Sectra AB (publ) (SECT-B.ST) Earnings Call Transcript & Summary

Good morning, and welcome to Sectra's financial report presentation with CEO, Torbjörn Kronander; and CFO, Jessica Holmquist. My name is Helena Pettersson, and I will help moderate the Q&A question after management presentation. The chat function is open from start, and you are most welcome to write your questions during the presentation. And with that, I hand over to you, Torbjörn.

All right, and good morning. We apologize we have some IT issues here this morning. So this is not done in a normal professional way, but we are -- fixes. So we do it in this improvised way instead. So 6 months report, I will begin with the interim highlights, and then Jessica will talk about financial development. I'll talk a little about the way forward, and then we have a Q&A session in the end. Highlights of the quarter. We have business in Imaging IT, our largest business unit, Business Innovation and Secure Communications. And Business Innovation is our greenhouse. And the big -- 2 big, I think people know, then we have education IT, which is used for education of medical and veterinary staff and students. We have orthopedics IT. We have our fairly new genomics IT. We have research department. We have IT security for critical infrastructure increasingly important these days. We have digital pathology and integrated diagnostics and the 2 latest here are done in Secure Communications and Imaging IT. And then we have added a new and that is diagnostic reporting adapted for the U.S. market, and I'll come back to that later. Second highest contracted order booking for a single quarter ever. The last year Q2 was even larger, but it's a very high order intake. We are in the transition to as-a-service model, and we have also launched several new innovative products. Happy customers drive growth. We have contracted order bookings decreased a little bit, but we're still second largest, as we said before. Net sales increased by 9%. That is affected by the transition to as-a-service model. The initial license sales are not many and none such in the U.S. and Canada now. And then we have profit per share, which has increased by 49% to SEK 1.30. We are in a transformation to as-a-service model, especially in medical. Our cloud recurring revenue increased by 61%, and now this is beginning to yield significant contribution because we are starting from an already fairly high number. Recurring revenue, of which cloud recurring revenue is a part increased by 18%. This includes also old service contracts on the old service model. But the growth is explained by the growth in cloud recurring. And then churn, recurring revenue, so important if you have as a service model continue to be very, very low. It's 0.5% over the last 12 months. The financial targets for our group are in order, stability and measured in equity assets, that should be above 30%. It's currently around 51% despite a quite large dividend given in Q2. We have profitability, which we consider a hygiene measure. It should be about 15%. We are at 21%. Note that the profitability of this quarter is due also to some temporary effects that is not recurring. And then we have the third goal that is our main financial goal that is a growth of EBIT per share over 5 years that should be above 50%. It's ways above that at currently 109%. And if you include the patent settlement, it's even more than that. Patent settlement was done in Q4 last year. We have won several large contracts in Q2. In Sweden, we have won a large region of Stockholm and Gotland. And this was -- these were in most of the cases, our customers already, but they have now got on over to a Software-as-a-Service model, and we've added a few hospitals that were not in the product before. In U.K., we've got another 4 NHS Healthcare regions, Blackpool, Lancashire -- East Lancashire and Morecambe Bay. In U.S., we have a large health care provider to implement Sectra One Cloud at 11 hospitals. These contracts in the U.S. are large because the customers are many -- or the hospitals are many in each of these contracts. We have also a new planning tool for advanced orthopedic trauma surgery, this planning tool we had a long time, but we have added more libraries from the large prosthesis manufacturer. These are used to plan operations so each patient gets the correct size of its prosthesis. And this was historically done in 2D, but we today do it in 3D. It's very important for us to be good with the customer's customer and orthopedics is the largest customer of radiology all over the world. The planning tool now covers almost 80% of all template orthopedic trauma surgery in the world. And the patients, of course, benefit from getting the rightsized and correct prosthesis or metal operated into the surgery operation. In Sectra Communications, we launched a version of our secure phones that is not formally approved. It is very similar to our formally approved phones, but they do not require such extreme carefulness with key distribution, et cetera. It's intended for industry and users that are not as forced to use the restricted secret level. It's called Sectra Tiger/E for Essential. It's a managed service and a new customer offering that we have seen a lot of interest for people who are not required to have the absolute highest approval levels, but still are very careful about not being [ e-stocked. ] Security service support smartphones and tablets, which is important. It's hosted and it's sold as a subscription model and in Europe. After the quarter, we have last week or 2 weeks ago, gone to a -- the world's largest radiology exhibition, Radiological Society of North America in Chicago. We had a record number of demonstrations, and that was despite that we had low international attendance in this normally a lot of Canadians and Europeans competition. This year, that was substantially down, and we have a few people coming from Europe and also a few people from Canada. So it was mainly U.S. customers, but we still have more demonstrations than any year before. We had also a record number of visitors. We are now considered leading the way as the most innovative tax company with the highest market growth. And the highest market growth is proved by class numbers as we have shown in previous presentations. The new products we show was the new reporting tool adapted for the U.S. Photon counting CT viewing, which is a new modality. Computer tomography has existed a long time, but photon counting is new. And we are the only PACS company who now can display those very important images. And users do not want to go to another workplace when they display that. They want to sit at the normal workplace and see these images, and we're the only company who can do that currently. We have enterprise imaging genomics leading -- having a lot of interest and education portal as well and our new cardiology viewer adapted, especially for cardiac ultrasound. We also showed many other new features. The new U.S.A reporting tool is a version of the reporting tool we have had many years, adapted for the U.S. needs, which is quite different from European needs. Reporting is a very important part of the diagnostic workflow and to have that integrated in the PACS is a very important step for us. And we hope that we bring some business going forward. Then I will leave the word to Jessica.

