Sectra AB

STO:SECT B

Earnings Call Transcript 2023-Q1

[Helena Pettersson, executive]

Welcome to Sectra's Financial Report Presentation with CEO, Torbjorn Kronander; and CFO, Jessica Holmquist. My name is Helena Pettersson, Investor Relations Officer, and I will be moderator of the Q&A session that will be held after their presentations. The chat function is open from start, so please write your questions during the presentation.

And with that, I hand over to you, Torbjorn.

[Torbjorn Kronander, executive]

Great. Thank you very much. So this is our 3-month report quarter 1 for this fiscal year. I will start with intro and some highlights of the quarter, and then Jessica will take over talking about the financial developments. I'll talk a little about the way forward and that will end up with a Q&A session. And again, you can chat questions or you can email questions during the presentation.

So the value Sectra creates for customers is in 3 areas or actually the business innovation is several. Imaging IT, which is our large part, where we do image management systems for hospitals. Images is an increasing part of the diagnostic and therapeutic process in hospitals, and we are experts in taking care of these images.

We started with radiology only. We added pathology with its microscopy images, and we have added gradually more and more image types. Today, we can handle all images in hospital. We are the only vendor who can handle all images in one simple system. This is our, by far, largest business area.

And we have Secure Communications, which is a very high level encryption. I'll come back to that a little later.

And Business Innovation, which is our greenhouse area, we have new ventures, and we just added a new one in genomics, and I'll talk about that.

Q1 Highlights. Order bookings exceeded SEK 2 billion, that is a record. We have never had so much order booking for one quarter. Now these over many years, and they are usage contracts. So high volume, very high volume, a lot of examples in these customers and the long contract types that ever results in a very large order value, of course. This is a contracted order value. So it is -- the promise we have from the customers is a little bit low.

We do have significant quarterly variations. Now I should expect that we have a continuous flow of SEK 2 billion order bookings per quarter. These orders are very, very large, and they come in sometimes on unexpected times or they can bundle up. These are 2 major orders. There is a lot of that but not all. And we're also transforming the company to Software as a Service, which is a big change for us. We sold upfront licenses, before we are gradually moving over to selling usage and getting paid for usages and I'll come back with the impact of that later.

The net sales anyway was plus 19%, up to SEK 484 million. Profit per share was down, the profit was down, and that is based on increasing costs during the quarter. We have several reasons for that, both in new orders, these are very large orders. They -- we need to recruit resources and add people for that, and they cannot start generating revenue right away. So they are costs in the beginning.

We also have a lot of built-up demand for marketing and sales activities. We have not been able to travel during the pandemic. And one large exhibition actually was moved to July, which is normally, in February, and it's also substantial cost. But the cost was up. We don't see that as a major problem going forward.

Recurring revenue was up, and that's important because, therefore, we really want to focus now. We want to transfer into the software-as-a-service company. And recurring revenue was up compared to last quarter by 23%.

Financial targets for the groups were fulfilled. Our targets are stability, equity/assets ratio, that's s a trust in the company. That should be above 30%. We are currently at 55% from financial position. And the second priority is profitability. The operating margin should be 15% or above, and we're above that as well. And then growth of profits is -- should be the main target when the other ones are fulfilled as thresholds and EBIT per share should grow over a 5-year period with 50% more. And we are substantially above that. We're at 73%.

Secure Communications highlights. We see increasing demand for cybersecurity, all over the world, both because the society is getting more and more digital. And, ransomware, et cetera, goes up tremendously, but we also see the crisis in Europe driving this demand. In focus for us right now is procurement and deliveries. We have a pent-up demand for deliveries. So we've not been able to deliver in March during the pandemic, due to our systems needs to be delivered by courier. We can ship them in a package. And now we can again travel, which is a very good for that target.

We also have a new President, Magnus Skogberg, who takes on as President of this area from August -- first August this year, and he is from -- history in Saab mainly, and is now getting -- warming his clothes in this area.

Impact of Ukraine crisis. We see increasing demand for cybersecurity overall. Secure communications and encryption products, and our products are approved both in EU, but also in NATO through our [ Dutch ] subsidiary. And that is very good because it's huge demand for secure mobile workplaces and secure phones all over Europe [indiscernible].

