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

Ladies and gentlemen, welcome to the Q4 report. [Operator Instructions] Today, I'm pleased to present CEO, Torbjörn Kronander; and CFO, Mats Franzén. Please begin the meeting.

All right. Welcome to our year-end report. This is Torbjörn Kronander, and I have with me, Mats Franzén, and we will go through the report. I will say next slide when we'll change slide, so we go for the second slide now, the value we create for customers. Sectra is doing business in Imaging IT, where we do large installation -- large IT systems installation, taking care of the images of hospitals and health care providers, to some extent also veterinarian clinics, but that is a small part of the business. But mainly the human medical care and we take care of the images in hospitals. We started with radiology. We're increasingly do other images as well, creating a sense on image repository in management system for hospitals. And then we have Business Innovation, which is small spin-offs of the medical side right now. One is special software for planning and follow-up orthopedic procedures, not the least follow-up, which is very important. And we also do an area of medical education, which had, had a boost as many medical students have not been allowed to go to the hospitals. They've been educated from home. And we create value, and we provide a means for them to be taught at home from the universities despite being locked in. And then we have Secure Communications, where we actually provide security for society, both for communications means, but also for critical infrastructure, et cetera, which is an increasingly large problem in modern society. And next slide, we'll go through Q4 highlights. Next slide. We increased our profitability, and we had a record-breaking order bookings for the full year. The order bookings for the full year is up 46% to SEK 2.6 billion and we have not been at that level ever before. We increased our profit by share by 16% to SEK 7.15 per share. And we also have a nice cash flow per share, which is up 26% to SEK 9.66 per share. Next slide. Our financial targets from left to right are in priority, equity to assets ratio. Our customers are very dependent on our systems. We have no fail option. If they fail our customers' businesses, we have a severe blow. Therefore, we cannot be risky. And in a way, we need to provide trust, that also goes with the national trust. So we have a target to be above 30% in equity assets ratio. We are currently at 54.2%, so well above the target in that aspect. The second highest priority is profitability, operating margin. But these are hygiene measures. The first 2 targets are hygiene measures, which should be above 15%. That's hygiene of health business. We don't need to be at the current 21.4%, which mainly came around because we have been very careful with cost due to the pandemic and so have increased our profits and margin, though we have not grown so much on top line. And the third, which is our main target we need to first fulfill, and that is unlimited upwards, that is growth of profits per share over a 5-year period, and that should be about 50%, which is an equivalent of 8% to 9% per year, currently well above double that at 115.7%. Next slide. We had seasonal effects. We also seen the pandemic, which has, of course, affected us as everyone else. We have large variations between quarters where we already had. They continue to be large. But over time, it will gradually decrease, not the least because we are in the transition to selling Software-as-a-Service instead of software-as-a-license. Thus it is quite a large change that we will live through over several years, but it's a change that most of the software industry is doing and so are we. And it will strain our cash flow a little bit over some years, but it will be very good long term. And -- but it will also decrease variation between quarters, as people will use for -- pay the usage instead of when they buy licenses. We also see, from the pandemic, travel and marketing cost increase post-pandemic, but we don't think we will go back to historic levels. They will be somewhere in between where we have been now and where we used to be, not the least, because we have learned and customers have learned that you can do a lot of things remote that we always before traveled for. Next slide, Q4 highlights in Secure Communications. We have established a cooperation with a Swiss firm, Wire, to have a user interface for digital Secure Communications, where we can provide a very safe underpinning to it and platform for that communication. That means we, by cooperation, reach much more functional than we could have possibly done ourselves. We also have an extended contract with Dutch ministries for Secure Communications as a service. We are increasingly selling also our communication products as a service, as a subscription. You pay per month and you get the phone that is encrypted one. We do not think we have adequate margins yet, but that has been because we have been doing some growth initiatives that equals some investments. And we have had growth, and we have had also increases in margin over the last year, although they are not at the levels where we want them to be yet. Next slide. Secure Communications, financial performance, we have a turnover SEK 207 million -- or SEK 208 million, which is up from SEK 189 million last year. We had an operating profit of SEK 9.5 million, up from SEK 2.9 million last year. And operating margin is 4.6%, which is above 1.5%, but quite a lot below where we need to get communications to be long term. Next slide. Our growth initiatives in Secure Communications is the user trend we've seen in the pandemic. People have been working at home. Also people who work with very sensitive paths and sensitive business. They need to sit at home with mobile secure workplace. They need to sit as if they were on the office. This has opened quite a large market for very secure remote workplaces, mobile secure workplaces, and we see a large trend there that would drive the market. We do see critical infrastructure. We provide a soft 24/7 surveillance of quite a lot of critical infrastructure, not the least, mainly in Sweden yet, but we're increasingly feel a little bit is