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

Good morning, and welcome to Sectra's year-end 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 after management presentation. [Operator Instructions]. So with that, I leave the word to you, Torbjorn.

All right. Thank you very much. Welcome here to our year-end presentation, 2nd of June 2023. Agenda for today is I will begin with some highlights from here [ that passed ]. Jessica will talk about financial development. And then I will give a little brief of our way forward, and then we'll have a Q&A session. And note again, as Helena said, you can give chat questions during the entire speech. If there is something that Helena determines that we should actually reply immediately, she will interrupt me or Jessica or -- and otherwise, we'll collect them at the very end of it. So Sectra is part imaging IT solutions, IT security images, that is our large business lines in imaging IT solutions. It's close to 90% of what we do at handling images in hospitals all over the world. IT security solutions is mainly mobile encryption devices and high-speed, very high assurance secrecy encryption systems. And we have a greenhouse of new things that we are developing. These are smaller units. They are bundled together in accounting and business innovation as medical education IT, which is about teaching both new medical students, [indiscernible] students and also continued education with portal that is globally accessible. That's more or less only an Internet business today. It's a cloud-based operation. [indiscernible] which mainly sells through Imaging IT with special software and systems for orthopedics, which are the largest customer group of -- all over the world. We have research mainly doing AI in various areas. And then we have within Secure Communications, we have a growth opportunity in IT security with critical infrastructure. In Imaging IT, we have digital pathology and integrated diagnostics, which has been moved from the business innovation when it matured and we saw it was more or less the same customers. Then during '22, we added Genomics IT, and I'll come back to that late. We are currently have directives in 19 countries. We have partner sales in many others and customers in more than 60 countries all over the world. And our largest markets are in the U.S., Scandinavia, U.K. and the Netherlands. Highlights from the year that passed, we went up 100% in [indiscernible] order bookings. We see larger systems. The hospitals today have consolidated. And they are larger groups buying things. And it's also very long-term projects, which means that the order value, of course, becomes very large. We have two substantial sector, one contracts. I want to come back to second one later, but it's about recurring revenue, selling Software as a Service instead of just upfront license deals. And we still have significant quarter variations due to large individual orders. So we see -- we still sell quite a lot in as a license in -- especially in some countries and markets. And that, we don't think gradually, we think that will go away, but we have huge variations between photostat. We have a positive trend in all business areas, which is very encouraging. All business units are profitable and growing. We have substantial currency tailwind, which is good in this transition to recurring revenue that come remedies. They changed a little bit, but of course, that's not substantial or cannot be trusted for the future, currency goes up and down. But this year, we have had a substantially [indiscernible]. And Secure Communications that has been a bit problematic for some time is now contributing positively with solid growth again, which is very nice to see. We are transforming the company to not only Software as a Service, actually. It's also hardware as a service. We do sell systems in communications as leasing contracts instead or as a service, but mainly transiting Imaging IT to Software-as-a-Service operation. Net sales increased by 21%, all over the company. Profit per share increased 20%. Recurring revenue, which is a very important figure, of course, when we're transforming to a service company increased by 26%. And churn, which is a new performance measure we have introduced this quarter is a 1.3%. So we lose very few customers, and that is a very important figure to recognize because within growth in recurring revenue, of course, can be complicated. You lose a lot of those customers, but we lose very, very few, only 1.3% last year. And financial targets for the group. We have three overall financial targets we have had for a substantial time. The first stability. Our customers must need to trust us. We are -- the hospitals are depending on our systems. They are crucial in their operation. And if our systems fail, the hospital more or less come to the grinding halt. Therefore, also financial stability is very important for them. We have a target to be above 30%. Equity assets ratio, we are currently at 47%, and we have a very strong cash position to that. Profitability, that's more of hygiene measure with us because if we run out of things to invest in that we believe in for the future, we can increase that figure a bit. But right now, the target is 15%. We are currently at 19%. Note though that we have currency tailwind of this one as well. And then the most important target is growth of profits per EBIT per share over 5 years period, which should be above 50%, which is substantially more than double as large this year, 110% growth in EBIT per share. And that's our most important target. But the first two can be seen as hygiene targets and growth of profits is still most important one, but we need to fulfill that two first. In Secure Communications highlights, considerably improved earnings. We've got NATO approval for our safety -- latest version of the secret level -- phones. We make our own phones, and they are built here. And we got NATO approval, which will of course, open up orders from NATO countries all over the world. And then we'll have growing demand, larger and more prospect and partly that is unfortunately due to the crisis in Ukraine. But we also see that we have products now that have a long development period really, fulfill a lot of needs in the modern society. In Imaging IT, we have -- we are growing in all geographic areas, and we are going more and more enterprise imaging, not in radiology. We are transitioning into a Software-as-a-Service model, as I said before, and cloud delivers. They are not exactly the same, these two. People confuse them. Cloud deliveries means that the server are in the cloud. But we can have on-premise Software as a Service. That means the customer gets a license installed on-prem but they pay as a service. So they are not 100% overlapping. And we have a few of those Software-as-a-Service deliveries, but on-prem, not on the cloud. And then we saw that cloud recurring revenue, which is the measure of how much we are growing in the field of cloud deliveries increased by a very large and promising 40%, which we have kind of forecasted for some time that this will grow and will continue to grow. Sorry about that. We are dedicated to global customer satisfaction. What sets us aside is that we have very happy customers. That has been proven again during the year. We've got the best in KLAS awards. KLAS is an independent company in Salt Lake City in Utah that does evaluations of medical IT systems. We are, for the 10th year in a row, happiest customers in the U.S., large hospital PACS, and PACS is what our main product on radiology. And we also have the happiest customers in the small hospitals in the U.S. Canadian, for the fourth year in a row, we are clearly #1. In Asia, Oceania, mainly Australia, we are #1 for the second year. Financial development, I'll leave the word to Jessica.

