Qt Group Oyj

OMXH:QTCOM

Earnings Call Analysis

Company Forecasts Growth Despite Challenges

The company refined its net sales growth forecast to 20-25% and expects its operating margin to be on the higher end of 25-30%, although it's clear that a 30% revenue growth target will not be achieved. Strong feedback from customers indicates the excellence of their products, a significant reason for the company's success, and they plan to maintain this standard. They've also laid out a vision for inorganic growth, searching for acquisitions similar to their past successful deals. With a focus on diversifying their offerings and maintaining profitability in various industries, they are confident in reaching their financial targets, aiming for an annual growth of 20-30% and an EBIT margin of over 25% by 2027.

CEO Introduction and Q3 Business Highlights

Juha Varelius, the CEO of Qt Group, commenced the earnings call by describing the third quarter as particularly challenging with only an 8% growth in net sales, attributing this to a confluence of late-quarter deal slippages, subdued consulting business, and adverse currency exchange rates.

Financial Performance Overview

Despite the headwinds, the company secured an EBIT margin of 24%, marking a 16% improvement. Human resources expanded modestly by 17 employees, totaling 746, signaling the company's ongoing commitment to growth without scaling back investments.

Financial Results and Currency Impact

The financial results reveal a nuanced scenario, where net sales saw a 13% year-over-year growth rate for the quarter but were negatively impacted by EUR 1.7 million due to the USD exchange rates. Year-to-date growth stood stronger at 17%, or 19% on constant currencies, showing resilience in license revenue while maintenance revenue decreased as expected from the subscription model transformation.

Profit Allocation and Operational Cash Flow

The company reported a net profit of EUR 5.5 million, equivalent to 14.4% of revenues, and a robust operating cash flow, which had increased positively by EUR 34 million year-to-date.

Market Outlook and Growth Potential

Emphasizing market-wide uncertainties, the CEO expressed confidence based on customer diversity across industries, ongoing product investment, and the increasing demand for user-friendly interfaces in a broad array of consumer electronics. While there might be a reduced reliance on consulting from clients opting to insource, the underlying business in licenses and runtime revenue remains strong.

Guidance and Strategic Goals

The company refined its 2023 guidance, anticipating net sales to be within 20%-25%, and operating margin targeted towards the higher end of 25%-30%. Due to the challenges of the year, the end-of-year prediction will likely be at the lower edge of the revenue growth forecast but maintain high profitability.

Strategic Initiatives and Quality Assurance Growth

Qt Group's strategy remains steadfast in providing tools enabling faster product development and quality assurance. They are looking into expanding the QA segment's market and have an ambitious goal of reaching EUR 100 million in revenue while exploring opportunities for inorganic growth.

Impacts on Potential Revenue and Future Deals

Commentary on lost deals indicates there were no 'mega deals' missed, with most larger deals in the range of EUR 1 million to EUR 2 million. There's a long tail of smaller deals waiting to be closed. The factors leading to a shortfall from internal targets were mainly due to deal slippage, exchange rates, and a mix of revenue types, with impacts amounting to single-digit millions, hinting at potential multi-million revenue implications if all sales were structured as 3-year licenses. Overall, deal slippage was highlighted as the key reason for not achieving growth targets for Q3, while also suggesting a cautious approach for year-end guidance.

Earnings Call Transcript 2023-Q3

[Juha Varelius, executive]

Good afternoon, everyone. My name is Juha Varelius, I'm CEO of the Qt Group, and we are here today to tell a bit about our Q3 results and also our outlook for Q4 and beyond.

With further ado, the agenda is, as usual, business highlights, financials by our CFO, then outlook and guidance for 2023. And then we have this time a bit of strategy update to share with you. If we look at the business highlights in [ 2020 ] (sic) [ 2023 ] this Q3, it was obviously a soft quarter for us. We had a net sales growth only of 8% and comparable currencies 30%, and it was definitely on the low end, what we were expecting.

However, it was a typical quarter in a sense that large part of the sales queued towards the end of the quarter, and we had some slippages over there going -- slipping into the next quarter, some of which we've already closed and some that are in progress. So we're not looking to lose those -- lose those deals per se, but we weren't able to close them in Q3.

But nevertheless, it was a slow quarter for us. I'm going to talk about the future outlook. On this occasion might be a good already to highlight that if we look for the whole year and we looked at where we are at the moment, I would say that the most headwind we are having from currency exchange rates, so the U.S. dollar exchange rate has been a bit ahead of headwind for us. Then our consulting business is slower than we expected ourselves. So we have a bit of a headwind over there. And then the mixture of the 1- and 3-year license terms are more towards the the shorter-term licenses, i.e., the 1-year licensees, and that has effect on our revenue.

If I look at the number of licenses we're selling, it's pretty much where we budgeted and expected for the whole year so far. And if I look at the run time revenues, they've been growing nicely, and they are in line what we were expecting this year. So what we see is that the -- definitely, the consulting business has been softer. What we've done there is that we've got our subcontracting over there. So our profitability on that is still on a good level. But of course, the revenue is lower but the underlying business selling licenses, our customers doing a product development and testing and seeing the run time revenues growing.

