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

Welcome to Sectra's financial report presentation for the 6-month report with the CEO, Torbjörn Kronander; and CFO, Jessica Holmquist. My name is Helena Pettersson, Investor Relations Officer, and I will moderate the Q&A session that will be held after the presentations. The chat function is open from start, and you are most welcome to write your questions during the presentations. We will also address some additional questions that we have received via email before this meeting. And with that, I hand over to you, Torbjörn.

All right. So most welcome to our 6 months. We will begin with interim highlights given by me. Then Jessica will come in and talk about financial development. I'll talk a little about our way forward, and then we have our Q&A session. Actually, we will accumulate the chat function questions and the e-mails to that session at the very end. Our business operation in Sectra is medical imaging IT, which is handling images in hospitals or in health care systems, I would say. And we began with only doing radiology. We are increasingly doing other images as well. We got a very large order from a U.S. organization and this -- in the Q1, and that was actually handling all images in the entire enterprise. So we only got the order for radiology upfront. But increasingly, we're doing that, and we are also moving a little into other things outside of images in imaging IT, and I'll come to that later. We have also our greenhouse where we do future projects and smaller businesses, which is not big enough to build kind of their own business unit yet. But they run as independent organizations in order to provide speed and motivation. And then we have Secure Communications, which done more or less in mobile encryption systems and encryption systems for -- on the secret and top secret levels, which is the highest possible security levels we see. And we just added 2022 Genomics IT in the Business Innovation area. And that is -- means that we are also moving a little bit outside of only images. Genomics IT, I'll come back to that later, but it's a large growth area in -- especially cancer care. Highlights from the quarter. We had strong performance in all operating areas for several years. We had some issues with profitability in our cybersecurity area but both driven by the crisis in Europe, but also that we have now come to a fruition of long investment projects. We see a much stronger performance in cybersecurity. We are also in a business model transition within medical IT operations, which means we're [ going to ] selling our systems, not at a license basis where you get a large amount of money upfront and then have a service revenue, but while people pay for usage during the entire lifetime of the system. That affects us a lot, but that effect has been partly compensated by currencies. Then we have Secure Communications turnaround, as I said, driven by both regional products but also that there is a more tense environment in Europe right now. And we have currency which remains favorable for us and compensates a little, but we follow the business model transition in medical IT. And coming back is transforming to deliver as a service, which affects us a lot. The net sales increased 31% this year -- or this quarter. The profit per share, which is an important measure for us, increased 43%. Recurring revenue, which is an example of this delivery as a service, increased by 32%. And churn, now if you get customers into a service environment, you don't want to lose them, and we have very low churn of recurring revenue customers here, which is less than 1%. The financial targets for the group were fulfilled. The stability, our threshold there is -- target is to be above 50%. That might seem high, but right now, it's very good, and on capital, all of a sudden, costs money again. But it's also good because we provide trust to customers. And then we have to be quite conservative on economic measures as well. We are high above the 30%, which is a target. Profitability, we are at 20%. The target or threshold is 15%. And these 2 are hygiene measures. They are not what we optimize for. What we optimize for is growth of profit in EBIT per share over a 5-year period. That should be above 50%, and it's almost 3x as that right now at 149%. Secure Communication highlights. We have considerably improved sales and earnings, very strong order intake compared to historical figures in Secure Communications. We do research there as well. And right now, we're looking to post-quantum encryption systems. So IBM just published that they have built better and better quantum computers and quantum computing might -- that some of you might know will remain a significant impact on the openness of the Internet because the Internet encryption algorithms are based on something called RSA and that -- and when someone builds a working quantum computer, that will more or less take the security of Internet down to a -- create a lot of problems in that area. We do research. There are new algorithms presented, but they have to be -- we have to be able to implement them fast and energy efficient as well. And we do research in that area. In Business Innovation, we have orthopedics IT, which provides solution for planning and follow-up of orthopedic implants, Medical Education, which both of these are in a healthy growth right now. Medical Education, we do systems and solutions for training of medical doctors and veterinarians. And it's interesting because