Thank you. Good morning, everyone on the call, and welcome again to our year-end presentation. During the past year, we made a few changes to our financial reporting, driven by the shift towards selling Software as a Service. In brief, those changes are increased details on order intake to reflect the new contract terms, also increased focus on recurring revenue as recurring revenue development is key to understanding our business in the future. We also introduced two new APMs, the first one in Q1, cloud recurring revenue, a subset of recurring revenue, capturing growth in our cloud business. And the second one being recurring revenue churn, which we report for the first time now in Q4. And the purpose of recurring revenue churn is to show the share of recurring revenue from customer contracts that have been terminated or not renewed during the period. And with that, I move on to some numbers. As Torbjorn pointed out, contracted order intake doubled in the past year. And is, to a large extent, explained by the two multiyear Sectra One contracts received in Q1. Demand in the market is high, and we've had a stable inflow of orders, smaller and midsized orders throughout the year as well. And in Q4, some of the orders we highlight are Sector One Cloud for Parkview Health in the U.S. as well as a contract renewal in the Netherlands where the customer is transitioning into a Sectra One Cloud solution. We also received to make the orders from two NATO countries for Sectra Tiger/S. Our net sales continued to grow. Sales grew by 21% to SEK 2.3 billion in the past year. Currency helped substantially, but there is underlying growth, both for the full year and in the fourth quarter. And both recurring revenue and nonrecurring revenues are growing. And the share of recurring revenue out of total revenue is currently at 58%, very similar to last year. And we had substantial or strong growth in cloud recurring revenue although cloud recurring revenue still represents a smaller part of our revenues. And recurring revenue churn was at 1.3%. Since per business segment we grew in all -- in all our business segments. There is solid growth in Imaging IT, 20% up, driven by growing customer base, larger volumes as well as positive currency impact. Secure Communications increased top line by 20% versus last year. We have seen -- over the past quarters, we've seen a positive trend although large variations are still expected within this segment going forward as well. Then we have sales per geographic market. And apart from the Netherlands, we grew in all geographic markets. We have the highest growth in the U.S. and Sweden and for rest of world and rest of Europe. Australia, Canada and Denmark are contributors to growth. Our operating profit. Our operating profit increased by 19% to SEK 456 million, equal to an operating profit margin of 19.4%. The margin is well above our target of 15% and very close to what we delivered last year. We note that investments in delivery capacity and cloud transition is partly offset by favorable currency effects this year. And looking at profit generation over the year, it is very much aligned with our traditional seasonal pattern with a weaker Q1 and a very strong Q4. And please also refer to our interim report for more details around seasonal variations. Operating profit growth and profitability is stable in Imaging IT with an operating profit margin of 22%. The ramp-up of the organization and also higher costs for travel and marketing has, however, reduced the margin slightly versus last year's 24%. And in Secure Communications, we've turned a negative operating profit into SEK 19 million profit at an 8% margin. Again, large fluctuations from quarter-to-quarter. But in the past year, orders have been placed and also turned into sales and profit contributing to the financial outcome that we present today. Our cash flow is positive. We had positive cash flow from operations of SEK 441 million for the full year and SEK 382 million in Q4. Cash flow from operations is lower than last year due to increased tied-up capital in customer projects. Last year, we also received unusually large cash advance payments in Q4. The overall cash position is solid with cash and cash equivalents of SEK 945 million at the end of the fiscal year. Over to you.