The underlying business, we think is very healthy. And that's why we remain very confident for our future in that sense. We haven't seen losing business to any new technologies or new competitors. Of course, the market is tough, and it's tough for everyone, but at the end of the day, we just need to perform a bit better. I'll talk about the Q4 and outlook when it comes to the outlook part. But so the main reasons for a bit slow year this year has been the product mixture consulting and then the currency exchange rates. Other than that, the underlying business is doing very well. And on Q3, unfortunately, we saw some last-minute slippages on our deals that happened basically during the 3 last days, some of them are already being signed and whatnot, and that ended up having a bit of a soft quarter for us.

Our EBIT margin was at 24%, increase of 16%. So profitability is still developing very well along the business, and we expect the profitability for the year to be on a very good level. Personnel totaled 746, so increase of 17 employees. We will continue our investing on growth. So there is -- we are not looking to slow our growth investments in any particular way. I think that the -- going forward, we're going to see more relatively more investments on the QA side. As you know, we've acquired a couple of QA businesses 1.5 years and a year ago. So 2 businesses actually and form of fraud logic. And they've been performing, developing very favorably.

So we're very happy with the development of our QA business, and we see a bright future for them. They're also doing a -- it's a licensed product business, so the profitability is pretty good. I'll talk about more on those -- the future outlooks in a minute. And now I hand over to Jouni to go through the financials.

[Jouni Lintunen, executive]

Thank you, Juha, and welcome from my behalf as well to the earnings call of Qt Group. Juha have talked quite a bit already about the Q3 and kind of softness. In that respect, as a repetition, we did grow by 7.7%. We have seen, especially in early -- first 3 quarters, we have seen a headwind from USD. And in Q3, the amount of that was negative EUR 1.7 million. So our net sales grew by 17% -- I'm sorry, 13% in Q3 isolated. The growth is coming, no surprise from the licenses of consulting and the maintenance revenue is going down as expected because of the subscription license model change. And that will kind of be above the level we are seeing right now and then start going up gradually when the license volume is increasing.

For the first 3 quarters, year-to-date, we are seeing revenue growth of 17%. In constant currencies, it is 19%. So 2 points difference in between there. We are seeing shorter maturity from the new customer sales than what was happening last year. Then on the other hand, renewals with the renewal base is growing all the time. And I mean those licenses to be expired. They are renewing by default on the same term that they have initially been sold.

We will keep on seeing the fluctuation quarterly going forward as well. That's because of the timing of the distribution license deals, timing of any larger developer license deals and also, we will keep on seeing the exchange rate impact affecting our revenue numbers. And assuming that USD remains about the level of end Q3, namely 105 or 106. We expect to see for the full year, like EUR 2 million, EUR 3 million negative impact from that. Here is a slide about the Q3 and first 3 quarters income statement. No major news on this one. We see a decline in the Materials & Services, which is the account that we are using to by third-party consulting services for our customer projects. And when consulting is down this year slightly, we are offsetting the margin impact by lowering the outsourcing other purchases.

Headcount expenses are up by 11% in Q3 and 21% for the full year. We are seeing a headcount increase of [ 95% ] or 15% during last 12 months' time. So it's pretty much the same ratio at what we've seen organically being earlier as well. Personnel expenses are up by 11%, which is slightly less than the headcount increase in that regard. There are some somewhat lower bonus accruals now for this period that explains that. No major changes in depreciation bucket. And other operating expenses are flat year-on-year on Q3. And for the first 3 quarters, they are up by 9.1% explained by increased travels, IT and facilities costs, for example.

This leads us to the EBITDA margin of 24.1, up by roughly 2 points from last year or EUR 9.2 million. The intangibles amortization, the run rate is EUR 2 million a quarter. and they are coming from the froglogic and Axivion intangible amortizations. EBIT margin is slightly up from last year's 18.8% or EUR 7.2 million. And in Q3, the exchange rate changes were somewhat limited, meaning that then it does not show up in major movement in the financial items. And also, the Q3 effective tax rate was around 22%. And for the first 3 quarters, it's roughly 20%, which is in the range that we have been indicating also going forward.

Net profit is 5.5 million or 14.4% of the revenues and EPS is 0.22. On the balance sheet side, the -- well, just to start from the cash flow. Our cash flow has been so far in the year pretty good operating cash flow up by positive EUR 34 million and ending cash balance is EUR 31.3 million, up by EUR 24 million. The receivables -- customer receivables, parts, trade receivables and then contract assets, which are tied to the longer payment term deals. It's down by EUR 6 million from December '22, so down by roughly EUR 6 million. And then the -- if you go to equity and the liability side, no major movements here except that loan liabilities and some of the earn-out liabilities have moved from long term to short term now.