in the old days, the medical knowledge lasts for a long time, but now doctors have to relearn all the time, and we do provide tools, both for basic medical education for resident training but also for continued simulation and training of medical doctors. And then we have introduced Genomics IT as a very new and exciting area, and I'll come back to that in a few moments. Some example of customer wins during the quarter. In Sectra Education, we have actually equipped a simulation hospital in Italy. So the Italians have built a complete hospital that is just for training. There's no real patients. It's a lot of dolls and mannequins, and they are training people in a simulated hospital. And it's like a full hospital with ORS and [ Sectra ]. But we are helping out with the training material and the computer systems for this environment. Imaging IT Solutions highlights. We can say we have a cloud recurring revenue, which is actually the proportion that amounts to not only service contracts for old parts but what we sell over the cloud to new customers and old customers transform into this environment. That has increased a very large portion of 66%. We have low churn of recurring revenue, as I said before. And we do lead the U.S. market now in consideration selections. That is news that came out this -- only a few weeks back. This is actually -- KLAS is a company in Salt Lake City in Utah who do surveys for the medical market and medical IT systems, mainly. And they go out and ask customers both on what they think, that is a quota measure; how good does a customer or vendor perform. And we have had the highest customer ratings in the U.S. for 10 years in a row. We don't know how it will go this year, but we will know that in February or March this year. But they also do reports on where vendors consider. They ask customers, are you considering to replace your IT systems and if so, who are you leaning towards? And who have you decided to go with? And as you see, Sectra is now #1 in the U.S. market for considerations. We have 44 health care systems that's considering us. 22 has decided for us already. And we have actually hidden out the other vendors, but you see that no other vendor is even close to us, which is, of course, a very promising sign for the future when we have that situation. Example -- another example for customers is Guelph General Hospital in Canada. They are the first Sectra One Cloud customer in Canada, who are using Microsoft Azure as a platform below us. They do 125,000 diagnostic imaging test per year, which is a midsized hospital, and they have gone live just recently. Very happy with the solution. Other example of partnership that address customer needs. We do genomics IT, and that is in collaboration with University of Pennsylvania, who was already before a radiology customer. They have ordered digital pathology from us, and then they came to us 2 years ago and asked, can you help us out with genomics. And genomics IT is especially important in solid tumor diagnosis, diagnosis of cancer. And in the old days or just a few years, you did a few DNA tests or sequences -- sequencing of tumors. Now, the workload has increased enormously. And that's kind of our specialty. When medical procedures go from research into production, we are a production company. So they asked us to help out with building such an IT system and is just close to going into clinical trials right now. We have built -- we have had a large effort over this summer and fall and is now evaluated by the customer. If they approve this version, it will go to clinical tests, not clinical production but clinical tests in the spring of next year. Very promising area that we look forward to because it will make us a very complete vendor of systems for diagnostics of cancer. And then we have -- we are using a lot in AI. We have decided not to make our own AI solutions right now, at least. We are working with a platform more like the Apple App Store, where we provide to our customers vetted solutions for AI, but we introduce in our workflow. So customers can choose whatever AI they want, or they can use also AI that they developed themselves. They can bring it into our system in an actual way, and we can actually drive workflow and decisions by this AI that can be used for many different vendors. And we have an integration and exchange of information between various health care systems. We made a collaboration with General Electric to help out with our common customers. Now we do compete with General Electric impacts, but we also see a lot of customers who are in need of more efficient solutions. We had published a collaboration product together with GE, where we can have their systems integrated with ours, saving a lot of time of people who have the GE modalities and our IT solutions. We also work with large EMR vendors to provide efficiency again. People -- doctors are running out of time. They cannot be forced to log into a lot of different systems. Everything has to be done in the same platform or in the same environment, and we are good at that. Another customer example is NHS National Services Scotland. That was after the quarter, while we last Friday, signed a -- or Friday -- before last Friday, we signed a large contract with entire country of Scotland. This is large. They do about 5 million radiology exams per year, and we will do all the radiology IT in that environment, gradually taking it into service over the next 1 to 2 years. Financial development, I will leave the floor to Jessica.

