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Edited Transcript of SECT.ST earnings conference call or presentation 3-Sep-19 8:00am GMT

Q1 2020 Sectra AB Earnings Call

Linkoping Sep 12, 2019 (Thomson StreetEvents) -- Edited Transcript of SECTRA AB earnings conference call or presentation Tuesday, September 3, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Helena Pettersson

Sectra AB (publ) - Chief IR Officer

* Mats Franzén

Sectra AB (publ) - CFO

* Torbjörn Kronander

Sectra AB (publ) - President, CEO & Director

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Conference Call Participants

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* Kristofer Liljeberg-Svensson

Carnegie Investment Bank AB, Research Division - Head of Health Care & Financial Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to Sectra Q1 Report 2019/2020. Today, I am pleased to present CEO, Torbjörn Kronander; and CFO, Mats Franzén. (Operator Instructions)

Speakers, please begin.

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Torbjörn Kronander, Sectra AB (publ) - President, CEO & Director [2]

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All right. This is Torbjörn Kronander.

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Mats Franzén, Sectra AB (publ) - CFO [3]

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And this is Mats Franzén.

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Torbjörn Kronander, Sectra AB (publ) - President, CEO & Director [4]

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Welcome to the Q1 report of Sectra fiscal year 2019/'20. So the title of the speech is successful initiatives in the U.S., now Sectra's largest market. We are very pleased that the U.S. is now the largest market because that has been our goal for the last 3 -- about 2 or 3 years.

Next slide, highlights from Q1, next slide. It says all financial targets for the group fulfilled. Well, actually, the title is wrong. We actually have not fulfilled the third goal this quarter because of excessive or a lot of personnel costs of the large installations. The stability, equity/assets is fulfilled. The operating margin is fulfilled. The growth per share is not fulfilled for this quarter.

Next slide. Why is it not fulfilled, and what happens now? The large -- the issue is that we had a enormous order intake in the end of '18/'19, and that has entered delivery phase. And our contracts strictly are such that we own and build hardware and we have a lot of personnel costs in these large implementations, not the least the training of often thousands of people in the hospitals, and that costs money. Some of it can be activated as works in progress, but a lot cannot. So that is one reason we are taking this investment. We think that will go on for the first half year, so that would also have an impact on Q2, while in the Q3 and Q4, this will reverse itself into income instead. And we also have a situation with a nominator. We have compared to the EBIT -- 12-year EBIT -- 12-month EBIT 5 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 2 are the reasons. We see no reason not to keep the goal, and we have a very firm view that goals should be met.

Order bookings for the group, next slide. We had -- as I said, we had a record high order booking in '18/'19 where they are in delivery phase. We also have a little over intake this quarter, but our variation between quarters are very large, and with the new accounting principles for the long-term contracts that we introduced this year. That variation, unfortunately, will increase. So individual quarters should not be determined too hard, look at the 12-month average going backwards since then.

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. In order, we got down 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, call it 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-years contracts.

Next slide, also Imaging IT Solutions in the U.S. This has been a special focus area, as we have said, for 3 to 4 years that growing in the U.S. was a very strong target for us. The main reason is that we -- in the markets where we are, we have often very hard 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 opportunity to grow. It's the world's largest market. We top the customer satisfaction rankings, with a low -- a small market share. And our continuous stream of orders from prominent hospitals in U.S. prove us right. And the U.S. is now Sectra's largest market, which is the first ever -- time ever when Sweden has not been the largest.

Next slide. We are currently selling direct in 19 countries: France in medical; Finland, security, established '15/'16; and Canada was established '16/'17. It's a good thing that both France and Canada in medical are progressing well, and Finland is also coming around. So 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 local language.

We sell in partner -- by partner sales in other markets and business units. We have customers in more than 60 countries. Our largest markets right now is the United States, Scandinavia, 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 the stationary environment is level 3 VPN. Level 4 VPN have 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. It's still minute, it's very, very small, but an interesting opening.

Next slide, Secure Communications. And the trend is that we are seeing increase in 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.

And I would like to remind you that we have a special Capital Markets Day for communications, September 26, in Stockholm that will only handle communications, as that is quite different from our main business, medical. We decided we'll have a separate day for it.