Business Innovation, our greenhouse area. There, we have -- the focus there is increasing usage and recurring revenue. And when you go into a transition from a company that sells licenses, into recurring revenue, you concentrate a lot about how much people use it. So we are measuring this in all areas, how much usage and we have a very healthy growth of usage, both in Medical Education and orthopedics. And we also added a new business unit for genomics IT, and I'll come back to that a little bit later.

Genetic information is increasingly important in diagnostics and precision medicine, especially in cancer. In cancer, the new normal is that you sequence the cancer and the patient and you adapt individualized medicines for cancer patients. But five years ago, you had the same treatment for breast cancer, the same treatment for prostate cancers, et cetera. Now you measure the cancer and you measure the individual and you have adaptive treatment for these people.

And genetic information is increasingly important and is growing. This has been done in the old days or before. Now, I would say, still is done by research tools. So the IT handling and the handling of this information is done by research tools. Now research tools is not enough when it becomes clinical production. When things become conveyor belt medicine or it is needed when there's a lot of patients.

The old ways of creating this information simply explodes, and it doesn't work. And that's where we come in. This is a project in close collaboration with a customer, University of Pennsylvania Health in the U.S. It's one of the leading cancer hospitals in the U.S. And we have a collaboration we would develop.

And if it comes out as planned, we will be -- they will take it into clinical use, because they are in very high need of information systems that is production-oriented that goes in line with the pathology and radiology for integrated medicine -- integrated diagnostics environment. This has potential to significantly impact patient care because we'll speed up a very crucial product cancer care.

It's one more step towards integrated diagnostics tests. And it fits also very long -- very well with the long-term ambitions from the Sectra, be a leader in diagnostics IT. Images is one part of diagnostics, but genomics is not. That's not images. Everything else is the same. The workforce is the same or similar, but we are now venturing into an area, neighboring images, but it's not images. Still a lot of data. We have a lot of benefits to know how to handle a lot of terabytes of data as the genomics is a huge data provider to hospitals, but it's not images.

And this will also -- we are building this as a cloud solution and will only be sold as a software-as-a-service model. We will not sell this as a license model.

In Business Innovation and the growth initiatives, in orthopedics, we have new technologies for Implant Movement Analysis to see if the prosthesis that was put into the patient several years ago, if it's -- if that patient has pain, if it's really get stuck or if it needs a revision or reoperation, and we're very good at that. We have some very interesting scientific proof coming out that this actually works very well.

You can avoid revision operations, which is very expensive. It takes a lot of time of course. And it's also dangerous for the patients. A version of that can be used for studies of prosthesis for clinical research and they will sell our services to the prosthesis manufacturers, who need an objective, very accurate tool for measuring if these prostheses move during the research study.

In Medical Education, we have transitioned. We have this huge tables, virtual dissection tables that we sold to universities all over the world. We have transitioned this very successfully into an environment where we are selling content. We have built in thousands and thousands of cases of medical examples that we now can use for teaching and this is due -- through the cloud.

And we actually, yesterday, we [ OneClicked ] took in a new version of this, which will increase the benefits for the universities a lot. And that was done by OneClick. [indiscernible] we upgraded 60 characters, 6-0 characters to OneClick, and that's how the new cloud world looks.

Both areas with significant growth in recurring revenue. Sectra One was introduced 2 years ago. That is actually the common framework that we sell Software-as-a-Service. And we have 1 framework if a customer comes in with radiology imaging contract. They can also within that contract begin using pathology, cardiology, orthopedics, whatever. And to this, we are now adding genomics, which will bring other service in that Sectra One environment. We have a huge interest in this way of selling things now as not the least for the United States.

Imaging IT Solutions, our largest business area, substantial Sectra One contracts coming in. Recurring revenue increased by 23%. And we have a big transition now to software-as-a-service and cloud deliveries. And this will impact our earnings in the next few years quite a lot, and I will come back at that bit later.

