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

Good morning, and welcome to Sectra's financial report presentation with CEO, Torbjorn Kronander; and CFO, Jessica Holmquist. My name is Helena Pettersson, Investor Relations Officer, and I will be the moderator of the Q&A session. Management will address your questions after their presentation. The chat function is [ ready ] and so don't hesitate to write your questions. And with that, I hand over to you, Torbjorn.

All right. Welcome to our Q3 report '22-'23. We'll begin with interim highlights from the quarter and the financial development will be done by Jessica. We'll talk a little brief about Sectra way forward and then we have a Q&A session in the end. And you can also do chat all the way. So the main business lines of Sectra, just to repeat what we're doing is Imaging IT Solutions. We'll manage all images in hospitals and health care providers. And we are the only provider in the world who can do both radiology, pathology, cardiology, ophthalmology, all the different type of images in one single system. So other vendors by acquisitions other things have done that so they can have solutions for instance, pathology and radiology at the same time, but we are the only one who can do in one system. That's important for caregivers because it saves a lot of money and staff on the site. Then we have IT Security solutions, which does very high-level encryption systems and communications -- secure communication systems, which is about 1/10 of the company. And then we have our greenhouse with medical education, IT providing systems for training on medical staff, both basic training university level, but increasingly also clinical continued training, all our people already experts. And we are also seeing some interest from veteran medicine there. And orthopedics IT specializing the special tools of things that orthopedics doctors need which is based on the packs for Imaging IT, which is currently system for providing image management, but special functions for orthopedics and musculoskeletal radiology. We have a research division, mainly doing research within things. We are going to take commercial with 5 to 7 years forward. They mainly AI. And then within the 2 main areas, we have IT security and critical infrastructure as a little growth opportunity there. And the Imaging IT, we have digital pathology and integrated diagnostics, which is almost becoming a normal business line to get with radiology products in Imaging IT. We added last year also genomics IT, which is an area that needs to be industrialized and industrialized in a positive sense. Health care cannot have manual handling and everything when the number of patients grow. Genomics and new generational sequencing of specialty cancer care is growing very rapidly, and they need now industrialized systems that can manage that increasing flow of patients. We're doing that together with University of Pennsylvania in the United States. And we have come quite a long way in development. The aim is to have a ready product that will then integrate into digital pathology and radiology by somewhere early in 2024. Highlights from the quarter. We have all-time high contracted order bookings. Note please that we are increasing seeing larger and larger orders, very large chain hospitals and hospital health care organizations are placing orders with us, especially in the U.S. And they also the term are increasing, they are long term, and we get such a product, which is not a Software-as-a-Service booking, it's another one. This is on-prem bookings or a part of the long-term SaaS bookings. It means we get very large values, but the long term of the contracts increased the order values. We have 2 substantial Sectra One, our Software-as-a-Service contracts coming in over the period. But please note that we have significant quarterly variations, future large individual orders for, for instance, on-prem solutions, et cetera. So if the variation is very large, it's decreasing with the software-as-a-service, but it's still very large. Net sales has grown by 25%. Profit per share has grown by 9%. Recurring revenue has increased by 23%. And we should also note that we have had a substantial currency tailwind here. So we've been helped with the strong dollars and euros which is down compared to Swedish krona. And recurring revenue, as we are transferring to software-as-a-company to software-as-a-service company, that's an important thing to mention going forward. Our financial targets are fulfilled. First priority one is equity to assets ratio that is financial stability of the company. That should be above 30%. It's well above that, that's 50. Second in priority is profitability, operating margin that should be above 15%. That is currently at 18%. And then the third priority target, which is actually the highest importance, but we need to fulfill the 2 first as hygiene factors. It's growth of profits per share over a 5-year period. That should be above 50%. It's currently almost double that at 94%. In Secure Communications, we see a real change because we have had problems here. It has not been as profitable as we wanted. It still has some way to go, but we have a positive trend that is significant in that, partly helped out by the security situation in Europe, partly that we have had long-term investments that are now coming to the end and we'll begin to deliver phase of these products that we've been delivering or developing for 7 years. In business innovation, we see rapidly increasing recurring revenue. Orthopedics and musculoskeletal are very synergetic with radiology. It's actually sold through Imaging IT to a very large proportion. And that also helps our PACS business. And in new medical education portals, we see dramatically increased usage and very good order intake in medical education. And we have Genomics IT as said before, but that's not yet delivering any revenue. It's -- today, it's mainly cost for development. Imaging IT Solutions, our biggest area. We have grown order bookings in all markets and notably mostly in the United States where we are growing rapidly. We have transitioned to SaaS and cloud deliveries and these transition goes even faster than we expected. Most of the orders were today, we don't see so much in the figures till today, but we will see it next year in the coming years as this is growing even faster than we believe. And the cloud recurring revenue has consequently increased by 39% in Imaging IT, and it will increase even more going forward. We also are very proud that we, for the 10th year in a row, got the KLAS award. That means that we have the happiest customers in U.S. large hospitals for our products. We are also -- and that was for the 10th year in a row. We have the happiest customers in small hospitals in the United States in Canada and in Asia/Oceania. In Europe and in pathology, we're #2, and we would like to get up to #1, but we didn't make that this year, but we're extremely happy and proud to have the happiest customers in the United States for the 10th year in a row. And that's a lot of work to achieve, and I can only thank our staff and personnel, all of the world to accomplish this. Then I will leave the word to Jessica, who will tell you a little about the financial development.

