Sectra AB

STO:SECT B

Earnings Call Transcript 2022-Q3

[Helena Pettersson, executive]

Welcome to Sectra's financial report presentation with CEO, Torbjorn Kronander; and CFO, Mats Franzen. My name is Helena Pettersson, Investor Relations Officer, and I will be moderator of the Q&A session later. The chat function is open from start, and you are welcome to ask questions during the presentations. Management will handle them after their presentations.

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

[Torbjorn Kronander, executive]

All right. Thank you very much. We have our 9-month interim report. And we will start with the Q3 highlights, and then we'll go, Mats Franzen, our CFO, will take over financial development presentation. I'll come back and talk about our way forward, and then we'll have a Q&A session at the very end. You can put your questions as Helena said, in chat or in emails.

The value we create for customers, et cetera, is in medical, medical diagnostics based on images primarily, that's by huge extent of the largest business area. We do see Secure Communications, security on the highest conceivable levels for communications especially and also monitoring of critical infrastructure. And then we have our greenhouse with Business Innovation and that does orthopedics imaging, which is quite different. That's more therapeutic planning and follow-up, and then the diagnostics part done in Imaging IT. And we do medical education, which is a rapidly growing area all over the world.

Q3 highlights. We are very happy that we, for the ninth year in a row, won Best in KLAS for large hospitals in the United States. We also won the small hospitals. We won in Canada, and we won in Asia/Oceania. Asia/Oceania is the first time we have received Best in KLAS. KLAS is a US corporation that does evaluations of products in medical IT especially, in EMRs, other areas, but also our area in PACS. And that is radiology PACS in the United States. And having the happiest customers is for us a very kind of encouraging and very motivating thing is also good for business. Most customers will look in this when they buy a new product, a large product of this size or importance is something you want to see how others are doing before they buy it.

The 9-month figures in general, net sales increased by 17.5% to SEK 1.3 billion. The profit per share increased by 49% and the recurring revenue, which is increasingly important, and that we do measure and follow up now. As we're moving the entire company into recurring revenue base, more than CapEx-based, increased by almost 12% to SEK 800 million. The financial targets for the group were all fulfilled. They are in priority from equity/assets ratio, providing stability for customers and ourselves, of course. Profitability, that's the operating margin. Our target is 15%. That might seem a bit low on -- for a software company, but we have chosen to keep it there. Due to the cost reductions during the pandemic, it has increased, but we do not intend to have it at the current level. We want to invest this in the most important target, which is growth of profits. And EBIT per share growth over a 5-year period should be above 50%, and that we are almost 3x higher right now.

Next slide. Specific uncertainties. Of course, right now, there's a crisis in Eastern Europe, invasion of Ukraine. That is not affecting us a lot, at least not in the short range. We do not have any -- we have a very small business in the eastern part of Europe and Russia, and we have no sub-suppliers in Russia or in that part of the world. Then we have COVID-19 pandemic, which is decreasing in importance right now and how fast that goes is very different in different countries. But most of our business is coming back to basics, but the world has learned quite a lot. We don't expect the travel and the cost levels come back to where we were before the pandemic, but we will end up somewhere in between.

In Secure Communications, we got a 5-year framework agreement with the Dutch Ministry of Defense. We have more or less 2 home markets, Sweden and Netherlands. And so in the Netherlands, we are approved also for NATO and EU. There is PACS 2 company -- 2 countries to be approved for EU sequencing, and we have both Sweden and Netherlands to stand on. In NATO, we go through the Dutch to [ sell Internet ].

We have, however, been having inadequate financial development in our communications side. It has been heavily inflicted by not being able to travel and also not being able to deliver our most qualified product needs to be delivered by courier. And if you can't travel, you can't deliver. We also see a very long delivery times on some strategic components. This is hardware, and that is also affecting us. We have a new Acting President from January 1. We are looking for permanent President as we are talking.

