Sectra AB

STO:SECT B

Earnings Call Transcript 2023-Q2

[Helena Pettersson, executive]

Good morning and welcome to Sectra's 6-Month Report Presentation with CEO, Torbjorn Kronander; and CFO, Jessica Holmquist. My name is Helena Pettersson, Investor Relations Officer, and I will be the moderator of the Q&A session later. The chat function is open from start and you are welcome to write questions during management's presentation.

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

[Torbjorn Kronander, executive]

All right. Welcome to our half year or 6-month interim report. We will start with interim highlights; we'll go to financial development presented by Jessica, our CFO; and then I will briefly tell you a little about our way forward and then we'll have the Q&A session. Note that, as Helena said, the chat function is open all the time. Sectra's main business line is Imaging IT solutions handling image management or handling images in health care. We started doing radiology, but we have extended that into pathology and other ologies as well. And image management is a very, very large portion or what is needed or data usage in hospitals. Imaging IT solutions is our largest business area between 85% and 90% of the company. Then we have IT- security solutions, mainly encryption for communication purposes and some monitoring of critical infrastructure. And then we have our growth opportunities, little greenhouse.

We have medical education which is kind of started by removing the cadavers or dissections by medical students, but we now have extended that and we have very large good progress in growing that though it comes from a small number from the start. Orthopedics IT developing specialized tool for the largest customers of radiology, which is orthopedics, and we do research. Inside Sectra Communications, we have also IT security for critical infrastructure and we have in Imaging IT, digital pathology and integrated diagnostics we've added. In the last quarter report, we reported we added now Genomics IT, a rapidly growing more or less extension of digital pathology, which is called molecular pathology. Q2 highlights. We have all-time high contracted order bookings. It's a combination of very large systems. Consolidation of health care is ongoing and we see larger and larger customers. Of course that means also fewer contracts but if you win them, they are very often very large.

It can be hundreds of hospitals in 1 deal and we have longer-term contracts, which means the order intake becomes very large, those spread out over long time. We have made 2 substantial Sectra One contracts during the period. Now we want to point out again we have significant quarterly variations due to very large individual orders and if we do license installations as we still do in some cases, we might have large revenue change between quarters also because when these are delivered, it makes a big difference when these large contracts are so substantially in our figures. We are transforming from a license-based company to a software-as-a-service company and this we have discussed for several years now. We are in the middle of that. We see a rapidly increasing wishful customers to buy services of a product with an upfront license sales and that is we have good progress in everything.

But we have very interesting recurring revenue increase, which of course in the software-as-a-service becomes the major parameter you look at and this is a 6-month compare to 6-month previous year. The financial targets for the group, which are from the last year a hygiene factor of equity to assets ratio. Many customers say today that the packs, the imaging management system that we deliver is the most critical IT systems of the overall systems in a hospital. You don't buy these from 3 guys in garage. You need a trustworthy company that you trust that is long term and then customers also want financial stability. So our equity assets ratio should be above 30%, it's currently at 52%. When this is fulfilled, the priority #2 also in our view a hygiene factor is profitability. That's more or less a check that we do at the business, but we have a target of 50%. Some people say that's too low, we think it's okay.

If we use what comes over that or we could use that for growth of profits, which is the third priority goal, but the most important. Long-term EBIT per share growth over the 5-year period should be above 50% and we are well above that at 84% now. We do invest, but we could have taken out profitability in future growth instead. In Sectra Communications, our encryption division, we have seen growing demands. Larger and more prospects not the least driven by the Ukraine security situation, but also from a general trend in society that cybercrime is becoming a very big problem for society and that means you need more cybersecurity. We have a lot of procurement and deliveries in focus right now. We are working on component shortages, but we see a light at the end of the tunnel of that. And we have a new President, Magnus Skogberg, who joined us in June but became the President of Sectra Communications in August 2022.

The impact of the Ukraine crisis, we see increasing demand of cybersecurity overall. We see especially secure communications encryption needs. It's also an interesting thing that the critical infrastructure in society has become very highlighted by the crisis and we see an increasing understanding of the importance of critical infrastructure and how it's important to protect that also for cyber. As Sweden has now applied to become a member of the NATO, it will increase the market because we're already approved for usage in both EU and NATO with most of our products and that means that where we have that larger market, we can sell into it much more easily. Business innovation, our greenhouse, we see increasing recurring revenues. We have orthopedics and we have increasing synergies with radiology. Orthopedics is the largest individual customer group of radiologists and we have by far the best tools for orthopedics and musculoskeletal disease functionality of all our competitors.

