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

Welcome to Sectra's financial report presentation with CEO, Torbjorn Kronander; and CFO, Mats Franzen. My name is Helena Pettersson and I will be the moderator of the Q&A session after management presentation. The chat function is open and you are welcome to start raising your questions. If you don't see the chat function, it is on the top of your screen. It's a speech bubble with a question mark in it. If you don't see it, you may need to switch to full visual mode on your screen. And with that, I leave the word to Torbjorn Kronander.

All right. Welcome to our presentation of first half year. It's myself, Torbjorn Kronander, CEO; and Mats Franzen, our CFO, who sits here to the right of me. And then we'll go into the presentation, 6-month interim report. Agenda today is Q2 highlights that will be done by me, financial development done by Mats, Sectra's way forward done by me and finally, we'll have a Q&A session. As Helena said before, you can either send e-mail or you can use the chat function in the Teams meeting. We also have some pre-sent in e-mails that Helena will read when we have the session. The value we create for customers at Sectra. We are working in 3 areas, all are important to society and they have the benefits for 2 major areas I would say, medical and cybersecurity. Those are the benefits that these areas will have to grow and we have the basic idea that it's easy to grow and grow in markets. And as we have presented in other presentations more on that, both medical and cybersecurity has to grow in external forces and that's where we operate. Q2 highlights. We have our net sales, we had an extremely good first quarter. We also told very early on at that presentation that some of these were deliveries made earlier and that that level was not to be expected for the full year and that is also what we're saying now. The net sales was increased by 15.7% over the 6 months. Profit per share increased by 53%. And recurring revenue, which is a very important figure now, it must be made aware of that our change to software as a service model will change how the orders are delivered. We still get large orders, but recurring revenue is what we think is a very important growth factor now. While the top line revenue, as we spread this income over licenses sold over future years instead of the present year, will not grow as much as the underlying business growth. Now for shareholders will be long term a good thing, but it will not look like the mix. The mix will not look as it has been doing historically. All financial targets for the group are fulfilled. Our first target is stability. We are dealing in markets where trust is super important. If our systems stop in hospitals, the entire hospital stops and if our system doesn't work in cybersecurity, the most important secrets of nations are compromised. We cannot operate in such an area without trust and that also goes to financial trust. We should have a strong financial situation that is expressed by equity to assets ratio, which would always be above 30% and currently at 61.3%, good margin to the 30%. Profitability, that's a hygiene measure as we see it. Our target is to be above 15%. Now cost of the pandemic has been much lower than normal. We are seeing these costs coming back though. We need to go to exhibitions and we just recently participated in the first international exhibition in 2 years, which was the RSNA in Chicago, and we see some of these costs coming back. So with the target still to keep it above 15%, but we're currently clearly above that at 23.3%. And then the most important target, which is profit growth per share over 5 years, that should be above 50% and we're currently well above that at 134.8%. That is the most important target though it's rated -- ranked #3 priority. Seasonal effects and the pandemic, we have large variations between quarters. Some of these are due to the pandemic. When countries open up their lockdown, we can travel and this affects us a lot and especially it affects our customers in health care and our delivery possibilities in cybersecurity. We need -- all business negotiations at the highest level of security needs to be done in person, it cannot be done over net and all deliveries in this category are done by courier. If you cannot travel, you cannot deliver. And in medical if there is a virus situation, the thing you shut down or close down in order to open up to be more prepared for handling the pandemic has been this elective surgeries or elective procedures, things that are not acute. They have decreased and some business areas especially orthopedics have been affected because they deal exactly with elective surgery. It's gradually coming back and of course, people need new prosthesis, et cetera. They have not gone away. So this is a pent-up increased workload ahead of us. We don't know what impact that will be, but it has affected us over the pandemic. Travel and marketing costs will increase post-pandemic, but we do not think that it will go back to historic levels. The days when you did a trip to another country for a 2-hour meeting or people you already know are probably and hopefully over and that will increase efficiency and some of that travel will not go back as we see today. Secure Communications, Q2 highlights. The Norwegian defense forces procured additional units of our Sectra Tiger/S. That's our most qualified mobile encryption system. It's a mobile phone that we build ourselves. It's approved to the secret level in NATO and EU and Sweden and Netherlands. Not Sweden yet, but Netherlands. And then we have had problems mainly due to COVID, but also quite a lot of investments in the communications area and we are working to increase this to more normal levels for Sectra. Our growth initiatives in Secure Communications. Mobile secure workplaces, that's a very interesting area of interest. It was already coming before the pandemic and now it's even more important. People want to be working from remote, but they want to be on a secure network as secure as if they had been on the physical cable in the office. This is a growing area also on the level of qualified secret and restricted information and we are very