Sectra AB

STO:SECT B

Earnings Call Transcript 2019-Q2

[Operator]

Ladies and gentlemen, welcome to the Sectra Q2 Report 2018. [Operator Instructions] Today, I'm pleased to present CEO, Torbjörn Kronander, and CFO, Mats Franzén. Speakers, please begin.

[Torbjörn Kronander, President, CEO & Director]

Okay, thank you very much and welcome to our Q2 report for 2018, '19 here. And I -- some basic instructions. I will tell you when to change slide and also if you want to file a written question, there is an envelope at the lower end on your webinar page for you on the web, and you can e-mail those questions to us so we read them or you can come in and ask them at the very end.Okay, so next slide. Summary of the quarter. Our business area Imaging IT led the way but all areas showed growth. We had special focus and happy customers in the U.S., and that resulted in good order intake. Next slide. Highlights from Q2. We are fulfilling all our financial targets. The target is equity-to-asset ratio to create stability, and we have paid dividends so actually by redemption program, we have reduced our equity here, but that has not put us below the threshold 30% so we are well above that threshold. The second target is profitability, operating margin where we had set 15%. We are currently over 12 months at 17.4%, so well above 15%. And then the most important target and we would want to increase the most is our EBIT per share growth over 5 years and that should be above 50%, which is currently 119%.Next slide. Order bookings for the group. We doubled our order intake in the U.S., which is an important thing for us. We are currently one of the largest players in most of the markets where we are locally present. We have very large customer satisfaction in the U.S. We are leading that but we have a low market share on the largest market on the planet. This has led us to try to grow that market share and the order intake doubling is a good sign that this strategy is working.Second strongest Q2 ever, but challenging comparison. Our last Q2 and comparison quarter was exceptional and, of course, compared to that one. It could have been better but overall the trend is positive and good. We have substantial variation between the quarters as orders sometimes are very large. We must remember that this is the fact, individual orders can be of SEK 700 million sometime. And that means big change between the quarters.Next slide. In Imaging IT Solutions, we announced an agreement for PACS to Stanford Health Care and Lucile Packard Children’s Hospital in California in Palo Alto. That is a very prestigious order for us. Stanford is known as one of the most prestigious hospital organizations in the world that they chose us and has an important reference value for us. That is currently under -- that work is currently ongoing.Next slide. We have several other orders from large U.S. healthcare providers, Kettering Health Network, Regional Health Systems and Deaconess Health System.Next slide. Sectra -- Secure Communications received the NATO order for the Tiger/S SECRET level encrypted mobile phone. This is an important breakthrough and remember that Sweden is not a NATO country, but our operations in Netherlands is -- this is actually handled through the operations in Netherlands. To get this confidence from our -- from NATO customers is an important sign that we are very good in cybersecurity as a company.Next slide. In Imaging IT Solutions, we got a certification -- received Cyber Essentials national security -- cybersecurity certification in the U.K. And this is also an interesting trend. Cybersecurity is getting more and more important in imaging IT and also in general medical IT. And we have increasing synergies between 2 of our areas.Next slide. Secure Communications. Trend is positive. We have a good growth and our growth initiatives in this area is critical infrastructure. We are protecting primarily energy production and these energy distribution systems in the society. We also do mobile secure ecosystems rather than just having a secure phone as we used to have. We are now creating ecosystems of communication devices in this area. We also try to reach new geographic areas for our activities. The cost of these initiatives are charged to earnings, but long term, we will generate a positive return on it.Next slide. Some special things about critical infrastructure at Sectra. This is a substantial interest. It's clear that most societies are now realizing that we have built very sensitive societies especially as tensions and violence are increasing and military is important part. So it's actually defending the civilian society behind the military. And we are defending this in cybersecurity world. We have several customers now fully operational. There is new legislation coming both in Sweden and abroad that might drive demand here that is of course a good thing for us if that comes.Our growth strategy is to focus on the energy sector and not spread ourselves within. And then expand into new geographic markets based on solid reference in Scandinavia, and this is what we are right now pursuing.Next slide. Imaging IT Solutions. With continued trust and extended agreements with existing customers, quite a lot of the business here is after sales or more sales to existing install base. Example of growth initiatives, we have a special focus on the U.S. as I said before. We are doing digital pathology that I will come back to. We are increasing also doing digital cardiology or handling cardiology images. The 3 largest producers of images in healthcare is radiology, pathology and cardiology and covering these bulk production areas is important for us. We are doing more direct sales in new markets. Our most successful markets are where we sell direct, but it takes time to build those markets and entering a new country is costly and takes time. And we've entered now both the Canada and France, and that, of course, drove cost in initial phase. We have new distribution partners that is a