Next slide, a little about the critical infrastructure. If you want to attack a country today, use of military means is possible but quite redundant. Normal -- today's warfare is called hybrid warfare. And if you target the infrastructure of the attacked country, that country is in deep trouble with modern technology and just-in-time deliveries, et cetera. This means that protecting the critical infrastructure is as important to have a strong military defense. And especially if you can sit on the Internet in this drone 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 there, and we have a dominant market share in that area especially for electrical 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 in the markets we know, which is Finland, Norway and Netherlands, which will be the first countries we'll try to expand this business in.

Next slide, Imaging IT Solutions. The trend is adding new customers. We're also extending contracts with existing customers. For instance, several customers of our radiology solutions have already said openly that they will deal with us with pathology because as they have the back office on server already installed, it will be way too expensive to buy another package for that, which is exactly what we want. We want to sell in the installed base. We also have strengthened delivery capacity to take care of more customers. That is seen in the personnel cost. On the expansion in people, almost all are in delivery within Imaging IT. An example of growth initiatives in Imaging IT is United States, which is proceeding well. Digital pathology and integrated diagnostics, and integrated diagnostics especially considering cancer care where the pathologies and radiologies have been isolated pillars before, and now they want to work together to facilitate and especially speed up diagnosis of cancer, and we are uniquely positioned in that we have 1 system for both.

Cardiology is an increasing business. The 3 large image producers in medical and hospital environment is pathology, radiology and cardiology. And cardiology is the third pillar we have to work with. And we are using more external subsuppliers in cardiology, but we are increasingly building more and more [structures there] ourselves 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 also aim to selling into new markets, direct and indirect.

Digital pathology is the next wave in digitization of hospitals, as we've said in the next slide as well. So we are now on the slide regarding 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 is leading the world in digital pathology right now with the largest penetration.

Next slide. The last frontier in digitization of medical images, large synergies with radiology, as I said. Sweden is world leading and Sectra has a dominant market share. This is a good foundation for growth. We have seen that the countries who normally are on the front line on technology is coming along very well, especially in Netherlands, we see increasing interest in the Scandinavian countries and Northern Europe. The most important thing, of course, short term, is the FDA submission to be able to sell digital pathology in United States, and we have made some progress there. We think that within the overseeable future, we'll apply for FDA approval. And then typically, it takes -- the nominal time for FDA is 3 months, but with delays, it might take up to 6 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's a lot of other applications in pathology like secondary opinions and something called wet reads or frozen sections.

Next slide, Business Innovation, our small greenhouse for new ideas. If we take out the 2 new initiatives that we have in Imaging IT and Secure Communications, we have 3 left. One is medical education, that is actually selling quite well and not in the common countries. We are selling always exclusively through distribution there, and we have had some interesting orders from countries that we -- are completely new for 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, and therefore, we see an increasing interest for the continuous education center for medical doctors all over the world.

And then we have orthopedic surgery software tools for that. There, we have both preoperative planning, but we are increasing the postoperative follow-up where we have unique tools for seeing that a prosthesis is fixed or if it moves. If it moves, it should be reoperated, and that has been developed again in Karolinska. And we think that might be a very interesting thing for a lot of countries in the world. And then we have a research division, which is accounted for the same division and that's mainly doing artificial intelligence these days.

Next slide, new areas in orthopedics. As I said, Implant Motion Analysis, which is postoperative analysis, but we also have a version of that and that is a same product but a different customer, which is actually for clinical research of prosthesis. When a vendor of prosthesis develop a new prosthesis, they have to present evidence that it is actually not moving. And we can use the same tool, but we're selling it for clinical studies, which is not a small market either.

Medical education is moving from selling the large tables. Some of you might have seen the cloud-based content subscriptions where people or customers pay a multi-year 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.

And next slide, our AI is one of these hype things that happens, AI medicine. And a few years ago, literally everyone believed that radiologists will be made redundant, we didn't, and that has not happened and will not happen in the overseeable future. But you can use AI for a lot of things, speeding things up. We are also introducing an app store for AI application to be added to our solutions for managing medical services. There is hundreds of start-ups with 1 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 as workflows for radiology and pathology.