Thank you, and good morning. Before presenting the financial development, I will quickly repeat the changes that we're making to our financial reporting this year. Driven by the shift in our business model towards service delivery over time, we are implementing the following changes. The first one concerns order intake, and we provide more details around order intake during a 2-year time frame. And in 5 quarters from now, we will stop reporting order intake. We have increased the focus on recurring revenue as growth in recurring revenue will be essential for understanding our business going forward. We have also implemented cloud recurring revenue, a subset of recurring revenue, which serves as an indicator for how we are progressing in the transition to cloud deliveries. And we have announced earlier during the year that we will also complement the reporting with a new alternative performance measure for recurring revenue churn, and that will be in our Q4 report. And you can read more about these changes in the report we just published. Like Torbjorn said, our contracted order bookings are historically high this year. They are year-to-date at SEK 3.4 billion, of which SEK 1.8 billion is guaranteed order intake. And apart from the 2 large multiyear contracts that we secured during Q1, smaller and midsized orders have continued -- we've had an -- the inflow has continued to be healthy during the 9-month period, resulting in a book-to-bill ratio of 2 on a rolling 12-month basis. And in the third quarter, we highlight the orders for our digital pathology solution in France and Belgium as well as orders from the Swedish authorities for secure mobile communication solutions. And we also won our first Sectra One cloud in Canada. There is stable growth in our net sales. For the 9-month period, sales amounted to SEK 1.6 billion, an increase of 25%. And again, we repeat, we do have -- we do have strong currency tailwind with substantial impact on sales. Adjusting for currency impact, sales grew by 16%. The underlying sales development is driven by a growing customer base and also increased sales to existing customers. And the transition to SaaS has contributed to an increase in recurring revenue of 23% for the 9-month period. And the share of recurring revenue out of total revenue, which varies from quarter-to-quarter is currently at 61%, which is in line with last year. All business segments show an increase in sales versus last year. Imaging -- the majority of growth is generated by Imaging IT in absolute terms. Secure Communications, however, increased top line by 29%. This is -- we see this as a sign of course, of a market situation that is gradually normalized, although we still have challenges remaining. And Business Innovation increased sales by 15% versus the comparable period with a strong positive trend in cloud recurring revenue. All 6 geographic markets where we are present, increased sales versus the comparable period. There is no change in the pattern from previous reporting periods. We see the highest growth in the U.S., Sweden and the U.K. And in Europe and what we call Rest of the World, we had the highest sales increase in Denmark, Norway and Australia. Operating profit increased by 7% to SEK 259 million, equal to a margin of 16%. The margin is above target, but lower than last year as we continue to invest in cloud deliveries, and we also have a higher spend on customer events and travel than we had during the pandemic years. The operating profit in the third quarter increased by 27% to SEK 87 million with a margin of 15%. And adjusting for currency impact, the margin in the third quarter increased by 9%, whereas the margin -- the operating profit for the 9-month period decreased by 12%. Business line, Imaging IT, we see stable profitability, and they have year-to-date generated SEK 280 million at a margin of 19%. The ramp-up of the organization and the higher cost for marketing activities has reduced the margin versus last year. Secure Communications, as year-to-date, generated an operating profit of SEK 1.9 million, and we saw a positive development in earnings during the quarter, resulting in an operating profit of SEK 8.5 million in the third quarter alone. And here, the focus remains on deliveries, marketing and sales, which should lead to increased profitability over time. And we also have a positive trend in business innovation, which from relatively seen small numbers have almost doubled the operating profit versus the comparable period. We have positive cash flow from operations, both in the quarter and in the period. Compared to last year, we have lower cash flow as it is impacted by increased tied-up capital in current receivables. And the overall cash position remains strong with cash and cash equivalents of SEK 602 million. With that, I hand over to you again, Torbjorn.