faster cycle, but we have had less success in that historically. But we are availing new distribution as well. Next slide. Imaging IT in the U.S. You see a nice curve sloping upwards there. A special focus area for us, as I mentioned before. Opportunity of course. This is the world's largest market. Highest customer satisfaction is with us. We are leading the customer satisfaction rankings in the U.S. by a good margin. And we have a small but growing market share. This expands opportunity. And that's also why we're focused in the U.S. market. We have recent orders from well-respected customers strengthen the Sectra's market position as I said before. I stand for each one of those. Next slide. Digital pathology. It's clear this is one of last areas where it's completely analog in most of the world, and people are -- or the doctors and pathologists are still using microscopes instead of monitors and this is due to some special conditions pathology among them that the data size of these slides is very, very large. We have made this work and that is an important path forward for us.Next slide. We see a rapid growth in the area. There is large synergies with radiology for us especially in cancer care what we call integrated diagnostics is an important trend in the world. Sweden is, by now, the world leading country in digital pathology penetration. There is no other country who has a share of the households as large as Sweden when it comes to digitizing pathology. And we are actually dominant here in Sweden to build from. We also received previously and now installed, we have a nationwide telepathology solution in Netherlands, connecting all the labs in Netherlands with each other for sharing and collaboration, which is an important platform in the Netherlands. The growth strategy is to have one system for pathology, radiology and cardiology. We do have competition in both pathology, radiology and cardiology, but there is, up to now, no other vendor with one single system to take care of all these types of images and that, of course, is a competitive advantage as servers and server environments cost money for us. We do integrated diagnostics, which especially for cancer care is important to improve diagnostics process and FDA submission for digital pathology will be as soon as possible, but we are depending on that there is a scanner or the glass, microscopic glass that is approved independently. When that is approved, we can file ours. Hopefully, that will be done within 3 to 6 months, but as we said we are delayed and that is due to the -- this scanner has not been approved yet.Next slide. As you can see, this is the digital pathology world map right now. We have grown this quite substantially as you're seeing most of this area of installations is in Sweden.Next slide. Business innovation. This is our future, the 5 future growth products that we talk about and we have grayed out the 2 ones that are inside Secure Communications and inside Imaging IT, i.e. critical infrastructure and digital pathology. And the 3 mains we're leaving is medical education, where we are transferring the business into a recurring revenue model for higher ad buying content. We have sold visualization tables before. We still sell them, but the main idea is to move that area over to content subscription instead of selling only devices. That's a more long-term, more viable solution and we are increasing our clinical content in the worldwide photography right now.In orthopedics, we do software tools for orthopedic surgery, preoperation planning and postoperation follow-up. And then we have research and our research division is mainly doing work in artificial intelligence today.Next slide. The trend is new areas within orthopedics, visualization and planning for 3D trauma surgery, which -- some fractures are very difficult to operate because it's a complex splintering of the bones involved. We have system where we can actually simulate the operation before and saving time and cost. We also have a new product called IMA, implant movement analysis, which is intended to reduce the number of revisions, which is the reoperation of a previously inserted prosthesis. We have a version of that, which is computer tomography micro motion analysis, which is more or less the same thing as IMA, but not taking -- while using images away along in between and that is mainly for clinical research and studies if prosthesis are well suited to the human body. And there the customers will be large prosthesis companies and large hospitals themselves.Medical education, as I said, provides a transitioning from a device delivery to service delivery for cloud-based content subscriptions. In research, we have a large focus on AI for medical applications.Next slide. AI/machine learning is a big thing in medicine as you might know now. Our focus is not to replace physicians. We think that will not happen or will take a very long time. But to increase efficiency in our -- within our customers. The workload all over the world is increasing rapidly for physicians. Burnout is increasing for doctors all over the world and we are going to provide them with tools set to increase efficiency. And there AI can do a lot of things like simple repetitious tasks that a system can do for you instead of having to do it yourself as a doctor. We also have an App Store of AI applications in Sectra's solutions so we actually have an open interface to other companies of world to put their systems in our environment. AI will be huge in the future. We see that will permeate most business units in the future including secure communications. So it's important for us to be on the front line in that development.Next slide. Customer financing. Here the main income is from multiyear contracts in U.K., which leaves a significant exposure to the British pound. And of course, with Brexit hanging in limbo somewhere we don't where that will end up. That is a risk in that area but also opportunity. Next slide. I will leave the word to Mats Franzén.