Thank you. Good morning, and welcome to this part of the presentation. Our 6-month report shows a strong order intake, solid growth and increased profitability. And we also -- our cash flow development also continues to be positive. The demand for our offerings, both in Medical Imaging and cybersecurity remains high with contracted order bookings of SEK 4.7 billion in the period, a decline of 2% year-on-year despite the strong inflow as the comparable numbers include the 12-year contract with Quebec amounting to SEK 3.1 billion. Our book-to-bill ratio is at 2.6. And the second quarter order intake included several orders in North America, the Region Stockholm contract and the another Sectra One Cloud contract in the U.K., as you heard from Torbjörn's presentation. And Secure Communications received orders for additional Tiger/S and extensions for managed service contracts during the second quarter. Net sales in the 6-month period amounted to SEK 1.616 billion, an increase of 9% year-on-year. There is negative impact from currency on our sales. Adjusting for that, sales would have grown by 16% in the period. And the recurring revenue keeps growing, up 18% in the period, and the cloud recurring revenue part is up 61%. This shows that we are now starting to see customers from the large orders secured in recent years gradually go live, still on a small scale this fiscal year. The nonrecurring revenues are declining year-on-year, all according to expectation and as a consequence of the transition to cloud-based Software as a Service. The second quarter sales increased by -- sorry, increased by 13% to SEK 851 million, driven by the growth in our medical operations. Imaging IT reports sales growth of 12% despite the currency headwind. And the use of imaging services grow by -- through deployment of new customers, add-on sales and also existing customers converting to cloud services. There is strong growth in cloud recurring revenue, up 63%. This shows we are moving in the right direction, though we have many customers remaining to be deployed over the coming years. Secure Communications sales declined 7% year-on-year to SEK 184 million. This is a result of a delay in an ongoing development assignment, a delay caused by revised customer requirements. The fastest-growing volumes were noted in the U.S., which reported by far largest sales growth in the period. The U.K. report growth in local currency, but not in Swedish krona and the same applies to rest of Europe. In Rest of World markets, we also see growth, and that is driven primarily by the sales development in Canada. Our operating profit increased by 47% to SEK 307 million, and the margin was strengthened to 19%. Top line growth and higher investments in capitalized development are the main drivers behind the profit improvement in the period. In the second quarter, profit was also impacted by customer compensation for delays, delays which were not caused by Sectra. And we also have the impact of lower costs for our share-based incentive programs due to the share price trend in the quarter. Imaging IT increased operating profit by 54% and report margin -- a rounded margin at 21%. As I mentioned on the previous slide, increased sales and more capitalized work for own use are drivers behind the profit improvement, also lower consultant costs year-on-year. We continue preparing for large deliveries, and we will carry initial implementation costs that are expected to dampen profit development near term. In Secure Communications, the operating profit declined by 44%, and the margin is just below 11%. And again, I repeat, it's mainly explained by delays in an ongoing development assignment and the associated product deliveries with that development. And this delay is expected to impact the outcome for the rest of our fiscal year. Cash flow from operations amounted to SEK 160 million in the period, and there was strong profit growth driving the cash flow, partly offset by settlement of current liabilities. We have been utilizing the advanced payments received in earlier -- in previous periods. And in the second quarter, the cash flow was also impacted by increased capital tied up in current receivables as there was increased invoicing activity towards the end of the quarter. And with that, I'm handing over to you, Torbjörn. I don't know what's not working now, but...