And also we have paid out some of the loan that was taken for the Axivion acquisition that happened as well in Q3. Other short-term liabilities. The increase is pretty much driven by the earn-out liability from long-term liabilities side. So no major movements in the balance sheet. And now it's time to hand over back to Juha to go through the outlook and guidance for the year and strategy update. Thank you.

[Juha Varelius, executive]

Thank you. Thank you. So I already briefly touch the market, we don't see on a market. We don't see a substantial change in that sense that maturity of our customers in 70 different industries, they are producing new products new applications, and they continue their investments. So if I look at the market outlook, the only thing we've seen is that maybe a bit less consulting is being used and they try to do in source instead of outsourcing. So that we do see, but we don't see a -- if I look at the number of licenses we're selling -- if I look at the number of projects we are estimating there is to be -- we don't see a big slowdown over there. What we do? Well, this is going a bit. If I look into the next year, obviously, we see in the environment now that many businesses and different markets are not doing equally well. So that may have effect next year on the growth rate on the distribution licenses, but it's still too early to say.

And if I look this year, the distribution license growth so far has been a very satisfactory for us. So that's basically how we see. And of course, there is market uncertainty more so and how long this downturn will continue. If I look in Europe, Europe is maybe a bit slower. American economy is still doing amazingly well. And we do see quite a big activity also in Asia Pacific at least at this point of time. And we don't see that these big customers of ours would be scaling down their future development on their future services or products in any particular way.

Instead, we actually see new industries coming all the time. We see new customers coming that want to build the graphical user interfaces and digitalize their products that have not done so before. So we've talked a lot about automotive in previous interactions. And if I look now we see more and more consumer electronics and smaller and smaller devices, getting traffic user interfaces and getting a feel -- user feel like like on mobile phones. So everybody expects that every product usability is like on a level of mobile phones, basically. So our guidance for '23, we refined that our net sales will be in the range of 20%, 25%, and our operating margin will be on a higher end of the scale, 25% to 30%. And well, this, of course, if we look at the first 3 quarters and now the third quarter and we look on the -- in the fourth quarter that's pretty well, it's pretty obvious that we're not going to be able reached the 30% on our revenue growth. So that's why the lower guidance over here. I just still want to highlight the fact that this is a very profitable business. So even though are looking to make a -- on the lower end of our guidance, the revenue, the profitability is on the high-end. So that's the change of today.

Very quickly on the strategy, there is not a whole other change -- the -- we've all talked about this before that the product development cycles are getting faster. What we see in our customers is that the faster and faster the products are wanted to get to the market. So the development cycles need to be faster. There are more cycles and yet they are about the same amount of the software developers. So basically, the need for our type of solutions that we accelerate the development phase, and we also accelerate testing phase with our quality assurance tools. There is a growing demand. And we don't see anything changing in that. I already touched the fact that the more and more people are expecting that the user interface is on whatever product are more like a mobile like. So there is a great demand to have a great user interface. And the software in a product actually defines the value product, and that's spreading more and more wider. A few years back, we talked about automotive. Now we talk about all consumer electronics, and it's getting smaller and smaller products and so on.

So the the demand for this kind of a solution that the solutions we are offering it's growing. So if we looked at the -- we are offering what we do get, we have the best platform and tooling framework for the digital user experience is used in over 1 billion devices. And that's actually the cornerstone for our success. The fact that the continuous feedback from developers and users of our product, they're telling us that the our product is excellent and it's beyond their expectations. And that's basically the reason why we are so successful. And of course, we -- our intention is to keep it that way.

We help our customers to manage the complexity, reduce the regulatory risk and increase the quality of the products well that we already touched upon. So people using our services, our testing services and our products are very happy, and we help them into -- in their tasks to develop world-class products. If we look at the -- the difference we have on many of our competitors, we do cover multiple industries, and we are very horizontal. And that's the difference to many of our competitors. Actually, I don't know any of our competitors that would be so horizontal than we are. And that's 1 of the cornerstones. Like we've talked before, the other difference we have with our competitors is that we are very globally expanded. We have our own local sales network, all local presales engineers and so forth to deal locally with the customers.

And that's a bit different than we see in our customers. Many of our customers rely on the third-party OEMs or third parties and reseller networks and different strategic partnerships. Instead, we've invested quite a bit over the years that we are locally very close to our customers. And so there is a not big change on that. Well, as you know, we have a recurring revenue. We do sell subscriptions on acute and quality assurance. So we do sell licenses over there. And then we do get distributors license from Qt, so not from QA, but from Qt, we do get a distribution license. The quality assurance is expanding also to other markets than Qt. So this is not a hit on stone, but what we've said is that we hope to see in the future that 30% of the QA revenue would come outside of the Qteco system. So we see QA to expand our addressable market beyond Qt. Of course, we do see that our quality assurance tools are very well integrated to be used by Qt users as well. So all our products, they fit very well together, but they can be independent.