[Mats Franzén, Chief Financial Officer]

Okay, thank you, Torbjörn. Next slide, please. As you said, Torbjörn, there are large order intake variations between periods. And the second quarter this year being the second best ever. It has -- so happens that it's compared with the best second quarter ever. Last year, we had a big order in the Netherlands that made a significant impact for that comparison. For the last 5 years on average, the order intake increases as the years -- as the quarters go by, and approximately between 55% and 60% tends to be in the second half of the year. That is 5-year statistics average as it's again big difference between the quarters. The weaker Swedish krona. You can see when we make the comparables apples-to-apples it's about 7.5% in the big 3 comparable currencies, euro, pound and the U.S. dollars. And for the balance sheet dates it's a bit more of a spread where we see especially the U.S. dollar being impacted almost 10% change compared between now and end of October the last year.Okay, next slide, please. We can see that in terms of where do we have traction in sales in the nominal numbers. It's mainly in the rest of Europe in absolute numbers, where the -- if you were to see without one single market, it would be Norway actually compared with last year. And as for the rest of the world, we had strong partner sales and in our own domestic markets where we have our own presence, it's Australia and Canada mainly. All in all, the partner sales has been fairly strong compared with last year for the first 6 months. Okay, next slide, please. I won't delve in too much on this by business segment. It's clear that the -- what Torbjörn said previously that, segment imaging IT, that this is the driver of the nominal growth so far during the year. That's where the main bulk comes from.Going into earnings on the next slide. We see that not only the revenue but in the terms of earnings, Imaging has had a strong start of the year, the first 6 months. When we see -- when a few comments might be in place with business innovation and other operations considering the gloomy outcome of those bars, business innovation is in a product-generation shift, both in orthopedics and in medical education actually. And that impacts the financial performance adversely in the short term. Interest in customers is significant but that's nothing that has materialized in terms of earnings in the short term. Those of you who have been us -- with us for a while know that we have a new management in both of these areas since quite a short time back, and there is obviously a focus on accelerating the rollout of the products in those areas. As for the other operations, that's the group joint functions for administration, recruitment, finance, information and marketing and investor relations. And we have increased costs in the period here and it's mainly increased external consultancy costs and the larger extent they are temporary in nature. That's what we can say about now. Okay, next slide, please. As for cash position, we are SEK 40 million stronger in net cash position now than compared with the end of October last year. And as you know, if you look at the balance sheet, the interest-bearing debt is actually just the convertible debentures, which is an incentive program, which is of lesser magnitude in relation to the balance sheet as a total. So the cash flow from operation after changing the working capital is close to SEK 198 million, and it was SEK 75 million in the corresponding year last year. That is another SEK 25 million improvement. Now that he comes from different sources, obviously, but mainly, the main explanation is that the capital tied up in accounts receivable has decreased and to some extent, that is obviously variation within the normal, but to some extent I would say it's an effect of us having worked quite focused on cash management issues for some time now. And that plays out in this -- these numbers as well. But that's a long-run game obviously. So in this area, I think, we have a quite a nice traction until now. So that was everything from me. Torbjörn, next slide.