well positioned in that area. So it's not only voice, it's the entire mobile workplace. Critical infrastructure. There has been some significant events not at least the Colonial pipeline in the east of U.S. during the spring. Increased awareness that we have built a very vulnerable society and critical infrastructure must be protected again cybercrime. We are well positioned there and that's a growing area where we're investing right now. Higher security levels for secure mobile voice and network systems. As I said before, this is work areas where we've been working in for many, many years and are very well positioned. We also have high-speed network encryption systems and that would mean on the approved level. So Level 2, Level 3 and Level 4 network devices that are very high speed are on the approved security levels. We have Simo Pykalisto, who has been with Sectra for 18 years first as CFO and then managing communications has unfortunately decided to leave Sectra for another opportunity. We currently have an interim manager in place, Magnus Brege, who has a history as managing directors of various companies. He will formally take over that role January 1, but he's already here. And we are looking for a new permanent manager during the early spring. Business Innovation, Q2 highlights. We had an interesting interest in the education area. We just got our first install in the U.S. -- in Norway where we got the honor of delivering our education portal to Oslo Metropolitan University for Medical Education. That's a first in Norway. In orthopedics, we won a very prestigious award. We won the best software for postoperative follow-up with our Sectra Implant Movement Analysis to see if prostheses are really working or if they should be reoperated. And we also have seen a strong negative effect from pandemic effects in both of these areas, but especially in orthopedics. Growth initiatives in Business Innovation. We have in medical education, we are transitioning from a device delivery of our large tables for medical education used to replace the [ auto ] system more or less for students that we now have so much content that we're beginning to also sell content subscriptions. This is a very large change. We get recurring revenue. As with all parts of Sectra, we're moving this area heavily into recurring revenue. We are selling a larger proportion of recurring revenue in teaching all the time. We've also seen during pandemic that people are doing more and more education from remote and that has also sped this up. We have new areas within orthopedics. Sectra Implant Movement Analysis as said before is in order to determine which patients should be reoperated. This is when patients have already an implant and they have problems or pain and they come back and very often it's reoperated. Revision of a prosthesis is a dangerous operation and it's also very expensive much more so than the first processes. And to avoid the ones that could be avoided because it's actually not the problem with the prosthesis is important. That has been very difficult to do and we have a new technology, Sectra Implant Movement Analysis that originally developed at the Karolinska Institute of Stockholm that we are now having a lot of critical trials and we also see it in clinical uses in some part of the world. A variation of that is also more or less the same software, but used not for a patient but to evaluate new prosthesis to see if a prosthesis are actually staying at the place you insert it in the body or if it moves. There the customers or procedures manufacturers, they need a research team to see if the prosthesis work at all. And in research, which is the third area of business innovation, we are doing a lot of work in AI for medical applications and we're also looking into future application areas of various kind. Imaging IT Solutions, our largest area, Q2 highlights. We are seeing cloud-based deliveries are increasing. In Sweden, all the latest installs have been cloud delivered on our private cloud. But we've also seen an increasing interest, especially in the U.S. for public cloud. That is when Microsoft or Azure will host our applications. And we have now joined an international partnership with Microsoft are increasingly delivering our applications in the Microsoft Cloud. Very good collaboration and that can be important for the future or will be important for the future. In Europe so far we have done private cloud because of GDPR reasons. We cannot use the Microsoft Cloud in Europe yet. We hope to be able to do soon. And we also see our customer base growing. We have a good healthy growth, especially in the number of exams we have in our systems. As I said before, with cloud deliveries, recurring revenue is more important than actually the top line revenue because when we sell the license over time, it will affect the immediate sale after getting an order. Our growth initiatives in Imaging IT Solutions. We are looking into new markets. We just opened our first partnership in South America. That cannot be -- that will not be super large, but it's an interesting step into a new continent. Enterprise imaging, we are doing a lot of work in a system that is more or less parallel to the medical record systems and in all images of hospitals. As we have announced before, we are growing very well in digital pathology where we are definitely one of the world leaders and integrated diagnostics where you combine pathology and regularly especially for cancer diagnosis. We are increasing in cardiology also using a lot of images. And we have a new area, ophthalmology developed together with a very important customer in the U.S., which is now in clinical use and will be another important addition to our enterprise imaging. We are focusing on the U.S. that's the world's largest market. We top customer satisfaction, which we are very, very proud of. We have had this customer in the U.S. for 8 years in a row. And we still have a small, but growing market share in some other countries where we also have customers. We have a very large market share that will be difficult to grow. But in the U.S., we are still not a very large player. And then I'll leave the word to Mats, who will discuss the financial developments.

