Good day, and welcome to the Getinge Group Q2 Report Conference Call. Today's conference is being recorded. At this time, I would like to turn the call over to Johan Malmquist, CEO. Please go ahead, sir.
Thank you very much, and, a warm welcome to all of you. I am here, as always, joined by our CFO, Ulf Grunander, and, we will follow the normal format, on this call, which means that, I and Ulf will start by providing an overview of the quarter, which will then be followed by a question-and-answer session. We'll strive to close this call at 11:00 A.M. sharp, and if there are still outstanding questions, I think we'll try and take them individually with you if you care to call us. The phone conference here is supported by a slide presentation that you can access, either by following the instructions provided in today's press release, and if you should fail to do so, it's also posted on our corporate website. That said, let us move on to the presentation.
By way of a sort of overarching comment, I would say that this quarter shows a pretty mixed picture. Order development remains robust and on plan for developed markets, but order development in developing economies will, for 2014, be skewed towards the second half of the year. Earnings-wise, I would say that both Infection Control and Medical Systems have developed according to plan, but for Extended Care, we came in softer than we had anticipated, and I'll come back and comment a little bit on that. If we start with the slide, Main Trends in Organic Order Intake. As already said, organic order intake for the quarter and for the six-month period is flat versus the prior year. The overall trend that we see is that the order development remains good and on plan for developed markets.
If we were to sort of aggregate up Western Europe, the North American markets, and the other developed markets in Japan, Australia, and New Zealand, we would, for the first six months, have an organic order intake of just under 4%, which is a healthy number, and I think consistent with most other broader medical device companies. However, if we take the order situation in the developing markets, then we've seen a much weaker trend, so specifically, if we speak of the BRIC markets. We believe, though, that the order intake will be a lot stronger in this part of the world during the remainder of this year, and as you can see, later on, we have retained our volume guidance for the year.
If I speak a little bit from a business area perspective, you can see that Medical Systems has had a weak start to the year. Medical Systems has the most significant exposure to the currently weaker developing market and has also had difficulties to uphold overall growth, despite a decent traction in developed markets. The Medical Systems orders and sales numbers are also impacted by supply chain disturbances that are a result of the efforts we're currently undertaking to strengthen the quality management system. This is especially true for the cardiovascular division, but that actually, despite this, posted good growth numbers for the quarter.
When we look to Infection Control, the situation is somewhat similar to that of Medical Systems, with stability in developed markets and softness in developing markets, particularly if you take into account the full six-month period, which is on plan. Finally, when we look to Extended Care, we have seen a much welcome pickup in orders. However, a significant part of the order improvement relates to capital equipment, and less to recurring sources of revenue, which has had an impact on earnings, as you will see later on in this presentation. If we move on to the consolidated results for the group, pre-tax results for the group in the quarter amounted to SEK 549 million, compared to SEK 625 million in the corresponding prior year quarter.
The EBITA before restructuring costs was SEK 906 million, versus just over SEK 1 billion in the prior year. The organic revenue growth was quite modest, at just over 2% in the quarter, but was quite unevenly distributed across the different businesses, which has had a little bit of an impact on the plant utilization in the group. The decline in earnings is primarily attributable to the weaker gross margin. About half of that gross margin decline is related to negative currency hedging effects, which we have sort of informed about, and the other half is mostly the result of an adverse product mix and market mix. Largely, the expense development, if we exclude Extended Care, is very modest and a little bit under plan, actually, which probably it should be, considering the top line.
Moving on to Medical Systems result, the EBITA result for the quarter was flat compared to the prior year period, with a little weaker operating margin. Revenues grew organically by just over 1%, and expenses were flat or actually slightly down on an adjusted basis for currencies and acquisition. The drop in gross margin is, to a small extent, an effect of the negative currency hedging effect, but also by lower plant utilization within our capital equipment business, mostly surgical workplaces.... and also, as I said earlier, we're impacted by supply chain disturbances that are a result of the remediation work that we're undertaking to strengthen the quality management systems.
If we look to the highlights, we have, as most of you know, committed significant resources to strengthen our quality management system within Medical Systems as a result of the observations we got from the FDA and from audits that we have performed ourselves internally. We are making very good progress, I would say, on the plans at all the facilities concerned. The cost for the external support and the resources that we're utilizing at this time amounted to SEK 172 million in the quarter, and that has been booked against the provision that was created in the first quarter, and that amounted to SEK 800 million. We've also completed a small bolt-on acquisition in the quarter of a Danish company called Cetrea.
Cetrea provides software solutions for hospital resource planning that allows decision makers to access data on manpower and equipment in real time and to optimize its utilization. Cetrea has grown fast in the Scandinavian markets over the past few years. The software solutions that Cetrea provides have actually have relevance for all of our business areas and will actively be promoted across all of our business area, but it will reside legally within the Medical Systems business. I would say that we see good opportunities to take this product to international market through our existing sales channels. The company had revenues of approximately SEK 30 million in the last fiscal year, and this acquisition is expected to contribute to our pre-tax earnings, sort of from day one, inclusive of amortizations of overvalue, financing of the acquisitions, and so forth.
