Now we will open the floor for questions.
Thanks for taking my questions. So the first question is on a new guidance on page nine. The revenue guidance on constant currency basis was revised down by 2%. So we understand the ship hold in the SIS division is kind of unfortunate, but I think as Bob said, it is a one-off. So, but looking at page 35, it also looks like the GIS division forecast has been revised down. And I'm assuming the weakness is mainly in the U.S., maybe a little bit in Japan, but Olympus launched a really competitive GI scope that no other player has in the U.S. market, and yet the third quarter came in flattish on constant currency basis in the U.S. So could you talk to us about what went wrong in the third quarter that you had to revise your forecast?
Why was there a delay in the demonstration scopes or, you know, possibly is a certain competitor offering price to gain share, as the other competitors suggested on the call? And are we sure we're going to see growth in the U.S. in the fourth quarter? I'm asking this because I'm really struggling with how this downward revision reconciles with the discipline and execution that Olympus has repeatedly stressed in the recent quarters. That's my first question.
Yeah, thank you for the question. This is Bob. I'll start, but then I'll ask Keith actually to comment both what we saw in GI in Q3, in the U.S., and then what gives us confidence in Q4 moving forward. But before I do, you were right to frame it that ship holds, and I'm sure we'll talk about that dramatic impact on the SIS business. There was some ship holds as well in GI, not nearly as significant. And we saw good GI growth around the globe. So we got confidence in Q4, but Keith, why don't you talk about execution in Q3, and then what gives us confidence in Q4?
Okay. All right, thanks, Bob, and thanks for the question. So first I'll start with, we're not, we're not satisfied with the performance in Q3 out of the U.S., and the performance is not about declining competitiveness or clinician preference. It's we still see strong engagement with Olympus products and our, and our sales teams, and we continue to see interest across our portfolio, including new technology, like you stated, like EDOF and the EU-ME3. The issue here is really commercial execution. We had a pipeline, and we didn't convert that pipeline. So we need to be sharper in how we position the value of the portfolio. We need to do a better job managing that pipeline, and we need to convert opportunities with much greater discipline in the United States. And I just want to draw one example, and I'll...
I'm going to draw an example to China. I think this is a pretty good example of kind of how we approach this. Last summer, when we saw sustained underperformance in China, we really tightened our go-to-market focus, but we also improved our discipline around managing the pipeline with weekly oversight calls with the sales team and the sales leaders. We got a really good idea of what that pipeline looked like and how we could better manage that pipeline to conversion. What you saw in Q3 in China, after several quarters of double-digit decline, we saw 6% growth.
I'm not saying that every region will react the same and everything's going to happen similarly, but when we see declines like this in the market, and we can diagnose the execution issues, and we can put tighter oversight in place, and as Bob stated earlier, we have KPIs that we track. We can put in place things to make sure that we're doing better execution with that, with the sales team.
So again, I wouldn't say that every region's the same, but in the U.S., this is clearly an execution issue, and we've put things in place to make sure that this won't happen again, and we expect to see Q4 growth return in the U.S.
Thanks, Keith.
Thank you. The second and final question, the FDA inspection.
Sure.
So it looks like you received multiple observations from the FDA. Could you elaborate again on the observations that were found? I may have misheard you, but it sounded like these observations were in areas that weren't anticipated. So are the observations cited addressable in a reasonably short period of time, or should we, you know, should we not assume that the JPY 10 billion and other costs for Elevate will go away in 2027? This is my final question.
Yeah, thank you. A really good question, and let me frame the FDA inspections and observations. Again, the FDA conducted inspections at eight of our facilities in across U.S., Europe, and Japan late in the last calendar year. Some of those inspections, in fact, resulted in observations. And many of those observations, though, predated the work we had done in Elevate. That's okay, we own that. Others reflect where we've got to advance the maturity and consistency in the integration of our quality systems. But importantly, you know, it's very much of an open matter with the FDA because the FDA is still completing their evaluation of the observations and the actions, and importantly, we're taking proactive actions. So the steps I outlined in my opening remarks.
