Pexip Holding ASA

OSE:PEXIP

Earnings Call Transcript 2022-Q1

[Trond Johannessen, executive]

Hello, everyone. Welcome to Pexip's first quarter presentation. My name is Trond Johannessen, and I am the CEO. It's great to be here and host my first quarterly presentation after joining Pexip in the middle of April. I've gotten off to a good start, and I'll share some of my observations a bit later today. I'm here with our CFO, Oystein Hem, our Chief Revenue Officer; Asmund Fodstad is joining from a remote location and Mirza Koristovic from Investor Relations is here as well. Together, we will take you through the quarterly presentation.

Before diving into the Q1 highlights and the presentation, I would like to do a quick recap on what Pexip is about, what makes us unique and what our strategy is. Pexip is a global technology company with more than 500 employees spread out across the world. Our R&D and software development teams are located in Europe across 3 main hubs, while our sales and marketing team is global as the rest of our businesses. We are proud to serve more than 4,000 large organizations across enterprise and public sector in all our key markets. We have a clear focus on large organizations and solving the most complex needs in our industry.

We serve our customers together with our partners, and they enable us to scale better than we could do on our own and ensures that our product integrates well with the rest of the customers' IT systems. Since 2011, we have built a subscription base of USD 106 million in annual recurring revenues. And we have established Pexip as a leading player within attractive parts of the video communication market.

Our competitive edge comes from unique patented technology. Pexip has the best transcoding architecture in the world. And it is from this technology that we get our unique interoperability capabilities. This is why Microsoft and Google and others have partnered with Pexip to deliver interoperability to their customers. Also, since most of the computing happens centrally in the network, Pexip's technology is perfect for use with devices that run on batteries or have limited processing capabilities, so-called thin clients.

Tests indicate that Pexip's technology gives almost 10x more battery life to such a remote device than traditional video systems. We also have the ability to run on any computing platform. We can deliver an easy and scalable cloud service, and we also have the ability to deliver completely on-premise airgap data centers. This is why our capabilities in data privacy, control and security are truly unique.

The technology is built as a platform. This means that it's ideal for embedded video solutions in customized systems. We have many examples of working with specialized solutions within judicial, health care, finance and retail to build bespoke systems that integrate with the clients' other systems.

Pexip has taken a very focused and differentiated approach to the video communications market. We are not competing with the major video conferencing players. -- for generic meeting solutions. We are rather cooperating with them to enable customized solutions that they are otherwise not able or not willing to deliver. As an example, we often work closely with Microsoft to deliver tailored solutions. We are approaching a part of the total $20 billion market where our technology can really make a difference and where we have a unique and differentiated position. In most cases, we do things that the big players don't do. The market niches we are operating in make up an annual revenue pool of around $5 billion, and we target to take #1 positions in several areas of this market.

I will explain a bit more about the strategy and focus we have on the next page. Pexip's focused strategy centers around 3 main solution areas. Within Secure spaces, we provide solutions for organizations concerned with complete privacy and control over data. Here, we are proud to be working with government entities, defense organizations, public sector players and large enterprises across the globe that trust us to handle their most critical communication needs.

Within Video Innovation, it's for those that require an embedded or highly customizable video solution. We are working closely with actors within the judicial health care, finance and retail sectors to provide custom-made solutions to cater for their exact needs. For judicial specifically, we have recently launched a dedicated product that can be utilized to take courts through the digitalization process with huge resulting savings for them.

In Connected Spaces, we sold the needs of organizations that operate with several video communication systems within the same organization. And they want them to work seamlessly together. Pexip's unique technology makes it possible to build these bridges between the different protocols of the various video systems and enable a smooth user experience. As mentioned earlier, we work in close partnership with Microsoft and others in this area.

Now with that as a background, let us move over to the quarter 1 highlights. Year-over-year, we delivered 21% growth in annual recurring revenues in the first quarter with a resulting USD 106 million annual recurring revenues out of Q1. Total revenues were NOK 223 million in the quarter, which was 24% up from the first quarter last year. In Q1, we experienced a $0.8 million reduction in annual recurring revenues compared to the end of Q4. But this is including a onetime negative effect of NOK 2 million. Adjusted for this, we had an underlying annual recurring revenue increase of $1.2 million. The EBITDA ended at minus NOK 52 million, a negative 23% margin, and we had an extraordinary high cash outflow due to share buyback and portfolio purchases. Even so, we are comfortable with the current cash position on our path back to profitability.