The Secure Communications impact of the Ukraine, again, is increasing interest but slow market. We do see that the cybersecurity threats that are imposed by, especially Russia, has resulted in increasing interest for cybersecurity and cybersecurity product. But it's a slow market. We will not see any effects in the short term on the communication space in that. In Business Innovation, our Q3 highlights, that we got the Region Vestfold, which is a substantial part of the west part of Norway, has orders starting doing Implant Movement Analysis, which is a postoperative follow-up of patient implants, which is very important because it determines if you need to re-operate or revision a previously done implant operation or if you can solve it by some other means. We also see that results vary significantly between quarters in the relatively small business units. Focus on the -- both of these is the increased recurring revenue. So top line growth will not be -- would have been in normal times as we are moving over to recurring revenue focus.

In growth initiatives, in this area, is the new orthopedic area, which is, as I said before, Implant Movement Analysis, which determines if you need to revision operation or not. A revision of a previously inserted implant is extremely expensive and also quite dangerous. If we can reduce the number of revisions, you have to do by seeing if the implant is indeed stuck or not, you can save quite a lot of money for and time for surgery. We also have a version of that. That is done, used by research, more or less the same technology, but you evaluate if prosthesis are good or not, that is also growing. And in medical education, we are positioning from a business where we sold to you this huge kind of item like tables for theater demonstrations for patients, or for students into a service where we have cloud-based content subscriptions. We have quite an extensive set of examples of medical diseases and medical situations that will now allow customers to subscribe to. And that is a rapidly increasing part of that business.

In research, we are focusing on AI for medical applications in diagnostics, and we're also looking at the future applications and areas. We have 4 to 5 PhD students working in that area. They are PhD students on half the time and they work on research for second half the time. In Imaging IT, Q3 highlights, Emory Healthcare, a previous radiology customer and one of the Ivy League Hospitals in the US, expanded enterprise imaging to include digital pathology. This is an important trend that we see previous radiology customers extending into other ologies as well, becoming enterprise customers instead of just radiology customers. We have also Sectra One subscription service ordered by Medical University of South Carolina Health in United States, also a very prominent university. And we have ophthalmology, which is a new ology for us in eye care, had been deployed and is now operational at a major US customer, one of the largest chains in the US.

In Imaging IT, we have growth initiatives in new markets. We have contracted an indirect sales region to South America, which is an area where we have not been present before. We have enterprise imaging, and we are the only vendor who today can do all images in the hospital in one single IT system. And this is important for the -- for both the CIOs, as well as for the cost structure of the hospital. Digital pathology and integrated diagnostics between radiology and pathology, cardiology is added and ophthalmology is new. We are focused on the US, and that's by far the world's largest market in medical IT. We top customer satisfaction, but we have not a very large market share. And this is a place where we can grow. We have more difficulty growing in countries where we perhaps already have 70% to 80% market share.

Then I'll leave the word to Mats Franzen for the financial development.

[Mats Franzén, executive]

Thank you very much, Torbjorn. As usual, for those of you who follow us, we start with the order intake. And as you know, you have seen the -- as previous quarters, a lower number [ 2% ]. This is in line with our own expectations, considering that we had a tremendous comparable year that goes for all 4 quarters. We do have a good traction on sales. Now after 3 quarters, we are up 17.5%. Currency-neutral, that's 1 percentage point below that. This is -- for this year, the first quarter, when we actually have some tailwind on currency for the full period. For the first 2, we had some slight headwinds up against this. But as you know, the Swedish krona has deteriorated quite significantly in relation to major currencies we trade in, and that's especially the U.S. and the pound sterling.

So you see the numbers on the slide. They are almost 10% for the US dollar, which is big for us. As we speak, comparing now as we are pretty much halfway through the fourth quarter compared with balance sheet date end of January, we have seen a further deterioration of the SEK, about 4% against the euro and the pound and some 6% to 7% or 6.5% on the US dollar. Now the sales by geography, we see that the US is indeed a strong contributor alongside United Kingdom and the rest of Europe. And the rest of Europe is primarily -- in absolute numbers, Norway, actually, when it comes to relative numbers and percentage growth, although that doesn't contribute that many millions yet. That's actually the French market, that is compared with quite insignificant numbers to start with. But it's nice to see progression there.

The sluggish trend in Sweden and the Netherlands is not related to Imaging IT. We're growing there as well, in Imaging IT. But there we have the effects of -- that Torbjorn mentioned previously related to Secure Communications that is hitting us somewhat. And when it comes to the rest of the world, it's as normal is the case, Australia, followed by the Canadian market, which also is progressing and promising.