Just also to, on the last point here, saying that the restructuring currently taking place within the cardiovascular division is progressing according to our most recent update, which suggests the completion in the first half of 2015. Moving on to Extended Care, a little bit more of a challenging situation. Extended Care clearly posted disappointing numbers for the quarter. The EBITA dropped by some SEK 100 million, on organically flat revenues. The weaker result comes from essentially two factors. Firstly, we have suffered from an adverse product mix with a higher proportion of capital equipment and weaker wound care rentals. We have also incurred additional expenses in the quarter. These incremental expenses relate to the TSS integration.
So when we acquired TSS back in the end of 2012, we entered into a number of service agreements with the vendor, covering, among other things, the IT, IA services. As scheduled, we migrated both the TSS business and the legacy Extended Care business in the United States into a new business system, a new IA system. That transition has been challenging, and we can conclude now, after the second quarter, that we haven't had full transparency and control over the situation during the last two quarters. The result is that some SEK 50 million worth of expenses recorded this year are actually expenses that should have belonged to 2013. In addition to that, we have some SEK 20 million in additional expenses associated with the sort of implementation of this new business system.
So of this total amount of SEK 70 million, approximately SEK 50 million is now sort of allocated to this quarter, and that is the reason why you see this rather significant drop in earnings. We will continue to bridge the delta we have between 2014 and 2013 at this point in time towards the end of the year, so we'll narrow that gap. But I don't think we'll get fully up to the level of last year's performance come the end of the year, but we'll be closing this gap that we have right now in a significant way. If I move on to the highlights on Extended Care, there are really only two elements. So we have launched two new products that are destined for the intensive care environment in hospitals.
The first is a medical bed called the Enterprise 9000, which is sort of the, upmarket bed or the most, advanced bed we have in our product range. The intensive care area is still probably the best and most lucrative segment of the medical beds market, with opportunities for growth both in developed and certainly in developing economies. We have also launched a new and rather innovative device that is, also destined for the intensive care environment. It's called the SARA Combilizer. This is a mobilization device to reposition a patient from a lying to a fully upright position. I think there's ample evidence that early mobilization of patients, that have undergone surgery or for other reasons are in recovery, promotes patient recovery and can reduce length of stay quite significantly.
So this product is actually already part of clinical evaluations in Germany and U.K. and also in Sweden at the current time. Finally, then, Infection Control. The EBITA results was comparable with the prior year period at SEK 135 million. Organic revenue growth was healthy at 7.6%, simply the way that the order book on hand has been sort of shipped out in the quarter. If we adjust for negative currency hedging effects that are quite substantial in this business area, a little bit over SEK 30 million in the quarter. If we adjust for that, the gross margin is up, and we are making progress in the performance improvement program we have in this business area.
This is despite actually quite a negative product mix, where we had stronger sales on the life science side, with which typically comes with lower profitability. Expense development was on plan, and I would say that we are sort of on track for the plan we have of expanding the operating margins within this business area. On the highlight side, we have three items. The first one is around the efficiency improvement program within Infection Control. As I've already said, we continue to make progress. In the quarter, we initiated negotiations with unions in Sweden, with the aim of transferring the production of washer disinfector that are currently manufactured at our plant in Växjö. Those products, subject to negotiations, will be moved to our facility in Poznań, in Poland.
We also concluded the union negotiations that were opened up in the last quarter when it comes to transferring our production in Mansfield, U.K., to our Swedish facility in Getinge. This change will mean that all the life science sterilizers will be concentrated to a single manufacturing location going forward. This business area also completed a small bolt-on acquisition of a U.K.-based company called Altrax. Altrax is a complementary acquisition, you could say. It's engaged in the development and sales of digital and paper-based quality assurance system for the handling of sterile instruments in hospitals, predominantly. We already have a significant presence in this space through a broader and more sophisticated system, you could say, called the T-DOC system.
With Altrax, we will use this to access more price-sensitive customers and customers with lesser needs, and not least in developing economies, where these type of products are becoming increasingly important. Again, like the smaller acquisition within Medical Systems, this is a transaction that will be immediately accretive to earnings on an all-inclusive basis. We also, and finally, launched a new washer disinfector in the quarter. This is a product that has significantly better properties when it comes to cost of ownership, utilities, productivities, and so forth. It's also equipped with a new customer interface, HMI, called Centric. The intention is for this new interface system to be the uniform interface across all equipment made within Infection Control, which will significantly simplify training and retraining of staff.
This is an extremely user-friendly interface for the hardware. With that, I hand over to Ulf for some further comments before I wrap up with the outlook.
