Crayon Group Holding ASA

OSE:CRAYN

Earnings Call Transcript 2024-Q1

[Kjell Hansen, executive]

Good morning, and welcome to Crayon's Q1 2024 Results Presentation. My name is Kjell Arne Hansen. I'm the Head of Investor Relation. With me today presenting the key development and our financial results for the quarter, we have our CEO, Melissa Mulholland; and our CFO, Brede Huser. As usual, after the presentation, there will be a Q&A session. [Operator Instructions] A recording of the webcast will be available on our IR pages after the live event has ended.

And with that, I hand it over to Melissa.

[Melissa Mulholland, executive]

Thank you for joining our Q1 presentation. I am pleased to share that Crayon delivered over NOK 1.4 billion in gross profit in Q1, up 17% year-on-year, delivering a strong start to the year. The year-over-year growth performance is particularly strong on the back of what was our largest Q1 in Crayon's 22-year history in 2023.

Overall, we continue to see a high demand for Software & Cloud licensing across both direct and channel, which contributed to the growth performance. As businesses expand their IT portfolio to prepare for generative AI, we are seeing increased demand for software and security as well as productivity requirements.

Adjusted EBITDA margin was 13.8%, down 0.9 percentage points, which is in line with expectations. We took measures to reduce costs in consulting and are on schedule to improve margin in Q2 with increased utilization and pipeline in place.

In 2023, we saw a sluggish consulting market globally with notable deceleration and have made necessary adjustments as part of our ongoing focus to increase profitability. I have stated in prior quarters the importance of improving on net working capital and our continued commitment to do so.

I am extremely pleased to report that our efforts have demonstrated continuous improvement in Q1 bringing us back to a negative net working capital of negative NOK 1.1 billion, an improvement of NOK 867 million. This is the result of the company-wide engagement on improved collections and receivable processes. We will share the specifics of this information and the improvement in the financial section of today's earning presentation.

To deliver the growth ambitions for the company while increasing profitability and net working capital, we remain focused on 3 priorities: first, continuing to deliver growth by capitalizing on the strong market demand and focus for companies to expand their IT and licensing needs; second, margin improvement with cost management, resource hiring and the utilization of our consulting business; third, continuing to demonstrate net working capital improvement with focused efforts on the whole receivable process from contract terms to collection.

In looking at the market, Crayon is uniquely positioned to grow based on a highly resilient and vital part of running an IT state, which is Software & Cloud licensing. Starting with Software & Cloud. Despite the macroeconomic environment, the software license business maintains consistent and healthy growth globally. For Q1, Crayon delivered an impressive 20% gross profit growth considering a high comparable in 2023.

In looking at the market, we see global momentum to capitalize on the benefits of generative AI. As I stated in Q4, this is a transformative moment in history similarly to the introduction of the smartphone. To prepare and use AI, it requires a license as well as an understanding of data management, security infrastructure and cloud.

All 3 hyperscalers across Microsoft, AWS and Google have GenAI products available. And each have their own unique advantage depending on the customer environment, cloud infrastructure and applications as well as overall employee use.

As it stands now, Microsoft has the clear lead on captivating mindshare in the market. Transitioning this to Crayon, it has driven demand on Microsoft modern work inclusive of CoPilot, but also M365 E5 as companies seek to drive their productivity whilst remaining resilient within the evolving threat landscape.

At Crayon, we invested in E5 licensing back in 2021 as a critical component in our internal security architecture. And our security team leveraged the full capability set of E5 and Sentinel to build and deploy automated responses to threats against our user accounts and devices.

By the end of 2023, over 50% of security alerts were fully handled by automation as our security team increased the level of security automation over the last years. It was increasingly able to focus on proactive projects.

A prime example being Crayon's own CoPilot readiness. As Microsoft CoPilot was announced, our internal security team analyzed the E5 productivity tooling to identify what critical measures needed to be implemented to avoid unexpected side effects and such as confidential data exposure.