And as it comes to business segment, it's Imaging IT, who carries the full weight actually on a net -- on a gross level here. We do see that Business Innovation have -- in relation to the size, made some progress actually. And I would say this, to a large extent, one should be aware of the fact that it's a small business segment and that we're up against quite a weak comparable quarter to start with. When it comes to other operations, it's actually we invoice and eliminating group elimination hike-up, I would say, in platform costs, especially on the IT side to be able to deliver scalable growth in the coming years.

And as for operational profits, I would say 3 factors contributing to Imaging IT Solution, carrying home the growth for us overall during these 3 quarters is the sheer size. Obviously, by a margin, the biggest segment for us. Also the sales development in lately also help with currency as lately. And that will also -- still, although the operating costs are increasing as we invest over the P&L in onboarding new resources in terms of personnel and travel and marketing. We do still have a slightly better operating margin in that sense. Business Innovation, as you can see, had a better traction in profit than in sales. But again, it's highly volatile between quarters in terms of both revenue and cost trajectories for that quite small business segment.

So I'm getting to the cash flow. We do see that, obviously, the increased operating profit brings home cash that is expected with a comparable year. We do always -- and this is also sort of compliant with previous year that the third quarter is normally a strong cash quarter for us. Also, this is the case for this year. And although we don't make any forecast to do projections, I am cautiously optimistic that we will have quite a nice cash generation in the fourth quarter without going into specifics. Where we do see some cash [ flow] tie up is in current receivables, but that's not really a surprise either.

So with that, back to you, Torbjorn.

[Torbjorn Kronander, executive]

All right. So a little bump on our way forward. Focus forward is continuous, of course, high customer satisfaction. That is what drives a specialized unit growth. But you cannot have happy customers unless you have happy employees and good cultures. We are working on that all the time. And as we presented last quarter, we were voted to be the fourth best employer in Sweden, which we are very happy for, but it comes for a reason. Without the happy employees, we can't have happy customers.

Profitable growth, we want to continue to grow, but in a profitable way and skate where the puck is going to be, which I will come back to a little bit later. First, I will say choose your markets. That's also very -- we have chosen markets which grows. Growth is easier in growing markets. Healthcare, IT and cybersecurity are both markets where society dynamics enforces growth. Cybersecurity will grow because of increasing threats and increasing digitalization around us. Healthcare, IT will grow because healthcare needs to become more effective and consolidation is very strong. And technologies provide more and more data that needs to be handled and managed in hospitals.

We have also presented our new focus on increasing recurring revenue. We are moving over to a large, interesting pay per usage. The Sectra One subscription model will dominate future sales in medical IT. We see already a very large interest and uptake of it, but we won't see the impact for over several years. During the transition, apparent revenue growth, top line growth will be smaller because we are kind of holding that initial large order and delivery into a recurring revenue model that will, in combination, be much larger than original sale, but it will be spread over the years. So we are now measuring also usage in our different areas because usage is actually driving this business. This is normal for IT. Almost all IT business around the world are moving over to a pay per usage and so are we. I would say, pay per usage or pay per [ for a ] time unit, one of these things. The long term, the financial effects would be strongly positive for the shareholders, et cetera. But in the short term, we will see reduced growth and profitability for a few years.

Order intake variation will continue to be very large. It's increasing due to healthcare consolidation. The deals are increasing. We see a very strong consolidation of healthcare providers and hospitals. In the US, they're buying each other. In Europe, they're working together more and more. Or if it's one public medical provider, it's merged to create larger and larger regions. And they buy IT as a combined entity, which means order intake increases and it's also long term. And so the deals will be very large going forward, but they will not come every day. Revenue and profit variation will gradually decrease because we get paid per usage a month and that is more stable.

This can be seen as the quarterly variation for the 9 months this year has been less up and down our variation than our historical pattern. And then skate where the puck is going to be. We need to work on what we are going to make a business from in 3 to 5 years, as well as providing good products today. We see the trends, consolidated hospitals and IT systems, and that is why we have already early started up to work a lot with enterprise imaging. Hospital providers do not want 1,000 IT systems, they want as few as ever possible. And we are the only provider currently in the world that can do all the images in one single system, reducing costs for hospitals a lot. And more or less creating a parallel system to the EMR, the electronic medical record system by handling the images, which is normally never done in the EMR itself.

