products. Those on a TPS side, with our Monaco HD, which we introduced at the ASTRO, but in particular with our MOSAIQ Plaza you might recall that we always were blamed toward our Unity, but it didn't do anything in software in the last five years or something like that. People realized that we have really good offers now, our businesses which MOSAIQ Plaza, real offers existing offers which we now train and sell already, and I think that makes quite a difference also in particular with our large install base of MOSAIQ, because they can be added and upgraded there as well.

Johan Unnerus

Yes. But also, to be clear, if we look at the 12 month and then look at the 12-month support from Unity even if you didn't have any in this particular quarter, and if we reduce the 12-month order growth from Unity and looking at the traditional business, then you're pretty way below the 7% market growth. So that's something that clearly needs to improve.

Gustaf Salford

But that includes also - deals I mean so then you have to first discount the 7% too, right?

Johan Unnerus

Yes, okay. And…

Gustaf Salford

And then you have to make - because there was actually little bit argument in earlier quarter that I recall that if you do that then we actually were even better in what we call base business in comparison with Varian. So, from that point of view we - let us analyze that a bit more but it's not such an easy calculation that you pointed out.

Richard Hausmann

Now we are launching Unity and that is clearly part of our order growth and order intake, and that's how we see it last year and also the coming years going forward.

Johan Unnerus

Yes. But you also have to see you don't miss out too much on the base business, which in the prior periods did not include Unity. Yes. And anyway, the U.S. -- American part and the software services upgrade, it seems, well, nothing short of extraordinary that -- because it's a mature market in terms of linac penetration. And to not to be focused on potential upgrades seems strange. But yes, there's clearly something that we need to keep track on going forward.

Richard Hausmann

It was not upgrades, it was service - just service deals.

Johan Unnerus

Yes, but that's clearly very important in a mature market.

Richard Hausmann

Of course, and that's why - we know that our install base is growing in United States and we know that we have a high coverage of software of service. It really wasn't operational miss in my opinion, which we are analyzing right now and fixing.

Johan Unnerus

And finally - yes, on the public market in Europe, it's been slow obviously. Would we - should we expect support for Unity on that side, say, towards the end of this year? Or is that something that we will see more of the next year?

Richard Hausmann

I mean if you mean the public market for Unity in Europe, it is slower. But the market in Europe which is mostly also public is actually good. So for linac et cetera, so from that point of view. But yes, we are expecting an improvement on that one as well for Unity, yes.

Operator

Our next question comes from Veronika Dubajova from Goldman Sachs. Please go ahead. Your line is now open.

Veronika Dubajova

I also have three please. First, starting off on the U.S., there is a proposal moving forward towards introducing a bundled reimbursement for radiation. I'm curious what your thoughts are and what that might mean for the demands in U.S. sales coming at absolute number of systems and the types of systems that radiologist are interested in acquiring? And if you're hearing anything at all in terms of a slowdown in demand as we await more details about this bundled proposal.

My second question is a question on your growth margin guidance for the full year. I think that Q1 you stated that you expect those margins to still be in 1% to 2%, up 42% to 43% for the year. And I just wonder if you can confirm that since you are tracking meaningfully below that in the first-half of the year?

And my last question is, sorry to deliver the points about China, but I want to understand what confidence you get about this quota actually being realized? As far as I'm aware, there is no additional funding that has been provisioned for the theoretical 1,400 linac's that they're seeing today. The procurement still being funded by the five year plan which was announced last year which did not call for such a significant work in radiation oncology.

And if I look at the market today, our estimate suggest this is 200 unit market max per annum. So what you're talking about here is effectively doubling of market growth which seems pretty - you imagine given the lack of skill personal.

So I want to understand kind of, is your perception that there is more funding being dedicated so they send it. So where is that funding coming from and it's an additional to the five year plan and if not, why do you think these units more actually comes through if there is no funding commitment for them? Thank you.

Richard Hausmann

So yes, to get the questions right so Veronika it was first the bundle payment, the second question was – please repeat that one.

Veronika Dubajova

The second question was gross margin for the year.

Richard Hausmann

Yes, how it should improve in the second half. Okay, but if we start with your question on bundle payments. We saw the news from CMS and you report, I think already they said, we see positively on the Gamma Knife side is a bit better reimbursement and that's of course a positive signal. We are conservatively positive on more on the linac side. We are following the bundle payments discussion and the announcement there but our understanding is that it's still quite a lot of details that need to be clarified before you get the full impact on the purchase deficient of hospitals out there.

So we we’re tracking it. We are conservatively positive. I think that our stance right now.