With our modern work team, leading Crayon's CoPilot adoption and go-to-market motion, the knowledge we gained internally through the collaboration between our own modern work because as we support our customers, we also need to learn from our own internal journeys around this.

When we adopted CoPilot, already having E5 in place propelled in our ability to manage the data privacy and security needs to protect sensitive data while unleashing the benefits of CoPilot. To do this, it requires thoughtful ROI assessment as it generates increased costs for customers and will expect an adoption curve on GenAI. Given this complexity, that also needs to be considered.

Transitioning to cloud services. The overall IT market is expected to grow modestly, with Gartner projecting IT services spending at 6.8% in U.S. dollars, and 7% in constant currency in its latest IT forecast report.

According to Gartner, the global IT cloud market will have limited growth in 2024 as the AI hype does not translate into accelerated growth in 2024, but rather, it will be driven by traditional CIO spending patterns, which aligns to what we are also seeing at Crayon with software and cloud.

The market globally in IT services in the first half of 2023 had a slow growth performance with delayed and protracted contract signing as the expected improvement in acceleration in the second half of the year failed to emerge as the hype stranding AI and frozen budgets prevented CIOs from further investment.

Like Crayon, Gartner did not see the global CIO budget flush in IT services at the end of 2023, but does anticipate that some of these late allocated budget dollars will show up as spending in 2024. In translating this to Crayon's performance, we grew 5% year-on-year with an LTM growth of 19%. This is driven by a 5% decline in the Nordics and investments made in Europe to scale data and AI with our center of excellence. Measures to improve profitability are on schedule and expect positive margin in Q2 and further improvement in H2.

To provide more specifics to our business areas, we delivered outstanding profitability in both the direct and channel businesses, with the Software & Cloud Direct business resulting in 42% EBITDA margin and the channel business delivering 69% margin. Additionally, both business lines delivered solid growth with direct at 19% and channel at 42%. This demonstrates the necessity of software and cloud despite the macroeconomic environment.

Transitioning to the service business areas, Software & Cloud Economics was in line with the historical growth at 15% GP performance and 6% margin. The consulting business, as covered previously, delivered 1% growth and negative 4% margin. We have taken measures to improve throughout the quarter and are expecting back to profitability in Q2.

Turning to the markets. We remain focused on driving profit expansion and scale through our international markets. The Nordics represents 44% of our gross profit overall and delivered a solid growth performance in direct at 19% and channel at 23%. The driver of the decline growth in margin was driven by the consulting miss at negative 5%.

Europe delivered strong growth at 31% in Q1, which is a continuation of the performance in 2023 and strength of the business model. As stated throughout 2023, we continue to invest in expanding market share in key countries where we have been subscale. These investments are reflected in the negative 1% EBITDA margin in hiring sales resourcing and data and AI capabilities to deliver for 2024.

To provide some specifics on country performance, the channel business grew 53% across all of Europe, with the U.K. growing at 44% and the Netherlands at 153%. On the direct side, Germany represents 23% of our gross profit for all of Europe, and Germany alone grew 80% in Q1. This is based on the strengthening of our organization and investments made in 2023 to increase our sales capability in Europe.

For APAC and MEA, we drove 14% gross profit growth and 11% adjusted EBITDA margin. This is a strong performance for the quarter with the Australia, New Zealand business -- channel business growing 25%.

Turning to the U.S. Crayon delivered 9% growth, and it is continuing to focus on margin improvement based on continued investments made into the country. The business is on track as planned with a direct business growing 17% and Software & Cloud Economics at 13% GP performance.

Before leaving the market performance for Q1, I will briefly provide an update to the outstanding receivable in the Philippines of $45 million. As stated previously, we continue to engage with Microsoft and PS-DBM, the procurement department for the Philippines government to resolve this payment.

COA's audit findings continue to be undisputed and there are no questions around the fact that all services have been supplied. As such, we continue to follow up on this receivable and continue to expect a full settlement in due course. As stated prior, we will continue to keep the market informed over any significant developments.

The last couple of months, the industry has witnessed one of the biggest disruptions in the last 15 years. In November last year, Broadcom acquired VMware for $69 billion and set out to transform the company and increase profitability.