So we see increasing synergies with radiology. Medical education, we have started a new web portal that has led to dramatic increased usage from our users all over the world. And we also have the genomics product that we just started, When we did a press release of that, we saw large clinical interest. Genomics is a problem in health care today. Next generation sequencing is becoming something you do in all patients in cancer treatment or cancer diagnosis and of course that needs to become unindustrialized and that was what we see today happening. Though we are far away from revenues in that sector, yet the interest is promising. In Imaging IT solutions, our biggest area, we see a growing customer base all over the world but especially in the United States. We have transitioned into software-as-a-service and cloud deliveries. And we have cloud recurring revenue, our measure of how much recurring revenue we sell as a cloud service, increase by 30%.

We are more and more selling what we call Sectra One that compared to Microsoft Office in normal office applications. We can have all of these different Word and Excel, et cetera, in 1 single contract and we are going there as well. We are selling Sectra One subscriptions and they need to use all our products within that area and there is a large increase in interest in that from all over the world and we are now adding genomics. You can also do in the future genomics analysis and diagnosis in the Sectra One framework. We just came back from our largest exhibition that is a Radiological Society of North America that is the week after Thanksgiving every year. We had a very good booth and we had an extremely busy show. Our number of booth visits was increased by 1/3 and nothing short of a success on that one. And you see a picture of our staff at that exhibition on the picture.

We were also there named a Cybersecurity Transparent Leader by Censinet and KLAS to independent organizations from Sectra and this shows increasing synergies between our cybersecurity department or area and medical. This is becoming a major issue for health care IT today. Health care is 1 of the most vulnerable industrial areas of all society for cybercrime and CIOs all over the world are increasingly concerned about it. So there were good recognition between the 2 parts of Sectra, major parts.

Then I'll leave the word to Jessica who will tell you the financial development of the company.

[Jessica Holmquist, executive]

Thank you and good morning. I will start this part of the presentation by doing a quick recap on the changes to our financial reporting that we are having this year triggered of course by the transition into selling software-as-a-service. With a change in business model towards more and more service delivery over time, we will gradually see an increase in the share of revenues that are recognized over time and therefore, in Q4 we communicated that we introduced new reporting measures this year. The changes mean that during a transition period of 2 years, we will provide more detail on order intake than what we have done previously and then after 2 years, we will stop reporting order intake as it will become less important for understanding our business going forward. Instead, we will increase the focus on recurring revenue. And as part of that, we introduced an alternative performance measure called cloud recurring revenue telling us what share of the recurring revenue that comes from our cloud contracts.

Contracted order bookings are at SEK 2.9 billion for the first half of this fiscal year and guaranteed order intake is just about SEK 1.3 billion. The inflow orders has continued to be strong during the second quarter. In addition to the 2 multi-year contracts secured during Q1, several smaller and mid-sized orders or contracts have been signed such as Sectra One for Boston Medical Center and Sectra One Cloud for University of Rochester to mention just a couple. And in Secure Communications, the Dutch Ministry of Defense placed an order for expanded use of Tiger/S. Looking at net sales and recurring revenue. Net sales for the first 6 months increased by 27% to SEK 1.046 billion. This is the result of a growing customer base and also increased sales on existing customers. We also do have a strong currency impact -- strong currency tailwind with substantial impact on our sales. Adjusting for currency impact, net sales grew by 16%.

Recurring revenue continues to grow, up 19% versus the comparable period representing around 60% of total revenues. Looking at Cloud recurring revenue, we also see a positive trend with 30% growth up to SEK 110 million for the first 6 months of the year. And looking at the second quarter isolated, sales increased by 34% to SEK 562 million. We grew in all business segments. Majority of growth comes from Imaging IT up 27%. But also in Secure Communications, top line increased by 20% to SEK 93 million and we see that the market situation is gradually normalizing although with certain challenges in terms of an increased demand in combination with the strained labor market and shortage of components. We also have growth in Business Innovation plus 12% and a positive trend on recurring revenue. We grew in 5 out of 6 geographic markets where we are present and in the sixth we're in line with previous year.

The pattern from previous reporting periods remain. We have the highest growth in the U.S., the U.K. and the Swedish markets. And in what we call rest of Europe and rest of world, we increased -- we had the highest growth in Denmark, Portugal and Australia. Moving on to operating profit. Operating profit for the first 6 months of the year amounted to SEK 172 million, which is in line with last year, but at a somewhat lower operating margin of 16.4%. We continue to invest in delivery capacity and to secure execution of the large customer contracts recently won and also of course to support further growth. There have also been much more activities around the world in terms of events and user group meetings and internal trainings and of course a need to meet with customers again after the pandemic, which has impacted the overall cost level.