Thank you, Johan, and I will start with the cash flow. In the second quarter of 2014, the operating cash flow amounted to SEK 900 million, which represent an improvement of approximately 7%, compared with the same period last year. Even though the quarter included higher payment of a restructuring of SEK 180 million, the reduction in working capital of approximately SEK 150 million which improved cash flow. The good collection of accounts receivable continued in the second quarter and contributed well to the strong quarterly cash conversion rate of 73.1%. DIO is down one day since year-end 2013, and DSO is flat compared with year-end 2013. In general, good performance of the group's working capital.
If you take a look on the balance sheet, the closing net debt amounted to SEK 20.4 billion, and the closing equity amounted to SEK 16.3 billion, which resulted in a net debt equity ratio of 1.25 times and an equity asset ratio of 31.7%. If adjusted for acquisition and currency fluctuation, the net debt decreased in the quarter by approximately SEK 400 million. The group balance sheet at the end of June 2014 remains solid, and the group's finance capacity is in the range of SEK 6-7 billion. Thank you, Johan.
Thank you, and then just a few short words on the outlook. So, you could say that despite the soft order generation of the first six month of this year, and I would say also despite the ongoing supply chain disturbances caused by the remediation work we are currently carrying out within medical system, we believe that our organic revenue growth for the year will be in the area of the 4% previously stated. We also have made no changes to the expected restructuring charges that we believe will end up around SEK 960 million, of which the SEK 800 million pertains to the quality systems enhancement efforts within medical system. Negative currency hedging effect also, again, as previously stated, will be about SEK 250 million for the full year.
I think the one cautionary comment or additional comment I'd like to make is that in parallel to the efforts we are making to strengthening the quality management system, and where we have made good progress, we continue to have an active and productive dialogue with the U.S. FDA. The outcome of these discussions remains a risk to our projections in the short term. I think at the capital market day that was recently proposed, postponed, as soon as we have better visibility on that situation, we will reschedule it, and hopefully also then have the opportunity to present an ambitious and detailed plan on how we intend to strengthen profitability over current levels for the medium term. And with that, I think, operator, that we can move over to the questions and answer session.
Thank you, sir. Ladies and gentlemen, if you would like to ask a question at this time, please press the star or asterisk key, followed by the digit one on your telephone, and please ensure that the mute function on your phone is switched off to allow your signal to reach our equipment. If you find that your question has already been answered, you may remove yourself from the queue by pressing star two. So we come now to the first question for today, and it's Kristofer Liljeberg from Carnegie.
Yeah, hi, good morning. I have a couple of old questions. First, could you explain a little bit more what you see the drivers are for Extended Care improvements in the second half of the year? And second question is, if you could provide some update on the status now for Critical Care. I'm thinking about the launch of the new platform and planning of launching a new system for emerging markets. And the third question is, generally, what's your visibility for the better growth in the second half of the year, particularly down in emerging markets? Thank you.
Mm-hmm. Okay. Kristofer, please remind me if I fail to answer all of your questions here. So firstly, on Extended Care, I mean, we have, as I've said, some SEK 70 million worth of expenses recorded in the first six months of the year that are of a non-recurring nature. The second element is that if you trace the order intake and the projections on order intake that haven't fully been reflected in the revenue growth over the first six months, there is the anticipation of better top-line growth also going into the second half of the year. And the third element we have is a couple of structural measures that we are undertaking to improve the profitability. These are structural.
When I say structural, they're not just sort of activities we're initiating just to balance sort of cost to income, but sort of improvements to the underlying structure that will have sort of a longer-lasting effect. And since those initiatives have not been communicated, I would rather not sort of spell out in detail what they are. If we move over to critical care, then, as we have said previously, critical care has, over the last 18, 24 months, been a little bit of a drag on profitability within medical system. It's by far the single biggest impact, if we look over the last couple of years, that has sort of hampered continued margin expansion. The reason for that is that we have experienced a rather adverse market mix, not surprising.
Our growth in emerging market has outstripped that to developed markets, and the products that we're selling into emerging market is really a product that is more sophisticated than it needs to be. And to that end, we have initiated, since a year, year and a half back, the development of a new product platform that is destined for emerging markets. It also has a place in sub-acute settings in developed markets and can also be used for certain settings where mobility is essential. That product will, if things go according to plan, which they have been doing so far, will reach the market at the beginning of next year, and then we'll see a gradual phase in as we gain market approval for successive markets.
So, we should start to see some traction for that, and that product will come with, with significantly higher profitability. When it comes to the new Servo-u, very good reception in the market. We're making good progress. Customers who have placed orders, you know, have some very, very positive feedback on the product. And, so we think we'll continue to see a gradual improvement in the mix between the new Servo-u, which is sort of more profitable than its predecessor, Servo-i. And then we're also continuing to make good progress on the anesthesia machine. The profitability is still not on par with the business area, or the business area's intention, perhaps I should say. And, but it's gradually getting there through initiatives we have to improve its cost performance.
and also through the sort of natural progression of the volume. So things are pretty much in place to restore profitability in critical care, but there is, because it's sort of product portfolio dependent and product development dependent, there is, of course, some time before we will see sort of the full recovery. Then-
On the new Servo-u product, so it's launched, it's mainly Europe so far, or?