Gustaf Salford

Actually Veronika I might add if you look forward in the reimbursement for Unity, we see a bundling has a positive form because I mean the idea of Unity is that you promote hypofractionation by precision. And in essence I think that the bundling idea, sort of the time or the effort per patient, yes which is in essence lower on Unity than on a normal system is because of hypofractionation promotion is of course and particularly moving body part is of course an interesting one. So we are assuming positive on this one, yes.

Veronika Dubajova

But I mean actually if we use to more hypofractionation would you see a smaller installed base in the U.S. altogether?

Gustaf Salford

But as we discussed already even before many times and I think my colleague from our main competitor said the same thing, it’s an overarching need for - increased need for cancer care through the growth of cancer and secondary cancer and more possibilities to be treated with radiotherapy which overcompensates the effect of this hypofractionation as well.

Richard Hausmann

And then I think on the gross margin side and our confidence in it. It is we have a new model now in Elekta on our revenue side and this is - largely driven by revenue and leverage from revenue. And since we are doing at the start of installation, we have much better visibility of our top line going forward as well.

And then on the product mix and so on, that is what we have in our forecast and that will then contribute to our gross margin as well. If you go further down in the P&L on the gross expenses down to EBITA level, that’s more in our own control and it is to have the right balance between these few investments and innovation and growth but at the same time keeping the guidance we have around 20% at the end of the year.

Veronika Dubajova

But Gustaf I think you said at Q1 you were expecting gross margins to already improve to that 42% to 43% range in Q2 and you’ve come in below. So I am curious how much of visibility do you really have?

Gustaf Salford

Yes, I think what we communicated in Q1 was that we were looking at margin improvement in the Q1, sorry Q2. If we look at the full-year number we need to be at the number you mentioned in order to come down to a EBITA level of around 20%, so that was more the full year logic.

Veronika Dubajova

Okay. And on China?

Richard Hausmann

China I think - we are confident that there is a significant part of this program being realized and I think China has typically doesn’t do it like that that they kind of bring out huge thing and have no basis behind that.

I would however also say that it's not all public I think. The days of promotion of the private sector in China as well as you have heard and maybe and what we see actually what we seen is that this private sector would might also be used - to basically support this program. But that speculation a bit, but I think this is a very high likelihood that this will happen. There is interesting private sector models now in China as well.

Veronika Dubajova

But you have not seen any additional funding going to radiation as a result of the slowdown, there is not been announcement for adjusting more funding?

Gustaf Salford

We are not involved in a budgeting process of the Chinese government.

Gunilla Öhman

So, thank you, we're bit over time. So thank you very much, and welcome to our next quarterly report which is due the 22nd of February 2019.

Richard Hausmann

Thank you very much altogether. Talk to you soon.

Operator

Thank you. This now concludes our conference call. Thank you for attending. You may now disconnect your lines.

• Chia-Chun Wang^{1, 2, 7},
• Jin-Tung Liang³,
• Chiao-Ling Tsai⁷,
• Yu-Hsuan Chen⁷,
• Yu-Lin Lin⁴,
• Chia-Tung Shun⁵ and
• Jason Chia-Hsien Cheng^{6, 7}Email author

© Wang et al.; licensee BioMed Central Ltd. 2014

• Received: 5 June 2014
• Accepted: 29 October 2014
• Published: 6 November 2014

Abstract

Methods

Twelve patients with stage IIA to IVA rectal adenocarcinoma, treated with neoadjuvant concurrent chemoradiotherapy (45 Gy in 25 fractions to the rectal tumor and pelvic lymphatics) and bevacizumab, were prospectively enrolled. Chemotherapy included FOLFOX (leucovorin, fluorouracil, and oxaliplatin) (n =1). All patients received prone-position volumetric modulated arc therapy. A historical cohort treated with supine-position box radiotherapy, including six other patients treated with bevacizumab-based concurrent chemoradiotherapy in our hospital, was used for comparison. Setup errors, toxicities, and potential biomarkers were evaluated.

P =0.01). The magnitude of setup errors was similar between the supine-box and prone volumetric modulated arc therapy techniques. The estimated 2-year survival and 2-year failure-free survival rates were 100% and 72.9% in the prone volumetric modulated arc therapy group and 66.7% and 66.7% in the supine box group, respectively.

Neoadjuvant concurrent chemoradiotherapy has become the standard for locally advanced rectal cancer care. Previous studies showed that preoperative concurrent chemoradiotherapy reduced the recurrence rate and increased the sphincter preservation rate, when compared with postoperative concurrent chemoradiotherapy [1, 2]. The use of various chemotherapeutic agents and targeted therapies has been investigated in conjunction with neoadjuvant concurrent chemoradiotherapy. Nevertheless, treatment-related toxicities have limited the success of these combination therapies.