Growth initiatives in -- within Imaging IT, new markets, we are selling 2 more countries, also in fact, we have gotten our first order from an installation radiology [indiscernible] in South America, where we have been not present before. We are increasing the Enterprise Imaging part, extending our radiology footprint into pathology, cardiology and a relatively new area ophthalmology, which is another of the old man's diseases that are critical to treat, because it's a large area and very complex actually.

Ophthalmology is the disease of the eye. We are focusing in the U.S. It's the world's largest market. We are tops customer satisfaction for 9 years in a row, which is very important for us. Because we are not the biggest and most well-known company, and the #1 in this class is important that we have customers. But we have a small market share, but it's growing. It's a very large market to grow.

Then I'll leave the word to Jessica, who will talk about the financial development.

[Jessica Holmquist, executive]

Thank you, and good morning to everyone. Before we look at the financial development of the first quarter, we will just briefly look at the changes to the financial reporting that we announced in Q4.

So Sectra is changing business model and transitioning into selling software as a service with service delivery over time. And as more and more customer contracts reflect the new business model, an increasing share of revenues will also be recognized over time. And therefore, we introduced new reporting measures in this report.

The changes mean that we increase details around order intake. And we do this during the transition period. And in 2 years from now, that is in Q1 2024, we will exclude order intake from our financial reports. We also increased the focus on recurring revenue. And as part of that, we introduced the new alternative performance measure called Cloud Recurring Revenue.

And by that, we move on to look at the financials for the quarter. Contracted order bookings exceeded SEK 2.2 billion in the quarter. Guaranteed order intake was just above SEK 700 million. As mentioned before, we secured 2 significant -- 2 significant multiyear contracts in Imaging IT contributing strongly, of course, to the record high order intake.

Net sales amounted to SEK 484 million, up 19% versus Q1 last year. A growing customer base, increased sales to existing customers as well as positive or currency tailwind, particularly driven by the strong U.S. dollar increased sales in the quarter.

Looking at currency adjusted numbers, we grew sales by 11%. Recurring revenue continued to increase during the quarter, now totaling 64% of total revenues. And the part of revenue -- recurring revenue coming from cloud contracts also increased 19% and totaled SEK 50 million.

Sales by business segment. All business segments showed sales increase versus Q1 last year. Majority of the increase is generated in Imaging IT, which increased sales by 20%. Again, increasing sales is a mix from new and existing customers and also we have the positive currency impact this quarter.

Secure Communications increased top line by 8%. And there is -- we see an increased demand for cybersecurity and encryption solutions. But at the same time, the business space is both a strained labor market as well as shortage of components. And in Business Innovation, we are -- we see a positive trend on recurring revenue and a sign of progress towards -- or in the shift towards the new business model also in this -- within these smaller businesses.

Sales by geographic market. Also here, we see that we -- we had sales growth in all geographic markets where we are present. Adjusting for currency impact, we generated the highest sales increase in the U.S., the U.K. and in Sweden.

Operating profit for the group was SEK 64 million equal to an operating margin of 13%. Compared to the exceptionally strong Q1 last year, this is a decline of 29%. The product mix impacted the gross margin positively in the quarter, but we have increased operating expenses due to an accumulated need for marketing activities and also driven by the increases in our capacity to deliver.

Operating profit by business segment. Imaging IT generated SEK 80 million in the quarter and a margin of 18%. This is a good start to the year considering both seasonal patterns and ongoing transition to cloud deliveries.

Secure Communications showed negative operating profit in the quarter. In this business line, we continue the development of new offerings and also, we focus on deliveries now and marketing and sales activities.

Here we go. So last slide for me, cash flow. Following the strong cash flow generation in Q4 with large advance payments from customers, we now see a negative cash flow from operations minus SEK 64 million coming from settlement of short-term liabilities. And the group continues to have a strong cash position.

And by that, I hand over to you again, Torbjorn.

[Torbjorn Kronander, executive]

Thank you. We have some problems with the clicker and see if we could get this work. So our way forward, where we're going.