coming in from neighboring countries as well. This is costly when you begin doing it because when you have only a few customers and a high cost for having that soft operation 24/7, profitability is low. But when you increase volume, it will increase. However, the pandemic has really slowed down this area of this scenario, and we cannot go without meetings, physical meetings, and that has been slowed down. We also do the highest possible security level secure voice communications, mainly in EU and Sweden and in Netherlands, and that is secured voice on the secret level with high-speed network encryption units on secret and top secret level. Next slide. Then we have Q4 highlights in Business Innovation, which is our orthopedics and our education business. These have now also been put into their own legal entities to clean up the accounting structure a little bit in the company. But they are still accounting for the Business Innovation segment that they are much smaller than the other areas. This area has had a very strong negative impact from COVID-19. The number of electric procedures, for instance, in orthopedics has gone down by 80%. And of course, that is our main target for the Orthopedics business. And that means the customers have no money for the time being, and they then cannot invest. Next slide. As you see, our revenue in this area has gone down to SEK 55.8 million from SEK 78.1 million. We barely made profit, SEK 0.8 million from SEK 12.9 million, and the operating margin is not large, 1.4%. However, we think this will recoup. The people who need the prosthesis in new hip has not gone away. And there is a large mountain of need buildup and that needs to be taken care of in the next few years. Next slide. The growth initiatives in Business Innovation. It's medical education transitions. We have had some very spectacular orders and interest from large universities, not the least in Southern Europe and South America and Far East, where students have been at home and they won't be taught from remote. Before, we mainly did teaching in in-class, with a large table that we did anatomical teaching on. But now we also provide the same software, same support but in remote on a PC or a tablet remote. That means lower payment, of course, per seat. These cannot pay the price for a table. But very often, this also is going over to a subscription demand. So it's student who pays for subscription of their software. We see interesting growth in that area where people want to continue to be taught remote. We also have new areas within orthopedics, mainly in Implant Movement Analysis, which is post operation. When you have a prosthesis and it begins to hurt, the orthopedic surgeon has 2 choices, either to treat this with medicine if it's an infection around the implant or actually do a revision, that is to put in another implant. Revisions are very, very expensive; very, very risky, and you want to avoid them. And we have a new tool in our EMR implant motion -- Implant Movement Analysis that can be used to determine who needs to be reoperated, who do not. That is a very interesting area as the revisions are sort of expensive and dangerous. We also do more or less the same technology for something we call computed tomography micro motion analysis. It's basically the same thing, but this is for research and clinical evidence building on new prosthesis, when we have large prosthesis companies as [indiscernible]. They order a study from us, and we can analyze if the prosthesis is stuck over time. For instance, over the 3 months if it moves in the body. And then we have a research area, mainly focused on AI for medical applications and future applications at the time. Next slide. Then we have our main area, Imaging IT Solutions. The Q4 highlights, we have several orders in Sweden for cloud services. Almost everything we sell in Sweden now -- or, I would say, little everything we sell in Sweden now is cloud-based solutions that we provide from a private cloud, not a public cloud, but from private cloud, hosted by ourselves. Software for the hospital, so they don't need to have all the service on trend in the hospital itself. We also see an increasing interest for Sectra One, which is our sales -- Software-as-a-Service model, which means that we sell for use -- we get pay per usage and sell for the license upfront. We introduced that 1 year ago, and we see now 3 new U.S. contracts during Q4, and a large interest in this area, not the least because hospitals have a probable liquidity right now, and they still need to buy things, and then they often prefer to pay for usage. We have several new clinics and networks that have chosen Sectra's digital pathology solution. We have orders for also new countries in that area. We are big in Israel, for instance. We are big in Korea. We are big in France, areas where we have not been a large player before. Next slide. The financial performance of Imaging IT is that we actually shrunk a little bit in terms of in Swedish krona to SEK 1.397 million (sic) [ SEK 1.397 billion turn over, ] down from SEK 1.428 million -- SEK 1.428 billion from last year. And we have an operating profit that has gone up, so our margins have increased substantially. This is not the least because of the less travel and less marketing activities, much less exhibitions, et cetera. Next slide, growth initiatives in Imaging IT Solutions. We are selling into some new markets. For instance, some market in the Far East, both direct and indirect. We do Enterprise Imaging, including digital pathology, integrated diagnostics and cardiology. We are the only vendor to our knowledge yet, but there are more coming in that have all medical imaging in 1 single system, which means a large saving for the hospitals. They don't have to invest so much if they can use the same system for pathology, radiology, cardiology, ophthalmology, dermatology or other actually large image uses in hospitals. We are focusing on the U.S. and the world's largest market. We have the highest customer satisfaction ranking there. And we have a small, but growing market share in the U.S., which is also seen as you will see later, where use is now our largest market. Next slide. And now I leave the word to Mats Franzén, who will tell you about the financial development.

