Sectra AB (publ) (SECTB) Earnings Call Transcript & Summary

Welcome to the Sectra Q3 2019, 2020 Conference Call. Today, I am pleased to present CEO Torbjörn Kronander. [Operator Instructions] I'll now hand the floor to Torbjörn. Please begin.

All right. And good morning. This is Torbjörn Kronander and Mats Franzén from Sectra. Let's start with the first slide. We are growing with happy customers. And we are especially proud of despite -- we had a financially good quarter, but we are especially proud of, for the seventh year in a row, to have the most happy customers in the United States. Next slide, highlights and trends. Next slide, with the strongest Q3 we have had ever. We have go-lives at several health care customers pushing earnings trend in the right direction, which means up. And historically -- but please note that we -- historically, we have very large variation between quarters. So I mean you should never exaggerate a very low quarter at Sectra, but you should not -- neither exaggerate a very high quarter. Next slide. The good quarter meant that we are again back on track for our 3 financial targets. Equity-to-assets ratio should be above 30%. We are at 51.2%. Profitability should be above 15%. And that's our -- these 2 are kind of hygiene factors. We want them to be good, but we don't want to drive profitability [ too highly ]. Of course, we have a lot of things to invest for future growth then, which means when the 2 first targets are fulfilled, we are concentrated on the third one, which is the EBIT per share growth over 5 years which should be above 50%. And we are now back above that at 65.1%. Next slide, please, and a little data from Secure Communications. Next slide. The trend is we are expanding our secure mobile communications offering. We are growing in critical infrastructure. And we have special growth initiatives for mobile secure ecosystems, new geographic areas. And we're also now selling critical infrastructure in Finland and Norway, not a lot of business yet but where we see this is growing. We also have new legislation all over Europe that mandates power infrastructure or power grid operators and power producers to look upon cybersecurity issues. Next slide, Imaging IT Solutions. Next slide. And we are -- as I started in the beginning, we are very, very proud of that we again won the Best in KLAS award. We have this year not only won it in our target segment, which is -- or large U.S. institutions, and that is very large hospital chains, but we also won the small hospitals in United States. And we also won in Canada. Next slide. Why do we win Best in KLAS? KLAS measures many things, many aspects and when they evaluate this with customers. And customers [ filling ] quite an extensive form of what they think. And we are receiving for company culture an A+, which is proactive services. And keeps our promises. We keep our promises. Our products works as promoted. We don't lie about what we can do. When we say we can do something, we also deliver it, a very important thing for us all as consumers. And we also have the idea, if you behave to others as you want to be behaved to yourself, you will be fine. Loyalty, we have a grade A+. That means that customers plan to stay with us. We are not on the list of vendors they want to replace, and we are part of their long-term plans. They will buy again from us. They are likely to recommend us, and they also are overall satisfied with us. And then operations, services, relationship and value, grade A. We are not a low-cost solution, so we are not perceived as such either. Next slide. Here you can see some competing companies. We have grayed them out. We don't want to badmouth others. But as you see, we are top on the list here of 9.3 (sic) [ 93.9 ] out of 100 points. And we have quite long distance to #2 and even longer distance than #3. And then we have a bunch of companies between 60 and 80. Next slide. If we look at Canada, we are even stronger. We are more than 10 points better than #2. And this is simply because Canada is a new area where we're trying to expand and grow and just established -- only a few years ago established our own company there. Next slide. We have also done some good large orders in the U.K. There is a consortium of -- as in most markets, U.K. is consolidating. U.K. is -- consists of trusts, trusts as 1 to several hospitals in one organization. Trusts now are forming consortia for some acquisitions and some aspects, and SWASH is such a consortium. Where they were our PACS provider, we were their PACS provider before, but now they consolidate into one single entity, one single system. These are large, quite large, projects; and we booked one of those in the U.K. last quarter. Next slide. We also see that -- many of our existing customers adding functionality. We started there also with radiology PACS, but now they want cardiology and they want digital pathology in the same system. We are the only vendor who have all of these in the same system. And so we have new orders from Hillcrest Medical Center in the U.S. and hospital Zuyderland in Netherlands for cardiology and pathology. Next slide. Trend in Imaging IT Solutions. We're adding new customers. We're extending and increasing contracts with existing customers. We're strengthening our delivery capacity. We are growing with people, and that was you -- what you saw in the first 2 quarters where we increased costs. We had to do that before all of the deliveries that come now in Q3. And we are -- some example of growth initiatives: We have new markets. France and China are new markets for us, both. And we are also talking new distributionships where we are not doing direct sales. We have digital pathology and integrated diagnostics. We have cardiology. And we are focusing especially in the U.S., where we have very happy customers but we have a fairly small market share. So we have something to grow. In many countries, we are by far the biggest vendor. And then the growth opportunity is, of course, limited. Next slide. In the U.S., we have a special focus area, as I said before. We have some luminary customers, and that is very important. We have now some very [indiscernible] hospitals, for instance, University of Pennsylvania and HSS hospitals and special surgery on East Coast. We have Stanford University on the West Coast. We have Vanderbilt in the South and university of Cleveland -- Case Western university in the middle. And that is a very good reference base because where -- they also spread out of the geographical U.S. Next slide -- not. Stay on the previous slide. Sorry for that. Opportunities: The world's largest market, and we top the customer satisfaction. We are small but growing -- we have a small but growing market share. And then we'll take the next slide. Digital pathology