On the sales side, we experienced strong momentum within Secure Spaces, and we continue to win projects globally in the public sector. Working closely with Microsoft. We also closed our first sales through the Azure marketplace during Q1. As we stated in April, we are aiming for a relatively quick return to profitability, and we target a positive EBITDA in Q4 and for the full year 2023. As a part of executing on the focused strategy launched late last year and to ensure profitability, we have started the process of adjusting and rightsizing the organization to reduce the overall cost level.

Now let me hand it over to Asmund for an update from sales.

[Åsmund Fodstad, executive]

Thank you, Trond. It's a pleasure to actually be here at ISC in Barcelona. It's the biggest event in Europe for our industry and Pexip is here to meet the new customer opportunities as well as existing customers and partners. We have had over the last 3 days in enormous interest at our booth. So I'm happy to share that and especially around the judicial product that we launched this week. My apologies if there are some noise behind me because I'm here in the middle of the trade show.

While okay, Q1 Pexip delivers 21% year-over-year increase in annual recurring revenue. In terms of Q1 stand-alone, this is an overall last quarter with an underlying growth of $1.2 million and a record nice growth of a negative minus $0.8 million due to the change in pricing model with one of our major partners. -- leading to a $2 million off -- one-off, sorry, we are, of course, disappointed about the growth in Q1, which comes down to development in new sales and in particular, on upsell to existing customers.

This is due to mainly 3 core reasons. One is lack of hardware endpoints, deliveries to customers due to supply chain issues, reducing the therefore upsell to these existing customers. Remember, it's the infrastructure part, but Pexip is selling. The second is lower net upsell due to the strong growth in capacity over the last 2 years, which we see is making it difficult to continue to upsell to some of these customers. The third is related to our refocus on our new strategy, which we believe greatly in our 3 core business areas. We see strong customer interest in these areas, but our execution on our pipeline is still at the early stage for these 3 areas.

A positive development out of Q1 is certainly that we continue to see positive development onshore as we continue to grow in segments were structurally lower churn and the customers stay loyal to Pexip. New customers represent the main driver for the ARR group. This page shows the split of growth from new and existing customers. Overall, growth from new customers is at USD 23 million, which is in line with previous months. What is different is the decline in net upsell, which is driving, of course, a been reduction in net retention.

As I stated initially, this is driven by excess capacity from the last 2 years as well as a lower-than-planned use of [indiscernible] for many customers. As return office is not fully in place at different deals around the world. As an example, U.S. Federal just came back to office at the end of April. This is also hit by the $2 million mark. Again, on where our cost is churn continues to decline and is now at 9.2% per year, down 0.5% from Q4.

Let's share some of the customer wins that we had in Q1 2017 to explain better where and why Pexip went. Let me start with a new customer in one of Pexip's sweet spot segments, Secure Spaces. For this Ministry of Justice, security and privacy is of the highest importance. Pexip win this customer with our uniqueness of being able to install the solutions on premises in the Ministry of Justice own data centers. With the change of geopolitical climate these days, secure and private solutions are mandatory customers like Ministry of Justice. And again, Pexip offers a unique technology for these kind of customers. The customer will utilize our virtual meeting rooms, our One-Touch Join solution and the endpoint management solution to the fold. So they are utilizing most of the Pexip portfolio.

Going forward, we are already working with them for a tailored virtual court solution, which I just said that we released earlier this week, which again, is a unique add-on to the Pexip Infinity platform and, of course, represents a potential upsell for Pexip to this exact customer. We win this customer in fierce competition with Cisco. We basically, we outcompete with better on-premises solution, branding capabilities and management systems for their entire video content state. Pexip has the best technology available in the space, in fact, second to none.