Thank you, Torbjörn, and good morning, everyone. Next slide, please. When we look at the major numbers here, we see that the order bookings for the full year had quite a good trajectory. Now we usually say and we keep saying, I think, with a good reason that order intake is fairly volatile. Now we can see that as for this financial year, we actually have had good traction for all 4 quarters, actually. So there hasn't been that much of a swing in order intake. I wouldn't go so for as to call that a trend shift really. It's -- by default, I think, it's something that also can happen, obviously, that you have a stable period as well without the overall trend being materially different. We didn't really meet last year's fourth quarter in terms of order intake, although it was substantially well above sales. And adjusted for currency, we saw a slight traction upwards in terms of sales, which is a good thing considering the times we're living in. And the order -- the book-to-bill of the order bookings ratio is now 1.6, and it was just short of 1.10 last year. And as you all know, we have had quite a lot of headwind in terms of currency over the last year, especially in the later part of the financial year that we have been able to accommodate that, I think. Next slide, please. So the major currency fluctuations, and we have had some limited possibilities, partly in terms of deployments whether recurring revenue has kicked up strongly. We don't report that separately, but that has been a good buffer for us there. And as most of you know, I guess 70% of that, I would say, in foreign currencies, mainly European euro, pound sterling and U.S. dollar. And following up on that, the markets where we have a high share of new sales have been adversely affected, the most whereas the markets where we relied more heavily on an installed base. Customers in recurring revenue has been more resilient due to impact from the pandemic. And service sales in the U.K. has been -- has increased. But also in terms of hardware, it has been declining, which also can be interesting in terms of analyzing the gross profit for those who do that. Next slide, please. So obviously, by the sheer number and the sheer size Imaging IT is most adversely affected in terms of currency. And what this -- it's good thing for us here is that Secure Communications actually continued to report sales growth, whereas as we have been touching on previously, the Business Innovation has been struggling more in terms of elective-related business, like the orthopedic side. Next slide, please. So earnings-wise, we had a good earnings development throughout the year and not least in the last quarter. And as Torbjörn previously mentioned, the margin this corresponds to, I would say, a bit pumped up by the fact that we do not have an as-needed basis in terms of operating costs. And we do not see that this -- last year is something that's a steady-state going forward. Hopefully, we can see this is going back to it, but if not post COVID, but at least normalizing to the extent that we can visit customers and do what we do more, direct interaction with customers, although we have learned a lot during this year in terms of doing business remotely, obviously. Higher gross margins, we said. Normally, fourth quarter is strong, not only in earnings, but also in gross margin-wise since it's a higher share of license software revenue, which has a higher margin, if you compare with fourth quarter [indiscernible] gross margin for the full year. Also, we managed to actually beat last year's fourth quarter somewhat as we had more hardware in the fourth quarter last year in the U.K., especially, which is a small amount there. Now it's more heavy on the service side where we had better margins. The software portion between the -- in the fourth quarters are fairly the same, about 32%. We don't go into detail on the margins, but that gives you sort of a point around on what happens on the aggregated level. Next slide, please. As for cash flow, it was a strong year for us. We focused on this, but also, obviously, we have had some help in terms of business shrinking somewhat on top line more than we thought, and we managed to get a better profit than last year, obviously, and that doesn't carry as much capital tied up in working capital as we would otherwise have seen. And in all fairness, we also have had some -- a bit lower investment levels. So all in all, that has contributed to a really strong fourth quarter in terms of cash flow. But as you can see from the graph here, the -- in between quarters are very volatile in how cash flow develops. And that was it from me.