Next slide, and then I'll leave the word to Mats Franzén on the financial figures.

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Mats Franzén, Sectra AB (publ) - CFO [5]

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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 last one that, as you know and as we have seen before, the variations between quarters and indeed also between years can be quite significant if you look at the quarter for last year, for example. As for this quarter compared with the last first quarter, the Swedish order intake wasn't that 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 3.7 percentage points of a nominal growth comes from currency, and that is much related to the U.S. We had a weaker Swedish krona, not so much in relation to the euro and pound sterling, which is also important currencies, of course, 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. And as you can see on this slide, this is a nominal amount. No currency recognition 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 us for a while there, we'll probably be, everything else being the same, a bit more volatile ups and downs in terms of the U.K. sales developments since our managed contracts now are ready and recognized for the deployment phase during the deployment, which has been less than 1 year, whereas they were previously recognized for the duration of the full contract period being between 5 and 10 years.

So please go to the next slide. And 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 year 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 not -- 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 earnings, in the short term, 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 other contracts were signed last year, and they are deployed during the year, and we foresee that we will have a point of cash flow improvement for the second half of this financial year. And the capacity enhancements is also in personnel costs, obviously, which you can see from the income statement where it's -- a big chunk of that would 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 year.

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 and 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. And it has been -- investment in infrastructure for cloud solutions for -- and 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, but there is a small now portion of rent interest within the financial net pertaining to the new IFRS 16, and 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.

So that was pretty much it from the finance side of things for now.

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Torbjörn Kronander, Sectra AB (publ) - President, CEO & Director [6]

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So then Torbjörn is back, and we'll go to the next slide. So about our way forward. Next slide again, our markets are positioned in healthcare IT and cybersecurity. That is not a coincidence. We like to position ourselves where market grows and especially where society trends mean that they have to grow. There is no option, they have to grow. And both of these have, of course, the demographic situation and the growing cybersecurity threats. They have to grow. And 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, everything coming and going, long term over the last zillion years or so. Customer satisfaction is what drives business, and we will try to keep that up also in the future and set that top of our list of priorities.

Next slide, you see some quotes from Edwards Deming, which was the consultant who changed the Japanese industry from -- for crafting stuff that costs little to very high-quality stuff that costs average or higher cost. Profitable business comes from repeat customers, customer that buys large part of your service and that brings friends with them. And I think we see that clearly in these large institutions in the U.S. now with both units working in Pennsylvania halfway and Stanford University halfway, one on the East Coast or one on the West Coast from some of the most prominent universities and medical schools of the United States. We see them telling friends who then comes to us, which is a very important thing to get recommendations from your previous customers.

Next slide. And our philosophy about 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 quarters, but long term, that's a good trajectory.

Next slide. Yes, 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 problems, for those interested in mathematics here. Well, essentially, it means it's impossible to crack the Internet security today. With a quantum computer, which works in a completely different way, you can actually buy an algorithm called Schwarz algorithm, crack the problem of factorizing very large numbers and 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. At the Capital Markets Day of our cybersecurity, we'll try to tell what the world 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 artificial landscape, AI landscape, where we see mainly applications for pathology, radiology with deep learning where you learn -- teach computers to see and understand images. We see this increasingly growing, but not anywhere close to take over job of radiologists or pathologists. 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 demographical 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 (inaudible) who invented the phrase, "Where there is change, there's margin," and you just have be a fast participant in the change.

Next slide, being a shareholder in Sectra. 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 for now, I think, the seventh year in a row. And they are no ordinary dividends proposed.

Next slide. Why should you own shares in Sectra? We have high customer satisfaction proven by external faculties. We have strong brand in markets where trust is critical. If our cybersecurity products or our medical products don't work, all our customers come to a grinding halt. These may be a nation or a hospital systems, they cannot break, and that means trust is very important, and that means brand is very important. We have a good brand.

Profitability is strong, cash flow and a solid balance sheet. Our cash flow this quarter was a little bit down, but there's no reason believing that will continue. But long term, the first 2 quarters of this fiscal year, as I said, will be burdened by the investments. But in Q3 and Q4, it's much better.

Substantial increasing recurring revenue and positioned in nice -- 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 owns shares, and we have sustainable investments in R&D with exciting future opportunities.