Yeah, absolutely, we've, we're, it's mainly Europe today. It's not yet approved in China, for example, or in some developing markets that require approvals. It hasn't yet cleared its 510(k) in the United States, but that's in good progress. So, yeah, we should get there.
Okay. Thank you. Then the third question on the visibility for the better growth in the second half. You mentioned extended care, but what about the rest of the business?
Yeah, no, I—this is based obviously on quotes and quotations we make, and we can see that we have a much healthier pipeline. I mean, the slower growth in the BRIC markets, which is really where the challenges have been, are sort of all down to sort of distinct situations. In China, we have seen that the worst storm, if you will, over corruption is easing. We've also seen significant destocking in our distributor network, which means that at the beginning of the year, the volume of products set up in the distribution network was significantly higher than it is today. So our order intake looks a little bit more negative than the actual order intake from end customers in China. So that's progressing.
Then when we look to Russia, where we said that the order patterns were going to be different this year compared to prior years because of changes in the budgetary processes, we did see a good influx of orders from Russia at the end of the second quarter, and we expect that trend to be maintained now through quarter three and four. Brazil remains a little bit of a concern given the political situation in an election year and so forth. But again, it's believed that once the election is completed, that there should be a surge of some kind of orders coming out of that, and it's also supported by the project pipeline we have.
When it comes to India, it's also sort of initially in the year been sort of politically a little bit more turbulent than it was the year before. So there are reasons why the BRIC markets are a little bit softer, sort of specific reasons for the BRIC countries. But then obviously, there is a little bit more uncertainty, and growth in that part of the world is not what it was if you go into the recent past. But all things equal, I think we have good reasons to believe that we will see a nice pickup in orders in the developing part of the world.
Great. Thank you.
Thank you, Kristofer.
Our next question comes from Michael Jüngling from Morgan Stanley.
Good morning. Thank you for taking my questions. I have three. Firstly, on your order growth, outlook for the second half, could you perhaps provide some growth assumptions for the second half by region, so Western Europe, North America, and rest of world? Secondly, on the EBITA margin outlook, how would you describe your margin visibility today compared to where you were 12 months ago? And the third question is also on group, EBITA margins. I mean, since 2012, we've seen a fairly meaningful, deterioration, and therefore, would you say that the business, also with the Q2 results, is now more sort of permanently impaired, meaning that margins will be more in the high teens, over the medium term than perhaps the 22% number or so that you've quoted previously? That's all. Thank you.
Okay. And again, Michael, thanks for your questions. I'll try and answer them. When I get three of them, I normally try to pick up all three of them, but if I miss something, please remind me. So first of all, just sort of to be, it's easier for us to project on revenues, right? So when we say organic growth of four-ish for the year, I just want to make the comment that we are referring to the organic revenue growth. Obviously, if the order growth is lower, then our order book is somewhat compressing, right? But still making that point.
When we look to the sort of how will that happen in the second half, I think that is based on the assumption that demand in the developed market remains roundabout where it is today, and that we see that sort of meaningful pickup in developing economies when it comes to the orders. I think that's the very simple answer to the question. To your questions around, I mean, we typically do not comment sort of on individual years, but I would see the situation here in the second quarter as you know, to some extent, a little bit extraordinary. The Extended Care situation is an extraordinary situation in that a good portion of the decline is sort of based on non-recurring items.
We will always, I think, suffer the risk of mix issues that we have, but I don't believe in any way that these would be sort of permanent mix changes. And, we're certainly not, I, I can reveal that much, that when we're going to eventually reveal our, our midterm, plans for margin expansion, which, which, by the way, will be detailed by some very concrete actions. It's not gonna be sort of a wishful thinking kind of exercise, and, and it's already been prepared sort of internally. But our, our, ambitions will certainly be for levels of profitability, in, in, in 2020 and beyond, right? So you were sort of asking, are we looking at high teens? No, the answer to that is, is no. We're, we're going to look at, much higher levels of profitability going forward.
Could I just sort of follow up then on the margin guidance of beyond 2020? Given that I presume at the Capital Markets Day, you were gonna give us some fairly sort of precise details on how the cost savings program and the efficiency program will go. Because you haven't announced it, I suspect those things haven't stopped from being implemented. So at what point in time do we start to see these efficiency programs hit the P&L? I mean, do we start seeing things in the second half, or is it more of a 2015 type starting point for those new efficiency programs?
Yeah, it's a... Without sort of jumping into the discussion of our sort of financial targets and how we-- it's easy to sort of go down that road, I feel, by this question here. But, it's different activities have different maturities, and it's very much related to footprint. I still believe that the most effective way of lowering the cost base is to consolidate the footprint both supply chain-wise and commercially. And so a significant element of the margin improvement will come from there. Some, although by no means the more meaningful improvements, will be initiated already.