All right. And then Torbjörn Kronander, that is me, come back. Next slide. Sectra's way forward. And then we'll take the next slide, again. Our focus forward is continuing to strive for high customer satisfaction. All business is set around that. And also in the pandemic, a lot of our customers provide very critical functions for society to function. It's a hard job to keep them able to do that in a very efficient way. And then they need to be happy. They cannot be stressed for because the IT system, et cetera, doesn't work. And we then have the high customer satisfaction. You cannot provide high customer satisfaction with unhappy employees. It simply doesn't work. And so we strive a lot of having good, smart employees, who know what they need to know by culture. And we -- that company culture is very important. That has been a little difficult during the pandemic. We cannot call people together for training, et cetera, as you cannot travel. So that's something we have to increase spending on in the fall here to kind of get all the new people we have on board, to get to this kind of culture sessions, et cetera, and that we'll only do here in Sweden, not a tremendous cost, but very important to keep our employees motivated so they can provide customers with good service and products. And then, of course, we need to have profitable growth. We will not hesitate on that one. And then the fourth one that we strive for is skate to where the puck is going to be. It's very important for us, at Sectra, to develop things for the world as the world will look a few years out from now. If you always develop things to where we are, that would be a problem. I'll come back to that in a few slides. Next slide. This year has been great. As we informed last report, we won 5 best-in-class awards in PACS and digital pathology. We were best-in-class for large U.S. hospitals, which is our prime area of interest, which means we have happy customers with quite a large margin to the Sectra One in the U.S., large hospitals. And of course, we can never compete with real big companies and marketing campaigns. And marketing, we need to have happy customers who tell each other that they're happy. And we see that in increasing demand in the U.S. coming up as we have seen from the sales growth in the U.S. We also won PACS in Canada. They do not differentiate large and small hospitals in Canada, so we want it all over. We also won small hospitals in the U.S. That is not our prime segment, but we won that because we have the great culture to take care of everyone who trust us as customer. We won PACS for Europe. That we were second in last year, so that's an improvement, and we're very happy for that. And then there was a new category, digital pathology, which is actually non-unit. There are not enough customers in the U.S. Yet to do that ranking for the U.S. only. But in the world outside of the U.S., we won that also, happiest customers in digital pathology, which is a new area, which is very important for us. Next slide. We like quotes at Sectra. This is a quote for Edwards Deming, a person who was consulted by the Japanese government after the war when the Japanese changed from junk industry to have very high-quality industry. And we like that quote. And we have it in memory all the time. "Profit in business comes from repeat customers, customers that boast about your project or service, and that brings friends with them." And that's kind of how we motivate our high customer satisfaction's ranking and how it actually works. Sometimes people forget that in the new Internet area, but it is as true as ever and will forever be is in our view. Next slide, skate to where the puck is going to be. It's rumor that Wayne Gretzky was the best hockey player in 8 years in a row. He was not particularly good in anything on the field. But when they asked him, "Why are you so good, you're not good in anything? You're not good in skating? You're not particularly good at shooting? Why are you good?" And he said, "I don't skate to where the puck is. I skate to where the puck is going to be." That is you can read the play. That is very important for us. If we start developing products today, they will be ready 2, 3, 4 years out from now. And if we only develop for the needs of today, we will be wrong when that time comes. And we've been very successful with that. In digital pathology, we started where we saw this opening up as opportunity possibility. We're still unique, even though more companies are coming in now. In that we were there when the market came. We have been doing this over and over again. Sometimes we have failed, but most often we've been