Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's Vitrolife Interim Report January, September 2017 conference call. At this time, all participants are in listen-only mode. There will be a presentation followed by the question-and-answer session. At which time, if you wish to ask a question, you will need to press star one on your telephone keypad and wait for your name to be announced. I must advise you that this conference is being recorded today, 2nd of November, 2017. I would now like to hand the conference over to your speaker today, Thomas Axelsson. Please go ahead, sir.
Good morning, welcome to Vitrolife Interim Report, January to September 2017. The speaker today will be Mikael Engblom, the CFO of the company, and myself, Thomas Axelsson, the CEO. Mikael, please let's go into the presentation by starting with page number two. As a summary of Q3, the quarter once again showed a high growth rate also good profitability. The sales was SEK 246 million, that is an increase of 17% in Swedish currency. The growth was 20% in local currency. Time-lapse was the main driver for the sales, especially in the region Asia Pacific. Our EBITDA was SEK 98 million, that's a margin of 40%. Please change page to number three, we can go more into details.
I would like to inform you a little bit about our views on the growth opportunities for Vitrolife. In Q3, we could see a good growth for time-lapse and also for the business itself. Let's see how the growth opportunities are. I would like to share then, that the last couple of weeks, like last couple of months, I've been traveling around meeting customers in Australia, China, Japan, and last night I came back from the big meeting in U.S.A., ASRM, which is the American association of the reproduction medicine. There is a common global trend, and that is the environment for IVF, artificial reproduction technology is getting more and more competitive, more regulated, and also that the patient is getting more influenced, and is getting more influence of the treatment.
How will this change the human IVF market? I do believe that it is going to be a continued growth within it. The patients themselves, and most of them are paying themselves, is asking if they can afford the treatment. If they can afford it, they will hopefully maximize it by asking for the right kind of treatment. The right kind of treatment is, that can be discussed, and often it includes a couple of therapy steps that is making the treatment more expensive. In some territories, for instance, the good within in Asia, the patients, in many cases, they're just asking or have an ability to have an IVF. They can't go in and ask for, say, the best possible treatment because that will then be too expensive.
The driver for the patient is single embryo transfer, and that's something that Vitrolife has been working with for a long, long time with the sequentially, and also with a situation where we do see that the best outcome for the patient is by single embryo transfer. It is also for the patient to ask for vitrification, so that can also increase the output. We have been working with the time-lapse, and there is a mix between the clinics themselves asking for it and also the patients. The genetic screening, of course, is something that in some countries can be included, in other it can't not, and that is a big factor for the coming growth.
At the ASRM, there was an abstract, a publication, the star publication, that just came out, and that showed that there isn't any real improvement for paying for PGS or PGT, if you are under the age of 35. I do believe that it's still going to continue to be a big trend globally for asking for more pre-genetic treatment due to that it gives some security regarding the embryos to infant, and also that it is a good, as a driver for the clinics to include better treatment. However, we can see that the growth rate of PGS has gone down. Like in Japan, where I was, the combination of the time-lapse and later on, the approval for PGS will ensure we have good growth opportunity.
There are other things that we can see that the patients are asking for, and that is through their ability to go out and get information on social communities and also by looking through different clinics' web pages, that they can see and judge what they would like to have included. For instance, the embryo over the age of 35 is clearly improving the output, and that is, of course, available at Vitrolife. Meeting with good customers that are in contact with government and also with the authorities, we can see that the increased regulatory situation is something that will impact the business. We are welcoming that.
For instance, I can tell you that it is a very uncommon situation in Japan, that, for instance, culture media, other products for IVF is not looked upon as a medical device. That has made the Japanese market divided into globally approved products, where we are one of them that is selling into Japan, that of course has proven products for other markets, and domestically produced products that do not need any approval. We welcome a situation with a better risk analysis and demand for a better process documentation. The treatment demand from the customers is also helping us because they are, as I say, asking for more information. As a consequence of this, there are growth opportunities.