Thank you. Good morning, and welcome, everyone. We have a strong quarter behind us from a financial perspective. We -- there is high demand for our offerings across all business areas. And contracted order bookings for the period was close to SEK 3.5 billion, of which SEK 800 million is guaranteed order intake. And the largest contract secured this fiscal year is the 10-year Sectra One Cloud with a U.S. hospital chain, which came in during the first quarter. During the second quarter, we received several orders for our digital pathology solution and for Sectra Education Portal, just to mention a few. And as Torbjörn just said, after the end of the reporting period, we signed a 10-year agreement with National Health Services in Scotland, also Sectra One Cloud. Selling large systems over many years mean that order values can be very high for individual contracts, and we can expect to see quarterly variations in the reported order numbers as you can see on this graph. Moving on to sales. Sales for the period amounted to SEK 1.372 billion, an increase of 31% versus the comparable period. And the sales -- the increase in sales is driven by strong underlying growth and also the favorable development in currencies. Adjusting for currency impact, sales grew by 26%. And the SaaS transition continues to drive recurring revenue growth, up 32% year-on-year, and the cloud recurring revenue part is also growing at a high pace. And we report very low recurring revenue churn at 0.6% on a rolling 12-month basis. Just to mention the quarter, the second quarter, we increased sales by 40% to SEK 788 million. And at this point in time, that is the highest reported sales in a single quarter. Sales by business segment increased year-on-year for all segments. In Imaging IT, we're growing as new customers are deployed and existing customers expand their use of our solutions. In Secure Communications, we have managed to turn prior year's weaker sales development into growth with an increase by 50% on top line year-on-year. And this is driven by the strong demand for high assurance and encryption products as well as cybersecurity. Business Innovation also has a nice -- has a good trend in sales development in the period. However, they still represent a smaller share of our total sales. We are growing in all geographic markets where we have presence, and the trends from previous reports remain, meaning that we see the highest growth in the U.K., the U.S. and the Swedish market. And in Europe and rest of world, we have the highest growth in Denmark, Canada and Australia. Moving on to operating profit, which increased year-on-year by 43% to SEK 246 million. And the operating profit margin was improved to 17.9% versus 16.4% in the comparable period. And the positive trend in earnings come from growth in all segments. Again, the currency helps us, and the increased profitability in Secure Communications, of course, also improves profitability. And we report the highest operating profit for a second quarter, with operating profit growth of 64%. We will see less of these quarterly variations as we -- as the share of cloud-based subscription business increases over time. All business segments also increased operating profit year-on-year. In Imaging IT, a weaker Q1 was followed by a strong Q2, and the impact from the shift in business model and also the preparations for large deployments is partly mitigated by growth and currencies. And in Secure Communications, we have improved considerably versus last year, and the profitability is moving in the right direction. At the end of the reporting period, we had reported an operating profit of SEK 12 million, close to 9% in margin. But in this business segment, there is a lower degree of recurring revenue business with natural variances between the quarters. Cash flow, we -- in the period, we had a negative cash flow from operations of SEK 41 million as a result of increased tied-up capital in receivables and inventories. In the second quarter, we generated a positive cash flow from operations of SEK 58 million. And all in all, at the end of the reporting period, we had a cash balance of actually SEK 499 million to be correct in the roundings. And we see that pattern for cash flow generation remains similar to previous years. And during the second quarter, we finalized the acquisition of 2 properties: the headquarters in Sweden, plus an additional property. And this transaction has a positive but not material impact on financial outcome. That was my last slide. Over to you.