at Sectra. And pathology, as we have discussed before, has not been digitized. The large image data centers make this very, very difficult, but it's coming. And we are now leading -- in a leading position in digital pathology. Next slide. We have a new customer in digital pathology, and that's the largest university hospital in Switzerland, Geneva, who choose our solution for going completely digital pathology in all of the primary diagnostics. Next slide. And as I said, it's the last frontier in digitization of medical images. There are large synergies with radiology. A very large portion of the workflow is very similar as for the doctor in diagnostic situation in preparing or achieving or making images. Sweden today is, by far, in the lead in the world of digital pathology penetration. And we have a very dominant market share and to grow from, which is -- gives us a good platform for extending into the world when now digital pathology is coming on in more and more countries. We also have a nationwide telepathology communications solution in the Netherlands. We are increasing sales in the U.K. and, as we've discussed before, Switzerland. Our growth strategy is to have 1 single system for pathology, radiology and cardiology imaging. These are the 3 largest image producers in the hospitals. And of course, the IT departments prefer to have 1 system to do all of these instead to have 3 different systems, which is very expensive to maintain and more cumbersome to work with. We also see upside for only the back end, where we'll have 1 system doing all 3 of them. And you more and more work as teams in hospitals. So tumor boards, for instance, there's a big benefit to having radiology images and pathology images on the same system where you can discuss them in these tumor boards. We have -- for the United States, we need an FDA approval. We have filed the application together with Leica, which is one of largest scanner providers. We have based it on their scanner. And the situation there is right now that we have achieved questions from FDA. We have replied to them in a positive trend. We have not -- no questions we have not been able to reply to. And it's back to the FDA. But you never know with the FDA when a final approval comes or if there will be more questions. Next slide, Business Innovation. Next slide. Business Innovation is our greenhouse of new projects. Right now we have Orthopaedics and educational systems there. And in Orthopaedics, we have our new segment, implant motion analysis, which is a post-operative analysis if a prosthesis is fixed or if it's loose. If it's loose, you have to reoperate. And if it's fixed, you shouldn't. We have some initial very, very positive results from Sweden, where you see that you can, in some cases, make about -- reduce the number of reoperations or revisions by a factor of 2 or half. That is a very promising result. And we also see heavy growth, but it's growing from a small, small size today. We have a version of that and same software models that we use now for clinical evaluations from prosthesis vendors. It's the same thing, but you can follow up a new prosthesis if it moves [ and offsets on ] clinical research. That is also growing. In Medical Education, we have transitioned. We are moving from device delivery to service, including cloud-based content subscriptions. It should be noted that education is the one area where we actually have been affected by the co virus -- or coronavirus situation, as we have sold quite a few of those systems into China, and that has come to nothing right now. But it's a small part of Sectra growth, so there is no overall large impact of that. In research, we have a large focus of AI for medical applications. And we have several collaborations going on in artificial intelligence for medical all over the world. Next slide. We would like to mention some risks related to the coronavirus outbreak. And this is very much discussed right now, and I think we are owing the market a description of how it affects us. Next slide. We have seen several large exhibitions canceled. Mobile World Congress, for our communication security area, was shut down and canceled. And we also see now that the exhibition -- a large European exhibition of radiology that was [indiscernible] next week in Vienna has been canceled -- or postponed. It will be instead held in July this year. This, of course, gives a long-term impact. If you don't see customers, you can't sell to them. But how large that will be and how far away it will be, we don't know. And also it depends very much how long this shutting down of exhibitions will be. We also see a risk that, if the outbreak is anywhere near what it was in Wuhan in China, hospitals might get overloaded. And that might lead them to say, "We don't do any large deliveries of IT and large undertakings," or that situation. That may lead to delayed installations. We have no indication of that today, but these are things we see as risks. It also -- it may also be that we have a lot of personnel or staff get sick. That will also impact our delivery capacity in Q4. Shortage of third-party products, hardware may delay installations, but we are not a hardware company. So we are not that dependent, but sometimes on these projects, we need to include hardware. And of course, most of that is produced in China. If we can get -- if we can't get the hardware, it may delay installations. We have not seen anything on that either yet, but it might come. We also -- as in all times of uncertainty, normally, volatility of currency increases. That, of course, goes in both directions. It might be a risk. It might mean opportunity. We don't know, to be frank. How do we mitigate risks? We are quite good now. Work remote in global teams. If we have an installed in a hospital, we don't need to go there with a lot of people. We can work remote, or we can work from other countries. We also have extensive recommendations to staff how to behave and, for instance, try to avoid hand contact with people and so on. And we have a very strict instruction to stay home if you are sick. We also restricted some travel that are not absolutely necessary so that -- for the company. We have looked over our supply chains and try to take measures beforehand where we see risks. But we should say that we are, compared to many other companies, in a good situation as we have a substantial recurring revenue. More -- significantly more than half of our revenue is recurring, and that will not be affected by this situation. Next slide. The benefits of recurring revenue is, of course, that -- as I said, more than half of our sales is in recurring revenue. It's an increasing amount and we don't see that being affected. Next slide. And I leave the world to -- word to Mats Franzén, our CFO.