All right. On way forward, where are we going? We have a Capital Market Day in January. If you're interested in more details, we recommend you to see that as well. It's available on our web page. But the priorities, et cetera, is customer satisfaction first. And in order to get higher customer satisfaction, you need to have at the employees [ otherwise going first ]. And that will lead to profitable growth. And we also have the saying we want to skate to where the puck is going to be, that we have been quite good at over the years. We see trends early on, and we have been able to design products and services that are -- when they are mature, the customers want you to fly them. Pathology in the radiology system is a very good example. We started that development 8 years ago. No one else did it, and we are now ahead of the market in that situation we have both pathology and radiology in the very same system, forcing competition to acquire other companies, which means they don't have the same system. So we've been good at this, and we keep going in this trend as well. And the increase in recurring revenue will continue. It's a very large interesting pay per usage. People not the least in the United States, they want to pay for the usage to have our software instead of a very hefty license upfront. This, of course, changes our way of doing business very much. It will be good long term, but it will hit us our growth or at least obvious growth in the beginning of this transition. We haven't seen so much of it yet. We have seen some, and that has been partly compensated for by the tailwind in currency, but we'll see more going forward. I'll come back to that later. Long term, the financial effects will be strongly positive on this, but it takes a few years initially to compensate for the change in the streams of revenue. And I would like to show it like this. This is the old type we did business, upfront license. And then we had more service income. The blue staples there over a long period. In the new world, we will have the orange staples instead from early on. And of course, that first year, there's a major difference in recognized revenue, but in the long term, it will be profitable compared to several nation license. An example might look at this. And typically, it's 5 to 6 years before breakeven. But long term, you see that the software service model will be grossly positive for our shareholders and the company. The interesting thing is perceived as very positive also for customers despite that they actually pay more. They get a different type of service. They don't have to employ also many IT people because we take care of all their costs, they don't have need -- we do this in the cloud, they don't need to have on-premise installations, no compute on-prem, et cetera, and that is perceived as a very good situation for customers, and that is also was the SaaS right. But there will be an increasing impact of this over the next year to come, and it's important that we realize that we will have a more significant impact from starting from next year that will have this 4 of these kind of moving revenues and profits forward. We think we are very well positioned and in the kind of combined diagnostics. We were recently early this week actually invited to present at the U.S. National Academy of Sciences. They had a special symposium integrated diagnostics in precision medicine of cancer treatment. We were only tax company invited and that shows that we are perceived now as a leader of the technology in this area, and that might be a very important thing to have going forward. Why should you invest in Sectra? We are positioned in markets that are forced to grow, both cybersecurity and medical must grow despite if there's a background of [ societies are old ] because we still get sick and cybersecurity is, of course, increasing as a threat all the time, not the least in Europe now with the crisis in Ukraine. We have high customer satisfaction in all areas. We cannot present that in communications, but we do measure it also for secure communications. We have high employee satisfaction with a strong corporate culture, which is needed to have that high customer satisfaction. We have strong brands in markets where trust is critical. If our system stops, the entire hospital stop. If it's a 25 hospital system that we do have in some areas. If our system go down 25 hospitals more or less come to a grinding halt. We have heard from several customers that we are the single most important IT system we have in the hospital for maintaining, running business. The EMR, the medical retro systems are also very, very important, but they're not acutely important as well. And then brand is very important. And of course, in a brand in if we -- if a nation should trust the most important secret star systems, we need to have a strong brand also that trust is critical. We are both medicine and communications. We are trust-based, people trust us, and therefore, they pay a premium when we settle. We are profitable. We have a strong cash flow and a solid balance sheet, but we also have a rapidly increasing recurring revenue. We have a very low churn starting from next quarter as Jessica said, when we started report churn and that is how many of these customers will lose. But I can give you an early signal that is very low for being a software-as-a-service. We have to get we have sustainable investments in very exciting R&D within exciting opportunities, where we do can all become very large over the years. We have taken a few of these products, and we have shuffled down because they didn't work out. Some we have sold, we sold digital mammography many years back and some were integrated into the other business areas and some might go to their own business unit, which then should approach the other ones in size. And all management Sectra owns shares, a thing that we think is important. All the management should be shareholders to give that feeling of actually, it's our own money that we manage. In -- that kind of concludes the presentation. In 2023, upcoming financial events is June 2, year-end report. September 7, we have the Annual General Meeting here in Linkoping, Sweden, that will be on-site at something kind of reemerging of the pandemic something happens, but we hope that will not happen, so then we will have own [ time here ]. Your feedback is important. These meetings should be productive and good for you. We try to change them with the feedback we get. So if you have any feedback on this meeting and these presentations, please send an e-mail to [email protected] and tell what you think we should change. Or if you think it's good, that's also a nice like to have some of that. And with that, we open for questions. If you follow online, please use the chat function.