Subsequently, the channel distribution business called Aggregation with VMware was put on an RFP. And I'm happy to announce that we were awarded the sole channel distribution contract in Asia Pacific and India. This is a significant win for us, and it was made possible by our acquisition of rhipe.

In EMEA, we will continue to serve our channel customers, and were recently awarded the VCSP premier contract. This contract means we will be offering support optimization and licensing services to our channel customers in Europe.

The channel distribution contracts were not awarded to Crayon as our overall market share was smaller than our competitors. For our direct resale business, we have the same resale rights as before, and we'll be able to serve our customers with the new Broadcom offerings.

Turning to a customer story. I'm pleased to highlight a customer win on Microsoft CoPilot with Verdane. Verdane is a specialist investment firm with businesses across Europe for an asset size of EUR 6.9 billion. Verdane wanted assistance with streamlining operations with AI and established M365 CoPilot as a foundational means to increase productivity as well as efficiency.

They partnered with Crayon to integrate CoPilot into its operations and subsequently became the largest cloud solution provider client in all of Western Europe. Crayon facilitated an assessment-based approach with workshops to plan and prepare for the readiness required for CoPilot implementation and adoption across the whole organization.

As an outcome, 87% of the operational experts at Verdane have reported enhanced quality and productivity in their workday with an improved quality of 67%. Additionally, CoPilot has streamlined the market research and sales process, enhancing their market competitiveness.

As Verdane CIO, Morten stated, "We were early adopters and already knew a lot about AI. So instead of putting us into a standardized project plan, Crayon adapted to our actual needs, which enabled us to move quicker."

ESG continues to be a priority, and I'm pleased to share our 2023 full report being now available. Over the last year, we achieved 1.88% decrease in carbon intensity by revenue, a new global sustainable device management program, as well as 32% of our workforce was women.

In addition, we have given back to our communities through charitable giving through Crayon Cares program, which is integral to our culture. We have also continued progress with labor and human rights due diligence.

And lastly, as part of ISO 37001, we achieved our certification for anti-bribery and corruption in management systems. As we continue in 2024, we plan to increase our efforts with a focus on developing an enhanced ESG strategy with new targets, including science-based emission reduction targets preparing for CSRD and ESRS compliance, including a transition to integrated annual reporting.

And we'll be completing a double materiality assessment to underpin both the ESG strategy and CSRD-ESRS readiness. And lastly, we will continue to identify activities within scope of the EU taxonomy regulation.

With that, I will now transition it to Brede to disclose more details regarding the Q1 financial performance.

[Brede Huser, executive]

Thank you, Melissa. I look forward to taking all of you through the financial section of this Q1 earnings presentation.

Starting with working capital, I'm happy to see that working capital performance remains solid also in Q1. We see clear improvement across the global organization from the focus and attention we have given this over the last periods.

Net working capital ended at minus NOK 1.1 billion. This includes a payment extension from a vendor of NOK 450 million. However, even excluding this impact, working capital improvement improved significantly compared to Q1 prior year from minus NOK 218 million to minus NOK 637 million.

I would like to comment specifically on our DSO development. DSO increased from 51 days in Q1 '23 to 55 days this quarter. In general, we do not see any underlying negative changes in the DSO across our regions. Focus on working capital and collection is clearly yielding positive results.

The change from Q1 last year to Q1 this year is in addition to a very strong quarter last year, mainly due to the fact that Easter last year was in April compared to the entire last week of March this year. This created some slippage into Q2. All in all, I'm very happy with the development in our net working capital situation and our collection processes.

Average LTM net working capital as a share of gross profit ended at minus 6%, an increase from minus 2.6% last quarter. As a reminder, our full year outlook for this KPI is minus 2.5% to minus 10%. We will continue to give net working capital the highest attention also going forward.

We have already covered many of the items in the P&L, but I would like to highlight a few additional points. As a reminder, our gross sales is NOK 14 billion for this quarter. This is the number of our AR should be measured against and with this volume. And this volume naturally leads to significant swings in our net working capital.