Thank you very much, Torbjörn. I would like to go to the next slide, the trends in order bookings and net sales, please. As you can see on these slides, we have had an order intake just short of 7% up compared with the comparable period last year. And as Torbjörn said previously, we shouldn't make too much of short term or even comparing with previous year numbers in terms of order intake because they tend, by nature, to be quite volatile over periods and in between periods. Looking at the net sales. We are almost 23% up; adjusted for currency, just below 20% up, which is obviously healthy, within this fairly wide range of expectations we have had, although there might also within sales and profits be quite big changes between quarters. As for the third quarter, the net sales was 38.8% up; currency neutral, just short of 35%. The main bulk of that came from bigger customer projects within Imaging IT Solutions mainly in the Netherlands, the U.K. and the U.S. where the -- especially the order increase was strong, whereas Sweden had a bit of a more sluggish development in a shorter context. And the main bulk of the order intake pertains to long-term contracts actually, where software upgrades and support elements are substantial but, anyway, do reflect a big volatility in terms of the order intake. We can go to the next slide, please. Geographically, the U.S. showed the strongest development compared with last year, as major deployments were actually taking place in that part of the world, up 38.6% in Swedish krona denominated. In the -- in U.S. dollars, it's about 30%. I didn't mention that in the previous slide, but we have had a continuous depreciation of the Swedish krona, as you can see. As for the third quarter, the currency effect compared with the first 6 months are fairly small, to be honest. Next slide, please, where we see the sales trend by business segments. And especially in Imaging IT Solutions, we had bigger deployments, Kettering Health Network in the U.S. and Radboud University in the Netherlands. And we can see that the interest for -- also in new markets such as Canada and France are increasing, although the volumes on that are not significant as of yet. A bit of comment on the Secure Communications up SEK 25 million here in terms of revenue is that it's growing, but it's mainly project-based development, which has, everything else the same, lower margins than some of the other products we see in the business. So top line healthy, a bit more of a struggle in terms of the profitability in that segment. Please, next slide, where we see the operative earnings. And for the full period, we have an increase of 31.3%, which is obviously healthy. Again, one shouldn't make too much of short-term sweeps even if this is a 3-quarter period. And the operating margin is progressing in the right direction. We had almost 22% margin in the third quarter. On the other hand, we had quite weak margins in the first 2 quarters. Those of you who were listening understood that we have invested quite significantly in accommodating the deployments that were upcoming. And as with currency fluctuations adjusted, the operating profit was up 24.5%. So without further ado, I would like to go to the last slide in terms of the finance numbers. We did have, pertaining now to cash flows, significant -- several large contracts tying up cash. And as you can see by the bars to the right of that slide, that we had a bit of a heavy situation in the -- especially in the first quarter, now recuperating from that. From the full 3 quarters period here, we can see that we are ahead of the curve. Again, it's in with our internal expectations, so there's no big thing of making that something special up or down, but we think this has progressed in the way that we -- within big limits and as expected. So with that, Torbjörn, I would like to give the word back to you.