good at it. Productivity of health care is at core of society's needs. That would be there now. It's also there 4 or 5 years ago away. Medical community needs consolidated IT systems. We can do all imaging in 1 system. They need to improve workflows and integration. The level of burn out in U.S. radiologist is scaringly high. And more than 50% of U.S. radiologists say that they are on the risk of being burned out. And our job is to help them out to make them more effective, so they can come home to their families in normal time despite the increasing workflows -- workloads. And we also use AI to gain efficiencies. AI will not replace doctors or medical radiologists for a long time to come, perhaps not ever, but it can help them out in becoming more effective, and that's our job to help the market with that. Secure mobile workplace. You don't have to go to the office, do your work also in sensitive environments. Secure Communications channels, you can communicate and say, you can do teams meeting over a secured channel instead of being forced to do it in unsecured channels. And complete -- some completely new areas, which is Implant Movement Analysis, allowing orthopedics perhaps to do 4 new implants instead of 1 revision that was done unnecessarily, also risking the patient lives. And digitize pathology imaging, which is only in its very infancy right now, a very early phase in the market where the whole world will, of course, go digital also in pathology after a while that market matures. Next slide. We are increasing recurring revenue. The intent is to become a Software-as-a-Service company. Pay per usage improves value for both customers and vendors. Most of us pay now, for instance, Microsoft licenses. We then go to -- they shop on the corner to buy that box of Microsoft Word, Excel and PowerPoint as we did 10, 15 years ago, we buy an Office 365. We pay per month. We pay probably more over 10 years for that than we would have done otherwise. But we're happy with it. We get upgrades. Microsoft makes more money. We, as customers, are more happy we got the model, and we are moving there also in our products, especially in Imaging IT, but also in the other areas. We have a new business model, Sectra One introduced in May last year, and that would play a very important role in Sectra's future. You pay a combined payment, and you get everything we have in Imaging and you pay after a while you use the different parts. The transition will be over several years, but it has been accelerated by COVID-19. Next slide. This is something we repeat internally all over and over again. It's quite easy to create happy customers. Just live and act, the only rule that you have in all religions that we have encountered, all believe systems and all religions have 1 come rule, which is a little variation of the same, but it's do to unto others as you want them to do to you or in the negated form do not do to others what you do not want them to do to you. That is a cultural thing we try to enforce or motivate all over the company, and it's working quite well. It's quite easy. Just don't remember it -- just don't forget it. Next slide, our philosophy regarding shareholders is that if you have happy customers, you have happy employees that can provide sort of support to customers to make them happy. You have a good long-term strategy in growing markets. It's much easier to grow in the growing markets than in market that is stable. And both cybersecurity and health care is growing by external forces. And if you have reasonable cost control, then shareholders will be happy, but it comes in that order. And other things we've shown over the last year that it has worked. Next slide, the proposal to the annual meeting, which will be in September here in -- or actually, it will be virtual this year. We have a split 5:1, and we have a share redemption program of SEK 4.50 per share. Or if we do this before that split, it will be 90 -- apologies, SEK 0.9 per share after split. Upcoming financial reports and the AGM. We have a 3-month interim report coming up at September 3 and the Annual General Meeting at September 14 this year. I remind you that your feedback is very important for you. Please go to the www.sectra.com/irsurvey and fill in your feedback on these presentations. We'll try to modify them and improve them after feedback we get from you, or send an e-mail to info.investor@sectra.com to tell us what you want us to do different in the general presentations. Next slide. Then we have the time for questions. If you follow online, please use the e-mail button or send questions to info.investor@sector.com, and we'll try to get back.

