Ladies and gentlemen, welcome to Sectra Q1 Report 2019-2020. Today, I am pleased to present CEO Torbjörn Kronander and CFO Mats Franzén. For the first part of this call, all participants will be in a listen-only mode, and afterwards, there will be a question-and-answer session. At any time during this call, you may email your questions in or use the Q&A button. Speakers, please begin.
All right. This is Torbjörn Kronander.
This is Mats Franzén.
Welcome to the Q1 report of Sectra in the fiscal year 2019-2020. So the title of the speech is "Success Initiatives in the U.S., Now Sectra's Largest Market." And we are very pleased that the U.S. is now the largest market because that has been our goal for the last about two or three years. Next slide. Highlights from Q1. Next slide. It says all financial targets for the group fulfilled, but the title is wrong. We actually have not fulfilled the third goal this quarter because of excessive or a lot of personnel costs for the large installations. The stability equity target is fulfilled. The operating margin is fulfilled. The growth per share is not fulfilled for this group. Next slide. Why is it not fulfilled, and what happens now?
The issue is that we had an enormous order intake in the end of 2019, and that has entered delivery phase and our contracts typically are such that we own both hardware, and we have a lot of personnel costs in this large implementation, not the least of training of often thousands of people in the hospitals, and that costs money. Some of it can be activated as work in progress, but a lot cannot, so that is one reason we're taking these investments. We think that will go on for the first half year, so that will also have an impact on Q2. While in Q3 and Q4, this will reverse itself into income instead, and we also have a situation with a non-recurring.
We have compared to the 12-month EBIT five years ago, and at that point, our EBIT grew rapidly for those corresponding quarters, which means we have a more difficult target to reach, so these two are the reasons. We see no reason not to keep the goal, and we have a very firm view that the goal should be met. Order bookings for the group. Next slide. As I said, we had a record high order booking in 2018-2019, where they are in delivery phase. We also have a little lower order intake this quarter, but our variation between quarters is very large, and with the new accounting principles for the long-term contracts that we introduced this year, that variation, unfortunately, will even increase, so individual quarters should not be determined too hard. Look at the 12-month average going backwards instead. Next slide.
In Imaging IT Solutions, we are seeing an interesting momentum in digital pathology, an area where we are unique. We are still the only vendor who has digital pathology and digital radiology in the same system, which saves a lot of money for the hospitals and also benefits working together in the hospitals. And there are a few other companies who have PACS for pathology, but they do not have it in the same system. The order we got now with North Tees and Hartlepool NHS Foundation Trust, and this is a collaboration between 10 trusts in the U.K. for digital pathology, which is a large order for pathology in the U.K. Next slide. Also Imaging Solutions. We won Vanderbilt Health, which is by some called the Harvard of the South.
In the U.S., it's a leading, very well-known U.S. medical center, and we continue our good trajectory in large, prominent Ivy League hospitals in the United States. These are multi-year contracts. Next slide. Also, Imaging IT Solutions in the U.S. This has been a special focus area. We've said for three to four years that growing in the U.S. was a very strong target for us. The main reason is that in the markets where we are, we have often very high market shares and happy customers. In the U.S., we have very happy customers, but we have a relatively small market share, and of course, it's the largest medical technology market in the world, so that's an opportunity to grow. It's the world's largest market. We top the customer satisfaction rankings, and we have a small market share.
Our continuous stream of orders from prominent hospitals in the U.S. prove us right. The U.S. is now Sectra's largest market, which is the first time ever when Sweden has not been the largest. Next slide. We are currently selling direct in 19 countries: France in medical, Finland in security, established 2015-2016, and Canada was established 2016-2017. It's interesting that both France and Canada in medical are progressing well, and Finland is also coming around. This is, of course, also one of the reasons we have to invest, because when we get orders in this market, we have to have people to maintain and install them in the language. We sell by partner sales in other markets and business units. We have customers in more than 60 countries. Our largest markets right now are the United States, Canada, U.K., and the Netherlands.
In secure communications, we acquired the assets of a small Swedish company called Columbitech. We also bought the shares of its American subsidiary, which means we now have a computer security or Sectra Communications company in the United States. The main asset of that company was actually a very well-working mobile VPN that we already know. We have used it before, but now we own it, and for mobile communications, the demands are a bit different than from stationary, and this is a level 4 VPN for the technical people out there, while the normal thing in a stationary environment is level 3 VPN. Level 4 VPN has large benefits in some special application areas. This also opens up for a future market in the U.S. for secure communications where we have not been before. The thing we knew is very, very small, but it's an interesting opening.