That's another other principle we have that each of our products, they need to be so strong that they are -- they can stand on their own feet so they have to be successful on their own as well as integrated together. We are looking for -- on QA, I've said before that if I look it in 2013, 2014 in the early days, and I saw that where we grew with Qt, we set the EUR 100 million target. I see a -- for our quality assurance tools, a similar path just stay a bit faster. So we see no reason that it will hit the EUR 100 million mark on its own quality insurance markets in the coming years.

We haven't set a time line for that, but we do see that the development can be faster than on Qt because we already do have the sales network. We do already have customers that we can sell to whereas when we started Qt, we had to build the sales network and get the customers. So the QA acceleration will be faster. And it's also a very profitable business. We are looking for inorganic growth opportunities as well. And like I said, we are looking in organic growth opportunities in the sales in the software development process. So we look at us from design to developing to testing and everything there is in between. And that's the domain we are looking for acquisitions to be made. We're very careful on our acquisitions, and I don't think we're going to be doing -- my guess would be that our acquisitions are like the 2 acquisitions we've done before. So we acquired basically the businesses were about EUR 6 million on revenue, and we paid roughly about EUR 30 million on it. That's kind of the size we're looking for. So we're not looking at megadeals. Instead, we are looking trade products that we can put in our sales channel basically.

So financial targets for 2027, we're looking at annual growth of 20%, 30% annually, and we are looking at an EBIT margin of over 25%. And of course, on the EBIT margin, we pretty much -- we're pretty much there. And on a growth, we're pretty much there as well. So if I look at the growth next year, that how do we see that the obviously, that guidance for the next year and year after, that's -- that we can basically already see that what's happening. We know quite a bit the outlook for next year. And so we're very comfortable with this guidance. This, of course, means that the -- in few coming years, we're going to double the size of the company, and it's going to be on revenue-wise. And it's going to be -- we see that the profitability will remain very strong going forward. So we're very excited about the -- our future ahead, even though I must say that the market is not the best at the moment, but the -- of course, that's -- over time, that's going to change as well. But we do believe very strongly that we can meet these numbers very well in the coming years and the next year, particularly.

So that's the end of my presentation. And if you have any questions, please? If you use the mic, yes.

[Matti Riikonen, analyst]

It's Matti Riikonen from Carnegie. A couple of technical questions first. You mentioned quite a lot of negatives affecting the Q3 report like deal slippages. Could you just kind of somehow quantify what importance did they have? How many millions of revenue did you lose into the next quarter? And when you said that some of those deals have been signed already, what size of deals were they?

[Juha Varelius, executive]

Well, we missed our internal target by a few million, and that's about the -- and those inside.

[Matti Riikonen, analyst]

So no quantification?

[Juha Varelius, executive]

Well, let's put it this way, that the -- if I look on the -- so the deal slippage, the typical deals we have now in Q3 and Q4 on a higher end, they are typical deals are around EUR 1 million to EUR 2 million, the bigger ones. So there are no mega deals. There is no EUR 5 million deal that we lost. They are was slipped. They are the bigger deals now. And the bigger deals to close in Q4 are in a range of EUR 1 million to EUR 2 million. So that's basically the -- and then there is a very long tale of smaller deals when we talk about [ 100,000 ] and whatnot. So if I look now what deals -- the few deals that we were expecting to close on a Q3 that moved into Q4, they were in EUR 1 million last side. And they a couple are signed and 1 is in the signature. PO is there signed tomorrow. So it's very typical for us when you think that the -- how much work there is before you are in a deal signing.

There is usually -- if it's a new customer, there is testing, there is proof of concepts. There is deal negotiation, it would be very uncommon that the customer would go all the way that far and then not -- that deal would fall off. If the deal is going to fall off, it's going to fall off well before that situation. So that's why I'm so confident that deals that usually slip over to the next quarter, there are deals that it's only price negotiations or very terms negotiates or something like that. So they are very close. So unfortunately, they were a bit too many of them this quarter, and that's why it's soft. And that's basically the reason that I think that your technical questions are coming towards this. So I'll answer, if not, I'll answer anyway. If I look at the -- if I look at our pipeline on Q3 and well, Q1 and Q2, if I look at the pipeline in Q3, if I looked at what was the close rate for the pipeline. If I look now at the pipeline for Q4, and if we can keep same close rate that we had on Q3 than we are in our guidance, right?

So we do have a pipeline over there. And if we close at the same rate, we closed on Q3 than we've done. So we don't have to sell anything further. There is also no big mega deal that it's like win or lose that if we win, then everything is fine. And if we don't, then we lost, it's a high volume of deals that we need to close on Q4. If I look to Q4, it's -- this is not exact science, but to give you an idea, I would say that 50% of the Q4 revenue will be sold in December and 50% of that will happen in the 2 last weeks of December. And why is that? I don't know if I could change that to be a bit even, I would do that, but that's -- and that's how it works pretty much each quarter, and it's been all along.