Thank you, Jessica. So what are we going forward? I can also remind you that we had a Capital Markets Day in January, which is available on the net, if you want to see more in-depth kind of ideas going forward. Looking forward for us is high customer satisfaction that drives customers to recommend us to other customers, which is our most important growth forward. But we cannot have high customer satisfaction, unless we have happy employees. So we need employees and culture that works as well and happy employees. We want to continue to grow profit, growth with profit but not necessarily driving profit margins where we can but invest in future growth as well. And skate to where the puck is going to be. That's a quote from Wayne Gretzky that when he was asked why he was so good in hockey, said I'm better than others in seeing where the puck is going to be. And we have been traditionally very good at that. We saw pathology coming before others, we saw mobility in sec -- security coming. So that is a very important thing for us to position ourselves well for business to continue to grow and prosper 3 to 5 years out. And that is what we are using that excessive or excess profits that we could have taken above the 15%. In medical, we are concentrating on the age-related diseases, main reasons that these are things that society has had to deal with. Entire Western world, people are getting older and older and [ big deals ]. And the last year, living is very, very expensive. And that means we should be good in these five areas new degenerative disease, cardiovascular disease, cancer, which is a very kind of core of what we want to do. Musculoskeletal disease, grossly underestimated disease area and vision. And vision, we've added over the last 2, 3 years because people who cannot see are also very handicapped and very expensive society. And just adding genomics, as I said before, that fits into the cancer area of -- area but it's not images. So we're not only doing images anymore. We are also adding adjacent areas to -- needed in diagnostics. That means we're slowly transforming into diagnostics company from a pure imaging company. In cybersecurity, we have a new digital reality. Cybersecurity market will grow because it has to grow. We have increasing demand in society. We are very well positioned. We are regarded as one of the top companies in the world in mobile security and very high speed, high level encryption. And the current crisis in Europe will boost and has boosted demand even further. We are also transforming to as a service company, both hardware as a service and primarily in Sectra Communications but mainly a Software-as-a-Service company. We're moving away from the initial license sales to a longer-term revenue stream. And for the first 3, 4 years of such a contract, it looks a little less profitable and good than it would have looked if we've got an upfront license. But after 4 or 5 years or something into the stream, it will be grossly good both for customers and for us. Customers prefer the model of where you pay if it works and when used, and they get continuous upgrades, et cetera. And we, of course, get the revenue stream that will be substantially stronger somewhere down the line. We are currently, as Jessica said, at 58% of the company. We have a huge -- usage in all product areas right now and especially in the U.S. where almost all contracts discussed now are cloud deliveries and pay per usage contracts. This demands new roles as well. So we have created customer success managers that monitor usage, work with customers, and we monitor who use it so we can see if usage goes down in some parts of the world, and we can do there and find out if there's a problem with the product or why they're not using it as much. And that, of course, increases customer value as well. During the transition, revenue and profit growth will temporarily be smaller than they otherwise would have been. We have seen over the last year a little effect that we could have presented better figures in the old model. But going forward, that stays with us for a long time, that revenue stream. But there will be an impact in the year that comes here in front of us here. Long-term financial effects will