We sort that out. So sorry about that. As I said, we had a little IT issue this morning, which caused a change of rooms and some fast -- late [indiscernible] So when asked why it was so good in hockey, many of you have seen this before, Wayne Gretzky, who is the best in hockey over many, many years said, I do not skate to where the puck is. I skate to where the puck is going to be. Sectra has been good in that, and it's very, very important. We also continue on that, trying to see ahead of where cybersecurity and medical diagnosis will be a few years down the line. We are right now in a huge change due to mainly AI, and it's very important we continue to be prepared for what's coming. Philosophy shareholders is that if you start with a rational strategy in a growing market, then if you have happy customers and in order to have happy employees, you must have happy employees -- for happy customers, you must have happy employees. If you're dare to expensive when you're worth it and have reasonable fit for shareholders will be happy. And I think we have showed that over the last years. But it comes in that order. We will compromise a quarter if needed to keep happy customers that is best for shareholders long term. In medical IT, the growth areas because of demographics are age-related diseases. Almost all countries in the world have a very difficult to handle demographics. And the main diseases then is neurodegenerative disease, cardiovascular disease, cancer disease, musculoskeletal disease and vision. And we should be good in all diagnostics and image-related diagnostics, but we should be very good in these areas. We sell this in the form of new contracts we sell -- we call that Sectra One. You sign one contract and you get all. We can compare that to Microsoft Office when you don't anymore buy Excel or the Sectra One by one. You have one contract and you can use the different types of images or different services different. We've added 2 new things to this over the last year and that is genomics and now we have integrated reporting added as an additional service as well. Integrated reporting is a very interesting area, as I said, that is the output of images of diagnostics, and we have good hopes for that going forward. We have all -- as I said, we have all imaging-related diagnostic data in one single cloud-based systems. We are the only vendor who have this operational in clinical use based on the cloud that enables better care for patients, more efficient workflows. And workflows are now critically important as staff in the medical world is overloaded and they must have efficient work or risk burnout. And if part of the staff is burn out, then, of course, the remaining get even higher workload. So it's very important for customers to have that. That result also in low cost and reduce complexity for the hospitals and improve cybersecurity as you don't have to have many different systems. You have fewer systems, which means you can be safer than with many different systems. In cybersecurity, we stand for a new digital reality. Cybersecurity is growing and has to continue to grow because of our complexity in society and sensitivity in society, which we have seen not the least in the Ukraine crisis now. We have an increase in international tension and cyber crime, which drives this area a lot. And we are well positioned. We have a very strong brand name in cybersecurity, and we have new products and service coming out in a rapid pace. So we are well positioned. Health care -- sorry for that. Health care and cybersecurity are markets that due to external pressures have to grow. Even if there is a recession in society, both of these health care because of demographics and cybersecurity because we are building a more and more complex society, they have to grow, and that is a good place to be in. Our priority going forward is that quarterly variations are still very large. We want to point that out. Q2 was a very good quarter, but the long-term trend should be seen over 12 months, not in individual quarters. Don't expect significant positive effect from the large contracts in '25-'26, which is our fiscal year ending in late April. We will see some effects, but not significant. They will begin to come next fiscal year and then gradually grow over the next 1 to 3 years. Also note that when going live with large customers in the cloud, the cost increases well before revenue. We need to spin up all the different machines or virtual machines in the cloud before we get revenue. So that means when you start up these very large contracts, cost goes up well before revenue, which will come when people begin using it. We have very significant go-lives ahead of us. And also, please note that we are very exposed to currency, especially in U.S. dollar to Swedish krona right now. Our upcoming financial events is March 6, we have a 9-month report. June 5, we have our year-end report. And in September 8, we will have our Annual General Meeting in Linköping Sweden that will be on-prem. Also note that we -- your feedback is important. We do these presentations for you. Again, we apologize for a little IT issues this time, but things happen. We did the best of it. But send an e-mail to [email protected] if you have any input or suggestions to improve it. We have shortened the presentation a little bit based on previous feedback we got. And then we open for questions.