Operating expenses include NOK 21 million, a provision of NOK 21 million relating to the time value of the outstanding receivable in the Philippines as regulated under IFRS 9. To be clear, this is not a reflection of any increased risk for nonpayment, and this provision will be reversed when we collect the receivable. The amount is still undisputed and we expect to receive the full amount.

EBITDA adjustments include restructuring costs of around NOK 11 million relating to capacity adjustments in the consulting business as well as share-based compensation of NOK 8 million. Interest expense increased compared to Q1 prior year due to increased market rates. Compared to interest expense in Q4 of '23, it was reduced with NOK 8 million as we had a lower utilization on the debt facilities throughout the quarter.

I would also like to remind that we recently refinanced our bond with a lower amount and at 1% lower margin. We closed the refinancing of our new bond in April. Our new loan amounted to NOK 1.2 billion, and this is a reduction of NOK 600 million compared to the existing loan. That's a 4-year tenure and an interest of 3-month LIBOR plus 2.75%. And we are also currently in the process of refinancing the bank facilities.

As well as improving working capital, we have a high focus on improving and optimizing available liquidity in the group to ensure we minimize utilization on our debt facilities and thereby reduce our interest costs. And I would also like to mention that net income for the quarter ended at a positive NOK 10 million, an increase of NOK 101 million from last year.

In the balance sheet, I would like to highlight the following items: other current receivables include unbilled gross sales of NOK 1.4 billion, mainly related to 1 month accrual of consumption-based sales. Also as a reminder, this is sales for a period where we have a claim but not yet invoiced to client.

The invoice is based on actual consumption. We will verify consumption then produce invoice. And to be clear again, this is a gross number and is to be compared with gross sales of NOK 14 billion in Q1.

Factoring amounted to NOK 247 million in Q1, down from NOK 460 million in Q4. As I said last quarter, we do not aim to increase the use of factoring beyond what we have done historically. However, we will utilize it more in local markets such as India rather than in the Nordics as we see increased operational benefits from doing so.

Supplier financing was NOK 146 million, increase of NOK 19 million compared to Q4. And I would like to repeat that this does not impact our working capital. This is a local financing solution for Crayon Middle East and is used solely towards Microsoft invoices. And lastly, both RCF and overdraft were undrawn at year-end.

As already mentioned, we delivered a cash flow from operations of NOK 97 million, an improvement from NOK 69 million in 2023. This is driven by the changes in net working capital.

At quarter end, we have a strong cash position and have a liquidity reserve of NOK 2.7 billion included undrawn credit facilities. Net debt-to-EBITDA ratio ended at 1.2x, significant reduction from Q1 last year of 2.2x. And this leverage ratio of 1.2x is based on the old bond loan of NOK 1.8 billion.

We are keeping our outlook for 2024 unchanged. LTM gross profit growth was 18%. And on an LTM basis, adjusted EBITDA margin ended at 16%. To reach a goal of 18% to 20% margin for the year as a whole, we assume a profitability improvement in consulting reaching a normalized margin towards the end of the year. This is in part driven by the measures we have implemented in Q1. And finally, average net working capital last quarter as a share of gross profit ended at minus 6%.

I will now hand it back to Melissa for her closing statements.

[Melissa Mulholland, executive]

Thanks, Brede. To conclude, Crayon has a growth-centric business model that delivers software and cloud licensing, ROI on cloud spend and consultancy expertise.

We have been on an international growth journey and continue to see opportunities to increase market share while improving profitability. We are well positioned to support our customers with long-term market opportunities such as generative AI given our scale and global strength. We have a strong balance sheet with a continued focus on cost management and working capital efficiency as part of our ongoing commitment to maximize shareholder value.

We will now transition to Q&A.

[Kjell Hansen, executive]

Thank you, Melissa. There's only a few questions in the chat so far. The first one comes from Martin Jungfleisch at BNP and goes to you Brede. Where was that NOK 25 million bad debt expense recognized and in what segment and geography?