So the deal signing goes towards the end of the quarter. And 1 reason, of course, is that in these big customers we have, it's business usually does all the things they do. And then they decide that he is what we want. And then it goes into sourcing and then the sourcing keeps negotiating to the last minute, trying to get a better deal, trying to -- so they will negotiate to the last minute they can, and then it's signed, and that's kind of how it goes.

Can affect that? Well, yes, giving bigger discounts, but we don't do that.

[Matti Riikonen, analyst]

All right. Just for reference, when in Q2, you said that some deals slipped. Have you closed all the deals now in Q3?

[Juha Varelius, executive]

Well, probably, yes, I can't remember all those deals, but probably yes. They usually don't slip. Customers, they -- when they buy our stuff, they have something they're going to started using them for. So they can -- it can slip over a quarter, but slipping 6 months would be very unusual because it would mean that the project is not starting. And our customers are starting projects that manufacturing something or they're doing something to help their manufacturing. So usually, there are delays. There might be volume changes, but the thing that somebody decides to manufacture something and builds everything up for that and then calls it off very, very, very unlike event hardly ever happens.

[Matti Riikonen, analyst]

All right. Then the second softness factor you mentioned was consulting. And what was the share of group sales in Q3 for consulting? And how does that compare with the group share in Q3 last year?

[Juha Varelius, executive]

That I have to look somewhere. We've said a long time ago that we don't want to see consulting to be more than 20% of the total. It's nowadays that the company has grown. It's -- we're in a 10%. So if we are looking for the whole year effect on consulting softness, what we were expecting. We're talking about single millions though. But single millions there, some single millions of exchange rates and some single millions on the mix and There, you have a double-digit millions.

[Matti Riikonen, analyst]

Right. Then the third part you discussed was that the contract maturity mix was more geared towards the shorter contracts like 1 year. And could you somehow quantify that? What is the difference between if in different world or the contracts would have signed as 3-year contracts. And now many of them are signing in 1-year contracts. What's the kind of difference in your growth rate that comes from that?

[Juha Varelius, executive]

Well, I can't. It would be substantial. But to give you exact number from here, it would be that if all -- everything we sell would be 3-year licenses compared to the mix we are having now, it would be a double-digit millions. But to give you an exact number, I don't want to say it here when the webcam is running because I would probably give you a wrong number, and then I would [indiscernible] later. So that is something we would have to look into. I'm sure Jouni doesn't have that. We would have to calculate that. We've never calculated it that way because we're selling -- some people want to buy a 3-year license, there is obviously benefits for that you fix the price and then you don't have to worry about 4, 3 years. Other people want to buy a year early license for many various reasons, maybe cash flow reasons. I would think that the -- now our customers, we saw a spike on 1-year deals when Ukraine war started. And so basically, whenever there is some sort of a crisis or the outlook gets dimmer, we see our customers starting to secure their cash flow and then we see that they prefer more than 1-year licenses even though it's not economically beneficial for them.

What we think -- of course, we could change that we could lower the price on a 3-year license. We could try to drive people more towards the 3-year license. However, we see that many -- most of our customers using our services, they do it year after year after year after year. So the customers we have, they are very long-term customers. So if I take a view that if I would really want to suboptimize and have a very high revenue on 1 particular year, maybe then it would make sense to try to sell the 3 air licenses at a discount. If we take like a bit longer-term view, we see that all the 1 year licenses we're selling this year, they're going to renew next year. So in a big longer-term view, we're not worried about the mix at all. But of course, it does affect our short-term revenue.

[Matti Riikonen, analyst]

Right. So then to wrap these 3 factors together, deal slippages, consulting and the maturity mix, which had the biggest impact on you're not meeting your internal targets for growth in Q3?

[Juha Varelius, executive]

On Q3, it was a deal slippage because the -- it's good to make this difference now that this product mix and the consulting softness and the currency exchange rates that, of course, has been there all year. So if I look at the whole year, how it looks now to where we're going to be on a whole year at the lower end of our guidance that's the effecting factor. Of course, we've seen this all the year long. So if I look at the -- our guidance on a Q3 that it was, say, a bit soft, it's the deal slippage is basically because on our -- if I look now our guidance, I look at the pipeline, I look at the mixture. If I look next year, but how the next year looks, we've basically -- we're budgeting our next year with the same mix we are having as of today. We're basically budgeting the consulting to be flat, right, and so on so.

So we're taking all this into consideration for the next year guidance as well. So for the Q3 guidance and why it was softer than we were expecting, is the deal slippages. All the other facts have been there all year long. And so we don't expect that to change going into next year. So we're budgeting and looking forward as that this is kind of a status quo on the 1- to 3-year deals licenses.

[Matti Riikonen, analyst]

Right. Then 1 technical question still, and then I give the mic to others. How has the distribution license sales in Q3? And has the share of group revenue coming from distribution licenses increased this year. Earlier, you talked about big manufacturers programs coming live this year?