There are going to be changes within the market, and that's why we are also guiding a little bit, that we will increase our R&D expenditures within the future so we can hopefully work with these opportunities. By that, let's go into more about the numbers for this quarter and look on page number four. As mentioned, was time-lapse, the reason behind pretty good growth for the company of 20% in local currency. The growth for China itself was 85%. We can see good growth for all time-lapse treatments, and of course, it's the EmbryoScope+, a big reason behind it. We can see that the biggest interest for time-lapse currently is in Asia Pacific. When I mention Asia, I would like to say that we have not yet got the CFDA approval.
It is approval for selling into the Chinese market. We don't estimate any change in the projected time when it will be approved, and we say this is going to be in Q4 this year or in the beginning of next year, Q1. The acceptance of time-lapse in Japan and Australia is due to the good data that we have presented and coming from the clinics. The bigger clinics, they realize that they can get an improved workflow within their laboratories. That's a big growth driver. Our biggest product segment, our media business, were only 9%, and the total sales was SEK 134 million. Growth for media was seen in Asia Pacific as well as in EMEA.
It was devices and the meters for also hydrogel, pipetting, labware grew with 9%, and sales of SEK 35 million. Business unit ARC grew with 11%. The change within the business unit ARC has been successful, and we are now almost only selling our own produced products, and that's the reason behind our margin. Let's go to page number five. Vitrolife has reached a milestone, and that is that in the rolling 12 months has achieved a sales of more than 1 billion. We are proud of that achievement. For the first time, was Asia Pacific the biggest region. The share of the sales in that region is 43% of the Vitrolife total sales, and with an incredible growth rate of 34% in this quarter.
The growth, as I said before, in that territory, has come from time-lapse, but also from every other product. Japan has had an exceptional growth in time-lapse. China is still continuing to good growth on media and disposable devices. Other markets in that region, such as India and Southeast Asia, is having double-digit growth. In India, sales was SEK 101 million. It's a growth of 15% in local currency. Russia, Spain, Germany, some other of our target markets also showed a good growth. The only troublesome business is part of Middle East. In America, the growth was only 1%. The growth in US was higher than the numbers in southern America, where we had a little bit of a decline.
What I would like to say regarding Americas and U.S., is that the good growth products that we have within the other territories, they are not yet approved as, for instance, EmbryoScope+, [audio distortion] or the identification product line only. By that, I will hand over to Mikael.
Yes. Page number six, the key financials. The gross margin during the third quarter was 66%, up compared to 62% the same quarter last year. Drivers for the improvement was economies of scale and increased sales, as well as the product mix improvements. For example, what Thomas mentioned about the business unit ARC and selling own products at higher margins. We had a one-time effect of changing the warranty accrual, which gave SEK 3 million revenue during the third quarter. It was related to EVO+ as a result of less warranty claims on that product. The EBITDA margin was 40%, and if we then exclude this one-time effect, the warranty accrual, it would be at 39%, so in line with the first nine months of the year.
During the third quarter, we had a negative effect on currency of SEK 7 million, if you look on the EBITDA. It was because of the strengthening of the Swedish krona during the third quarter in relation to the second quarter last year. We also did a repayment of the acquisition loan we had in relation to FertiliTech, SEK 31 million. Net, net in relation to EBITDA was a net cash situation of SEK 3.7 million in relation to the previous. We have a strong cash position. We'll move to page number seven. In terms of outlook, we continue to see a market growth rate of 5%-10% if you look in monetary terms, and it's driven by the global demographic situation of growing middle class, and that parents-to-be are postponing when they are having their children.
We also see the expansion of sales, and we intend to do that by, for example, investing in marketing and sales resources. Continuing, we intend to build an output product offering. As Thomas mentioned before, we are investing in product development, and we are also constantly looking at potential acquisitions. With that, operator, we are ready to take questions.
Thank you very much, ladies and gentlemen. We will now begin the question and answer session. If you would like to ask a question, please press star one on your telephone keypad and wait for your name to be announced. The first question comes from the line of Patrik Ling. Please ask your question.
Yes, good morning, everyone. Just a few questions, please. Maybe first, if you could elaborate a little bit on the gross margin expansion. I mean, it was quite strong now in the quarter, and you talked about, among others, mix changes. What we can see from sales is that you have a very, very strong growth here in time-lapse. Could you maybe elaborate a little bit, if time-lapse is reaching such a volume that gross margin for that business area is approaching what the rest of the business has, or is still a little bit diluting, on the gross margin?