be strongly positive. We introduced the Sectra One model a few years back where all imaging for the hospitals can be achieved in one single contract. We have some large contracts discussed now where customers have gone over to this and also where future contracts will be going into this. And we are currently the only company in the world that can provide all of these services, all of these types of inventories in one single contract and one single system which is important. We don't have multiple systems each one for each of these systems. We can provide all of it. And we added -- we have added or I would say, growing rapidly enterprise-agnostic software. It's becoming not only imaging software and that we have done by heading genomics to this. This is not yet on the market. We are doing a prime -- a preliminary, not preliminary, but a primary delivery into University of Pennsylvania in the U.S. where we are -- have a preliminary delivery in Q1 next year from 2024, we will have genomics added into this which means we do not only provide imaging anymore, we provide diagnostic data and the diagnostics software. Our philosophy with shareholders are, as we have said before, if you start with a good position in growing markets, ideally, markets that have to grow despite if there's a recession or good tide -- times, then if you have happy customers and in order to help the customers, you need happy employees. Reasonable cost control and some stubbornness, then shareholders will be happy. I think we've proved that over the last 10, 15 years that it has worked quite well. Why should you invest in Sectra? We are positioned in markets that are forced to grow. Both cybersecurity and medical IT must grow for society to cope with the demographic situation and the digitalization we see in all of society today. We have high customer satisfaction in all areas where we worked. We have high employee satisfaction with a strong corporate culture. We have a strong brand in markets where trust is critical. If our systems in medicine break, then the hospitals come to a grinding halt. And I heard the CIO from hospital in the U.S. in the phone who said we have gone through all our IT systems, including the EMR in this hospital, and you are the most critical for us. Then trust is very important, and that means a strong brand. In security, if people breach our encryption units, the most valuable secrets of a nation will be exposed. And that also provide on -- or demand some very strong brand and a lot of trust, which means that the barriers to entry, of course, are high into our markets. Why Sectra? Again, we're also profitable, we have a strong cash flow and a solid balance sheet. There is low risk -- short-term risk in the company. We have a rapidly increasing recurring revenue, a very low churn. 1.3% is very low. And we have sustainable investments in a lot of greenhouse products that might become very large in the future. Of course, that is yet to be seen. We have had operated products there that we have shut down and closed. We have also seen some that will have this divested with the digital mammography a couple of years back. And we also see some of that we merge into other business lines. Something will happen with these products. But if they grow as we think, it would be sustainable growth also in these areas. And we also have own management, top management own shares in the company which I personally think is a very important thing. We have a strong cash position. So our proposal to the general meeting in September is to increase the dividends, but not dividends, but we have a share redemption program but we'll do the payout by SEK 1.10 per share to shareholders. And then our upcoming financial events are September 15 -- our Q1 report and on September 7, we have our Annual General Meeting. And please remember that your feedback is important for us. These meetings, these presentations are made for you. If we can make them better for you, that's good for everyone, good for you, good for us. So please give us feedback, if you want us to improve. We have changed it a little bit, as you see this time, in order to cope with the feedback you have given us. And with that, I provide or open up for questions.