[Torbjörn Kronander, President, CEO & Director]

Okay, highlights after the period on next slide. Imaging IT Solutions, we have a Northern Pathology Imaging Co-Operative, which is a research project in the U.K., but we provide the platform for it, which is a strong thing to do because it involves some of the most forward-looking hospitals in pathology in the U.K. Next slide. Also in Imaging IT Solutions, we have opened a new distribution in South Korea where we have not been present at all before. We had nothing in radiology in South Korea, but our digital pathology paves the way to come into that important market and we've signed a distribution agreement with HuminTec in Seoul. Next slide. Local and global presence. We do have sales -- direct sales in 19 countries now. France medical and Finland security were established 2015, 2016. In Canada, we established ourselves in 2016, '17. And now the growth in these markets when you establish a direct sales relation that takes time. And these are not profitable, either one of them so far, but both present good opportunities going forward. We also sell through partner sales in selected markets and business units. In education, for instance, sales is almost exclusively through partners. We have customers in more than 60 countries, and our largest markets are Scandinavia, U.S., U.K. and the Netherlands. Next slide. We just came back from RSNA in Chicago, which is the world's largest radiology exhibition with almost 60,000 people together. We had the booth, you see on the image and I must say, we are very positive from the outcome from this RSNA. We had a record attendance in the booth and especially from large customers in the U.S. and some other countries. Next slide. Our way forward. Next slide. We can say that compared to historically everything is the same in the world as it ever was. Next slide. Customer satisfaction drives all business. It's very important not to forget that it's how market economy works. We are, for the fifth year in a row, highest-rated of all vendors for large hospitals in the U.S. -- U.S.A. We have the happiest the customers with a good margin. We are also, for the fourth year in a row, we have only measured it for 4 years, the highest customer satisfaction globally when KLAS measured it. And KLAS is an independent institute in Salt Lake City in Utah.Next slide, Deming is an old guru in quality and this is so true still. Profit in business mainly comes from repeat customers, customers that boast about your project or service and bring friends with them. That was phrased in the '50s and of course, it's still completely valid. Our philosophy for our shareholders stands, they have not changed. If you have happy customers, if you have happy employees, if you have reasonable cost control and perseverance and if you have a good vision going forward, shareholders will be happy. And it's -- that has been our motto and that has led to what we are becoming or have become today.Next slide. Yet everything is different. We're seeing -- in cybersecurity, we have the rise of quantum computers, which will turn the security world upside down, more or less all of Internet security and all certificate security of the Internet or all the Internet banking is at risk of being compromised when someone finally builds a quantum computer. There are quantum computers working today, but they are not big enough. There are not enough qubits in them in order to solve the problems that solved to breach or, yes, or to, what you call, breach an encryption, that is used in Internet. But nobody know or even when they will be for real. Perhaps they already exist. If one of the large companies cracked this, they would not tell anyone. This is a big change on the rise in the cybersecurity that people -- few people realize yet. Next slide. In the medical side and the security side, we also have the artificial landscape -- artificial intelligence landscape. This, of course, feeds through our phones with voice recognition and image recognition software, but it also feeds or changes the world of both medical and security. Next slide. Both healthcare and cybersecurity are adapting rapid change. We had a board member once that minted the nice phrase, "where there is change, there is margin." Our task, of course, to be fast and take care of the advantage when an opening space opens up. Next slide. Being a shareholder in Sectra. Next slide. Why should you be that? Well, we have high customer satisfaction. We have a strong brand in markets where trust is critical. Brand has different values in different markets, but we are -- areas where we have to trust the vendors. There are large barriers of entries in cybersecurity and medical IT. We are profitable. We have a strong cash flow and we have a solid balance sheet. We have substantial and increasing recurring revenue. We're positioned in niche market with substantial underlying growth. We are trying to avoid markets where we are not growing. All management own shares in the company. And we have sustainable investments in R&D with exciting opportunities in what I already explained before. Next slide. Upcoming financial report, Capital Market Day and Annual General Meeting. January 17, we will have Capital Markets Day, the exact location is not yet decided but that will be on our web page as soon as we decide. It will be Stockholm or Linköping. 6th of March, we have a 9-month interim report. May 28, year-end report and September 5, we will have our Annual General Meeting in Linköping, Sweden. Next slide. Obviously, I would like to remind you that these presentations are not done for our own sake. It's done for your sake. If you think they can improve in any way or we can do something clear or better, please tell us by going to the web page we have provided there, www.sectra.com/irsurvey. And then I open up -- next slide, we open up for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Hans Mähler of Nordea Markets.