All right. To the next slide, we go to Sectra's way forward. Next slide. We will try to stay in our path of having happy customers. It's a little more costly to drive this because, of course, it takes efforts to keep customers this happy, but it's also a proven recipe for future growth and profitability. So of course, we will try to stay on that path. Now it's increasingly difficult with more and more customers, but I think we have proven that we are able to stay on top. Next slide. This is a quotation, I like quotations, from Edwards Deming. Profit in business comes from repeat customers, customers that boast about your product or service and that bring friends with them. And sometimes in these days, people forget that all real business is about having happy customers come back to you. And we've seen now that the selling pathology and cardiology into happy customers' installed base, and that's a very, very good business. Next slide. We also need -- in order to keep customers happy, we need a staff that is happy. We have been voted the third best employer in Sweden and which we're also very happy for because without happy employees, you cannot have happy customers. It's not possible. Next slide. Then I will jump to the third -- to choosing your markets. We are positioned in health care IT and cybersecurity. By society dynamics, demographics and other situations and increasing digitization, these markets will grow. There is no way out of it. It -- they are mandated to grow. And growth is much easier in markets that grow. So we stay in these market that by external forces will have to grow. Next slide. Our philosophy for shareholders is that, if you have happy customers, happy employees, a good position in growing markets [indiscernible] need good cost control, and you need to be a little bit stubborn, then shareholders will be happy. And I think we have proven that. Next slide. Being a shareholder in Sectra. Next slide. Why should you choose Sectra? We have a very high customer satisfaction. We have a high employee satisfaction, with a strong brand in markets where trust is critical. And of course, brand is even more important in markets where you need to trust your vendor. If our systems in the hospital stop, the hospital -- the emergency department stops, and that means the entire hospitals will come down to a grinding halt. It's not easy for 3 guys in a garage coming to compete in such a market in cybersecurity, but most valuable secrets of companies are stored and handled by our systems. And again, this is not easy to come into, and it takes a long time to establish a brand. And we have that brand in these markets. We are profitable. We have a strong cash flow and a solid balance sheet, which means we have a good position to grow from. Finances need to be in place. It should never grow so fast, that you'll not have a solid platform below you. We have substantial and increasing recurring revenue. And we are positioned in niche markets with substantial underlying growth. And all management owns shares. All my management group are -- or have -- are shareholders in the company, which is a thing we like. And we have sustainable investments in R&D with exciting future opportunities. Pathology, which is now in heavy growth, started as a research project in Business Innovation, and where we saw that this made sense to move over to imaging IT, we've moved it to imaging IT. The projects we'll do in Business Innovation might be quite long term, but I mean they are not intended to stay that way forever. Next slide. Upcoming financial reports and our general assembly meeting. We'll have a year-end report and presentation in June 3. September 4, we have 3 months report and presentation, the Q1. Then September 8, we have our Annual General Assembly meeting in Linköping, Sweden. Next slide. We'd like to remind you that your feedback is very important, please. So please tell us what you think about these presentations. We provided a link here. And we will adapt and listen to you guys which we think about our presentation and to make them better in the future. And then we'll open up for question. You can use an e-mail, or you can come in and have oral questions now.

[Operator Instructions] We have one question in the queue so far. That's from the line of Kristofer Liljeberg of Carnegie.

A very good quarter. Congratulations. Trying to understand a little bit how sustainable this sales level is. I totally understand there's a lot of volatility, but I think it's fair to say that, some years ago, you improved sales growth from 0% to 5%, you were there a few years. Then you improved that to 10%, 12% we have seen in the last 2 years. Do you think it's fair to assume sales have accelerated further given your strong position now in the U.S.?

It's very difficult to say based on 1 quarter. We have said from the beginning, we've said already in the beginning of the year that the first half year this year will be a little strained by -- for our investments in this large -- and building up resource to deliver. And we are delivering in the second quarter. So that's about what we can say. If this is sustainable situation -- we still have a very small market share in the U.S., and of course, that's a growth opportunity, but it also takes something -- replacing an installed IT system is a very large project for hospitals. And 5,000, 10,000 users in typical hospitals sits on these kind of systems. As long as there are vendors where the customers are not happy with, that's a market opportunity for us. And right now we are placing other companies, but of course, when that addressable market of very unhappy customers is coming to an end, the growth will be a little slower. But that is not yet the case. So I cannot give you a lot of replies here, but it's not -- we are not in a bad situation in the U.S. now.

And related to U.S. You were very successful winning a lot of those large projects last year. Is it possible to say how many of these have now been installed and how much is still in the backlog, so to say?

We can't. You -- the delivery time from order to delivery is long. And you can look back on our press releases for the things we just don't know. And it might be up to a year or even more before you really see the installations, but I can't give you more information there.