Operating profit by business segment. Imaging IT has year-to-date generated SEK 191 million at a margin of 20%. A solid start or a solid first half of the year with earnings impacted by the strengthening of the organization as well as higher cost for marketing and travel versus the comparable period. Secure Communications has a negative operating profit year-to-date that reached break even in the second quarter, which is a step in the right direction and focus on deliveries, marketing and sales is expected to improve earnings over time. Cash flow from operations are negative year-to-date by SEK 25 million mainly as a result of settling our current liabilities during Q1. Cash flow from operations in the second quarter was positive at SEK 39 million. And the overall cash position remains strong with cash and cash equivalents of SEK 544 million at the end of October.

And with that, over to you, Torbjorn.

[Torbjorn Kronander, executive]

Right. Thank you. I'd like to reiterate our philosophy for shareholders. We think that with a good position in growing markets, you have to select your market, you start there and then you go very much for happy customers and you cannot have happy customers unless you have happy employees. And then if you have some perseverance and reasonable cost control, shareholders will be happy. I think we proved that over the last years over all Sectra's history actually and that is the general way we handle our business. In cybersecurity, going forward we see that as said before demand for cybersecurity is increasing. Society and defense communications must function and must be secure. And we have built a very sensitive society and the demand for cybersecurity will continue to increase both with increasing tensions in society, but also afterward will make society more and more vulnerable to IT attacks.

The crisis in Europe drives demand. We see a clear increase in demand on that one. And we protect society both against criminals, mafia. There is cyber mafia out there attacking not the lease health care, but also against national actors and terrorism who can attack very critical functions in society by Internet, which is of course very, very dangerous. In medical markets, we see the demographic situation means that society must address primarily the age related diseases. We have a demographic situation in most of the world that means we will get more ageing people and less people to provide healthcare for them. And in order to handle that cost explosion in health care, society must address the age related diseases which is neurodegenerative disease, cardiovascular disease, cancer, musculoskeletal disease and vision and hearing. And that is what we really are focusing our general capabilities, but we of course do medical imaging for all areas of health care as well.

We have added genetics, which in our at least first version of it will address solid tumors and sequencing of cancer diagnosis. Compared to competition in medical, you see some of the most important competitors of the years. Many of those have acquired and been acquired and this is a very disturbing situation for customers. You buy 1 system and then that company is acquired and you end up with something completely different. Now Sectra has been doing the same business. We have never sunset the customer and we have no forklift upgrades. If you were our customer like Visby Hospital, which is the first hospital where we did in 1994, they are still our customer. So we are much more long term than our competitors, which is increasingly appreciated by the market. We have also, as we said before, increasing recurring revenue. We have a large interest in paper usage.

Liquidity of health care is reduced after the COVID crisis not the least in the U.S. and people like to pay for usage instead of having a large upfront investment. Sectra One will clearly dominate future sales in medical IT. Actually we anticipated strong growth in cloud deliveries, but is definitely even more than we anticipated. Now we see almost all businesses, all these were discussing cloud business. The transition will mean that apparent revenue and profits will look smaller despite real large growth in real usage. That is because the upfront license is not anymore there. It's spread out over many years going forward. But long term the financial effects will be very strongly positive because customers continue to pay the same amount also after the normal amortization period is over. Sectra is well positioned in this market analysis. Profitable growth, as I said, it's easier in growing markets and ideally it's a market forced to grow by external factors and both cybersecurity and health care are such markets.

Health care must address the disease of the elderly or it will be really troublesome to keep the welfare states we've gotten used to. In cybersecurity because of the increasing complexity and increasing attack vectors into computerized societies that these markers have to invest. Might be a low tide or a high tide in the general economy, investment in these 2 markets has to go on anyways. We also have added Genomics IT for clinical production. Genomics IT have or genomic sequences of solid tumors have been going on for long time, but it's been done with research tools and it's now becoming mainstream business. Many hospital do it more or less for all cancer patients. That means it becomes industry production and efficiency of the tools become paramount and that's exactly our soft spot. We are very good on taking medical practice into production, so-called industrialization of health care in a very positive way.