New ologies, pathology, ophthalmologies coming in here. Pathologies right now a very large growth area, even though it comes from a much smaller level than radiology, of course, from the beginning. Ophthalmology is brand new. We only have one, but it's a large customer in the U.S. And ophthalmology is becoming more and more important, though it's much smaller than especially radiology, but also pathology. In cybersecurity, people are become -- becoming more and more mobile, they want to work from home. They've gotten used to working from home in the COVID pandemic, and, of course, they want as B2B as secure at home as they are on the workplace or on the road. There we see a large uptick for the interest of secure mobile workplaces, add to that the crisis and the growing concern for cybersecurity, we have a growth area there as well.

We do high-speed, very high-level security network infrastructures, and we also do see an increasing demand due to the crisis in, especially in Europe. In Business Innovation, we'll work on the entire image-based orthopedics planning and follow-up -- orthopedics surgery planning and follow-up process. And we also see that the life span of medical knowledge is becoming smaller and smaller, and it's not only education of universities. Becoming a medical doctor today or a nurse is to go into lifelong education of continuous education, and that is a rapidly increasing market as well.

Our philosophy of shareholders is quite simple, if you have happy customers, if you have happy employees, that's needed in order to create happy customers. And if you have a good position in growing markets, reasonable cost control, then shareholders will be happy, and I think we have proven that over the years. Upcoming financial reports and the Annual General Meeting. The next report -- the year-end report of this year will be June 3, 2022. And our Annual General Meeting will be in September 8, and hopefully, it will be fiscal, but that is not yet decided. And then I remind you that this -- your feedback is very important for us. If you have anything or comments on this on what you think about this presentation, please drop us an e-mail at [e-mail].

And then I leave over to questions.

[Helena Pettersson, executive]

Yes. And we have a few questions from the audience online. And if you have more questions, please start writing them. And I will turn the word to our analyst at Carnegie, Kristofer Liljeberg to start.

[Kristofer Liljeberg-Svensson, analyst]

Yes. I hope you could hear me okay? So I have a number of questions here, but maybe start with 3 of them. So the first one relates to order and whether you see an effect here on orders already from the transition of the revenue model or and if you have an impact from Omicron in the quarter, i.e., that is having been delayed? And the third question I have is regarding your comments about investments in medical IT. Should we see this bringing margin down to the Group financial target now after a few very strong years? And the reason I'm asking is that you, at the same time, say that operating costs will not come back to the pre-pandemic level. So maybe you could give a little bit more flavor how you're thinking about margin based on those 2 comments that you made?

[Torbjorn Kronander, executive]

All right. I'll reply. But that -- first the transition, the effect so far on revenue and profit is very small, but we see an increase coming. There are some effects already, but they are not significant. They will become larger, however. And...

[Kristofer Liljeberg-Svensson, analyst]

And -- sorry. And is that also true for orders? And frankly, will this change revenue model impact orders or will you book the entire deal in the order backlog, how are you thinking about that?

[Torbjorn Kronander, executive]

In orders, we will not see big. The order variation between quarters will be as large or even bigger than before because we also take a larger responsibility if we go to the cloud. So the order will continue to vary. The revenue and profit will be more stable, but also moving forward. Very often a hospital who orders things, they order for 5, 6 years forward, and then they say, we will buy that from you. So it's a very large order for perhaps a very large system, but we get paid for every year going forward instead of a gross sum upfront. Then for the next question was is Omicron or COVID has inflicted our order intake, well, some discussions has clearly become slowdown, but it's not a major effect. While some discussions has been slower than it would be a normal year due to travel restrictions and also a very large burden on the hospitals. And the third question was the transfer. Can you repeat the third question again, by the way, please?

[Kristofer Liljeberg-Svensson, analyst]

I'm just noticed that you have this margin target, and, of course, in recent years, the last 2 years, margin has been significantly above the target. And you still say that operating costs will remain below the pre-pandemic level, I guess, on a like-for-like basis, but also talking about that you want to invest more now in medical IT. So these 2 comments combined, what does it mean for margins?