Yes. I mean, we're not disclosing exact gross margins for our different business units, but what we're seeing is that the product mix within several business units have improved. The business unit ART Equipment, for example, we have, when we acquired the company last year, we had a substantial part of the business that was distribution to other manufacturers that was at lower gross margins compared to the sale of their own products. During this year, we have made some transitions where we have increased the sale of own products and decreased the ratio sale for other manufacturers. Within the business unit ART Equipment, we've seen a margin expansion. That's one reason of the product mix improvement. The second is time-lapse.
When we have launched the EmbryoScope+, that product has a better gross margin than the other products within the time-lapse business. Therefore, we've seen a margin expansion within the time-lapse. Also, as you're alluding to, we're seeing economies of scale as we increase the total sales in time-lapse. There's two different aspects of time-lapse improvements, both the economies of scale as a result of higher sales, but also the product mix within time-lapse. The growth in time-lapse is very much related to a high demand in, for example, Japan.
Okay, great. Maybe I could ask also about, Thomas, you said that some of the important growth drivers for you isn't yet approved on the U.S. market. In the report, you write it's expected to be approved in late 2018. How come that we have to wait so long for approval? I mean, I suppose these are filed 510(k)s, clear, and so on, and that's usually a 90-day approval process, so I would sign them after. Is it the correct interpretation?
If you look on the approval process, you know, one of the things I guided for is the approval process for the EmbryoScope+, EmbryoScope itself in China. If you look on the U.S., there is an improved process where the EmbryoScope+ is filing for. Depending upon the kind of questions that we are getting, you know, that's an ongoing situation. What we have in the U.S. also is that we are helping the customer buy the software, and the software are then the kind of questions that we are getting from the U.S. government, or, let's say, the FDA. You know, then we have to show them and give data for the clinical labeling that we will have around the product.
We look on the certification, and part of the certification, yes, they are filed, they have also asked for instance, on the certification of all sites, that they ask for, proof on a baby born, number of baby born, and that takes some time to gather that data, and we are doing that outside the U.S. It is, as I respond on the questions, that we are not really sure that it will come, but we believe that it, all of them will come next year.
Okay. Okay, great. On a related topic, I mean, you mentioned also that you're probably going to increase your R&D spend going forward. I mean, right now you're tracking on a level of around 7%. If you look maybe three years ahead, what level do you think a company like Vitrolife needs to be at, given the changes that you see in the regulatory environment and also maybe the changes that you feel that you need to do in order to stay competitive?
That's a good question. That's why I brought it up, or we brought it up, is that, I hope that the authorities in some markets will ask for more proof behind the products, as I mentioned, the Japanese market. To have products approved, often there is a process on clinical data and clinical data from a domestic market. It's going to be more clinical studies, safety studies, and all those things, which I'm saying is definitely to drive the cost. Another thing is that we have had, and if you look upon the growth the last years and for quite a few years, the growth has come from a combination of the traditional product portfolio with new products.
New products, we have done development within the time-lapse, we continue to do the software development, ease of use. We have introduced new culture media that also has, you know, been the reason that we are growing good on media. We have bought business in Germany, we are changing that by doing development. We also see other fields where it's a combination between maybe buying companies where we need to do the kind of process to get it globally approved. It is a situation where I expect that we will increase the R&D that we have done every year. If you look on percentage, it has decreased, but in absolute numbers, the regulatory and development situation do need to be increased so we can stay long-term competitive.
Okay, great. On the last question, on a sort of related topic, you alluded to the acquisitions that you made in the past. I mean, you also talk about, and you've talked about it before, that you are interested in adding new products to your portfolio. Could you maybe elaborate a little bit on, I mean, right now you have a net debt to EBITDA of - 0.7. At what levels do you feel comfortable? I mean, if you would do something larger, what type of situation do you feel comfortable with?
Yes, I can answer that. I mean, we have a financial target that we should be below 3x the EBITDA. That is our upper level from a financial target perspective.
Okay. net to EBITDA of 3x ?
Yes.
Okay, great. Thank you, guys. I'll jump back into the queue.
Thank you.
Thank you. The next question comes from the line of Christian Reinberg. Please ask your question.