We have an upcoming general meeting or Annual General Meeting and financial report in the Capital Markets Day at September 5. We have -- on Thursday, we have our Annual General Meeting. September 26, as I said before, we have the Capital Markets Day, only will be dealing with cybersecurity day, that day. And November 29, we have our 6-month interim report and presentation. And I'll remind you that these presentations are not made for us, they are 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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Kristofer Liljeberg from Carnegie.

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Kristofer Liljeberg-Svensson, Carnegie Investment Bank AB, Research Division - Head of Health Care & Financial Analyst [2]

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I'm interested to hear why the new deals are not generating any revenues yet because what the new accounting means that you would recognize more revenue in the deployment phase? And you talked, for example, about costs being hurt by training. Are you not booking any revenues for that?

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Mats Franzén, Sectra AB (publ) - CFO [3]

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I would -- Christopher, Mats Franzén here. I would say that we initially, in most cases now, have the different -- we met what is called the performance obligation. 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 -- we are heavy -- 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 term, 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 ours that still haven't been sort of a tailor-made suit for the customer, if you will.

There will be 1 specific exception to this that reminds very much to the -- without 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 a shining -- 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 the fiscal year being recognized where the New South Wales will be over a 13-year period. As there, we have seen and we have tested this to be 1 single performance obligation integrated and supplied to the customer all the time in equal shares with equal portions, if you will.

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Torbjörn Kronander, Sectra AB (publ) - President, CEO & Director [4]

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I'd like to 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, use -- have to use the old method instead.

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Kristofer Liljeberg-Svensson, Carnegie Investment Bank AB, Research Division - Head of Health Care & Financial Analyst [5]

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Okay. But -- so is it fair to assume that you have received some revenue, but not enough to compensate for the higher costs. And then there will be gradually higher revenues already in the third quarter and then even higher in the second half? Is that how we should see it?

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Mats Franzén, Sectra AB (publ) - CFO [6]

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Yes. We -- generally speaking, we would say that we foresee that the revenue and cash flow stream, that -- obviously, those are not one-on-one linked, but they should progress in a more positive direction for us in the second half of the year.

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Kristofer Liljeberg-Svensson, Carnegie Investment Bank AB, Research Division - Head of Health Care & Financial Analyst [7]

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Okay. And is it possible to quantify the effect that you still have on sales on a sequential or quarterly basis? Not an exact figure, but a ballpark figure?

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Mats Franzén, Sectra AB (publ) - CFO [8]

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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.

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Kristofer Liljeberg-Svensson, Carnegie Investment Bank AB, Research Division - Head of Health Care & Financial Analyst [9]

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Okay. And then a question related to that is, of course, the higher costs. And 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 anyway temporary or will they remain? And also, with the deals that you have signed, would you rather have to increase them further in the coming quarters?

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Torbjörn Kronander, Sectra AB (publ) - President, CEO & Director [10]

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Well, a lot of these deals are also the same as a hunting license where we get in with a large order if 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. So we add the personnel costs with more or less pay, but the growth of them will not be as paid unless we get new orders of the same size.

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Kristofer Liljeberg-Svensson, Carnegie Investment Bank AB, Research Division - Head of Health Care & Financial Analyst [11]

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Okay. So should we expect the sequential growth to slow now already? Or do you still have to do some other investments before that happens?

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Torbjörn Kronander, Sectra AB (publ) - President, CEO & Director [12]

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That's a little more than we can convey on a public hearing like this.

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Operator [13]

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(Operator Instructions)

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Torbjörn Kronander, Sectra AB (publ) - President, CEO & Director [14]

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Okay. Then we will see if we have any e-mail questions. Have we had any e-mail questions coming in?

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Helena Pettersson, Sectra AB (publ) - Chief IR Officer [15]

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Yes. We have one question from earlier today. Can you say anything about Q2 or coming quarters?

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Torbjörn Kronander, Sectra AB (publ) - President, CEO & Director [16]

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Well, as we said, the investment period, not the least in New South Wales where we take the cost upfront, will mainly affect the first half year. We will see similar situation in Q2 and in Q3 and Q4, we will see these 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.