Next slide. Secure Communications. The trend there is that we are seeing increasing demand. We have growth in critical infrastructure, and we have growth initiatives in critical infrastructure, mobile secure ecosystems, and we're also going to new geographic areas. I would like to remind you that we have a special Capital Markets Day for Communications, September 26th in Stockholm, that will only handle Communications, as that is quite different from our main business, Medical, which is why we'll have a separate day for it. Next slide. A little bit about the critical infrastructure. If you want to attack a country today, using military means is possible, but quite redundant. Nowadays, warfare is what's called hybrid warfare. And if you target the infrastructure of the attacked country, that country is in big trouble with modern technology and just-in-time deliveries, etc.
This means that protecting the critical infrastructure is as important as having strong military defense, and especially if you can sit on the internet and destroy infrastructure, it's a very large vulnerability, which is now being realized by authorities and lawmakers all over the world. Sweden is one of the leading countries in cybersecurity in critical infrastructure today. We have a dominant market share in that area, especially for electricity production and distribution. We are now taking this abroad. We are getting our first orders from outside of Sweden as well, and as we've said from the beginning, we'll start by expansion into markets we know, which is Finland, Norway, and Netherlands, which will be the first countries to try to expand this business into. Next slide. Imaging IT Solutions. The trend is adding new customers. We're also expanding contracts with existing customers.
For instance, several customers of our radiology solutions have already said openly that they will go with us to do pathology because as they have the back office on server already installed, it will be way too expensive to buy another PACS for that, which is exactly what we want. We want to sell into installed base. We also have strengthened delivery capacity to take care of more customers. That is seen in the personnel cost of the expansion in people. Almost all are in delivery within Imaging IT. An example of growth initiatives in Imaging IT is the United States, which is proceeding well. Digital pathology and integrated diagnostics, and integrated diagnostics is especially considering cancer care, where the pathology surgeons have been isolated pillars before, and now they want to work together to facilitate and especially speed up diagnosis of cancer.
We are uniquely positioned there in that we have one system for both. Cardiology is an increasing weakness. The three large image producers in medical and hospital environments are pathology, radiology, and cardiology. Cardiology is the third pillar we have to work with. We are using more external sub-suppliers in cardiology, but we are increasingly building more and more functional cells in that area as well. Especially in the U.S., a lot of people want one system for all cardiology, radiology, and pathology combined. We're also into selling into new markets directly and direct. Digital pathology is the next wave in digitization of hospitals. I should say next slide there, sorry. We are now at the slide with the title "Digital Pathology at Sectra." This is the only image area in hospitals today not digitized yet, but it has to come.
The benefits are too large for many reasons, and we are extremely well-positioned. We have a dominant market share in the country who's leading the world in digital pathology right now with the largest penetration. Next slide. Large and less frontier in digitization of medical images. Large synergies with radiology, as I said. Sweden is more leading, and Sectra is a dominant market share. This is a good foundation for growth. We have seen that the countries who normally are on the front line of new technology are coming along very well, especially in Netherlands. We see increasing interest in the Scandinavian countries and Northern Europe, and the most important thing, of course, short-term is the FDA submission to be able to sell digital pathology in the United States. We have made some progress there. We think that within the foreseeable future, we'll apply for FDA approval.
And then typically, the nominal time for FDA is three months, but with delays, it might take up to six months. But this is now in a better position than it was before. Next slide. This is our installed base of pathology right now. You see we have a few sites in the U.S., and that is used not for primary reading, but there are a lot of other applications in pathology, such as secondary opinions and something called web reads or frozen sections. Next slide. Business Innovation, our small greenhouse for new ideas. It will take out the two new initiatives that we have in Imaging IT and Secure Communications. We have three left. One is Medical Education. That is actually selling quite well. And not in the common countries. We're selling almost exclusively through distribution there.
We have had some interesting orders from countries that are completely new to us and interesting markets. Training of medical students is both basic training, as has always been done, but increasingly, it's continued education of already operational medical doctors and veterinarians. The field is moving very, very fast, and what you learned in medical school 20 years ago is not any longer applicable. Therefore, we see an increasing interest for the continuous education center for medical doctors all over the world. Then we have orthopedic surgery, software tools for that. Then we have booked pre-operative planning, but we are increasing the post-operative follow-up. We have a unique tool for seeing that a prosthesis is fixed, or if it moves, it moves. It should be reoperated.