High customer satisfaction is still a very important and will forever be a very important part for us. If we, as a relatively small company, we are going to fight and compete with very large companies as we do and we can't out market that, but we can have higher customer satisfaction. And then the gray line will work, and we've seen that very successfully in the U.S. In order to have higher customer satisfaction, you need satisfied employees. You can't do that unless you have satisfied employees and they need to work together and a good company culture can nurture that.

Profitable growth, we don't want to grow faster than we actually can't finance it, yet we need to have good future research and skate where the puck is going to be later be. We sometimes get criticism because we are -- only have a target of 15% profitability, but that will not change.

And the reason is that we need to invest in these future areas, Genomics will not be profitable in the beginning, but long term, we have a lot of hope for that. This pathology was not profitable for several years, and we're now one of the world leaders in digital pathology, which is growing very healthily. So we need to do those investments for the future and 15% is a healthy profit level that we keep as a part.

Philosophy shareholders for the Sectra to repeat it. If you want shareholders to be happy, you start with a good position in growing markets. I'll come back to that a little later. Then if you have happy customers, happy employees, really [ strong ] cost control and some stubbornness to that. Shareholders will be happy. It would be very difficult to avoid.

And we are not even trying to avoid it of course. But this -- I think we have proven over the years that this works. Good position and positioning in a growing market, happy customers -- for happy customers -- for customers to be happy, you need happy employees. And then you need to be a little stubborn and go on what you do and then have resulted in a nice shareholder trajectory over the last 10, 15 years.

How do we build less than competitive advantage? So you went to business school, you might remember the 4 Ps of successful product launches and marketing; product, need a good product. Promotion, you need to tell people you have it. You need to sell it in the correct place, correct time. And price, you need a reasonable price. These are the 4 Ps eventually taught at business schools.

We've added 2 to those; process, if you work with a lot of people, they cannot do randomly acts. So you need a process, which is very important to growth. And then the most important if you're going to compete in a rapidly moving market is people.

And these are the 6 Ps of Sectra's strategy and has been for a substantial time. And then you need -- you have these good people. We are very, very picky when we employ people. I still interview everyone myself, though we do employ quite a lot now. It's still one of the most important things we do. And if you can employ the right people, and then get them a right, good culture.

And we teach a very, very old saying at Sectra, the golden rule, if we can get our people to treat others as they want to be treated themselves, the oldest rule of humanity knows probably. And you can find it in all the religions. And still we are from IT management as CEO to talk about the oldest rule of the path it still holds.

If we can teach our people and get our people to treat our customers in a way they want to be treated, we will be fine and they will be fine.

In Medical, we have the growth areas of the age-related diseases. I've showed that many times that the curves of the demographics of the world is a little bit scary, and we need to treat the old man's disease primarily. That's neurodegenerative disease, cardiovascular disease, cancer disease, skeletal disease or musculoskeletal disease and vision and hearing.

And we are very strong in this area. We do medical imaging for all medicine, but we are kind of specializing. So we are very good in these 5 areas, sometimes with blue around this area. It means that we partner with others to get special application. When its green, we try to do all of it ourselves. And in cancer, we just added Genomics would be a very strong enhancer of our offering for cancer diagnostics for the future. It goes also very close to digital pathology and we're close to the genetic space.

In cybersecurity, demand for cybersecurity is increasing. Society and defense communication must function and must be secure. The security crisis Europe drives demand, increasing cyber threats also in other areas of society, not the least in healthcare. And we protect against criminals, but also against national actors and terrorism, and we see an increase in demand for that.

We have increasing recurring revenues. This is for the last [indiscernible] 56%, but I think Jessica just said in the quarter 1 was 64%. So this is increasing. We're measuring this very carefully now because it will be a long or several years' transition period. And customers want to pay for software of this and long term will be better for the provider as well. Four years will equal out the bots.

The second one will dominate the future sales in medical IT transition of several years, as I said. And during the transition, the apparent revenue and profit growth will be smaller. We look like we are not growing as fast, but the large growth in real usage would be very important because if you use a product a lot, you will not leave us. We are measuring all areas, the real usage of the products now and that looks very profitable.