Bevacizumab, an anti-vascular endothelial growth factor monoclonal antibody, is widely used in metastatic colorectal cancer [3, 4]. Although it augments the therapeutic effect of ionizing radiation [5, 6], bevacizumab has been shown to have significant gastrointestinal toxicities when combined with radiotherapy [7]. In several studies evaluating the efficacy and safety of concurrent chemoradiotherapy combined with bevacizumab for rectal cancer, a favorable outcome with acceptable toxicities was reported for capecitabine or fluorouracil with bevacizumab in neoadjuvant concurrent chemoradiotherapy [8, 9], while some excessive toxicities were still reported for capecitabine and bevacizumab or bevacizumab, oxaliplatin and 5-fluorouracil in neoadjuvant concurrent chemoradiotherapy [10, 11].

Intensity-modulated radiation therapy has gradually replaced traditional four-field box radiotherapy in rectal cancer treatment because it improves dose distribution and reduces bowel exposure [12, 13]. Volumetric modulated arc therapy, a recently developed technique involving arc intensity-modulated radiation therapy delivery, has been shown to further improve dose conformity and organ sparing [14, 15]. Prone positioning on a belly board has effectively reduced bowel doses in radiotherapy for pelvic malignancies [13, 16–18]. The clinical outcome of prone-position volumetric modulated arc therapy has not been assessed for rectal cancer. The aims of this study were, firstly, to evaluate early pathological and clinical outcome in patients with locally advanced rectal cancer treated with combined neoadjuvant bevacizumab and concurrent chemoradiotherapy using prone-position volumetric modulated arc therapy and, secondly, to compare the treatment-related toxicity of the supine-position box and prone-position volumetric modulated arc therapy techniques.

Methods

Patients

Eligible patients had histologically confirmed rectal adenocarcinoma within 15 cm above the anal verge. Pretreatment staging workup included complete physical examination; chest X-ray; colonoscopy; computed tomography or magnetic resonance imaging of the abdomen and pelvis; and optional positron emission tomography. Endorectal ultrasound was obtained for tumor (T) and node (N) stages in patients by computed tomography of the pelvis. Patients with T3 or T4 or N1 or N2 disease were included. An Eastern Cooperative Oncology Group performance status of 0 or 1 was required. All patients gave their informed consent.

Radiotherapy technique

Treatment was delivered with a 10 MV photon beam. We used an Elekta Synergy® linear accelerator upgraded with a volumetric modulated arc therapy function (Elekta Oncology System Ltd., Crawley, West Sussex, UK) for all patients receiving volumetric modulated arc therapy. For the six patients receiving three-dimensional therapy, we used the Elekta Synergy® linear accelerator for five patients and a Siemens PRIMUS linear accelerator (Siemens Medical System Inc., Concord, CA, USA) for one patient. The total dose was 45 Gy, given in 25 fractions of 1.8 Gy (one fraction per day; five fractions per week). Before March 2010, the four-field box technique was used in the supine position. After March 2010, the volumetric modulated arc therapy technique was used in the prone position on a belly board. Our institutional review board approved the protocol of this study. The volumetric modulated arc therapy plans were optimized using Pinnacle³ version 9.0 planning system software (ADAC Laboratories, Philips Medical Systems, Milpitas, CA, USA). We used a collapse cone convolution algorithm and a grid size of 4 mm [19]. Cone-beam computed tomography or orthogonal views were required for image guidance in all patients.

Simulation and target definition

Patients were instructed to maintain a tolerably full bladder. A belly board was used to move the small bowels away from the radiation field for patients receiving volumetric modulated arc therapy. A planning computed tomogram (maximum slice thickness, 5 mm) was acquired using the same immobilization technique as for treatment.

The gross tumor volume was defined as all known gross disease, as determined from a combination of imaging studies. The clinical target volume was defined as the gross tumor volume plus areas considered at significant risk of microscopic disease. The clinical target volume for a T3 tumor included all gross disease (rectal and nodal) as well as the internal iliac lymph nodes and the mesorectum (perirectal fat and presacral space). The clinical target volume for a T4 tumor included the same structures as defined in the clinical target volume for a T3 tumor and also the external iliac lymph nodes. To be more specific, the rectal clinical target volume was defined as the rectal gross tumor volume plus a 1.5 cm margin radially and a 2.5 cm margin craniocaudally. The nodal clinical target volume was defined as the nodal gross tumor volume plus a 1.5-cm symmetrical expansion of this volume. The clinical target volumes around vessels were defined as vessel volumes plus a 0.7-cm expansion of these volumes. The presacral lymphatic clinical target volume was contoured from mid S1 to S5. The planning target volume was the clinical target volume with a 5-mm margin.