[Brede Huser, executive]

The majority of the debt -- bad debt is recognized in the direct business in APAC.

[Kjell Hansen, executive]

Thank you. Second question also from Martin in BNP for you, Melissa. The strong HQ performance, most likely driven by publisher incentives. Were those recorded in the channel business? And is this a one-off or recurring income also for Q2 and future quarters?

[Melissa Mulholland, executive]

Thanks for asking. Just to remind everyone, group incentives as of Q4 2022 are now booked as gross profit in the HQ line. Q1 was an exceptionally strong performance. For the rest of the year, we will have -- we expect normal seasonality. With a peak in Q2 of 2023, we have now seen this in Q1. And this is also achieved by the successful development in the products that we're delivering for our strategic vendors.

[Kjell Hansen, executive]

Thank you. Next question will be from Øystein Lodgaard in ABG. Do you see further room for cost optimization in the software and cloud business? Any specific region?

[Melissa Mulholland, executive]

Crayon's business model has been and will continue to be very growth-centric, especially as we expand beyond the Nordics and international markets. So yes, we continue to see improvement there as well as profitability margin improvement, which is a focus across software and cloud. It's all about the scalability of the business model.

[Kjell Hansen, executive]

Thank you, Melissa. Next question from Oliver Pisani at Carnegie. The HQ line is very strong compared to our expectations with the Nordics and Europe on the soft side. Could you elaborate on the reasons for this mix and provide some color on how we should think about this going forward.

[Melissa Mulholland, executive]

So I think that the -- a couple of things. So Europe and Nordics had good growth. Nordics, as we stated earlier, from the consulting side, brought down the performance, but software and cloud as a whole retains that growth. Europe had very strong GP performance with, I'd say, an investment focus, specifically around consulting and services. And this was backed on the fact that we're scaling out data and AI, and we have a center of excellence based in Europe.

So as we see more demand coming through with CoPilot transitioning into data and AI projects, we will need resourcing to deliver upon that. So look at that EBITDA development as really an investment, which will continue to translate into profitability improvements for the back half of the year.

[Kjell Hansen, executive]

Thank you, Melissa. Next question is on [ Avensars ] at DNB Asset Management. Can you elaborate on the segmental EBITDA development? Has Q1 '23 been restated so the year-on-year is relevant? Looks like Europe and Nordic is slowing with lower margins down offset by HQ. I think the last part of that question was basically covered now with Melissa's comment.

[Brede Huser, executive]

And the first part of the question, yes, Q1 '23 is a relevant comparison with Q1 '24.

[Kjell Hansen, executive]

Thank you. Next question, Oliver Pisani. To reach the guidance for organic growth, you need to see accelerating growth over the rest of the year. How do you see the phasing of that journey over the quarters?

[Brede Huser, executive]

I think going forward, especially within consulting, we are seeing a turnaround in Q2, and we expect a more normalized market towards the second half of the year.

[Kjell Hansen, executive]

Next question is from Beltran Palazuelo. Any news on possible M&A and capital allocation?

[Melissa Mulholland, executive]

No news at this time. Our focus, of course, has been to deliver on the cash generation performance as we have demonstrated for the last 2 quarters as well as continue to improve on the consulting business. So at this time, no further updates in terms of capital allocation.

[Kjell Hansen, executive]

Thank you, Melissa. Next question, maybe also a bit to you both from [ Simons Floten ] . Can you comment a bit on progress for the cost reduction in the Nordic consulting and how you see that impacting margin in the second half of the year?

[Brede Huser, executive]

We have implemented in Q1, call it, cost-saving initiatives where we have adjusted the supply here in the Nordics. So there are about 50 fewer consultants now in end of Q1. And as I said, we see a stronger start of Q2 than we saw in Q1, and are seeing a slight turnaround now in Q2, and are expecting a more normalized market towards the end of the second half of the year.

[Kjell Hansen, executive]

Thank you, Brede. And as there are no further questions in the chat, that concludes the Q&A session.

[Melissa Mulholland, executive]

Thank you all for joining our presentation today. Have a wonderful day.