And importantly, and this is such an important point you raised in the last part of your question, which is I've committed to 100+ basis points of margin expansion for Olympus in our midterm plan, beginning in FY 2027. I wouldn't put this on the same category of cost that was in the Elevate thing. And regardless, committing to making sure we handle that. The observations reflect areas where we need to get better, advance the maturity, the consistency, the integration of our quality systems and processes. Like I said, it's an open matter, but we're in a direct, active conversation with the FDA.
I wanted to share it on this earnings call to put it in context for you, because we proactively put a number of products on ship hold, as I mentioned, and then through the quarter, worked through those, not all of them, but we're still working through those. I believe we have a very clear set of actions in place to address this. Thanks for the question.
That was very helpful. Thank you.
My first question is about the situation in China. So the third quarter last year, with the 10% high single-digit level decline, but for the fourth quarter, is it there's going to be the positive trend is going to continue? I want to confirm, many MedTech companies and the endoscope competitors, they're taking a tough outlook on the China market. But you can expect a strong recovery. So from January, in terms of a lot, there's a pressure in terms of CapEx for new building of the hospitals. Is it a headwind for your business in China? What type of risk do you see in the China market?
Thank you very much for the question, and let me frame how we think about China very specifically. So China moved from a very significant growth driver for Olympus to more recently a double-digit decline, as you mentioned. During that process, Olympus pivoted our strategy very clearly: local manufacturing, dedicated resources, continue to invest in physician training and service capabilities in the China marketplace, better government relations. So while risks exist in China, what you're seeing us believe is that we have a strategy that gets China to where we think the market is growing in China for mid-single digits. So we're coming from a position where China was underperforming, and this is, this is gradual. I mean, the reason we highlighted China in this quarter is we see the specific strategies that we put in place begin to show signs of growth.
Small signs, but positive growth, 5% growth from double-digit declines. But we're very mindful of the dynamics in the China marketplace. As I mentioned, we're very excited to have a new President of China, Rosa Chen, starting in March. Rosa has demonstrated exceptional leadership in China in healthcare, most recently coming from Danaher China. So I believe we've got the right strategy to win in China. But please understand, I also view it as gradual, but it's one that we believe we've turned the corner on. So thank you for the question.
So, this is my follow-up question. This is about optimization of the headcount. You have talked about the net reduction, 2,000 positions, so, it is a increase of the, cost of JPY 31 billion. Have you gone ahead in this initiative? And if you look at next fiscal year, in terms of the cost and effect, how much should we put in?
That's great. Izumi-san, why don't you take that question, talk about the spend? Thank you.
Hello, this is Izumi. I would like to explain. Initially, in terms of the structural-related cost, JPY 12 billion has been in other costs, but we have revised that to JPY 31 billion of cost. Because the rather than the progress has been accelerated, rather than that, it's more of a accounting procedure. There are items that we can provision it as cost from an accounting perspective. So there's reason why we have put JPY 31 billion yen. So maybe this JPY 12 billion yen of outlook has been conservative in the first place. This JPY 31 billion yen, that is about 90% of overall cost, the for the cost that's going to spend. For this fiscal year, the remaining 10% is going to be allocated next fiscal year.
So the reduction of JPY 24 billion effect, that is, looks unchanged. But how much is going to be generated next fiscal year? That will be explained in May, in the next year's business plan. That's all from me. This is a confirmation. So next year has been provisioned, and that has been. Yes, we can provision that for this fiscal year. Yes, it's not the overall cost that's increased, because initially, in total, this JPY 31 billion plus is the cost that we have anticipated in these two years. We thought that JPY 12 billion would be generated this year, but we have been able to accelerate the provisioning of this. That's all for me. Thank you.
Slide 8, about the actions for ship holds and the impact of JPY 9 billion. I would like to ask once again about this. FDA's inspection, while it was—it, it's still going on, should we expect more of these ship holds?
... Because I believe that the re-inspection will continue to happen, so should we expect the risk of this expense occurring in the next fiscal year as well? And, also, four different areas were impacted, and, I think there's some overlap with the products that was basically export banned in June. But, is the GI not affected or is it affected? Can you please give us more details?
Yes. Thank you very much for your question, and I hope my answer will be very clear. First, of course, there could always be more inspections, because there were facilities that were not inspected. I mentioned there were eight facilities across U.S., Europe, and Japan that were inspected. As I mentioned, yes, some of those observation during some received observations, during this process, we proactively, out of an abundance of caution, put a number of products on product hold, for patient safety. We then went through a very thorough process of evaluating patient safety, and then we've begun to release, as I mentioned, those products back into the markets, about 70% of that. There's still 30% that we're still remediating.