Thank you, Torbjörn and Jessica. And I will start with a question from a private investor that we have received by e-mail and it regards our financial targets. And I think this is for you, mainly Torbjörn. You talked about your operational margin target as a hygiene factor. At the same time, another of your motto is there to be expensive. And according to the latest Capital Markets Day, margins are significantly higher in the cloud businesses. In addition, revenues are roughly 2x in the cloud model. Once your large contracts become operational and you are paid per exam, I expect cost increases should be marginal. At the same time, development costs should be possible to optimize with AI tools such as Cursor. Based on all this, I find it hard to see how your margin would not increase over the coming years. How should we think about future margins? And will they be affected by any plans for entering new markets and developing more new products?

We have, as a goal, 15%. If we go up to much higher levels, it's because we run out of ideas, and we have a lot of ideas for improvement. Health care and cybersecurity will need new products. And as the largest shareholder, I am very interested on growing EBIT per share if you can because you can increase margins once, but you can continue with an increase of EBIT per share forever. So for us, 15% is a good measure, subject to the Board, of course, but we have no plans to change that right now. We will invest in future growth where we have the chance because these markets are so large. I would also like to comment on the AI for development. Yes, of course, we use Cursor or today the buzz right now is around a product called Claude Code, but that goes for all companies in the market. So that doesn't change the competitive landscape.

Okay. Thank you. And the next question comes from Nikola Kalanoski at ABG. Could you please let us know how you're doing on the implementations of some of your largest cloud contracts in the U.S., Canada and Scotland?

They are now -- we always start in this by working a lot with the customer on how the workflow should be, how the organization should be set up. That phase is over for all of these 3 are the 3 big ones. And I would say that with the server side is now implemented. Now we have to take hospitals alive, and we have prototypes or pilots -- not prototypes. Pilots gone live in the largest products, not yet in Scotland, but that will come. But you start with one and then you gradually take more on after a while. And that will take 1 or 2 years to go full live.

And then we go back to the first quarter. In that quarter, you mentioned that an international health care provider in the U.K. went live with Sectra One Cloud. Do we see full run rate revenues from that client this quarter?

No. That will take a little longer before that.

And we move over to a question regarding the Region Stockholm contract. You announced a contract with Region Stockholm that was quite large. There was a large difference between the client's estimated value of SEK 1.6 billion and the guaranteed order value of SEK 557 million. A few questions on this. First, could you please explain the difference between these 2 order figures?

Mainly what we are a little careful in what we promise. The lowest value if the customer doesn't use it very much. Now it would be very surprising if they don't use a system like that, but this is the guaranteed. Now the higher estimate is if they use it a lot, and then you have all in between. The estimate -- I mean, a probability-based estimate is probably between these 2 figures, but we only publish what we know we can -- we will get.

And the second question related to this is -- and Nikola, as he appreciate if you don't want to answer it in detail, but approximately, how much did you book as a contracted order bookings for the quarter for this contract?

Well, we haven't disclosed that, but I think Torbjörn already responded on that question.

And thirdly, I understand that this is an existing customer. What is the primary difference between implementing a fully managed cloud service for an existing client that already has an on-premise solution compared to an entirely new client?

Quite large difference except in the U.K. U.K. is a little different, but I will describe the Swedish situation. The Swedish situation, the customer bought the hardware and had IT services, local IT service on themself. We deliver software and support for the software if something happened. In a managed service or Software as a Service contract, we are responsible for that it actually works. The customer has very little staff working with the system, but we have to provide them services as well.

Okay. And one last question from Nikola for this time. There was a quite large discrepancy between the value of the order bookings that you announced prior to the quarterly report compared to the actual reported figure. Is the difference mostly attributable to unannounced Sectra One cloud contracts?