Moving on to Video Innovation, on a market where Pexip have had success since the beginning. Some of you have heard about Department of Veterans Affair before. They are the largest health care provider in the world and have been a Pexip customer since 2016. I'd like to say that they made a world record in video conferencing market in 2021. They serve more than 2.3 million veterans, and they had more than 9.5 million video telehealth calls on the Pexip in 2021. They used to run it on premises in their own data center and have now transitioned into a self-solution with Amazon, which we have helped them do. But they do that because security and privacy is, of course, still of higher importance for Department of Veterans Affairs.

This customer is also utilizing our Virtual Meeting Room solution for all their meetings. The win for us or the upsell like we like old in Q1 is a substantial add-on because their usage just keeps on growing. The customer has, in fact, increased every year since they became a Pexip customer. And it's a good example when we hit the sweet spot in the market, we become sticky and the customer grows with us. For Department of Veterans Affairs is important that it integrates with their existing workflows, like medical files, banknote, that it works with any of their software, any kind of hardware platform out there as well as has some soulful aspects to it, like members getting access to doctors, psychiatrists and so forth immediately versus hours and hours of drive every time they have a need for a concern. In fact, the VA claims that they save lives with the Pexip involved. Again It's unique to Pexip for these kind of customer who wants integrations, branding and secure solutions.

Moving on. Connected Spaces keeps on being our large segments, and we win a major logo in this segment. Solving the need for high-quality interoperability between market teams and their video endpoints and a seamless joint experience like One-Touch Join, mobile bypassing and endpoint branding, DLA Piper wants their meetings to be of high quality and everything should just simply work and Pexip solved that issue. Again, we've been competing with Cisco too on this one, but we are keeping all the technology requirements from this demanding customer. Who have a variety of technical solutions and want integrations.

I want to point out that this was successfully sold both together with Microsoft and NTT, which is one of the largest system operators in the world. Of course, utilizing the long-term partnership, but also underlying that working through these kind of partnerships make success for Pexip. With Connected Spaces as an entry point, which is very often the case for Pexip, with DLA Piper, we are already looking at a Secure Spaces solution for them. We were looking to displace another competitor to enable DLA Piper to have privacy meetings around M&A, legal briefings and of course, high network clients. Security, privacy, where does my data go is in meetings like those, are on the highest importance for this customer.

And as we saw with DLA Piper Pexip does not necessarily just fit in one of these segments. With the win of this large region, which is very specific to the Nordics. Pexip now has [ line ] items in regions in Sweden. We win it from Cisco, and it's actually, in fact, known as a prestige customer for Sweden. So that makes the sales team in Pexip extra proud. But it also gives a lot of kudos to both the Pexip technology and the Pexip team that we have a good technology and a good approval from such a prestige customer. Again, the customer integrates with Sur, which is one of the biggest or the largest medical systems in the world for patient meetings at Video Innovation. In addition, it's a direct replacement of Skype for Business for secure meetings and thirdly, an interruptible solution for different technologies and large variety on video networks. We deliver on all 3 solution areas. Going forward, Vastra Gotaland are also looking to deploy infield, end-to-end solutions with wearables, again based on the same unique technology. And again, it will represent a potential upsell for us to this customer.

To finish it off, we just launched Pexip Engage, which you also have seen. It is a complete scheduling and business intelligence system for what happens before, under and after integrating video client, Pexip integrated with the largest CRM providers in the world like Microsoft Dynamics and Salesforce.com. We have already gained a good traction on this with our customers, and it also builds further on established Skedify customers, like Tryg and TUI. Pexip Engage will give us a broader and better solution in the Video Innovation area.

And with that, I think I'm going to hand it back to you, Oystein.

[Øystein Hem, executive]

Thank you so much, Osman, and good luck with the rest of the sales event in Barcelona. For the section on our financial results, let me start off by giving a quick summary of the P&L before we dive into the underlying drivers.

Starting with the top line, our revenue grew to NOK 222 million in Q1 of this year, up 24% year-on-year. Our cost of goods sold is at 12% of revenue, in line with Q2 and Q3 of last year and is increasing due to both a higher share of service revenues in addition to strengthening the robustness of our platform. Salary and personnel expenses and other operating expenses grew 7% and 42%, respectively, taking our EBITDA to minus NOK 52 million, in line with Q1 of last year and with a 7 percentage point increase in EBITDA margin. Still, there is a long way to go into black numbers, and we recognize that growth alone will not take us there. So addressing this is a key focus for us going forward.