Okay. But you still have some of those large products to be installed in the U.S. in the fourth quarter.

Yes. We do have products still to be under installation both in the immediate and a little over the future.

Okay. How about the big win you did in Australia? I think New South Wales, which I think one of your biggest deals ever. Is that also going to be sales being booked upfront like in the U.S.? Or is that more spreaded out throughout the long period?

That is the biggest deal we ever did. So there is no doubt about that. It's spread out over 10 years, so it's a long period. And there will be no upfront license sales there.

13 years actually.

Yes, okay, 13 years. Sorry about that. Good, Mats.

Okay. And in the U.S. projects, typically, of course, you have service, et cetera, which is spread out also, but how much of the total order value would you say that's booked when you do the installation? Is that like 80%, 70% to 80%...

No. It's less than that. We typically have service and upgrade contracts running as well and depends on the length of the contract, but I will say 50%, 60% is upfront when it's such a deal. Now please note that we are changing the model of sales in the U.S. starting May 1, [ develop software ] service, and that will change the situation quite a lot in this.

Okay. Last question for me, also related to the U.S. I think when you had the Capital Markets Day 1.5 years ago or so, I think you said that you have the CapEx capacity to maybe take 1%, 2% market share a year. Now you have invested quite heavily also, but if you look at the U.S. sales rate -- or sales growth, I think -- of course, third quarter very strong, but also year-to-date, you're up some 35%, maybe 30%, 35%, adjusted for currencies, and that versus some 10%, 15% sales growth in recent years. So will you say that you have the capacity now to continue grow maybe not almost 40% but significantly higher than what we have seen in recent years?

I will say, I mean, we can never be content if the resource is linear to installation. So of course, an organization need to improve and make it become more efficient. And so are we -- so we can deliver more with the same staff, but we're also increasing staff. So it cannot -- 2-sided response. We've -- we are increasing staff, but we're also getting more effective in delivery with better systems, better routines and better processes.

[Operator Instructions] Okay. We have a question from the line of [ Odrok Nokdrok of Victory ].

I mean you -- congratulation for the seventh consecutive year to win the Best in KLAS in North America, but you're second best in Europe, I saw. And I was just wondering why you're just the second best in Europe and against a very small German competitor.

Yes. Of course, we'd like to be the best, but it's quite different to be more or less only delivering into 1 country and to delivering to about 10 or 15 that we do. It is -- we are much larger and we have many more countries. We are quite happy to being #2, but of course, we'd like to be #1. But it's a good small company, but they're mainly based out of Germany -- locally in Germany, and that's a little bit easier. But I would like to see us becoming #1 in Europe as well. So we will work on that.

[Operator Instructions] And we have a follow-up from Kristofer Liljeberg of Carnegie.

Question on the new sales model or payment model you will have in the U.S. and the potential impact here on cash flows. I noticed in the report you said you don't expect any large effect from this until late next fiscal year, but for how many years do you think there will be this [ could cancel ] between earnings and cash flow, i.e., this transition period before this even out year-over-year?

Several years, perhaps 3 to 5 years period. And then of course, we will have continuous delay of cash flow compared to this model. As long as we'll grow, there will be a delay. If we stop growing and become flat, then after 3 or 4 years, we'll be [ dissolved ]. But there will be an effect over several years, but we are starting quoting this by 1st of May. And with the lead time of these large projects, we will not see an effect for the -- definitely not for the first half year next year.

And how large do you think the effects could be on cash flows in maybe not so much next fiscal year but the year thereafter? Will this be [indiscernible]? So do you see it very linear between this 3- to 5-year transition period?

We don't know. We don't know. Old customers will not accept such a model. We will continue, to the people who insist on buying a CapEx model, to deliver in the old way to these customers, but there will be huge benefits of buying a Software as a Service deal from us. We don't know what the proportion of customers who will go for either model is, so we cannot give that precise, unfortunately.

[Operator Instructions] Okay, there seems to be no further questions coming through, so I'll hand back to our speakers for their closing comments.

Okay. We might have some e-mailed questions coming in here. Helena, can you read them?

Yes. We have one questions from online. How should we think about the rest of the year?

Well, we can't give any predictions. As we've said, Q3 was very good, but we will not have an investment phase as we saw in the first half year either, but don't extrapolate all too much based on Q3. But -- and that's all that.

No further questions online.

Okay. Then that concludes the presentation. Thank you very much for listening. And I'll again remind you of giving us feedback so we can improve these presentations according to your wishes and needs. Thank you very much, and goodbye.