Yes. Yes, that is correct. As I mentioned, we had -- we received several orders in North America, primarily in the U.S. during the quarter. And then we have the Region Stockholm order value, which was significant.

And I will move over to a few questions from the chat function. And the first one is from Jakob Lembke at SEB. Is it possible to put into context how much the compute cost is in relation to revenue on the SaaS contract once exams reach mature level?

We do not disclose that, but we have a margin also with cloud cost, of course, not as much as for our own software partner.

And the next question is also from Jakob Lembke. Do you still see strong potential to win large contracts in the U.S.

There are many vendors or many systems in the U.S. who still not decided what they will have for the future. We, of course, hope we can get more, but we don't know that yet.

And it seems like recruiting is slowing down. Do you feel that you have reached critical scale and will not have to recruit as much going forward?

We will have to recruit because, as I said before, the Stockholm contract, the new type of contracts require us to have people to do what the hospital did before. I mean hospital saves a lot of money in reducing staff that we take over responsibility for, not with as much staff, but we do need staff. So we will continue to grow, but perhaps not as fast as before.

And a final question for Jakob Lembke. Could you talk about the potential to convert your old license customers to SaaS?

Our intent is to try to get everyone over to SaaS long term, but that varies a lot between regions and customers. We have had a few -- very few transitions so far. We hope -- we expect there will be more coming forward.

Okay. Thank you. And I will move over to questions from Kristofer Liljeberg at DNB Carnegie. And maybe we have touched upon the first one. How large part of orders in Q2 was related to the U.S.

Well, we haven't announced that exact number, but a substantial part, a substantial part was generated in the U.S.

And I also think we have touched upon the first one regarding -- no, we talked about margins, but could you explain a bit what will impact operating costs coming quarters? They have slowed a bit during the last 12 months. But at the same time, the message is that the rather strong margins seen in recent quarters might not be sustainable.

Well, as I said before, the cloud cost when we do live, we have to allocate all the compute resources in the cloud that the customer will need clearly before they actually begin using the system on the revenue. And there will be a gap in between where the cost goes up significantly, but revenue has not yet come.

And then one further question regarding costs. How much of the higher external costs in Q2 versus Q1 is cloud related, reasonable to assume external costs will continue to increase in second half of the year?

External costs will continue to increase in the second year -- second half of the year, especially because of the large go-lives we have ahead of us.

Yes. And then I move over to another question from a private shareholder. And I think we have touched upon this earlier as well. I wonder if you can elaborate on some more on the cost percentage that is captured by Azure in Sectra One deals and how that will change with increasing volumes?

Azure, to explain, is the Microsoft cloud service that we mainly use. And of course, that cost will increase, but we have a margin also on that part. And we do not disclose portions or levels on that.

And then we have another question from Nikola Kalanoski. How large was the one-off customer compensation payment? And was that booked as nonrecurring revenue or as other operating income?

That was around SEK 8 million reported as nonrecurring revenue.

And I will go back to the chat function -- see what we have there. And the first one I see is related to what you just said, Jessica. In the report, you mentioned the compensation from a customer. How big was this effect on the operating result? And then we have one further question from Jakob Lembke. Historically, you have always had a seasonally stronger Q4 for nonrecurring revenues. Should we still expect this to be the case as the nonrecurring revenues become increasingly smaller component?

We will have a strong effect because we don't have so much license sales anymore. So you should not expect that trend to continue.

And then we have a further question from Nikola Kalanoski. If possible, could you please let us know how large the one-off -- yes, that was the one we took. And then I wonder if you have answered those. Could you talk about the potential to convert your own license customer to SaaS?

Potential to move all over, of course, in the long term, but that is not so much our decision, of course, lies with the customer to decide if and when they want to go over. The situation between the U.S. and Europe right now is complicating things because American clouds are not accepted in European Union at least not in all countries. We will see with time what happens with this.

Thank you. I think that was all the questions we have received today.

Okay. Then we thank for our side, and we would like to stop with our traditional Christmas song done by our employees and we have to start this up again, there is some issues with -- it seems not to work. We apologize for this situation. Many of you will have it -- we will have it on our web page towards Christmas. The IT situation today is depending on a computer in the room stopped working, and we had to move very late in the process. Okay. And that's from us. Thank you very much and Merry Christmas to all of you.