[Hans Mähler, Director of Healthcare]

I have a few questions. First on the U.S. market. You made good progress in the quarter and I assume you gained a lot of the market share there, but how would you describe the underlying market? We have seen a period of very strong growth for the equipment makers. Could you elaborate a little bit on how the underlying market for your products evolves? And also secondly, on the FDA approval of your digital pathology product, do you have any visibility on timing for this approval for the scanner? Or is it just one particular scanner or other scanners that has been filed that you can sort of rely on?

[Torbjörn Kronander, President, CEO & Director]

All right. In the U.S. market, there is -- it's kind of been a little slow historically over the last 3 or 4 years. Obamacare has created quite a lot of hesitation, but demand is still there and demand builds up but we see a loosening in investments in U.S. markets. We also see huge consolidation. Hospitals are now becoming chains of hospitals, and this, of course, drives change. When these large organizations become bigger, they need IT systems that grow with them. Scalability without taking the system down is an important factor and that is actually a strength of ours. So the underlying [indiscernible] we cannot save money anymore, we have to invest combined with the consolidation that drives big changes in the U.S., I would say. The second question is the FDA for pathology and as you rightfully said and I said in the presentation, we are depending on our scanner. We are right now trusting one scanner we know has been filed. And then as to filing application, it takes normally 3 months to perhaps 6 for application to be approved and when that is approved, we can file. Our application is actually complete here. It's just lying for the scanner to be approved -- lying waiting for the scanner to be approved. And unfortunately, we are bound by that. Now it should be pointed out though that we can sell pathology in the U.S. Despite of this we cannot sell it for primary diagnosis, but as a substantial part of pathology is not primary needs. It's secondary consultations with no treats or actually consultations from overseas to U.S. hospitals where they can have other countries and the FDA do not require FDA certification for actually diagnosing citizens who are not American. So it's not completely soft in the U.S. We do have substantial [indiscernible] of course, we will be much better when we get our approval finally.

[Hans Mähler, Director of Healthcare]

And it's correct to assume that it will be a 510(k) process given that you have a similar product already approved in the market?

[Torbjörn Kronander, President, CEO & Director]

That is correct. It will be a 510(k).

[Hans Mähler, Director of Healthcare]

And also following up on the first question, would you be able to give a growth number where you think the underlying market for Imaging IT is up in the U.S. currently?

[Torbjörn Kronander, President, CEO & Director]

That will be giving a forecast and we don't do that. We do have a fairly small market share. And we are growing good. How fast? That would be -- will be something we cannot -- we don't know. And if we knew, we can tell you.

[Operator]

[Operator Instructions] Okay, there seems to me no further questions at this time, so I'll hand back to our speakers for the closing comments.

[Torbjörn Kronander, President, CEO & Director]

We have received a few questions over e-mail here. And I'll have Helena who will actually read them for you now.

[Helena Pettersson, Chief Investor Relations Officer]

The first question is sales growth has been very stable last year, what explains the organic growth was now down for the first time in 4 years?

[Torbjörn Kronander, President, CEO & Director]

Again, we had a extreme quarter 2 last year. This -- actually this year was the second largest order intake in a quarter 2 we ever had. We have large variations between the quarter. In this case, we had a very good quarter 2 last fiscal year.

[Helena Pettersson, Chief Investor Relations Officer]

I also have another question. For the enterprise solutions deals in the U.S., are they paid mostly upfront by the customer or with a software-as-a-service model?

[Torbjörn Kronander, President, CEO & Director]

In the U.S., we -- mainly, it's CapEx. It's paid upfront by the customers. As you see, we have told in the report we have 60% to 70% of the order intake now will be -- is estimated to be revenue within 6 months. Last quarter, we had 40% to 50%. This reflects a little also the difference in sales in the U.S. where it's shorter cycles. Many service contracts with payments over many years, for instance, is almost predominantly done in the U.K. And in the U.S., it's mainly CapEx.

[Helena Pettersson, Chief Investor Relations Officer]

No further questions from the line.

[Torbjörn Kronander, President, CEO & Director]

All right, so that was all the questions. Then I would like to close this session. I thank you -- say thank you very much for listening, and wish you all good holidays and see you next year. Thank you very much.