In terms of recognized revenue. Our revenues grew to NOK 222 million and the growth of 24% is a result of a growth of 20% for self-hosted software and 29% for Pexip-as-a-Service. Both of these areas are growing in line with the underlying ARR development. In terms of operating expenses, the biggest cost item for Pexip is salary and personnel expenses. And if you look -- exclude share option-related costs, salary and personnel expenses grew 27% year-on-year. This is in line with the growth in head count of 32%, which is the main driver for the increase in salary and personal expenses. At the end of Q1, we have 551 employees, of which 310 in sales and marketing.

Looking at other operating expenses, that grew to NOK 60 million, a result of both a higher activity level overall as well as an increase in external services due to legal costs related to M&A, audit costs and R&D development. We also see that we have higher travel and event costs in Q1 of this year compared to Q1 of last year, as activity has started picking up, and we continue to have more customer meetings and more customer events. Then to the resulting EBITDA development. Our revenues grew NOK 43 million, and our gross margin grew to then an additional NOK 32 million in the quarter. However, this is balanced out by the growth in operating expenses so that we have an EBITDA in absolute kroner of roughly the same level as we had in Q1 of last year. Going forward, addressing this and taking us back to positive EBITDA in Q4 of this year and in 2023 full year is a key priority for us.

Looking at cash flow. Operational cash flow for this quarter was minus NOK 31 million. This is driven by a negative EBITDA and a positive impact from the development of net working capital. This is the expected seasonality as Pexip invoices a larger share of our customers in Q4, and hence, we collect that cash in Q1. In terms of cash flow, the key event this quarter was the extraordinary nonrecurring cash outflow, partly related to the share buyback of minus NOK 88 million in addition to higher CapEx due to portfolio repurchases. We announced that in Q4. And together with the settlement for the Videonor portfolio acquisition of 2020, the combined cash outflow for both of this was NOK 59 million.

With the share buyback that we did in March, we have covered our expected exposure for share-based incentives for the next 2 years, at least, without further dilution. And with the accelerated path back to profitability, we do consider that our current cash flow services are sufficient, both to drive continued growth and to take us back into profitability and a cash positive operation.

With that, I give the word back to you Trond.

[Trond Johannessen, executive]

Thank you, Oystein. Let me share some of my early observations as CEO and also talk a little bit about our targets and outlook. Pexip has grown steadily over the last 10 years, driven by unique video technology that solves the complex communication challenges for many of the world's largest companies. We are a trusted provider for the Fortune 500 large public sector organizations and other organizations that need customizable video solutions.

The video industry has changed dramatically through the pandemic. This has created opportunities and also certain challenges for Pexip. New and very attractive opportunities where Pexip's unique technology makes a real difference have emerged. Realizing these opportunities requires Pexip to innovate on technology and the go-to-market model. Therefore, we will, going forward, adapt the organization to be able to better execute on the defined strategy, capitalize on the identified growth opportunities and reduce the overall cost level.

Building on the unique talent, technology and customer base we have, we aim to return to growing profitably while maintaining the required speed of innovation. This is nothing new for Pexip. This is the formula that has been followed very successfully in the past. Over the next few months, we will execute on a new organizational design and go-to-market approach. The objective is to increase focus and efforts within the high-growth opportunities and at the same time, reduce costs in other areas. At the end of it, we seek to increase our growth as well as having secured our return to profitability. I will share more details with you when we present the second quarter in August.

So in summary, we believe that Pexip has a significant growth potential over the coming years through executing on its focused strategy to be a leader in core solution areas and market segments. All within the $5 billion revenue pool that we have identified as being our core markets. We have started the process to reduce the overall cost level and get back to profitable growth. In Q2, we expect to be back to ARR growth at a level in line with Q1 underlying growth. We target positive EBITDA in Q4 and for the full year 2023.

Last point before we go to Q&A, we will present our Q2 and first half results on August 11. Going forward, we will not publish a separate ARR notice at the beginning of the quarter as we shift our focus from mainly growth to a more balanced approach on growth and profitability. As such, we believe it is better to present our -- the full picture and the full results in a combined presentation than in 2 separate events.