[Torbjorn Kronander, executive]

The main change in the cost structure during the pandemic has been fewer exhibitions, which are expensive and less travel. Now all that travel that we did before, for instance, teaching customers and education of customers will not come back to normal levels. However, we have very interesting growth prospects and we need to invest, for instance, if we go into a new country or a new market, it takes several years before we get the first order, but we need to have people in the country. So we will come downwards from what we saw before. But we will also see that we might not come all the way and the cost structure will be different. We will not do as much travel as we did before, but we will invest in other areas.

[Kristofer Liljeberg-Svensson, analyst]

Okay. So what you're saying you're planning now to go directly in more additional countries?

[Torbjorn Kronander, executive]

No, I didn't say that. I said that if we do it and when we do it, it costs a lot of money. And right now, we are still investing in some of the new ones, but we see them growing rapidly, which is 2, 3 years later than we open up, but also indirect countries, we need to work with and it costs money in the beginning, that's for sure.

[Helena Pettersson, executive]

Okay. Thank you, Kristofer. Then I leave the world to -- word to Karl Noren at Danske Bank.

[Karl Norén, analyst]

So a couple of questions from my side as well. And if we start with 2 questions on the U.S., I'm just wondering if you could give any kind of indication of how the pipeline of larger contract is developing in the States? I think you wrote in a report that you have several larger procurement processes or that you are within several procurement processes. I'm just wondering if you could explain and elaborate a bit on how those ones are progressing and what kind of time frame we should expect before this one closes? And then a question on the competitive landscape in the U.S. Have you seen any changes in the competitive landscape? Are there any new competitors in the market or any other dynamic that we should be aware of? That will be my first 2 questions, please.

[Torbjorn Kronander, executive]

The first one is very difficult to reply to. We cannot tell you that. I can inform you and you can probably look at the net as well, that there are several very large processes going on, not only in the U.S. though. There are some very large going on in Europe as well. And that comes from the consolidation into consortia or larger groups that buy IT together in order to get synergies from growth. And I need to stop there. I cannot go forward on that question without making it more public than in the presentation. The second question was -- can you repeat the second question?

[Karl Norén, analyst]

Yes, it's on the competitive landscape in the U.S. and also in the Europe maybe that are you seeing any new competitors in the market or has the kind of dynamic changed or how would you describe it over the last, let's say, a year or so?

[Torbjorn Kronander, executive]

In the U.S., in radiology, specifically, we have had a strong competitor, but we have recently 1 or 2 deals against them, they are ProMedica's. But we only see them in the U.S., and they only have radiology. We are in enterprise imaging, which we see as our large growth area, where we actually handle all images in one single system. We do not have anyone that we know of in the world right now that has what we have. We are unique, but not all hospitals buy in that way. Some hospitals then regularly drives the business or pathology, for instance, sometimes the CIO gets involved much more and say, no, we want to consolidate as few IT systems as possible. In Europe, it's more varying competition. We see Philips, which acquired a company called Carestream, and that will compete with sometimes, but neither they have everything in one single IT system as we have. So it varies very much by local market. In the U.S., the strongest competitor have been Visage, but we are gaining on them right now.

[Karl Norén, analyst]

Okay. And then just a question on the outlook for Q4. I think you stated in the report that earnings in the next quarter will be impacted negatively by Secure Communications and a continued strengthening of the organization in Imaging IT. I'm just wondering, have we also -- have we seen this already in Q3 or I'm just trying to understand what's your kind of message is this year?

[Torbjorn Kronander, executive]

We are not having adequate margins in communications, as you can see in the report, if you look on the fine print at least, and we need to improve that. Now it doesn't mean the market doesn't exist. It's a heavily growing market, cybersecurity, but we have due to various reasons not been able to grow as we planned there.

[Karl Norén, analyst]

Okay. So it's not that Imaging IT margins will go down significantly? Because that's also maybe my last question on the long-term margins within Imaging IT, and also relating back to Kristofer's question that if you look at the Group EBIT margins are still about your target, but if we look for Imaging IT, it's, I think 28% on a rolling 12-month basis. I'm just wondering how we should see this developing going forward? I mean, you're saying that you are going to invest, but this is also your fastest-growing business area. So is this a stable sustainable margin level in Imaging IT or should we expect it to decline back to maybe 20% again?