That has been developed again with Karolinska, and we think that might be a very interesting thing for a lot of countries in the world. Then we have Research division, which is accounted for the same division, and that's mainly doing artificial intelligence these days. Next slide. New areas in Orthopedics, we have Implant Movement Analysis, which is postoperative analysis. We also have a version of that. That is the same product, but a different customer. It's actually for clinical research of prosthesis. When a vendor or prosthesis vendor develops a new prosthesis, they have to present evidence that it is actually not moving. We can use the same tool, but then we're selling it for clinical studies. It's just not a small market either.
Medical Education is moving from selling the large tables, as some of you might have seen in the cloud-based content subscriptions, where people or customers pay a monthly fee for having access to a rapidly increasing number of interesting cases of strange pathologies, and that is a content direction that we want to increase and maintain. Our research is AI. Next slide. Our AI is one of these hype things that happens, AI medicine, and a few years ago, people wanted to believe that radiology would be made redundant. We didn't, and that has not happened and will not happen in the foreseeable future, but you can use AI for a lot of things, speeding things up. We are also introducing an app store for AI applications to be added to our solutions of managing medical services.
There are hundreds of startups doing one small application in AI, and they cannot go to market. We have the tool and the channel for them through an app store for AI. AI will permeate most businesses in the future, but we see it mainly right now coming in workflows for radiology and pathology. Next slide, and then I'll leave the word to Mats Franzén on the financial figures.
Thank you, Torbjörn, and please, let's go to the next slide. A bit of a repetition. We can see the order intake in this quarter being a bit sluggish compared with the last one. But as you know, and as we have said before, the variations between quarters and indeed also between years can be quite significant if you look at the fourth quarter of last year, for example.
So this quarter, compared with the last first quarter, the Swedish order intake wasn't as strong as it was back then. On the other hand, the U.S. order intake for this quarter was better and contributed to a good development in that part. Not so much in absolute numbers, but in relative terms, the order intake for Business Innovation doubled compared with last year's first quarter, but that was from a fairly low baseline, so to speak. And the net sales, 2.7 percentage points of a nominal growth, comes from currency. That is much related to the U.S. We have a weak Swedish krona. Not so much in relation to the euro and pound sterling, which is also important currencies for us, but especially in the U.S., where we get some extra leverage from the healthy underlying apples-to-apples-based growth in the U.S. Next slide, please.
As you can see on this slide, this is nominal amounts. No currency reconfiguration here, but the United States is the engine in terms of the sales development. A technical note, perhaps, on the U.K. side, for those of you who have been following this for a while, there will probably be, everything else being the same, a bit more volatile ups and downs in terms of the U.K. sales development, since our managed contracts now are revenue recognized for the deployment phase during the deployment, which is normally less than one year, whereas they were previously recognized for the duration of the full contract period, being between five and 10 years, so please go to the next slide.
When we look in business lines or in segments, we can see that the Imaging IT Solutions is clearly the engine driving this, and that in turn being the U.S. scenario that's really helping us on the top-line level. When we see for Business Innovation, just looking at the delta, it looks nice, but on the other hand, Business Innovation had a fairly rough patch in the first quarter last year. And on a technical note now, for the delta group eliminations , here we no longer see any smoothing of managed contracts in the U.K. So this only pertains to internal sales between the segments. There are, for example, quite significant sales between Business Innovation, orthopedics, and Imaging IT Solutions, for example. But it's less than a percentage point of the total revenue now, so it's a fairly small portion of the explanation.
Please go to the next slide. When we come to the earnings in the short run, it's not looking as healthy as on the top-line level, obviously. As Torbjörn said, the Imaging IT Solutions where we are investing quite heavily now in delivery capacity to increase the number of deployments for the first part of this year, especially. Several of the contracts were signed last year, and they are deployed during the year. And we foresee that we will have a point of cash flow improvements for the second half of this financial year. And the capacity enhancement is also in personnel costs, obviously, which you can see from the income statement, where a big chunk of that will be in the U.S., but also in what is still smaller entities, being Australia, Canada, and France, where we have had big deals for the last years.