Okay. So starting with the order intake, we see the same pattern as we did in the first quarter. We are down first 6 months with some 37% and I think it was 37.5% in the second quarter. This means that we on a rolling 12 now are at SEK2.1 billion -- SEK2.150 billion to be more exactly, which is down 19% compared with the SEK2.6 billion we had for last financial year. The net sales is up some 16%. That was accomplished primarily in the very strong first quarter, which those of you who have followed us know is due to a temporal situation where we had order deliveries or deployments coming earlier for various reasons, which also then we said and we still say do not impact the way how we view things going forward. We do have a slight adverse currency situation. So 17.4% would have been the performance so far currency neutral, especially the U.S. dollar has appreciated in relation to the Swedish -- or the Swedish krona has grown stronger rather. However, now we have seen that reversed over the last 6 weeks or so. We can go to the next slide, which is neat. When it comes to sales by geographic market, we do have a strong performance in the U.S. continued and in Sweden, it's the only market actually where we have a contraction for the first 6 months and that is primarily due to communications side. The Rest of Europe is also the second largest contributor where actually about half of that is Norway and then we have Belgium and Germany comprising the lion's share of the residual. As for the Rest of the World, which also had quite a good traction during the first 6 months, we see that is pretty much evenly split between Canada and Australia. So looking at the performance in terms of segments. It is quite clear from this picture that it's Imaging IT Solution, which is the big contributor here and Secure Communication has had a rough patch for the first 6 months in terms of revenue developments. And that's pretty much the big picture here that we can see. In terms of earnings, we also see that the volume base increase in Imaging IT has clearly also reflected in the earnings or the profit numbers. We do have a somewhat stronger gross margin although we don't report that on a separate line item, but that's primarily due to the fact that we do not have as much hardware and third-party products. It's less than 8% this second quarter at least and it was about 17% in the comparable second quarter. We do on the other hand have an uptick in the cost now that we can see and which we foresaw as well due to hopefully being able to visiting customers and being able to onboard more colleagues for the future. Other operation has a slightly higher cost increase presently as well due to IT, especially IT consultancy and projects going on to accommodate the higher volume. As for cash flow, obviously, the operating profit is a good baseline to start with. We have had a good year so far in terms of operating profits. However, a considerable part of this is not converted really as we had such a strong sales. We do have that capped in operating working capital so to say. And we also have slightly higher investments. I would say this second quarter now being just some below the SEK50 million mark is pretty much the normal or historically versus actually '19 and '20, which is the odd year with this above SEK100 million. But looking 2 more years back, it's around SEK50 million in cash flow in this second quarter. So that's not outside the normal. Okay. Back to you, Torbjorn.