When I spoke about extended care, some of those initiatives are actually inherent in that second half year program, and some other sort of ongoing plant rationalizations are also a part of things that that will be initiated. But those typically have some time to show a sort of an impact into the P&L. I appreciate that this is maybe not an extremely precise answer to your question, but this is also why we will have the Capital Market Date, hopefully, in the not too distant future.
Great. Thank you.
Thank you, Michael.
Next on the line from Swedbank, we have Johan Unnérus.
Thank you. Thanks for taking my question. Actually, they all been answered, so I'll jump back in the queue. Thank you.
Thank you, Johan Unnérus.
Okay. Then from Danske Bank Markets, we have Mattias Häggblom.
Thanks so much. Last time you arranged a call with us, you expected to have a meeting with FDA shortly thereafter to clarify recent new communication. So just curious to hear, have you had that meeting? Did you personally attend, and what was the outcome of that meeting? And secondly, referring to, I guess, savings from the large sourcing program, I move to Gothenburg, relating to the SEK 11 billion. So that you have initiated and then later will quantify at the Capital Markets Day and translate into new targets. Are we seeing some of those savings already now? I guess the core of my question is, would margins have been even worse for this quarter, had not such initiative been taken? Thank you.
No. Answering the last question first, Mattias, it's no, you have no such impact at this point in time. I think we more need to look at the coming year to start and see impacts from those initiatives. So, I think that is the very simple answer to it. It's a matter of building the competencies, the resources, make the right priorities, and then there's, of course, a maturity in moving from a large number of local agreements into global agreements managed from corporate. But as you said, we will provide I feel good good update, good transparency on the intentions and the likely outcome of those initiatives as well.
I mean, when it comes to our sort of ongoing dialogue with the FDA, there has been a number of, let's call them larger and smaller meetings and so forth. To clarify things, we obviously need to explain and demonstrate the progress that we have made, build sort of a trustful relationship, show that we take the situation seriously. I believe that we're doing that, and FDA, of course, wants to gain certainty that these efforts we're making are leading to sustainable and good improvement to the quality management system. So there isn't really sort of anything specific that we can say at this point in time. When we have clarity on the situation, then we will...
Sort of very, very shortly thereafter, immediately thereafter, let everyone know where we stand. So, but, but it's, it's moving ahead, and it's moving ahead right now, I would say, at, at a better pace in the dialogue. So, you know, by, by way of guessing, I would maybe say that a month, two months from today would, would probably be the timeframe that, that I would hope that we can be fully transparent.
I'm just trying to understand the level of engagement. Have you personally attended any of those meetings?
Not yet.
Thanks so much.
Thank you.
Next on the line, we have David Adlington from JP Morgan.
Hi, morning, guys. Thanks for taking the questions. Two, please. Firstly, I just wondered why you didn't feel the need to put out a profit warning or pre-announcement this time around, given you EBITDA are missed by over 10%, but previously you have pre-announced. Secondly, there's been some consolidation among your competitors in recent weeks with Medtronic, Covidien, and Hill-Rom Trumpf. Just wondered if we get your views on the impact on the market, both positive and negative, please.
Yeah. No, I think that we have, I think a number of you, who, sort of maintain a continuous relationship with us, know that, we will, not do that going forward, because we, fundamentally attempt to provide some degree of guidance for the full year. I think since that is not an absolute number, a profit warning, as it is typically called in the press, is really the invention of the market and, and relates to expectations that haven't even been formulated by ourselves.
So I think that this approach that you see now in this quarter is probably the flavor of things to come, that we will hope that the analyst community will sort of attempt to understand that the patterns of our business, which is by no means a straight line from the first of January to the 31st of December. So, instead of seeing profit warning in the press, now we will see missed or exceeded the expectations.
Okay. Understood.
On your second question, David, on consolidation, I think it's sort of as we have also been discussing, and it's also sort of been part of our journey. I think there is no doubt that critical mass is sort of something important in a changing healthcare environment where our customers are getting better, so there's no surprise in that. I think that with the... There, there's pluses and minuses with consolidation, if I look at it from a competitive standpoint, that larger acquisition obviously necessitating with focus. Some of this company, particularly, I mean, Medtronic and Covidien, both independently, were very, very strong companies before this sort of merger or combination, and it's, of course, now an even stronger company. But for us, I would say that's just degrees.
It probably will not provide any significant change to our own competitive behavior. And Hill-Rom, I would maybe argue that they've, they're sort of broader to provide sort of more of a comprehensive patient-handling franchise. But they have acquired a, I would say, predominantly Europe-based company in there, that still today has its challenges in terms of profitability, but it's a very, very good company that produces products of great quality. So I respect them. I will respect them no less under their own or their new ownership, but fundamentally, I don't see any sort of significant changes in competitive behavior or the competitive landscape as a result.
Okay, great. Thanks. Maybe just one follow-up. Do you feel that you may have missed out on potential acquisitions because of the issues you're facing internally at the moment?