Industrialization means you do things very efficiently, but also with the predictably quality of care. So this is work and the predicted market CAGR of genomics is a large as 19% of the overseeable future. And repeating our upcoming financial events. We have a Capital Market Day, which is in-person event in Stockholm. We really invite you to come there. We will go much more in depth than we will do in this both in our old areas and also the new areas. And then we have a 9-month report in March 10 and we have a year-end report in June 2. And we have Annual General Meeting in September 7, 2023. Also remember your feedback to these presentations is important. So if you have any, we do this for you not for us. So if you think we can do it better or can be clearer, please give us feedback and we'll modify the presentations if we can along your wishes.

And then we'll leave it over to questions. If you follow online, please use the chat functions. And we have received a few e-mails already or chats already and Helena will read these now and can try to respond to them. Helena?

[Helena Pettersson, executive]

Yes. And the first questions come from Kristofer Liljeberg of Carnegie. Would it be possible to give a figure for how large portion of the order intake year-to-date is for SaaS versus traditional license model? Has the proportion changed in the last 12 months?

[Torbjorn Kronander, executive]

We don't publish a proportion of the order intake. We of course tell now the proportion of the revenues, but not the order. The order intake is very often mixed. A typical large installation of a software-as-a-service customer is both services which always come upfront, but also the long-term contracts. But we don't publish that. I can be very clear that it has increased a lot, but we don't break it down on that way right now.

[Helena Pettersson, executive]

And a follow-up question on that from Kristofer is are there any large SaaS contracts that will trigger a step change in recurring revenue or will it continue to gradually increase?

[Torbjorn Kronander, executive]

Some of our contracts and some of the discussions we are doing are very large. Of course if you lose them, you see nothing; but if you win them, you see something. And as they are so large mainly because consolidation in health care, contracts are much bigger now. It might be hundreds of -- at least tens of hospitals once in 1 contract. So we will definitely increases step-wise. Though as also these are spread out over time, they will not be enormous. But any such change is important.

[Helena Pettersson, executive]

Okay. I know Kristofer has more questions, but I will take a few from online first. And the first one is could you please comment on customer behavior in the U.S. in Imaging IT? Notably how many customers are you engaging with currently and how does that compare to previous quarters?

[Torbjorn Kronander, executive]

I don't really understand that question, but I'll try to detail my interpretation. So we have about a couple of hundred customers in the U.S. They are, as I said before, centralized. The behavior is more or less the same, but we see a liquidity problem in U.S. that we have not heard before. There is a huge cost pressure on U.S. health care right now and that is more pronounced, which has also led to that customers like the idea of paying as you go instead of paying upfront. That is the main difference in customer behavior we've seen over the last year.

[Helena Pettersson, executive]

And the second question from online. Could you comment on your win rate in competitive bids?

[Torbjorn Kronander, executive]

It's difficult. It varies very much on different markets. Some bids we do not want to win and of course we lose those. So it's very difficult to say the win rates. It's also different deals. Some are for enterprise imaging, that means people want or our customers want all imaging handled in hospital. In those we very often win because we are still the only vendor who can do pathology, radiology and all those different image types in 1 single system. If it's a 1 ology single like pathology alone or radiology alone, it's more of a equal race and then we sometimes lose and we sometimes win as normal in all businesses.

[Helena Pettersson, executive]

Next question. Do you have significant go live or ramp up in pay per usage contracts incoming?

[Torbjorn Kronander, executive]

As I said, the interest is increasing. There is a much higher percentage of customers and by far the majority of big deals we're discussing now are recurring revenue deals.

[Helena Pettersson, executive]

And then I have 1 more question from Kristofer Liljeberg at Carnegie. Can you please comment if the high nonrecurring revenue for Imaging IT came from a specific large contract?

[Torbjorn Kronander, executive]

There has been quite a few license deals sold before and we saw that big change that has been delivered over the quarter.

[Helena Pettersson, executive]

And then right now there is only 1 questions left online and that is could you help us understand better your cardiology solution and how it is positioned in the market versus competition?

[Torbjorn Kronander, executive]

We see cardiology as an extension of the general imaging system we do. Cardiology is 1 of the areas where we also use partners. So we have a fully functional system, but we have sub-contractors that do part of the very advanced functions you need for cardiology. We are increasing those ourselves, but we still are -- mainly the advanced functions are delivered by partnering with other companies.

[Helena Pettersson, executive]

Okay. Then we don't have any more questions for today.

[Torbjorn Kronander, executive]

All right. Thank you very much for your attendance. And looking forward to see as many of you as possible on our Capital Market Day in January. Goodbye and Merry Christmas to you all.