[Juha Varelius, executive]

This year, on distributional licenses this year is a very good year because the -- there's been a lot of new programs hitting the market this year, even though the market is slow. And we do expect the -- we're going to report the distribution license revenue. Obviously, we still have a 1 quarter to go. But the -- I think that the -- we're going to be very happy on our distribution license sales growth this year and it's particularly good. So I do expect that it's going to be a bit lower the growth rate will be lower. It's going to be growing, but the growth rate will be lower going into the next year. But let's see, we have a huge quarter ahead of us, right? We're going to be selling over EUR 60 million this quarter, which is if you take that a few years back, we made EUR 60 million a year. So there's still -- there's a huge quarter ahead and let's see where it settles. But I'm very -- so far, the distribution license revenue is developed very favorably, and we do believe that this is going to be a good year, definitely.

[Felix Henriksson, analyst]

Felix Henderson from Nordea. I have a few questions as well. Starting off with the developer license maturity mix? Because last time we discussed among the sell-side analysts and you guys, you basically hinted that the price differential between the 3-year license and 1-year license on a per year basis is really like nonexistent these days compared to the history when the 3-year license implied a discount to the customer. So my question is, isn't this sort of mix shift from 3-year to 1-year licenses also a bit sale induced because the customer doesn't have that much incentive to choose the 3-year license?

[Juha Varelius, executive]

Well, yes, there is still -- you're right. So if you compare like a couple of years back, the difference is a lot less. So yes, you could argue that there is a bit -- it's a bit self-driven that we're driving it towards that. On the other, there is still a small discount. If you take a 3-year license plus if you think the current inflation rate that you can fix your price for 3 years. Obviously, there is a value. Well, what is going to be [ 3 year ]the inflation rate 3 years going ahead? I don't know. But if we look at the inflation rate looking back, the people that did a 3-year deals like a couple of years ago, they have not done in trial a bad deal compared to 1-year deals, right? But if the inflation rate is pretty much close to 2%, what is the target for the central banks then, of course, we need to think and look into that, that the how do we change the pricing.

And -- but now that's basically you save the inflation, whatever it is and our price increases, and there are yearly price increases, so you lock into that and you get a small discount. But other than that, yes, it's pretty -- it's pretty close to [indiscernible]. Obviously, I don't have exposure to all of our customers. But the -- I think that the driving factor, and this is our belief that the driving factor choosing 1-year licenses is actually nowadays the securing the cash flow. So I don't know how much discount we would -- we feel that the -- for the customers that they want to secure their cash flow, there is no discount whatsoever that we could give them to get them a 3 year license in that sense. That's our belief in the market right now. And so the people that want to secure their cash flow and pay only 1 year, that's fine with us.

[Felix Henriksson, analyst]

Right. And then regarding the 2023 guidance, you already mentioned that it sort of requires that you close your Q4 deal pipeline with the deal closing rate that you did in Q3, but what does it require from the developer license maturity mix?

[Juha Varelius, executive]

Oh, the same.

[Felix Henriksson, analyst]

Same mix as.

[Juha Varelius, executive]

We now yes, -- so same mix that it's now the same mix that it has been. So it doesn't mean that the mix changes in any way. If it goes still worse, then yes, but I don't see that happening. I mean it's been very confident where it is, it is -- we don't see that getting any worse anymore.

[Felix Henriksson, analyst]

So basically, it's more or less what you saw in Q3, meaning that new deals will be done more or less with shorter maturities, but the renewals will be renewed with the maturities that they had previously?

[Juha Varelius, executive]

Yes. And that's what our experience so far, that's how it's been doing. So if everything stays the same in Q4 that we did experience in then we have everything in place. And of course, we do sell. Quality assurance is actually a business where the turnarounds are quicker. So our quality assurance is something that we can still find customers make offers and even close them on Q4. So it's -- what I'm trying to deliver over here is that the -- we don't need any surprise mega deal or we don't need any surprise. We do have all the ingredients in place to meet the Q4 targets, right? So that's the message.

[Felix Henriksson, analyst]

Great. That's helpful. Then regarding the new financial targets. Obviously, you mentioned that you aim to double the size of the business by 2027. But I'm curious about the sort of revenue mix that you envisioned, especially when it comes to the distribution licenses because back in the day, so I think you were talking about 40% of revenue coming from distribution licenses. I think over the past year, that's been talked down a little bit given that you now also have quality assurance, et cetera. How large share of revenues do you think that can come from the distributable license business in 2027?

[Juha Varelius, executive]

Felix. That's a good question. I should be able to answer that. Well, let me put it this way that the -- when we set the 40% share of the license business in previous years, if I look at the distribution license revenue as it is, it is developing as we invested, right? So it's not getting lower. The share is getting lower, however, because we do have a QA business to sell the licenses. And then the subscription model is especially when you have the 1-year subscription model, recurring revenue, that's becoming very -- that's coming bigger than we envisioned when we said that 40% of the license revenue will be the distribution revenue.