So please go to the next slide. And then we come to the cash flow. It's normally quite a sluggish first quarter, even more so this time. We have had some one-off items paying off final taxes in Sweden, and also trade working capital or net working capital, if you will, can be quite different between quarters. And we have released some current liabilities, especially in this first quarter. Investments is bigger this time, SEK 27 million, compared with about SEK 7 million. It has been investment in infrastructure for cloud solutions within Medical Imaging and also purchasing rights for software within Imaging IT. And then also, as Torbjörn mentioned, the acquisition of the assets in Columbitech. And somewhat technical, perhaps, that there is a small non-cash portion of rent interest being within the financial net pertaining to the new IFRS 16.
I would be happy to take questions on technical aspects should anyone have any questions on that. It's in the back-end pages of the report anyway. That was pretty much it from the finance side of things for now. Torbjörn is back, and we go to the next slide about our way forward. Next slide again. Our markets are positioned in healthcare, IT, and cybersecurity. That is not coincidence. We like to position ourselves for market growth, and especially where society trends means that they have to grow. There is no option. They have to grow. Both of these have to go to demographic situation. The growing cybersecurity threats, they have to grow. Growth is easier in growing markets. Next slide. We see going forward, everything is the same.
We still believe that customer satisfaction is an important thing, despite the internet and everything coming and going. Long-term, over the last zillion years or so, customer satisfaction is the price of business, and we will try to keep that up also in the future and set that top of our list of priorities. Next slide. This is a quote from Edwards Deming, which was the consultant who changed the Japanese industry from crappy stuff that cost little to very high-quality stuff that cost average or higher cost. Profitable business comes from repeat customers, customers that boast about their supportive service, and that brings friends with them, and I think we see that clearly in these large institutions in the U.S. now.
We've got University of Pennsylvania happy and Stanford University happy, one on the East Coast and one on the West Coast, and some of the most prominent universities and medical schools of the United States. We see them telling friends who then comes to us. It's a very important thing to get recommendations from your previous customers. Next slide. Our philosophy for our shareholders is basically if you have happy customers, happy employees, reasonable cost control and perseverance, and a good position in growing markets, then shareholders will be happy long-term. There are variations between the quarter, but long-term, that's a good project. Next slide. Yet everything is different. We have in the security world, we have quantum computers around the corner. When they hit, they will be able to factorize very large integers, which is today an NP-complete problem for those interested in mathematics here.
Essentially, it means it's impossible to crack the internet security today. With the quantum computer, which works in a completely different way, you can actually buy an algorithm called Shor's algorithm crack, the problem of factorizing very large numbers in polynomial time, which means more or less that all the internet certificates and all the internet banking and all the HTTPS security will stop to be safe. Now, no one knows if these things have been built or not, but they are probably possible to build, and one day they will be built. The capital markets side of cybersecurity will try to tell what we are doing about what happens when quantum computers hit the street, because then things have to change, and they have to change fast. Now, no one knows when this will happen. Next slide.
We also have the AI landscape, where we see mainly applications for Python, radiology, and deep learning, where you teach computers to see and understand images. We see this increasingly growing, but not anywhere close to take over the job of a radiologist's role, and that will not happen in a very long time to come, but we can make them more effective, which is important in the current demographic situation of the world. Next slide. As I said before, healthcare and cybersecurity is also in rapid change, and we have a quote from our old shareholder or board member, so I'm going to hint at the phrase where there's change, there's margin. I just have to be a fast participant in the change. Next slide. Being a shareholder, etc. Next slide.
We are keeping our way of doing not dividends, but an equivalent program in redemption program, and we have kept our SEK 4.50 per share redemption process to the shareholders from now, I think, to the seventh year in a row, and no ordinary dividends proposed. Next slide. Why should you own shares, etc.? We have high customer satisfaction proven by external faculties. We have a strong branding, marketing trust is critical. If our cybersecurity products or our medical products don't work, or our customers come to a grinding halt, if it may be a nation or hostile systems, they cannot break. And that means trust is very important, and that means plan is very important. We have a good plan. Profitability is strong cash flow and a solid balance sheet.
Cash flow this quarter was a little bit down, but there is no reason to believe that we will continue for long-term. The first two quarters of this fiscal year, we have said, will be burdened by the investment, but the Q3 and Q4 look much better. Substantial increase in recurring revenue and position in niche markets with substantial underlying and forced growth. These are not growth by liking. These are things where society has to grow. All our management own shares, and we have sustainable investment in R&D with exciting future opportunities. We have an upcoming general meeting, annual general meeting, financial report, and Capital Markets Day is September 5th. On Thursday, we have our annual general meeting. September 26th, as I said before, we have a Capital Market Day only dealing with Cybersecurity Day that day. November 29th, we have our six-month interim report and presentation.