Yes, good morning. A couple of questions from my part also. When we look at the U.S. and also China, with your new products, once they are approved, do you see the same potential, compared to the size of the population as you have seen in Japan and Australia, for instance?
No, I wouldn't do that with China, because the population is, as you know, quite big. If we compare then, the ability to do an IVF, that is still a challenge in China, due to the cost. What is a similarity between the growth that we've seen in Japan, and specifically, we still believe there's going to be good growth there, is that there is larger clinics. The larger clinics, if we specifically talk about time-lapse, there is a potential for them to increase the clinical output and also to change the workflow.
EmbryoScope+, for instance, and that will improve the workflow and the number of clinics that are larger than five to 700 cycles a year in China are quite big. I do see a good potential in China, and just the situation in China is our biggest market today.
Yes.
I don't foresee that that will be changed. It's going to be good growth opportunities there. In U.S., that's more tricky. I mean, I came back last night from U.S., being at the biggest exhibition there, and there are different way of running the IVF clinics globally. In the U.S., there are more small clinics, there are very focused on return on investment. That means if they can sell something to the patient, then they will sell it, because then they have a higher price and more revenue themselves. The PGS situation in U.S., and it has grown a lot, I do think it's still going to grow a little bit, but not so much than before. The growth there has come from two things.
I mean, the patients are asking for it, but also that it's been very, very profitable for the clinic in itself to sell that kind of extra treatment. That means that for them to invest in time-lapse, and U.S. clinics are a lot smaller, they would be challenged with the time-lapse, for instance. I don't believe that the growth in time-lapse in U.S. will be in any way in the numbers or in the ratio that we've seen in Australia, we've seen in Scandinavia, we will see probably also in China.
Okay. Okay, still it's they know about the product now?
Yes, they know about the product. There are a mixed feeling in the U.S., where some see that there is advantages, but they don't wanna invest because they can quicker by sending biopsies to laboratories. There's been a big question that the ones that currently are looking forward to invest are the larger clinics that are having, you know, a workflow possibility.
Another question, you have improved your margins substantially. Of course, the big question is, can you continue to do that? Now you say that the R&D to sales percentage is going up, and you didn't really quantify on the last question, but, can we expect further margin improvement from here, or have you reached the peak, do you think?
I mean, we're now reporting 40% margins. Then we have a target that we should be above 30%. Looking at the big margin expansion over the last years has primarily come from the operating expenses in relation to sales.
Mm.
We see that we need to invest in R&D, as Thomas mentioned, and we are also looking at strengthening our sales and distribution structure. I mean, we're not guiding towards improved margin expansion from these levels that we are currently reporting.
Okay. The MAA, also, could you be a bit more specific? What areas, what companies, what kind of companies are you looking at right now? Where should they benefit the current business you have?
Of course, we've not mentioned the companies. We are mentioning on, as always, on companies that is coming out with therapy changes that we hopefully can then take from a small domestic market to a global market. We are looking into opportunities that's coming from the development in Japan, Australia, some European countries on the technology development. We are also looking into projects that are already in the phase where should be product launches. We are looking into this globally. It's on partnerships, it is regarding technology development, and also to fill in the gaps. There isn't any changes in that field. We are continually looking into this, Christian.
Yeah. I know. Can we expect some acquisitions this year, or what? Can you say something about that?
I don't wanna comment that.
My last question is really about the gross margins in the different regions. What's the good explanation behind EMEA is lagging behind the two other regions on gross margins?
Yes. I mean, one of the reason is, or the most important reason is product mix. In the EMEA, we have a relatively higher sales of, for example, disposable devices, and the products from the business unit ARC. In Asia, we are having a relatively high sales on media, which is the business unit where we have the highest margins.
Yeah.
It is very much a product mix question.
Okay, it's not, it's not the market itself as such, it's only the mix.
Yes. I mean, there are differences in all markets in terms of average selling prices on our products, but the main reason for the difference is the product mix.
Okay. Thank you. That's all for me.
Thank you. Once again, if you would like to ask a question, please press star one on the telephone keypad. Dear speakers, there are no further questions at this time. Please continue.
Okay, thank you very much for listening in today. Thank you. Bye.
That does conclude our conference for today. Thank you for participating. You may all disconnect. Dear speakers, please stand by.