So the share will be a bit lower, but the absolute amount that we see on our distribution license revenue, it's not -- it's where we have been expecting it all along. So it's growing very nicely, and there are more and more devices. And of course, we're also looking added value in that sense that we can increase the value to our customers on the distribution licenses and increase the prices of those as well. But the volumes are growing as expected. But the share on will be a bit smaller. But that's a very good question. I need to think about what kind of guidance we give on that in the future?

[Felix Henriksson, analyst]

Because that's -- you've been talking about the quality assurance has been envisioned being [ 100 million ] business eventually. So it would be helpful to also get kind of an ambition level on the distribution license side as well, obviously, for us.

[Juha Varelius, executive]

Yes.

[Felix Henriksson, analyst]

Maybe sort of related to this, the margins, obviously, distribution license growth is a driver of that. And now you set out to target more than 25% EBITDA margin for the longer run. That sort of leaves the upside sort of open. So right now, if you look at the sell-side analysts, expectation level already for next year is that you're at plus 30%. My question is, is there any reason why we shouldn't expect plus 30% margins for you in the medium term or [indiscernible] .

[Juha Varelius, executive]

Well, yes, I give the same answer that the -- I basically gave 4 years ago when I was asked what -- why do we on profitability. On this business, if we want to have over 30% profitability next year, it's very easily done. I mean, it's -- in that sense, it's the -- having over 30% EBITDA next year, we can deliver it very easily. So now the question is that the -- how much do we want to invest for the future and how tight we want to put that EBIT margin, right? And then the question is the -- what's driving -- what's the volatility on that? If you think the distribution license sales and license sales per se, the -- it's very profitable business in a way that if you sell -- if we now sell 1 million more on licenses, it kind of goes to the bottom line directly, right?

So if you put the -- we do know that we have a bit of a fluctuation on our top line, and we do know that we do want to invest also for the future growth because we see still a tremendous amount of growth opportunities like 1.5 years ago, we didn't talk about QA at all. And now we are talking about that we bought EUR 12 million of revenue, and we're talking about that in a few years, it's going to be EUR 100 million revenue with a profitability. So we don't want to give a -- we want to leave room for growth investments. So I would say that the -- whenever the profitability starts hitting 35% or 40%, we've run out of ideas how to grow in the future.

[Felix Henriksson, analyst]

Makes sense. Final 1 for me before I let others ask. Just out of curiosity in conjunction with the strategy update. Have you done any sort of assessment or calculation of your sort of total addressable market or your market size at the moment? Because I think that would be massively useful in estimating your sort of potential?

[Juha Varelius, executive]

Yes. We do. And it is where -- there is no ready-made report. There is nothing that we would be able to use and say that this is exactly our market. We've used this type of numbers that on Qt our market is roughly EUR 1.5 billion. As the current setup, we've said that on QA, it's double of that, but those are not exact numbers. So on the other hand, we've said that the -- given the market and given our size, we're still very small. And the markets, both on QA and Qt environments are fairly fragmented. So we don't see even a consolidation happening on yet for example, on QA. So we do see a lot of growth opportunities going forward. So we don't see that -- if I look at our product portfolio, I would say that if you think the old fashioned S curve that where you have the -- I would say that our consulting business is on the top of the S curve. So it's not going to go down, but it's not going to grow a whole lot. But other than that, we do see that more and more industries are coming into this business all the time, and they are doing their first graphical user interfaces.

We see more and more businesses coming but they built something and they're getting in trouble of testing all that they have. We see more and more customers that they build something and they are wondering if their architecture on a software architecture is in in good shape, and they want to use our tools to check that. And we see still the market in -- we see new customers coming into this field all the time. So in that sense, we don't see a market limit. And we see a big, big market.

Having said that, when we think -- we -- obviously, we need to think about with like now we're concentrating a lot on Q4 execution, but we're also concentrating next year, and we are looking for many years forward. And many, many years forward, I mean, 5-plus years forward, we're also looking that we need to still want to grow this company, and we are looking at where we're going to be getting more addressable market. And QA, again, fits very well on that because large part of our QA offering can be used in -- on our Qt business, but we're looking to get addressable market outside of the Qt system. I think that our next product investments will be such that they will again expand our addressable market. So that's kind of on our long-term vision that we make sure that we have enough addressable market going forward. And when we do add new products in our portfolio that fits into that strategy.

[Matti Riikonen, analyst]

So Matti Riikonen from Carnegie. A couple of add-on questions. First regarding the distribution license revenue and the cyclical impact when you started the year and made a budget for distribution license revenues, both coming from kind of apples-to-apples customers basically manufacturing the same goods as they did last year. And then net new customers starting some new programs. Are you able to quantify the cyclical impact of distribution license revenue, i.e. has there been kind of some negative from the overall economy turning weaker, consumers buying less goods and and that kind of impact. It would be interesting to hear your thoughts on that. What kind of magnitude are we talking about? And how do you think going forward because the economy doesn't seem to be easing or it's certainly easing not improving. So the situation is not easing. So that must be a consideration for 2024 as well.