I'll remind you that these presentations are not made for us. They're made for you. So please give us feedback on how you think they work, and we'll try to adapt and make them better. Next slide. I open up for questions.
Thank you. If you do wish to ask a question, please press zero one on your telephone speaker now. If you wish to withdraw a question, you may do so by pressing zero two to cancel. So just as a reminder, that is zero one if you would like to ask a question. Our first question is from Kristofer Liljeberg from Carnegie. Please go ahead. Your line is open.
Hi. Good morning. I'm interested to hear why the new deals are not generating any revenues yet? I thought new accounting means that you would recognize more revenue in the deployment phase.
And you talked, for example, about cost being hurt by trading. Are you not looking at any revenues for that? Thank you.
Thank you. Hi. I'm Mats Franzén here. I would say that we initially, in most cases now, have the different we map what is called the performance obligations. So everything else being the same, we will see this being recognized earlier on, like in the U.K., for example. But in the short run, I would say that we have a back heavy, if you will, where we have a lot of hours and sort of work that is being done and resources committed that doesn't, in the very short run, translate into performance obligation that is handed over to the customer.
So in the very short run, it's more of the back end having the people doing a lot of hours that still haven't been sort of a tailor-made suit for the customer, if you will. There will be one specific exception to this that reminds very much to the managed contracts in the U.K. that we had previously, as you know, revenue recognition over the duration of the contract. And that will be for New South Wales in Australia. So all that we commit in that project, which is a very big one for us, as you know, that will be recognized over a 13-year period. So that's the shining example that is the exception to this general description that most of the deployments actually now have a fast track, more of a fast track, let's say, within a fiscal year being recognized.
New South Wales will be over a 13-year period. And there we have seen, and we have tested this to be one single performance obligation integrated and supplied to the customer over time in equal shares, in equal portions, if you will. And I can comment on that as well. And that might seem very confusing that we both have the new rules and a few of the old rules, but we are not in control of the contracts. And depending on the contracts, how they are written, we will, in a few cases, as New South Wales, have to use the old method instead.
Okay. So if it's fair to suggest from that you have received some revenue, but not enough to compensate for the higher cost, then there will be gradually higher revenues in the third quarter and then even higher in the second half.
Is that how you should see it?
Yeah. Generally speaking, we would say that we foresee that the revenue and cash flow stream, obviously, those are not one-on-one linked, that they should progress in a more positive direction for us in the second half of the year.
Okay. And is it possible to quantify the effect this will have on sales on a sequential or quarterly basis? Not an exact figure, but a ballpark figure.
I wouldn't do that for now, to be honest. I'd rather not do that and seem a bit opaque rather than giving you a number that's not sort of firm enough, because these projects are highly tailor-made and things develop as we go. So I'd rather not do that.
Okay. And then a question related to that is, of course, the higher cost.
Historically, they have always been down sequentially in the first quarter versus the fourth quarter. Would you say that the higher portion of the costs you have now are they in any way temporary or will they remain? Also, with all the deals that you have signed, would you rather have to increase them further in the coming quarters?
A lot of these deals are also to be seen as a hunting license. When we get in with a large order, customers buy more. For instance, if you buy radiology, very often they buy pathology and the other way around, or they add services and contracts. The personnel cost will more or less stay, but the growth of them will not be as big unless we get new orders of the same size.
Okay.
So should we expect the sequential growth to slow now already, or do you still have to do some further investments before that happens?
That's a little more than we can convey on a public hearing like this.
Yeah. Okay. Thank you.
Thank you.
And just as a reminder, if you do wish to ask a question, that is zero one.
Okay.
Then we'll see if we have any email questions. Have we had any email questions for me?
Yes. We have one question from earlier today. Can you say anything about Q2 or coming quarters?
Well, as we said, the investment period, not least in New South Wales, where we take the cost upfront, will mainly affect the first half year. We will see a similar situation in Q2, and in Q3 and Q4, we will see this turning around and giving income and positive cash flow instead.
Any other questions? All right. That concludes our presentation. Thank you very much for listening.