That concludes the presentation for today, and I hand it over to Mirza to handle the Q&A.

[Mirza Koristovic, executive]

Thank you, Trond, Oystein and Asmund for your presentations. My name is Mirza Koristovic, and I'm the Director of Investor Relations at Pexip. We will now go into the Q&A session, and I will take you through it. We are pleased to welcome Oystein Lodgaard from ABG Sundal Collier, one of the analysts covering Pexip. We will have a Q&A session with Oystein before we take the questions from the audience received on [e-mail]. So Oystein, the floor or the screen is yours.

[Øystein Lodgaard, analyst]

Thank you very much, Mirza, and thank you for the presentation today. I'd like to start with one question on the product strategy. So with the launch of Pexip Engage and Pexip Virtual Courts, it seems that you're moving in a direction with more -- creating more tailor-made off-the-shelf products specific for different sectors. Is that more of a general trend and how you work with the products going forward?

[Øystein Hem, executive]

I think it's a -- it's -- both of them are good examples of us seeing a very concrete user need and then delivering a solution, which is quicker to adopt for those accounts. I think at the core of what we do is the Infinity platform. And we will continue to have a or platform play where we enable capabilities that will very often find its way into the hands of other solution providers to build the end-to-end solution. However, for Justice and for the meeting customers on video. That is very specific use cases where we see that we can accelerate that by providing a full end-to-end solution. So we will continue to be flexible in that approach.

So where we see solution areas that we can solve directly, we will do so. But the core of our strategy is built on our platform and making those capabilities available both to our own products and to the products of other technology and service providers.

[Øystein Lodgaard, analyst]

Interesting. And also we're right now in a more uncertain environment with more uncertainty, there's a war going on in Europe. Are you seeing that impacting the demand for your Secure Spaces products?

[Trond Johannessen, executive]

Asmund you like to...

[Åsmund Fodstad, executive]

Sorry I was mute -- was trying to answer -- it's both. So we have -- as an example, we were above the close of a couple on customers when that broke out. When then very typically onto critical infrastructure, everything freezes. You're not allowed to touch stuff -- so even though they want more capacity low better solutions. So we've seen both sides of it. We do see that with the goal and the institutions and so on, of course, Pexip need to make sure that we have secure privates and basically where they go. So it's both.

[Øystein Lodgaard, analyst]

And you also state here that ARR in Q2 will be in line with the underlying growth you had in Q1. Could you maybe specify them? Is the -- are you then referring to the Q1 ARR growth, the dot in Q1 or more the year-over-year growth in ARR that we saw in Q1.

[Øystein Hem, executive]

So when we put it like that, we mean the underlying ARR growth of Q1, which was just in excess of USD 1 million. And what we're seeing right now is an expected growth in Q2 in that sort of -- on the same line, although there continues to remain uncertainty in terms of how many deals we are able to close.

[Øystein Lodgaard, analyst]

Right. That's good. That's very specific. And moving over to the next subject. You talked about rightsizing your organization and adapting your organization. To me, that sounds like you will begin to reduce the number of employees. Is that how we should interpret it that you would like to exit the year with a lower number of employees than what you have now?

[Trond Johannessen, executive]

We are in the process of planning the exact execution of the details of the program. I think it's clear that we will, in some places, probably invest more and increase the number of people, in other areas reduce. The net of it is likely to be a reduced number of employees out of the year.

[Øystein Lodgaard, analyst]

Could you say something which areas you would like to invest more in a way you might want to reduce?

[Trond Johannessen, executive]

Particularly within the Secure Spaces, within the public sector markets where we have a real traction, certain parts of the Video Innovation market. We mentioned these 4 verticals within judicial health, finance and retail, where we see real traction today. We need to make sure that we have enough resources and the capacity to really capitalize because this is where our technology is unique, and we have a unique differentiated position and the timing is kind of now to take that market and take the #1 position there.

When it comes to Connected Spaces, in certain cases, the competitors' products have become good enough so that the number of use cases where Pexip finds really attractive opportunities. It has been reduced, particularly in the enterprise segment. So we are probably going to have a more efficient approach to that market going forward.