All right. Thank you very much, Jessica. So I'll talk a little about the Sectra way forward. We are, as we have said many times now, transforming into an as-a-service company. And that is not valid for Secure Communications, but for Imaging IT, which is our large [ part ] is highly valid. This goes even faster than we anticipated in the beginning, but it makes a lot of figures a little special to review right now for this time. Very one -- important one, though, is increasing recurring revenue, especially the cloud recurring revenue. That has increased by, running 12, 58%. We have a large interest in pay per usage in all product areas. We do have some of that in communications as well, where we rent our secure phones, but that is a small part of Secure Communications. But in Imaging IT, we see it all over the area. Not the least in the U.S., where U.S. hospitals today have a financial liquidity problem sometimes, have to [ commit ], and they would like to pay for usage instead of paying upfront. Of course, if we want such a transition, you want low churn. As we have shown here, we are below 1%. That means you're sitting on an integrated talk mathematics here, which is, of course, long term, very interesting. Revenue and profit growth will temporarily be smaller in this transition, and we have said that for several years now. But we are now somewhere halfway through these transitions. We think the new business coming in is almost all of it recurring revenue. Long term, the financial effects will be strongly positive as you can imagine, after 5 -- 4, 5, 6 years, depending on kind of the type of contracts. And this will be good for us financially. But the important thing is, will also be very good for customers. The customers like this way of paying. So it's -- usually is a win-win with the customer side. In medical IT, we are driven by the demographics of the world. I was in Japan a few weeks back, and we see it especially in Japan but also in Europe and the U.S., that we have a demographic situation where people get older and older and live longer and longer. And that means we have a problem. The main -- well, a main driver of health care is the age-related diseases. Society have to deal with this or we will not be able to go forward in society -- or with medical anymore. It will be too many old people. So the things that will really be growing in the future are the age-related diseases. This is neurological, especially in neurodegenerative disease; cardiovascular disease; cancer disease; musculoskeletal disease; and vision. And we are -- we do imaging and diagnostics for all of these areas, but we are especially concentrating on these. There will be growth drivers from the future, these 5 areas. And we see a blue square around it. We do partner with other companies and other organizations for some content. And when it's green, we try to do all with those. So in cancer, we try to do a very large portion of the imaging side and also now genomics for cancer diagnostics. As you see, we added diagnostics there, and I discussed that before. We have it now in 3 clinical test trials in Japan. And we will try to make it live in the spring, depending on the feedback we get. And then we have a huge interest for these technologies from other areas of the world as well, but we want to make a good product first with 1 or 2 customers. Vision for medical imaging going forward is to collecting all imaging-related diagnostic data in one system. That saves money for the hospitals in staffing and service, especially we have the service out of the cloud, but it also means reduced complexity for them. And not the least, reduced vulnerability for cybercrime. Cybercrime has become a major problem for hospitals, and it's very important that you reduce the number of IT systems to reduce the possible places where you can get infections into your IT environment, and we are good at that area. So we had radiology and pathology in one single system. We started that 8 years back. We saw that pathology were going digital. We invested a lot in it, and we -- Sweden is, by far, the leading country in the world right now as to the proportion of pathology or histopathology that is digital. We are the clear market leader here. But we've also taken this outside of Sweden. We have grown a lot in pathology all over the world. And this huge -- we see also competition on this now, but they do not have everything in one system, which is, of course, is a big problem for the hospitals. The hospitals want as few IT systems as possible. And we are still the only one who have it all in one single IT system. And then we are now adding not only that, we're adding genomics, which means that genomics is taken from research to production in one single