But importantly, as you mentioned, while cost continues, my commitment to you is that we're going to handle that largely with inside of SG&A. So as we delivered 100 basis points of improvement, plus year-on-year, your mid-range modeling should be what I offered to you back in November, which is three, four, five, with a 100+ basis points of margin improvement. Now, this remains an open matter, with the FDA, as I mentioned, so they're still both completing their evaluations of the observations, but also our proactive actions that we took, and which included, as I mentioned, a risk-based review of our product portfolio, continued global harmonization of our quality systems, targeted strengthening of our quality and regulatory capabilities. So we're moving through this.
And then the last part of your question was, these actions did specifically address four areas: GI, ET, urology, respiratory, and surgical. So GI, to your point, did have a product, products that were impacted. And again, I won't go through the specifics because they were across all the products, but some of those have already been released, and some of those we're continuing to remediate at this point. So hopefully that provides a great deal of clarity both on where we are and what we're doing about it. Thank you for the question.
Thank you. A follow-up question. You are showing us a range now, and is this range based on expected additional ship holds, or is this range based on something completely different? And for the next fiscal year, will we see another kind of range forecast based on remediation or related to remediation?
Yeah. So thank you for the question. I actually, we believe that ranges are a more transparent and accurate framework to express the outlook, considering both internal and external factors. They don't anticipate any additional ship holds. It just, as I mentioned, as we move these products back into the marketplace throughout Q4, there's a dynamic nature of that. And also, which you're undoubtedly familiar with, range is the common practice for our peers in the industry, in the MedTech industry. So I would anticipate continuing to do ranges going forward, but it has nothing to do with less confidence and more about providing transparency in terms of the dynamic nature of what's happening. I would like Tatsuya to comment as well on that.
Yes, I would like to add. Providing guidance within range, well, I think the investors that follow us would compare us against the U.S. MedTech companies, and we believe that this range would make it easier. And as Bob has just mentioned, ship hold products, we expect the ship hold to resolve in the fourth quarter for these products, and depending on the timing of the re-release, the sales could be higher or lower, depending on the situation. So we wanted to include that in this range. That's all from me. Thank you.
Thank you.
So I would like to talk about the core operating margin for the mid to long term and what your idea is about that. The core, the adjusted core op operating margin, you have been reduced that from 2-3 percentage points. In the previous announcement for next fiscal year onwards, the more improvement from 1 percentage point or more for the adjusted core operating margin, is that the baseline should that I should use? And your what is your future outlook of your adjusted core operating margin?
... Thank you for the question, and it's a really important question. We are not lowering margin expectations in our three, four, and five plan. So while the first step is a bit of a longer step from 20-- FY 2026 to 2027, we're not suggesting that you reset your models for the next three years. We simply have, and there was some conservatism. The bottom line is, it needs to be more than 100 basis points per year in annual profit improvement, and those are the steps that we're putting in place. And hopefully, that's very clear. So this is just the first year. We've got a little more work to do to get there, but we've not changed our destination nor our timing to be a mid-single-digit revenue growth player and a 20+% operating margin company. Thank you for the question.
Thank you very much. This is a follow-up question. One thing I want to follow up is that, in terms of your revision, the core base gross margin has been reduced. Is it based on the ship hold? Is it there's no change in the profitability of the products because there's a single-use products and the contribution of new products that are being talked about? I just want to ask, this is due to the change in the product mix. Can I confirm about that point?
It's another good question. No, this has less to do with mix shift and more to do with the specific dynamics related to the product holds that hit us in the COGS line from the field corrective action, some of the inventory work that was done. So it's on a go-forward basis. That's why on a go-forward basis, we're not resetting our gross margins at all. We've got to deal with these proactive actions that we've taken, but we believe our fundamental mix has not shifted. We're excited about single use, but think about that as market expansion as opposed to replacing or cannibalizing some of the reusable scopes that we had. So that's, we think, we think the pie gets bigger for that. Izumi-san, anything to add on the gross margin profile, please?