And we have got a number of questions today, and I will start and take them in the order that we have received them. And the first one I have received by e-mail from Kristofer Liljeberg, analyst at Carnegie. And the first question is, please explain strong sequential growth for the recurring revenues.

That, I did not fully understand it.

Me neither.

So Kristof, can you please specify that a little more, how do you mean what the question is?

And we take the next question. Why are both personnel and external costs lower in Q4 than in Q3, historical seasonal patterns is for higher cost in Q4?

There's a temporary effect. That's what I can comment on.

Okay. And the next question from Kristofer is what explains gross margin being 85% in Q4 compared with around 90% in the first 3 quarters this fiscal year?

That's a mixed question. It depends on the share of hardware versus software and services.

And then we have -- I'll take his fourth questions right away. Why is share of recurring revenue not going up more compared with last year?

We have strong growth also in our nonrecurring revenues. We deploy a lot of new customers in our medical systems, and we also have deliveries in Secure Communications, which are accounted for as nonrecurring revenue.

And then we go over to some questions from David Vignon at Stifel, a new analyst covering Sectra. And the first question is, could you share some insights into the progress you've made in Imaging IT outside of radiology and breast imaging, both in terms of offering and in terms of commercial momentum? Particularly interested to hear your thoughts on cardiology.

Right. So we can say that we do have an offering in cardiology. It's not complete yet. We do what we do very well, but it's a subset of the needed functionality cardiology. We do have customers using our cardiology solution as well. But it's not as broad as we would like. So we use partners and subcontractors to work with it. In the most interesting area of growth outside of pure radiology is pathology, which is growing rapidly. But not in all markets. It's come from the north. As you can see, it's very common pattern of new technology. Mobile phones, for example, came from Scandinavia, moved to Europe and then into the U.S. So we see the same pattern here. Central Europe and Southern Europe is not yet large in pathology. But Northern Europe and especially U.K. is growing rapidly, and we see a large increase in demand also in the United States. And cardiology will come. But as I said, we are not complete there yet.

And the next question is, could you share some insights into competition in the U.S. as well as on pricing dynamics?

Our main competitor in the U.S. is Visage or [ Promedicas ]. They are good in radiology, but we are much wider. We have all the ologies in different imaging capabilities. They have been better than us in radiology before. We have closed that gap. So it typically is a race between us and these options. Some prefer one and some prefer the others. I would say that it's the main competitor we see in the U.S.

And the third question is a bit similar to the one before about the personnel costs during Q4 that decreased slightly. Could you indicate why that was the case? And how we should see personnel cost increase in fiscal year '24? Should we expect personnel costs to grow slower than revenue?

It's a figure we do not disclose going forward, and we cannot disclose that, but we need people to deliver. And even if it's on cloud, you still need a lot of product management, you need integration engineers, you need application specialists to teach the customers. So we will continue to grow personnel cost in the next year, and I cannot give the relationship to the revenue.

And then we move on to questions from [ Carl ]. What was the driver of the strong margin in Secure Communications?

Deliveries of products. We have -- conventionally, we've done a lot of development -- contracted development work in Secure Communications where the -- especially the Swedish government has all the large development products. Now we have gone over to product deliveries and -- where the margin is much higher.

Next question, Imaging IT grew recurring revenues strongly. Is it only new contracts? Or can you comment anything on how much of the growth that came from existing customers?

We do not reveal that figure but it's substantially growth in both areas. We see existing customers who want to go into Sectra One and also new customers who want to do that.

Third question, were there any larger orders in the order intake for Q4 or more day-to-day business?

I would say it's close to day-to-day business, but of course, there are large orders coming in as well, not the least in communications it's in the security area.

And then we have another question from David Vignon. Could you share some more details on pricing dynamics in the U.S., both Sectra versus Visage and Sectra versus incumbents?

We do not see a lot of pricing -- there's always a price issue, of course, especially U.S. hospitals are strained on profitability. I have to put it. So there's always a price discussion, but with super critical systems as ours, people pay for quality. If you can show your stabilities above others. Downtime is extremely expensive, that there is a little more -- or a little bit of position than most other software industries because of that reason also.

And then we have another question from Kristofer Liljeberg. What do you mean with temporary effects for lower costs? How big was this effect and why? And I think he refers to the personnel costs.

I mean that it's not a trend that -- it's not a new trend. That's what I mean when I say it's temporary.

It's also use of consultants which is also accounted for as personnel cost. And that might go up and down.

So if you have any more questions, please write them now. Otherwise, we will end this Q&A session.

All right. Seems there are no more questions Okay. Thank you very much for attending, and we see you in September next time then. Have a nice summer, all of you. Thank you.

Thank you.

Bye-bye.