I think it's the fact that we, you know, we have a long-term ambition ourselves of building a larger company, and I wouldn't say that there hasn't been anything sort of that has been actively promoted that we have missed out on. But, for natural reasons, at this point in time, we're more building a pipeline of opportunities rather than sort of proactively initiating discussions, simply to make sure that we, we have our house in good order and can sort of go into those type of discussions from a position of strength.
Understood. Thanks very much.
Thank you.
Next on the line is Lars Hevreng from SEB.
Yes, thanks. Could you just, you mentioned regarding Extended Care earnings performance, that you would not expect to bridge the earnings gap, as you said in the... I guess you referred to the 2013 earnings level of SEK 1.3 billion. Could you just give some highlights on what earnings do you expect for that division, in particular, based on the SEK 70 million extras that you referred to? And the other question, of course, given the Infection Control targets, you stated in the report that the 17% target is a three to five year ambition. Is that later compared to what you earlier said, or I think you talked about 2017 or so. And if so, what's the reason for that change?
...Yeah, no, on Infection Control, I think that's an easy answer. There isn't really a change there. When it comes to extended care, I was more referring, I mean, as we stand now after six months, we have a gap between the two years of approximately SEK 170 million. What I'm saying is that we will close that gap, compared to 2013, come the end of this year. So, but, I don't believe that we will fully close it, in this current fiscal year, other than if you were to exclude the non-recurring items in a sense. So that was just, that was more to sort of underline that we see the current extended care performance as not representative of where the underlying business is.
And when it's not fully close the gap, if we include the non-recurring, then if we take out this or treat the SEK 70 million as non-recurring, then the gap would be closed.
Yeah, I'm not going to go into that detail of on an individual business area, Lars. But what I'm saying, inclusive of the what it will stand in the P&L on the... When we close 2014, will be a number, which in absolute terms, on an EBITA level, will be below the outcome of 2013. But that is not sort of reflecting the underlying performance, obviously. And I think one needs to consider that if we have this SEK 70 million, of which a large part is prior period adjustments on top of that, then one typically needs to think about 2013 as being somewhat overstated to the same magnitude, right? So I don't think that you there isn't sort of a fundamental, but it is a reality, obviously.
With the prior period adjustment, you can say that the underlying performance as we left 2013 was overstated to some extent. That's, that's also a fact, I mean. But when you look at the relative performance, and sort of the implications for the future, I would say there, there are none. The story on extended care is unchanged.
Okay, thank you.
Thank you, Lars.
Before we come to our next question, just a reminder, to ask a question, please press star one on your telephone keypad. Now we have Hans Mähler from Handelsbanken.
Hi, I have a three detailed question, if I may. First of all, your decision to move all the graft production to France, was that the result of the discussions with the FDA? And then secondly, when it comes to TSS, when do you now expect that acquisition to become accretive? And also, lastly, a question for Ulf. When it comes to the uptick in the amortizations within Medical Systems, are they all related to the Pulsion acquisition? That's all.
Okay. No, the decision to move the grafts to France were taken long before the discussions with the FDA started, right? And on your second question, I, to be quite honest, this is a very integrated business today. I actually wouldn't know the answer to that question, to be frank, on the accretiveness of the TSS, which I believe was your question.
Correct. And if we go back to the graft business, I guess you took the decision after you received the first 483, right? Or was that some kind of behind the transfer?
Yeah. No, no, it was most likely taken possibly a year after we received the Form 483 in Wayne. But again, at that stage, I think that we did not anticipate, obviously, what has come now later in terms of regulatory compliance challenges.
Understood.
And, Ulf, on Pulsion?
Yeah, it is correct. The majority is in Pulsion, but also there is an those amortization are stated in foreign currency. You also have a little bit of a currency impact on that, but the majority is relating to the latest acquisition of Pulsion.
Understood. And then also, can I ask you, Ulf, about your acquisition room of SEK 6 billion-SEK 7 billion? I think that is a bit lower than what you communicated in the past. Have you taken any headroom for potential consequences of ongoing FDA discussion, or is this just a clean number right now?
No, it is not lower if you compare it with the same period as last year, because it is, so to say, we took the dividend in the first quarter last year. Sorry, we took the dividend the first quarter this year, and last year, we took the dividend in the second quarter. So it has more to do with the dividend, which when that was paid out.
Understood. Thank you very much.
Thank you.
Next on the line, we have Scott Bardo from Berenberg.
Thank you very much. I have several questions, please. Firstly, on the ongoing FDA discussions. Clearly, there have been a lot of broker speculation related to scenarios and impacts from these ongoing discussions. Some of those scenarios outline a picture where manufacturing facilities could shut or you're completely banned from selling products into North America. So clearly a lot of apprehension in the capital markets. Could you please add some comments surrounding some of these scenarios and what your expectations are here? You mentioned, again, that this is to satisfy the quality control systems. Is this just to satisfy quality control systems?
So perhaps if you can just put a little bit of additional perspective on where we are in this point of discussion to help us through the next few months. Thank you.