Long term, the financial effect would be strongly positive for our company, thus recurring revenue, but it takes a few years to get. We normally see where others see a problem, we see opportunity. We especially have 2 niches that we concentrate in. And that's when health care must scale up and become streamline production. That's exactly what's happened in genomics right now. It goes to be -- they were able -- the hospitals were able to use their research tools to handle the information on genetics and genomics. But now it's getting too much, and we see that from many countries.

In genomics workload is increasing so rapidly. They need good production IT tools to handle it. And when top-level security needs to go mobile. And we have seen that over the pandemic. We also see you need to have a very high-level security and you cannot isolate that only one room so as it was in the old days and that's where we come in security.

We have this saying that I don't -- when Wayne Gretzky, one of the best hockey players in the world asked how he could be so good. His answer was, "I do not skate to where the puck is. I skate where the puck is going to be." And we have that as a mantra, et cetera. We want to build the products now that would be demanded by the world 3 to 4 years from now because that's along the development time we take.

Examples, Imaging IT Solutions, consolidated hospitals, there's a huge consolidation going on in health care in all -- literally all countries. And when they consolidate half of they need IT systems that scales with it, and we are good at that. Enterprise Medical Imaging, you want fewer and fewer IT system hospitals and a few years back, perhaps had 2 in IT systems. They all need to communicate and the providers want fewer IT systems. So we can have all images in one single system, a huge cost saver and efficiently booster for hospitals.

We are adding to this Pixel-EMR, new ologies, pathology was one, ophthalmology and now genomics, which come in, not really images its outside imaging ecosystems, but it will be sold as one system in long term.

Cybersecurity, secure mobile workplaces. People want to move and work from home, but they still need to be very highly protection of the workplace because before they set in an environment with few rooms with a table between them for the network. Now they want to do that from home. And we are very good at providing mobile security. Both as we used to do and still do a lot from mobile phones that are highly secure while increasing within data on these lines as well. High-speed, high security network infrastructures. We see an increasing demand, as I said before, due to the crisis all over Europe.

In Business Innovation, the entire image-based orthopedics planning and follow-up process needs to become more efficient and a better position. We can also determine if people need a revision operation or not, which saves a lot of time process if they can avoid without risking patient. Lifelong education of medical staff and also a good education of students when the students want to sit at home that had an explosion of interest during the pandemic where they had universities shut down, and we actually had tools do teaching of students from their home.

And other medical areas that are not on the threshold of becoming industrialized or that are on the threshold as Genomics. And we've post-quantum encryption systems, which is very interesting, NIST, which is a standard institution in the U.S., just standardized what will come after the current standards in the Internet encryption world when quantum computers come around. And we are working on post-quantum encryption systems.

So summing up what we do. We do -- if you start on the lower right, Imaging IT, by far our largest area. Digital pathology and integrated diagnostics, it's a huge growth area, of course, radiology in the basis. Secure Communications, we also do a little growth areas in IT for critical infrastructure. and Business Innovation, Medical Education, Orthopedics IT, Genomics IT now, and we do research mainly in AI for meds.

So we're well positioned for profitable growth that is much easier in growing market. Ideally, it's a market that is forced to grow by external factors, the demographic situation requires medicine to grow. So it's not matter good and bad times, it will have to grow because we are getting more and more people.

Cybersecurity, we've built a very, very sensitive society. And people are moving more and more and they want to work from remote. That's another area that will be growing despite it's good or bad times. It will be forced to grow. And health care and cybersecurity are such markets.

Genomics IT, it's an addition for clinical production. It adds to the growth opportunities. It's a predicted market growth of 19% for the overseeable future in genomics. And we are now doing -- providing IT tools in collaboration with one of the best universities of the U.S. to help them out in handling all this information that is too much to handle manually anymore.

And I'd like to have quotes. So the Sectra's journey can be described by, first they ignore you, then they laugh at you, then they fight you, then you win. And that will conclude my presentation.

The upcoming financial report on the AGM on September 8, we have an Annual General Meeting in Linkoping, Sweden. On December 16, we have a 6 months report. And with that, I would also like you to send feedback on these presentations. Are they good? Are they efficient enough? Do they provide the information you want? Please let us know what you think. It's important for us that also you are happy with the presentation and the e-mail is [e-mail]. And then I'll leave over to questions.