system, again, and we don't see any competition even close to thinking that direction yet. And the growth of whole genome sequences and also [ race ] or genomics as a whole is estimated to be very high double digit for the overseeable future. Almost all cancers are being now scrutinized for genomics or mutations because the genomics influences what treatment you give to patients today. So that is called personalized medicine. It is the fastest growth area of cancer treatment all over. And you need a very accurate diagnosis to do that. A little about cybersecurity. We are living in a new digital reality. The cybersecurity will grow because cybertheft, cyber fraud, cyber espionage have grown very much, not the least in hospitals. We see a very large increase in cyber, especially ransomware in hospitals. Sectra is very well positioned. We have high trust, especially in Europe. And the current crisis will boost demand even further as we have seen in both the order intake and deliveries from Secure Communications. Threats are expanding. Attackers are getting smarter. What people very often see is AI is not only -- or AI is seeing as a good thing mainly. But AI can also write very -- it can be a very fast means of creating attacks for vulnerabilities and, for instance, in operating systems, et cetera, which means the attackers are getting smarter. They're also using the latest tools you can have in IT. And if [ we earned 2 ] couple of years back, took 1 week to create an attack if a vulnerability was discovered and, for instance, in Windows or an operating system, today, you can have an attack within hours because these guys also use AI. So it's getting worse. And it's also getting worse because the attackers use psychology and behavioral science to find vulnerabilities. The main way in to attack a system is by the users in that system will click on the wrong thing or try to install the wrong thing and then you have an infection. The larger and larger impact for IT systems are growing and not the least in hospitals is -- in hospital chains or perhaps hundreds of hospitals, if they get infected and then spreads between them, you can take a lot of hospitals down. And we saw that a couple of years ago in the U.K., where a ransomware attack you call WannaCry attack and almost shut down all hospitals in the U.K. for a week. Now that is a horrific impact in health care, and it's good to have that knowledge insight. So we have synergies between the 2, but it's not only that area. It's all over the world. IT systems are getting more and more attacked by people who try to get benefits out. And it demands more and more countermeasures, thus invest in society. So this is a market will grow by [ several force ]. As well this taking care of the elderly because it has to grow regardless if it's a low tide or high tide in society as a large. So why should you choose Sectra as a shareholder? We are profitable. We have a strong cash flow and a solid balance sheet. We also have a rapidly increasing recurring revenue, especially from the cloud, and we have very low churn. Being below 1% is not common in this sector. So we have sustainable investments in R&D. So despite that we have this machine that creates profits and long-term stability, we also have some very exciting things going on in Business Innovation that might, by themselves, grow very large. Now the things we do in Business Innovation, sometimes we shut them down. Sometimes, we close them. Sometimes, we spin them off, and we have done all of these. Sometimes, they grow into business line, and sometimes, we incorporate them into an existing business line. As we did with digital pathology, we moved it into Imaging IT. We had a mammography product several years back. We sold that off. And we also had an osteoporosis product once, and that didn't work out. We couldn't sell it, and we shut that down. Management in Sectra own shares, which I think is a very good thing. It's not only options. We actually own our shares, and everyone in the management group owns shares. And that's generally a good thing. I will say the upcoming financial events and annual meeting '24 will be -- the Q3 report will be March 8, and we have a year of end report in June 5. And in September 10, we have our Annual General Meeting here in Linköping, Sweden. As for these presentations, your feedback is important. We welcome you to send us an email. We want them to -- these to be productive. We change them a little bit. Now based on input to you, we added this customer news and customer wins to the presentation, but give us feedback. It's got to be efficient for you, listeners, and we want to tell you what we can tell about the company and our set. And then we go to the question sections.