[Øystein Lodgaard, analyst]

Makes sense. That makes a lot of sense. And you've previously talked about that you will launch new product features, which will improve your competitive position within that segment. Can you -- have you got some initial feedback from these new features that you've launched? Or what is your thoughts on that now?

[Øystein Hem, executive]

Asmund, anything to share from IFC in some?

[Åsmund Fodstad, executive]

To also your previous question, Oystein, of course, number one, it's important to understand that the Pexip Infinity platform is the fundamental everything that we deliver. So that has always kind of open API SDK, which gives us flexibility when we do see that, as an example, the judicial side of it, where you can tailor-make different court flows, et cetera, et cetera, which again, is unique to us because we have the transcoding and so forth. And our competitors have a hard time actually doing that. That is easy for us to pick up and easy to address. It's not really tailor-making. It's kind of off the shelf. So that has a lot of traction. Of course, we're pushing that as well because we know we're unique there.

But that, combined with then also what we predict as new almost video economy, which is inserting video in any kind of workflow like we see in IKEA, which we have seen in the medical also and now on the judicial side. that's where we can play in less central, and that's also where we want to double down on the efforts and the investments that we asked against all odds. And yes, we see good traction.

[Øystein Lodgaard, analyst]

And lastly, you also mentioned a new go-to-market approach. Is that something you would like to give some more flavor on today? Or should we wait for more on that in Q2?

[Trond Johannessen, executive]

We will definitely give more flavor to that in Q2, but we are talking about being more focused and bringing together the best of our technical expertise, the best of our commercial expertise and going after certain of these opportunities in a very targeted way. And we -- our experience is that when we bring our best people together and we bring them out to the client and we sit down and we solve the clients, complex communication problems, we are very often successful. So that's a formula we're going to try to do more of.

[Mirza Koristovic, executive]

Thanks Oystein, for joining us today and for your good questions. We will now move on to the questions received at [e-mail]. First question. Do you have control over the development in the company in light of previously being stuck on your ARR target of $300 million in 2024, then suddenly downgrading this goal. And does the management feel humbled towards its shareholders seeing the consequences this entails for the company and its shareholders.

[Øystein Hem, executive]

Yes, I can take that, and that was before your time, Jon. I think we set out with an ambitious target of reaching $300 million that we had good confidence in reaching then I think both the market changed as also then changed our confidence in that. And then as your confidence in reaching a target changes, there is no other way than to take it up because to maintain a target over time, but not believing in your own execution of it is not a possible solution. And while I recognize that, that is abrupt, I think it's the only way to do it.

That's, of course, something that we are humble in that are recognizing that we did not reach that target. It's a -- retracting on a target is painful, although we still strongly believe in the capabilities of our technology, of our people and our future growth opportunity. So it's -- it's also something that we take with us now, and we plan making sure that we develop a plan that we will execute on and where we will find success.

[Mirza Koristovic, executive]

Thank you. The next question. Are you returning to profitability in an accelerated speed because you see that your cash position will not be sufficient if you don't.

[Øystein Hem, executive]

I'm happy to take it. I think we're accelerating our return to profitability because it's the right thing to do. So we've invested heavily for growth over close to 2 years. And while we found good growth and we've doubled the company in the same period, we have not been able to find the same growth as we expected. And then the only sensible thing to do is to scale those investments back and to accelerate the return to profitability and balance going forward, growth and positive cash flow.

[Trond Johannessen, executive]

Having said that, we also stated and we strongly believe that the cash reserves we have at the moment are sufficient to both secure the return to profitability and be able to invest in profitable growth.

[Mirza Koristovic, executive]

All right. And I'm pretty sure the last -- this last question that I see here is to the new CEO. Trond, what are your top 3 priorities in the next 6 months?

[Trond Johannessen, executive]

I think I can make it simpler. I can think I think I can make top 2 priorities. It's to be making sure we execute on this focused strategy where we double down, capitalize on the really unique opportunities we have ahead of us in certain other market segments and solution areas where we operate; and secondly, to ensure that we do deliver on the target of returning to profitability in Q4 and for the full year -- full year next year.

[Mirza Koristovic, executive]

Thank you. I see no more questions, so that concludes our Q&A session. Thank you very much for your attention, and have a nice day.