All right. And I will continue with Sectra's way forward as we plan and look for it. Focus forward will be continuously to work for higher customer satisfaction or high customer satisfaction. That is kind of in our genes and we have a very strong belief if you have customers which requires happy employees, then you will have profitable growth if you're working in markets that are growing and that will be good for shareholders long term and very often short term also. We also want to skate where the puck is going to be as we are saying it. We are investing in things we believe will be important not only in next year but 3 to 8 years out. And a very good example of that is digital pathology where we saw this as an important growth field that was the last area of medical imaging that was still not digital. We started up at a loss. It was losses for several years and we invested there. And today, we are a trajectory in a world-leading position or one of the world leaders in a completely new area that will spread all over the world. So that is how we operate. Some of this doesn't work out and we have to shut them down. We rather have a few that works out until it gets us in the right position than not daring to take these investments at all. This is a quote that we very often use. Some of you who have heard us before have seen it before is you can imagine a lot of things, but the world is not so different from the way it always has been. Profit in business comes from repeat customers, customers that boast about your project or service and that bring friends with them. Both quotes from Edwards Deming, who was consultant for the Japanese State after the war and this has been the rule for eternity and will be really going forward also, but you should never ever forget it. You need to keep your current customers happy in order to get new ones. But in order to have happy customers, you need happy employees. Sorry for the misspelling there. You cannot have happy customers if the employees are not happy. So we work a lot with employee satisfaction as well. And very happy to announce that we were voted by our own staff in anonymous votes to be the 4th best employer in all of Sweden. This is super important both for recruitment, but also for our employees to do good work with our customers. Customers feel the attitude and the morale and the mentality in the company and that affects very much the customers' impression of Sectra as a whole. Increasing recurring revenue. As I said before, this will be an increasing important goal for us to increase this. We have a large interest in pay per usage. We introduced last year a Sectra One model and we see now that the interest in buying from customers in that way where you buy for usage instead of the license has increased tremendously. Actually, the norm of the discussions we're having with future customers right now is most often in this model than a license sale. A little different in Europe where the way the European purchasers work that there is more license content here. But in the U.S. who are faster to move, we see huge interest in Sectra One. Transition to this new sales model will be over several years. And during the transition, as I said before, the apparent revenue growth top line will be significantly smaller despite large growth in reusage. Reusage is actually determined as a long-term profitability more than anything else especially you get paid per usage of course, but also generally. So our top line growth will be smaller while the long-term profitability will be better than before coming out of this change in model as you've seen in many other IT areas, other markets around us. Long term the financial effects will be strongly positive if people pay per usage instead of paying for initial license. Skate to where the puck is going to be, future things we are working on. In Imaging IT systems, it's enterprise medical imaging including pathology. Pathology is still in a very, very early market phase. A small fraction of the world's pathology departments are digital today. We are very well positioned in that area. Also, health care is under significant strain and pressure for production. There are too few medical doctors and medical staff all over the world compared to the inflow of patients especially elderly patients. And the way to sell to these people is of course to improve the workflows and make them more effective not only running faster because that will work. So we provide our medical customers with tools so they can be more efficient without working even more are something we already did. Consolidated large-scale IT systems. There's a huge consolidation going on in the world between providers of health care, both in the public health care countries where you merge large groups and regionalize, but also in private systems where there's more mergers and acquisitions and some chains by other hospitals. We are well positioned in that area. We have very scalable IT systems. We see that very often we replace other vendors' systems who did not scale. These health care providers need systems that can go with and without forklift upgrades and we're strong in that area. In cybersecurity, high speed, high-security network infrastructure that is approved network infrastructures. And of course as all over the world networking becoming more important also in authorities, defenses, et cetera; but these people need high-security networks that are approved to secret or restricted levels. This is a huge growth area and we are well positioned with our new products. Secure mobile workplaces, people want or need to work from a remote. At least this has been very obvious in the pandemic. People will sit on a closed-down network with a cable that is orange or red. They need to be able to sit remote and be as secure. That requires very special security solutions and what you normally can buy on the network as for EPNs, et cetera, are not appropriate for these needs for the high-security levels. So we are good there and we're increasing in that area. Secure mobile workplace will be a large area of growth in the future. And then of course safeguarding critical infrastructure as we discussed before. Business innovation, the spare part human is becoming reality, especially for skeletal thesis. There are many, many tens of thousands orthopedic devices you can actually insert into the human body and these people will need more preoperative planning to get the right device into the right people. But also, as we said before, revision should be avoided because they're very, very expensive and also very expensive and our Implant Movement Analysis is unique in that ability to avoid unnecessary revisions. We also see in education the lifespan of medical knowledge is getting shorter and shorter. What is state of the art was before 50 years, now it's perhaps 1 year and then it's a lifelong education not only of university students but also existing medical staff and we will have a very good Internet-based business in providing content and curriculum for such training in the education area. A rapidly growing area as well. Our philosophy for shareholders. As said before is if you have happy customers, happy employees are needed to have the happy customers. A good position in growing markets and especially if the market has to grow by external force. Reasonable cost control and perseverance, you need to be a little stubborn at times. Then shareholders will be happy. And I think we have proved that over the years and we'll try to continue proving that. And that leads us to the end. Our upcoming financial reports and the AGM is now decided. The 9-month interim report will be March 9, 2022. The year-end report will be June 3, 2022. And our Annual General meeting will hopefully and the planning is that we will have it as a real-life event. Now these virtual meetings are not very nice. It's not as nice as a real meeting. So the planning is for having meeting in literally in-person as we have done historically September 8, 2022. I will remind you that the feedback on these presentations is important. Please let us know what you think. We try to adapt them to serve the needs of information from you shareholders and people who follow us on the net. So send e-mail to [email protected] if you have any comments or any suggestions to improve these presentations. Then we open up for the questions and you can also use the chat function. And Helena will read questions to me and to Mats and then we will reply here.