[Torbjorn Kronander, executive]

I cannot. We do not give forecasts and predictions like that. I can only say that the transition in the cloud deliveries is also costly. We get revenue at a while when doing business on the cloud or in Sectra One, but we do have cost upfront in -- as in normal delivery. So that reduces margins as well. When most of the businesses over in the recurring revenue model, we have -- we will -- I think, and as most [ software ] has done, see very healthy margins, but there is a transition period before that happens.

[Helena Pettersson, executive]

Thank you, Karl. I will address some questions from the audience online. And the first one is, how would you describe the order pipeline in Imaging compared to last year?

[Torbjorn Kronander, executive]

We cannot divulge anything about the pipeline in a presentation like that unfortunately.

[Helena Pettersson, executive]

And the next one is, where do you position yourself versus Agfa HealthCare? If I'm not mistaken, Amsterdam UMC has chosen you for radiology, pathology software, but choose Agfa for enterprise-wide imaging?

[Torbjorn Kronander, executive]

Well, Agfa is one of the old competitors we've been -- have been competing with for many, many years. They are large. They come from the film business. They have had a struggle, but they are probably gradually getting out of that. Enterprise imaging is, however, quite differently defined in different areas. For enterprise imaging, by our definition is doing all the images in the hospital in one system, but for some, it's everything, but radiology and pathology, and, of course, that is not everything as we claim to be. So I don't know the details of the Amsterdam bid, but by far the largest business in a hospital like that is in radiology, pathology and cardiology.

[Helena Pettersson, executive]

And I think maybe this is already answered. But as Agfa HealthCare on the enterprise-wide imaging platform, could you have provided the same service?

[Torbjorn Kronander, executive]

I don't know the details. My estimate and my guess would be, yes, we could. But as I said before, sometimes there are special department with special needs that we don't even know about.

[Helena Pettersson, executive]

And that was the questions from online. I don't know if any of your analysts would like to ask more questions.

[Kristofer Liljeberg-Svensson, analyst]

Actually, it's Kristofer from Carnegie. Could I have one more?

[Helena Pettersson, executive]

Yes.

[Kristofer Liljeberg-Svensson, analyst]

Just on the financial net line positive with a big amount, is there some FX gains there or something else?

[Mats Franzén, executive]

We do -- yes. Thank you, Kristofer. No, we do not enter into any FX position. So it's not driven by any derivatives, but rather that we have internal loans quite significant in foreign currency to which we have -- which has helped us in revaluation in the quarter primarily.

[Karl Norén, analyst]

It's Karl here again. Maybe one -- just one last question from my side as well. On the financial targets, Torbjorn, I think we've discussed this a bit before, but when you now move into the cloud, do you see any reason to maybe revise your financial targets as of now, given that this will impact revenue growth and also earnings growth? I guess that's quite reasonable to see, but how do you see this?

[Torbjorn Kronander, executive]

I think during the transition, we hope to fulfill our financial goals. Also though we do a huge investment in future revenue when we go into the cloud, we hope to keep the targets we have. Long term, of course, is a reevaluation you do all the time when old customers are on the cloud, we have a completely different situation, and then it will be reevaluated at that time.

[Karl Norén, analyst]

Okay. And maybe just if I may, just one more because I listened to ProMedica's earnings call, and I mean they are also going in and focusing more on the European market. Can you say anything? You said earlier that you don't really see them yet, but what do you expect when they do more of a target that may be, what do you say, entrance into the European market, and I think the older have some contracts in Germany, for example?

[Torbjorn Kronander, executive]

We have -- and for the rest [ of the ] -- ProMedica is the owner company of Visage that I spoke about before. We have never lost anything to them in Europe. That doesn't mean we won't do it in the future. We know they have the development department in Germany now. So -- and they have some old relationship in Munich that they have extended. But we do not know what will happen going forward with them. And it is a very different market for radiology PACS in Europe and in the U.S. But otherwise, we haven't seen any large deals and we haven't lost to them in any head-to-head deal that we know of.

[Helena Pettersson, executive]

And we have no further questions from the online audience.

[Torbjorn Kronander, executive]

All right. Then we thank you for participating, and welcome back in June for our year-end report. Thank you, and goodbye.