Not so much. Yeah.
I think Bob has explained this clearly, but this time, the decline in the gross margin, the increase in COGS, basically is due to ship hold and the, due to the disposal that we go to the inventory or the, some costs of the recalls that we conducted. This is one of factors. In terms of the fundamental product mix impact, it's very, very limited. That's our understanding. Understood. Thank you very much. That's all from me.
Slide 15, leadership team. Izumi-san is leaving the organization, and I see most of these people on this slide being non-Japanese. Manufacturing R&D are more Japan-centric, so I'm wondering: How can they motivate the Japanese employees? I'm not talking about sales activities. I'm talking about manufacturing and R&D. How can they motivate the employees to really drive the product development for the future?
Thank you for the question. We believe firmly that leadership is not a function of one's passport, but leadership comes down to the experience and authentic approach that one has. So specifically, with the new leader who will be responsible for global operations, David Shen. David Shen has operated globally in many factories around the world and has a very wonderful track record of connecting and building great relationships across culture. And I believe fundamentally in Olympus, people want to be on a winning team, and they want to continue to get better and better, so I'm excited about our global operations transformation. I want to be really clear, though.
The heart of Olympus will always remain in Japan, and we have tremendous factories here in Japan, and we know that we also can do a better job driving sustained cost improvement year over year by doing things better and more efficiently in digitization. So I'm really excited about the experience and the expertise that David brings. Similarly, with R&D, Sayed's been the Chief Technology Officer for a while, but importantly, you know, leaders surround themselves with great people. And when I look at both the leadership teams surrounding David and Sayed, they're made up of exceptionally talented Japanese leaders, and we continue to work on the development and succession planning as well. So, I'm excited about the team that's here, but please note that intentionally, we are developing amazing Japanese talent within each one of these functions as well. So thank you for the question.
Thank you. That's all from me.
So SIS voluntary recall. So for Izumi-san, in terms of the ship holds, the cost of ship hold from the fourth quarter onwards, it will not appear. I just want to confirm that. Another point is that, So this voluntary recall, you, if you consider the patients, I think it, it has been a good move. But Olympus, in the past, in the SIS area, you have been continuously conducting these recalls, and after a ship hold, then another product will have to be voluntarily recalled from the market. I think you have repeated that cycle. So from that point, fundamentally, this, is there any way to change that culture, so to speak? Do you have any thoughts about that?
I'll take the question second. Izumi-san, you want to take the first question?
Yeah. I would like to first answer from my side. In terms of the impact of the ship hold in itself, it will continue into the fourth quarter because of the ship hold, because we are going to lose the revenue. That is about a JPY 18 billion impact in the fourth quarter is going to appear. On the other hand, the cost related to ship hold, for instance, disposal of inventories, basically that will be ended in the third quarter. There's no additional cost that will appear in the fourth quarter related to those types of cost.
Pick up your question on surgical, and I'll actually ask Seiji to comment here as well. He's right next to me. Importantly, you know, you correctly pointed out that patient safety is fundamental to Olympus, and it's my personal top priority as Chief Executive Officer. So we will proactively, in an abundance of caution, when we see a signal, you know, take a product temporarily off the market to make sure, and that's what you saw us do in Q3. Your question, though, gets deeper than that, which is: Is there a fundamental cultural issue here with inside of surgical? I don't believe so. When I think about where we're at in our quality journey of strengthening the global harmonization of our quality system, strengthening our quality capabilities, advancing the maturity and consistency of our quality systems and processes, we're doing that across.
Seiji, I'd like you to comment on how you feel about the quality of the products and your approach with inside of SIS.
Hi. Hi. I'm Kuramoto from SIS. I would like to respond to your question. So as Bob has just mentioned, specifically in SIS, I do not think that is a fundamental issue in SIS, because we are always putting patients first. And the products that I sell in SIS, like energy devices, the therapeutic devices, there's some products that have a higher risk. So we put patients' safety first, and we have taken proactive actions to put some products off the market.
Going forward, from our point of view, for the therapeutic devices, because we want to grow in this area, we want always to put patients front and center, and enhance the quality to be able to answer this. So this is essential. This is a thing that we have to go do for growth, and we want to go forward on this initiative. Thank you. No, that's all for me. Thank you.