Yes. And I will start with inviting our financial analyst, Karl Noren from Danske Bank, to start asking questions and you are welcome to unmute your microphone. Are you there, Karl? Okay. Then we will start with one question from the chat. And the question is how will you present numbers during the transition period from license to SaaS? It would be helpful to have some sort of measure of underlying performance as reported numbers will obviously be affected negatively.

We are currently reporting since a quarter or 2 back recurring revenue in a way we didn't do before. We are working on actually making that even more fine-grained so you can see in detail how we proceed. We look forward to making this report even more detailed in the future. Right now you have to look at the recurring revenue figures.

And then I will go on to read some questions from Kristofer Liljeberg of Carnegie. The first question is can you please explain the sequentially higher gross margin in Q2? Is it explained by a low number of new installations?

I would say, if I may take that one, primarily it's due to the significantly lower proportion of hardware and third-party content in the second quarter. It's below 8% compared with some 17% in the corresponding second quarter last year.

And the next question is when commenting the growth for the first 6 months of the year in the report, it mentioned that growth was supported by early deliveries. Does this imply growth will be lower in second half than in first half?

That's a question we cannot reply to. We do not do forecast at Sectra. So it's up to every analyst to interpret this themselves.

The next question is what was the organic figure for rolling 12-month order growth?

The total order intake, we do not separate organic or otherwise, is SEK2.150 billion compared with SEK2.652 billion for the last full financial year. That's on the level we report this.

And does operating cost in Q2 reflect business back to normal or should we expect costs to continue to increase sequentially?

We will increase costs still. All of the world is not open yet. So costs will be expected to increase a bit higher. But however, we'll not -- we don't think it will come back to pre-pandemic levels.

Okay. Then we'll do a new try with Karl Noren. If you can unmute now?

Yes. Can you hear me?

Yes, we can.

Great. I have a couple of questions. But if we start off with Secure Communications. I was wondering if you can comment anything on the weaker development here in Q2. Is it only the pandemic you would say and when do you expect net sales to recover back? Any comments on the order intake would be helpful.

It's mainly due to the pandemic because, as we said, the national security area where we deliver this secret level devices. If we can't go to the customer, we can neither sell nor deliver our products. It's nothing like in medical, we can both sell and deliver over the network. It's not possible, you're not allowed to even discuss this over Teams for instance. So after a while the pandemic decreases, we expect the order intake to rebound and then, of course, it takes a little more time afterward until you get revenue out of it. But we do expect an improvement when the pandemic lockdowns goes down.

Okay. And then maybe a question on the order intake in the IT Imaging. I'm just wondering when you move, as you say, now more into software as a service and pay per usage with Sectra One. Can you just tell us a bit more on how we should think about the order book? Will that change anything of how you report the order intake or will it be exactly the same as before?

Very often customers, it's a little different in different countries. But if we take the U.S., which is currently our largest market or also where we're growing, as a prime -- I will respond to that first. Then we normally get a fixed order when they guarantee to buy everything from us for a certain number of years in these orders. Now of course the order in reality is longer because it's also the order beyond this initial 4 or 5 years where if the customers are happy, they will stay with us. But that's not this on the order intake, it's not a guaranteed order. Then revenue recognition, unfortunately, varies quite a bit. If it's something where we're responsible for the entire delivery, we can count this upfront as a future income and we can count that as revenue and profit upfront though it's spread out cash flow-wise over several years. It's not completely depending on us. We need to take this revenue and profit each year-by-year. The order will be the same, but the outcome of revenue will be different. This is very unfortunate. We wish it was not the case, but that's an IFRS problem that we have to live with.