[Juha Varelius, executive]

It is. And like I said, this year, we had a big program sitting to market. And so we're having -- that's why early on in the year, we knew we said that the distribution license revenue will be growing nicely. Of course, we've seen on we've seen on some of our customers' softness on their volumes that they were expecting. They're selling less. But so ongoing next year, yes, of course, on consumer electronics, I mean, with these interest rates and if the interest rates keep on staying such a high level, some of the consumer electronics companies or products will be selling less. That's very obvious. On the other hand, we serve 70 industries, like I said, and distribution license revenue comes from hundreds of different sources. We talk about automotive very often, but it comes very horizontally on [ 100s ] different sources. And then our distributional revenue is such that, like we said, if I use the automotive market that we get a roughly about per screen per car. So if you think that there is the volume changes need to be very substantial before we start feeling substantial pain. And then we always have a -- we do have pockets on different industries where are doing actually very well at the moment. I'm not talking about the distribution license revenue per se, but our defense sector, for example, these unfortunate times is doing very well. So we do sell the difference quite extensively.

[Matti Riikonen, analyst]

All right. And I take that as an answer as also to the fact that we have seen many automotive companies now cutting production or delaying some production starts in both electric vehicles and traditional vehicles. Do you think that, that will be of any concern to you this year or next year?

[Juha Varelius, executive]

Well, not this year, no. But the -- like I said, the -- when we're going to announce the distribution license growth, let's see where it ends up after the Q4, that what's the growth this year. I'm already now saying that the growth rate will be less, it will be growing, but the growth rate will be less and the -- let's see where it ends up yes. But of course, I mean, consumer electronics cars, whatnot, with these interest rates, obviously, there will be less demand next year. Well, it will slow our distribution license growth rate a bit. It will not slow our developer license sales. I don't think that and the consulting, we're estimating that we'll keep it flat. Basically, we're not looking at the growth in there. So -- but let's see when we get closer to next year.

[Matti Riikonen, analyst]

All right. And then out of curiosity, if we think about the automotive market and electric vehicles and then traditional. Is your market share basically the same in both. I'm not talking about monetary terms, but your kind of share of different models. So exposure to kind of OEMs, the whole product product mix?

[Juha Varelius, executive]

Okay. I can't answer you on that. What I can answer is that the we do have quite a bit of automotive makers where we've started like on a 1 program and 1 car model. And then they found that [indiscernible] Qt is very good, and then the usage has expanded. And so that's more like that the -- I would say that it's more typical that the own particular automotive manufacturer, if we are in, we are in -- on many places, we are on many screens and many car models. And if we're not in, then we're not in. And so the -- usually, what happens is that once we are selected, we have found so good that they start using us pretty much very widely, which makes sense. And so I haven't looked into that.

We do have -- I've said some time before that the -- I think that the Chinese electronic car manufacturers will be -- there will be big players in the future. It's a very fragmented market, but we're there. And in that sense, on electric vehicles, we're well positioned. But from the user interface point and the point where our software is being used, it doesn't really matter if it -- what's the engine or what's the power source of the vehicle.

[Matti Riikonen, analyst]

All right. Thank you. And then finally, a technical one. Regarding contract assets. There was a slight increase again in the number. Just out of curiosity, how do you book them? What is your mechanism in recording contract assets?

[Jouni Lintunen, executive]

If I go first to the topic contract assets going up from Q2, if that's what you mean. That's driven because of the exchange rate change from Q2. USD has gotten a bit stronger. But yes, I mean, operatively, there is no increase in that regard. And the contract assets, well, then slight increase as well on the distribution license accrual that we do at the end of every quarter. So these 2 are driving the slight increase on that. We booked them as if we have the kind of longer payment term deals, that's 1 part, and that's going down. And then distribution is revenues that we accrue on a quarterly basis, that's part of the contract as a short-term 1 then, and that gets relieved then next quarter.

[Matti Riikonen, analyst]

And is that based on some estimate of how the customer will then eventually end up paying you and who is doing that estimate? And how does it work?

[Jouni Lintunen, executive]

Yes. That's based on the estimates, and that's on the information we've got from the customers. And it's done by well, obviously, accounting with the help of account managers. And then at the kind of after the quarter end, we will get the reports from the customers. And then at that point of time, we will then issue the invoice and release the accrual at that point. And that's something that we want to be cautious though, we must not kind of over estimate these volumes, so no risk in that regard.

[Juha Varelius, executive]

I think we're pretty much on time. So thank you very much, everybody watching and participants over here, and thank you very much for very good questions. As a closing remark, we did have a bit soft [ Q4 ] (sic) -- we're looking -- Q3, we're looking for Q4. We do have all the ingredients to build a great Q4. And looking forward next year, we do believe that we are in a great position to continue the very profitable growth for this company, and we're really looking forward to that. Thank you.