Thank you, Torbjörn and Jessica for your presentations. I will start the Q&A session with some questions from our analyst, Kristofer Liljeberg at Carnegie. And the first question is, can you please explain what was the main driver for the unusually high nonrecurring revenue in the second quarter? Was it related to specific contracts in the U.K. where sales increased strongly year-on-year?

Yes. Yes, we had some -- we had a larger share of hardware sales, and we also had some license sales in the old -- we recognized some revenues according to the traditional sales -- license sales model, and that impacted nonrecurring revenues.

In EU, could be pointed out, there is still a big debate if you can use an American vendor for cloud operations. Now in Northern Europe, North or Scandinavia, we have our own private cloud provision. But in Southern Europe and Mid-Europe, it's not possible to use that. So we have a much higher share of the old licensing model in Europe that we have. And a few of those [ contracts ] that goes between quarters because the size of the deals are very large. So it can affect quarters a lot. And that variation will continue. I can only say, if something slips into another quarter, it will affect that quarter heavily, and we have -- we -- that trend will continue that variation of the nonrecurring revenue, going up and going down between quarters. The important figure for us now and the long-term stability will come for recurring revenue, and that's increasing on a predictable trajectory run.

Yes. And the next question from Kristofer is about recurring or non -- still nonrecurring revenue. Looking at orders to be delivered within next 12 months, it suggests nonrecurring revenue should be lower coming quarters. Is that correct? Or are we missing something in the calculation?

It's something we cannot reveal. We don't do prognosis, but we can only say that it was unusually high this quarter.

Can you please explain why receivables are increasing more than sales growth? Is it related to any specific contract or general trend?

Yes. It's rather a timing effect where we received a larger payment beginning of November, just coming into the third quarter that impacted numbers substantially.

And a final question from Kristofer here. Can you provide some insight into when the recently new large contract will start to generate revenues?

If we gradually take -- be taking in because these -- especially the chain in the U.S. is a lot of hospitals, more than 100, and they will not be taking live at once that we've taken live gradually. We begin to see the first going live '24, and then we'll go on for a year or so or even more before all of them are live.

And then we have a question from the chat. It's from Rickard Anderkrans, Handelsbanken. And the first question there is on the mammography segment. Is it an important part of your business? And what trends are you seeing there now?

Well, we don't -- we spun off our hard work from mammography many, many years ago. So this is the portion of mammography we do PACS, which is sim software for viewing and handling those images. It is not a very large portion of what we do, but screening mammography is a part of the general Imaging IT business. It's not significant.

And a follow-up on that, are you seeing any cautiousness from customers not wanting to sign long-term contracts relating to mammography as new modalities such as liquid biopsies, are entering the field?

We do see this. We have one contract where we provide all screening software for our country who actually not prolong as long as we expected. But we do think that things do take time in medicine and it will not be an impact within the next 10 years. But long term, liquid biopsies may take over the digital mammography screening area, but that would be very long term.

And then a question on the large U.S. order. What is the EBIT margin contribution today? And what do you expect the margin contribution to be in a more steady-state long term?

That is figures we don't reveal, so we cannot say that.

And then I will go over to some questions from Nikola Kalanoski at ABG, new analyst covering Sectra. And the first question is, what is your appetite for continued hiring going forward?

We are hiring a lot of people still because we have these huge orders that need to be completed. And if you want to deliver something, you have the people to deliver it. It will continue as long as we see the growth we saw. But of course, we don't want to hire as much. We don't want to increase personnel costs in the same proportion as we do increase. Otherwise, our growth would not make sense. So we were slower than revenue growth, but it will continue.

And the next question is -- I think we have touched upon this. Could you say anything about the ramp-up process for the large USD 220 million contract, how it's proceeding and how long it's left until the implementation is finished?

I -- we replied to that question just a few minutes ago, right, that we -- the first hospital will go live somewhere in '24, and then it would be 1 or 2 years before everything's live.

And the next question is, do you experience that upselling of additional modules has become easier with clients that have purchased Sectra One Cloud?

I would say so, yes. We haven't seen a lot of it yet. I mean the first Sectra One customers are just now going into usage, but it's way easier when they don't have to do new RFP that just take another module live in their system.

And then a question about Canada. It appears to face a replacement cycle of legacy medical imaging hardware in the coming years. Does the same apply for legacy medical imaging software as well?

It does. Clearly, so we'll see a large increase in interest from Canada. [ We'll ] do well there [ or -- yes ].

Are there any specific difficulties in selling Sectra One Cloud in Canada compared to the U.S.?

No. It's the same basic rationale behind it.

And I note there are no further questions in the chat, and I'll just check, so I haven't received any more in the e-mail. No further questions.

All right. Then we'll continue to this portion, and this time of year, right, we are approaching a holidays. And we, at Sectra, has a tradition of singing and music. Some of you have seen our Christmas card before. These are performed and produced on a voluntary basis by our fantastic staff. I had, myself, not seen the one today before. I actually saw it today. So we will end up with our best wishes from Sectra to all of you out there.