Okay. And then a question on the number of exams in your larger markets in your systems, you said that you have seen quite nice growth there I think I heard. Can I say anything on how the recovery is looking? I guess the U.S. is back to normal almost, but how is it looking in Europe and other markets?

The U.S. is not back to normal. But it's interesting that this area of the market has been back, is more or less normal. It shows that the consolidation of hospital et cetera because of the financial strains of U.S. health care, most of the income for U.S. hospitals come from elective procedures and when you take that out, there's a massive impact. That has increased the rate of consolidation in the U.S. So we don't see a large effect in the U.S., but U.S. is far from back to normal as far as the pandemic go. In Europe, it's very, very different in different countries. As you know, I mean Austria has a lockdown again. Germany is in between somewhere. The U.K. has as well introduced new restrictions so has even Sweden and it goes a little up and down. We do see business going on in Europe as well. But exactly what happens now with the Omicron mutation, we have no clue to be frank as I think no one else has. Otherwise, you need to be prepared and be aware of that. The predictability of the market is more difficult than is normal.

And then as the last one on you stated now on the recurring revenue side that this could impact revenue growth or will impact revenue growth. Could it be that it will be hard for you to reach your financial target rate of growing your EBIT with about 15% per year during this transition time or do you still see that Sectra should be able to reach these targets?

Well, we haven't changed that target neither up or down being you could consider that being above it for many times, it should be risen up. But it will be impacted to some part of this. But long term we think it will be better than if we didn't do the change to software as a service. But we are still having that target and there is no big difference in our predictions of being able to reach it and I cannot give predictions any more than that.

Thank you. And I see no further questions through the live event, but we have a number of questions that we have received by e-mail before this meeting. And the first one I think is actually the one you answered right now. The financial targets are by far exceeded quarter after quarter and year after year. Are you having any discussion about updating the targets?

Of course, there is actually discussions, as said before, but we are in a transition that we think as all other software markets are doing the same thing. Long term it's good for both customers and which is kind of the best things you can have. But it may affect these figures, we don't know yet. But we are right now -- the Board has not decided to change them for the time being.

The margins were good in the first quarter, which I interpret was due to a higher percentage of sales of software. Will the higher operating margins as well as the share of software or total sales stay at current levels also in the future?

We cannot comment on that. We see with going into the cloud that the hardware content will decrease, but we cannot say how fast and how that will come about.

The next question is the group's cash equivalents is large and the cash flow is good while the share redemption amount to shareholder is kept the same. Have you discussed the revision of the dividend policy for example that's a certain percentage of earnings to be distributed?

I think I cannot comment upon. It's a discussion of course held in the board for every new year. But the current level is what we've kept for several years.

And the next question who are your main competitors?

Of course, that's very, very different in the different areas. We have also a situation where it varies between countries. In the U.S. there are a couple of competitors that are doing good. We have a company called Change. We have the large companies like Philips who acquired a company called Carestream. We have a company called Visage that will compete within the higher end, but only in the U.S when we are international. In Europe, there are very few local players in the local markets and in different plays in that in Germany for instance than what we see in the U.K., et cetera.

And then final question. When you look at the future, how much demand do you see for your product and why?

As we said before, we have by intent and planning decided to work in markets where the market itself will grow by external force. There is no way that cybersecurity will not grow. It has to grow because we're getting more and more digitized in the society and cyber criminality is going up. And then the people working against that cyber criminality, that, of course, will increase the market. Then we need to keep or increase our market share in that growing market. In medical, it's mainly the situation that we need to curb or limit the growth of health care expenditure as a percentage of GDP in the entire world. It's kind of continuous. These derivatives of these curves have to be kind of leveled off. We can't use all resource available on the planet to health care and that change will require a lot of improvements in efficiency and workflows and how we work with health care. That's also a market that has to grow by external force and the main impact of that external force is actually the demographics where people get older in all of the world and old people have more disease and you need to work with that.

Okay. That was the last question.

All right. Thank you very much for your questions. Please also give feedback on the way we do this now. We have done it over Teams and we of course would like to know if it's better, worse or the same as we've done before. We thank you very much for today and looking forward to hear you again in quarter 3. Goodbye.