Yes. And we will start with a few questions from Kristofer Liljeberg, analyst at Carnegie. And the first question is, can you please explain the strong sequential growth for recurring revenues in Q3, explained by a new contract that started to generate revenue.

That question, I didn't perfectly understand.

No. The last part, is it explained by a new contract that started to generate revenue?

Yes. Next question?

Okay. That was the answer.

Answer is, we have got a new business that are starting to now be in even though it's not a major part of what we did. We are -- have seen some effect already now.

And the next question is connected to the Capital Markets Day and what you said there, because you said that the transition to a subscription-based revenue model would have a larger negative impact on sales next fiscal year. However, based on orders to be delivered within 12 months, plus recurring revenues, it seems sales will likely remain up in double digits. Can you please explain what you mean with the previous comment?

The proportion of the new business we will get next year will be -- will increase from recurring revenue. So we would probably -- or we don't know. We do prognosis. But if we grow next year, the proportion of recurring revenue will be larger than this year, clearly so.

The next question is, can you please explain the reason for the large increase in receivables?

We have [ pace of ] a couple of large projects that impact the balance sheet. I'd say it's a timing question.

And another question from Kristofer is, are there temporary effects causing the increase of external costs?

Yes, we have some very large products and some hardware purchase we need to do. We sometimes -- I mean few products we own also the hardware, which we kind of send our lease out of the customer, we get paid for it. And we have -- sometimes we need to upgrade that hardware and that will affect our business as well. And then we are increasing marketing and people. We have some very interesting contracts we think will come our way, and we are growing, and we need to have people to deliver that.

And then we have one question from the chat function. Can you please elaborate on the competitive landscape and the win rates across markets?

It varies very much market to market. We don't see any strong competition in all our markets that we see a company that we'll see in all markets at the same time. We do have strong competition by local players, not the least in the United States, where there is one other company [indiscernible] who seems to be growing right now, and of course, we'll compete with them.

And I -- if you have any further questions, please write them in the chat function. Now it seems you've answered all the questions. So...

All right. Okay. Then we thank you for listening to us and look forward to seeing you again in June at the year-end report. Thank you very much, and goodbye.

Thank you.