No, I think, Scott, this is, as I say, a discussion. We are having a privileged discussion, and it's we're not going to sort of interfere with those discussions by making sort of comments in public. So I'm really sorry. It's not an area that I sort of in a position that I can comment about. The good thing I believe is that whatever uncertainty, which it, of course, generates, is not gonna last for that much longer, I believe. So even as I said, hopefully a month, two month time, we will be able to provide clarity.
Okay, understood. But could you at least share with us whether a complete supply restriction in North America is one of the scenarios that have been discussed at the meetings, or has this not a topic that's not been discussed as of yet? Can you share anything there?
I don't share anything with you, Scott. Sorry.
Okay. All right, thank you. Just a few on the business then. On Infection Control, I think you reiterated around 17% margin target. There was some discussion within the release about on a three to five year time horizon. It doesn't entirely square with the previous targets, I think, which was a 17% margin by 2016, 2017. Am I correct in assuming that that target's been pushed back a little bit? Secondly, on the currency environment, you mentioned that there's SEK 250 million worth of transactional impacts that you faced this year. Can you please give us what currencies you used to adopt that calculation? So what spot rates or your assumptions both for Swedish krona/dollar, Swedish krona/euro?
It seemed to me that the Swedish krona is weakening quite nicely, at current rates. So I wonder whether you anticipate that impact being far less into next year?
Yeah. I think firstly, on Infection Control, there isn't really a change to the financial targets. And so again, come the Capital Markets Day, we will make sure that everybody is on the same page. We're not referring to any new targets. We have not intended to communicate any new timelines or whatever, so whatever has been said previously is still what goes. When it comes to the currency, I think we typically divide sort of currency impact on our P&L into two buckets, if you will. One is what we call the transactional effect or the hedging effect, which is basically that when we sell to the different geographies, we sell in the receiving country's currency, and then we sell those currencies forward to get predictability.
During the gradual strengthening of the Swedish krona over the past couple of years, we have had a situation where our hedging performance has gradually, or the positive impact, you could say, of good currency hedging has been eaten up by this gradual reinforcement, specifically around the Swedish krona. And that is what we refer to when we stipulated SEK 250 million. The second effect you get is when you translate foreign P&Ls into Swedish krona, which we refer to as the translational effect, and that has improved somewhat, but it's sort of a moving thing, and we don't. It is an improvement, but we don't have a number here and now to give you. I think we provide typically a bit of guidance around this.
I believe in our annual report, we have an element of-
That will allow him in there, giving some guidance. What happen if the currency moves 5% in different direction?
But since we haven't locked translational effects, right? They can continue to change, but since they're based on an average, the closer to the end of the year you get the less sort of variation. You get both positive and negative.
Okay, thanks. So just wanted a last question just on corporate sort of communication. I know there's a, there's a few things this quarter, some change in the communication policy from the company. Also, I think for the first time, I see you report an adjusted EPS number within your financial disclosure. So as we think into to next year or after the Capital Markets Day, is it your anticipation not just to give quite an open, vague top-line related guidance, but actually to give some sort of earnings guidance? Of course, I appreciate your company development. You can call it a profit warning, or you can call it miss versus street expectation. It amounts very much to the same thing in terms of downgrades to estimates and expectation.
I just wondered if you could help at least steer the market with some more refined guidance next year.
No, I mean, we will, as part of our Capital Market Day, provide sort of a longer-term guidance, and I think that longer-term financial targets will be a little bit divided into years going forward, sort of what does it look like over the next two years, say, what does it look like three to five years from now, both when it comes to sort of the margin evolution and also when it comes to potentially costs associated with the profit improvement program. So that type of detail we will provide. On an individual financial year or a coming quarter, I think that you're likely to see us commenting, obviously, on sort of numbers which are without our help, very difficult to estimate, like transaction effects on currencies, restructuring charges to the extent they are there.
Those types of details you will still see. But when it comes to the sort of what is inherently a business risk and trying to assess, then I would say that I think that you will see a top-line guidance and not much more. And in the discussions that we've had, sort of beyond the analyst community, the feedback that I get is that we've been a little bit too ambitious in our way of trying to guide the market, and that there is no call for sort of a detailed guidance, but some form of top-line indication or something to go by is, of course, welcome. And this is a little bit the plan we have going forward.
I think that we, in the way that we have communicated, whether you would agree or not, but I think that we have set up ourselves a little bit for failure in our earlier communication. We're trying to avoid making that same mistake going forward.
Okay, thank you. So just to understand then, we should expect some sort of midterm ambition, but annual and quarterly earnings should be subject to quite a degree of inherent volatility then, if you're not going to provide any sort of overriding steer on profitability for a year. So currently, we should expect earnings volatility to be relatively standard over the next or on an annual basis?
I mean, the earnings volatility is inherent in the business. The level of or so the ability to predict sort of presupposes a very, very active engagement from our side, and then we run into the risk of actually providing guidance for individual quarters and years, which then becomes the norm against which the performance, which by nature is volatile, is measured, and that there is where the problem is. So I think that our ambition historically has been to uphold an honest and straight dialogue, but I don't feel that it's in the company's interest to do it.