[Operator Instructions] Our first question comes from Kristofer Liljeberg from Carnegie.

I'll start with 3 questions, and then I'll get back to the queue. First one, I wonder about this difference in reported sales growth and the FX adjusted growth. So reported is 3%. FX adjusted is 23% in the quarter. While at the same time, your major currencies down or 5% to 9% worse year-over-year. And also, if you look at the FX effect you have reported for individual quarters doesn't appear to -- they appear to be lower than the full year figure. So that -- if you could explain this, it will be very helpful? Then I wonder about large sales in rest of the world in Q4. I think it's by far the largest quarter ever for that region. Is this digital pathology, you mentioned that, but is it something else? And then I also wonder if you could discuss a little bit about the operating leverage in the large service segment? I think that was the only segment that was up in reported currency in Q4. And at the same time, you have this, I think, gross margin, second highest level ever or something.

All right. I will leave the first about FX to Mats Franzén.

Yes. Kristofer, yes, you're right. The way we calculate this is on accumulated values less previous accumulated periods. I mean in times with large currency is the sort of fluctuation that might skew the quarterly numbers in a way that, that might be bigger than they should be if the quarter was calculated in isolation. Now we will revisit this and do the quarterly-wise numbers and see to what size effect that might had and then we will be able to get back to you.

So we thank you for that observation, and that leads us to an improvement opportunity that we appreciate. You're good at finding small things or important things in our accounting, Kristofer. Thank you very much.

So -- but the reason it's becoming so big, that's because of the large currency movements this year?

Yes.

A normal year, you wouldn't see that, right?

Right. Right. So we haven't seen it at all in the last 2 years in any quarter, first also. So that's a bit unfortunate this quarter.

And the second question about our large rest of world products, and what they are including. Rest of the world is actually a mix of pathology that has been in several markets, but also in radiology where we have some difference there. We also have an impact from New South Wales, which is now becoming operational and thus paying off money to us. And New South Wales in Australia was an order we took more than a year ago. But they are now coming online, and they are contributing on a recurring revenue basis. And your third question, can you please repeat third question, Kristofer?

Yes. I'm just trying to understand what type of operating leverage you have in the large service segments? And I understand there's a lot of different type of product sales you have in there. And the reason I'm asking is that, I think, at least on a reported basis, that was the only segment that were up in year-over-year. And at the same time, you have this, but historically strong gross margin. So if there's a correlation between these two?

I wouldn't say that there is a clear pattern to that. I mean you're correct in that, that this year, I think we're about 62% of total revenues is in the service side, where if it was 57% or something like that last year. And we have seen a strong traction also in fourth quarter now at some -- just short of 55%. And last year, it was 51%. So the trend is clearly upwards. But I wouldn't be able to answer in more detail on how that really plays out in different projects or markets for now. But the observation is true and it carries some above average support in terms of the contribution compared with the hardware side, but not as good as the software on the other side. So it's in between, but it's helpful.

But in the service, is it correct to assume that there's a lot of man hours here, so that operating leverage is less than for the software?

Yes. Man hours is a significant contributor in that part of the revenue stream is.

Our next question comes from [ Paul Morin from Danske Bank. ]