If you follow online, please use the chat function and Helena will tell us what we get.

[Helena Pettersson, executive]

Yes. Thank you, Torbjorn and Jessica. We have a number of questions in the chat. And if you have any further questions, please write them and we will handle them one by one. The first question is about Secure Communication.

Have your component problem in security eased somewhat now? Could we see that in sales -- could we see that in sales development going forward?

[Torbjorn Kronander, executive]

I will say, it's not as bad as it was, it's still a problem, but we are not in [indiscernible] in immediate crisis for components over the next year. Longer term, we need to do some redevelopment, but we know that well in the past.

[Helena Pettersson, executive]

And then we have some questions from Kristofer Liljeberg at Carnegie. And the first one is, how many years in the future could be included in contracted orders?

[Torbjorn Kronander, executive]

That varies a lot. The longest ones might be 10 years or even up to 15 years but then it's more option at the end. But it can be that range of contracts. In the U.S., it's very seldom more than 5 years.

[Helena Pettersson, executive]

Are part of the higher operating costs of temporary nature?

[Torbjorn Kronander, executive]

The costs are not on the temporary in nature. We have employed people, and we need to do the market activities. But if the revenue goes up, then marginally. So we need people in order to deliver. It was a little pent-up demand for travel. So I would say it's a little higher than it could be a normal quarter. But we will have increased costs for the people we need to deliver all these huge orders we have received.

[Helena Pettersson, executive]

We have a third question from Kristofer. Growth in recurring revenue accelerated to 15% from 11% to 12% in the recent quarters. Is that explained by specific large contracts kicking in or more the general trend with larger share of subscription?

[Torbjorn Kronander, executive]

This is a general trend. We are moving there in all business areas, and we're doing it. We want to pass this transition period as fast as possible. And we have all business areas going into that area. And new functionality we add is only Software-as-a-Service as a service, as I told you in genomics before.

[Helena Pettersson, executive]

And then we have a question from [ Carl Lori ]. Is it possible to comment on how large the renewal of the 10-year Sectra One contract you signed in Q1?

[Torbjorn Kronander, executive]

That's a thing when it's not published, we cannot say that publicly.

[Helena Pettersson, executive]

There -- has another question. Will the genomics, to some extent, [ resolved ] in connection with digital pathology as there are some similarities between the two, especially in the future maybe?

[Torbjorn Kronander, executive]

Yes, that is correct observation. Now as we sell sometimes digital pathology together with radiology, especially for cancer, we can also sell genomics together with pathology but we are more unique in genomics than we are in pathology. It's a very similar situation to pathology 6 years ago. We can also sell genomics isolated from pathology and radiology.

[Helena Pettersson, executive]

And going back to the first -- earlier question from [ Carl ] about the renewal contract. He says, I know you don't guide, but I think we need to get some more information on how one should think regarding growth going forward?

Sectra has been quite clear that sales growth should be somewhat lower when you now are transitioning into more SaaS revenues. Do you believe that this report is a fair representation of what we should expect going forward in terms of total sales growth and the growth of recurring revenues?

[Torbjorn Kronander, executive]

As we said before, we don't give guidance. We can tell you the general trends. How much would be actually stepping over that line and give guidance. We cannot unfortunately get deeper to answer that question.

[Helena Pettersson, executive]

And then we have another question from Kristofer Liljeberg. Could you comment on the competitive situation? It seems pretty obvious it's you and Visage that gains share in the U.S., they are growing even faster. What do you think is the reason for that?

[Torbjorn Kronander, executive]

They are very specialized. It's a good company. They are very, very specialized in radiology viewing. And we do wider things and more things than that, and they are growing only in the U.S. We don't see them much outside of the U.S. So it's a fact. We fight with them. That's good.

[Helena Pettersson, executive]

Okay. Thank you, Torbjorn and Jessica. We've no further questions in the chat.

[Torbjorn Kronander, executive]

All right. Then thank you very much for your attendance. Please remember to give us feedback on the presentation. We are trying to improve all the time. Thank you very much and goodbye.

[Jessica Holmquist, executive]

Thank you.