It sort of takes away the fact that the business has, because of its capital equipment nature, which still makes up some 45% of the business, there is that element of volatility that sort of has significant impact on our own ability to predict the business, even on a quarterly basis. So, it's not by being sort of, it's no more than trying to do what we think is, is good for our shareholders and the, and the company, really.
Okay, thanks for answering my questions. That's great.
Thank you, Scott.
We might have time for a last question from Michael Jüngling from Morgan Stanley. Please go ahead.
Thank you. I have three more questions. Firstly, on the sales growth guidance, if your 4% proves to be incorrect, and maybe there's a risk now that there is some downside, are you able to react quickly enough in the second half to avoid a further large margin crunch? Secondly, on the FDA side, for Medical Systems, has the escalation of the events a month or so ago been driven by customers complaining about your product lines, or is it more driven by the FDA, or is it more driven by FDA's own internal workings?
And then thirdly, on Medical Systems, is there a risk here, a material risk here, that the orders that you've taken in cannot be delivered because of your capacity constraints, and therefore, we see some meaningful cancellations in the third quarter, similar to the weakness that we've seen perhaps in the last quarter? Thank you.
Okay. Thank you, Michael. I think I'll... Let's take them one and one, and I'll answer them one and one, so I make sure that I really provide you the answer you're looking for, or rather, the answer to your question at least. So your first question, Michael, was on-
The first question was, if you perhaps miss your 4% organic sales growth guidance this year because EM doesn't deliver, are you able to react quickly enough to avoid perhaps another sort of meaningful margin crunch?
Yeah.
event in the second half of this year?
Yeah, absolutely. I think so. I think that our, our, the, the way the year will pan out, I would say that, we always, there's an element, I would say, of, sort of natural adaptation, in, in the business. And I think that we're going into... As you can see, if you take out the Extended Care side, if you take our biggest business area, Medical Systems, you will see that there is very little sort of expense momentum in the business. And, I think that is, sort of the, the way we will run the business for the remainder of the year. So I think that, when we speak specifically about the, the operating margin, I, I, I think we'll do a, a decent journey in the second half of the year.
... Okay, second question was on the FDA de-escalation. Is that more driven by customers complaining about your product lines, or is it more about FDA's own internal workings?
No, in general, I would say that we have no sort of customer complaints that are directly. So this is really driven by compliance and sort of regulatory aspects, and not sort of growing customer concerns or anything like that. I must say, I feel we have extremely strong support from our customers at the present time, and, which, of course, when you get supply chain disturbances on sort of critical devices, like in the cardiovascular space, I think the ability to maintain good deliveri and so forth requires the support of your customers, which I really feel we have here.
The third question is on Medical Systems. If you have some ongoing concerns in rectifying the FDA's problems, could you assess the likelihood of the third quarter being horrible for Medical Systems because you can't deliver on orders, therefore, there's cancellations?
The worst, I would say that in terms of supply chain disturbances, the worst quarter was the first quarter. Now, in the second quarter, we have seen an easing, and we're gradually getting better on the supply situation, right? So, I would say that going forward, I would be more inclined to see it's getting better and better.
Okay. And I forgot to ask on the FDA, have there been any sort of recent deaths in with respect to your product lines that may have caused concerns?
No, not any recent I can think of. I don't know, I mean, you know, that old and frail patients die in hospitals or even associated with our products and equipment. It happens, it happens with all suppliers, but there are, to the best of my knowledge, no spectacular or unusual incidents in the recent past, no.
Great. That's all. Thank you very much.
Thank you. Okay, I think that to the extent, I don't know, operator, if we have any sort of, persons wanting to, in the queue, wanting to ask questions, or?
We still have four people queuing.
Okay. I think that it's with respect to everyone's time. I think we're now a little bit after 11 :00 A.M., and those individuals who want to ask questions, both Ulf and myself will be available during the day to take those questions, and you should feel free to call us. But I think in the interest of everyone's time, I would suggest that we close the call here. And I just want to sort of reiterate a few of the statements made. I mean, there's no doubt that we've had a challenging quarter, but we remain very confident in our future. I would say that we have, and as you will see, hopefully, in the not too distant future here, solid plans in place to strengthen the profitability and our competitiveness.
We've also, I say that the one of the takeaways here, that there is the anticipation of improving orders from the developing markets, which has been very soft in the first part of the year. That we think will obviously, if we assume that the developed market retains their current level of performance, will, of course, be very essential to improve the growth going forward, and that we believe to be the case. And finally, of course, as soon as we have any details around the status on our regulatory improvement journey, then we will make sure that we make that information publicly known very, very quickly.
But I wouldn't expect anything in the immediate, say, over the next couple of weeks, but I would maybe more think that a month, two months from today is a reasonable timeframe. So with that, I thank you for your participation, and look forward to taking any additional questions outside of this call. Thank you.
That will conclude today's conference call. You may now disconnect.