Pexip Holding ASA

OSE:PEXIP

Earnings Call Transcript 2023-Q2

[Trond Johannessen, executive]

Good morning, and welcome to this presentation of Pexip's second quarter results. My name is Trond Johannessen, and I am the CEO. Together with me today in this fantastic new studio here at our headquarter at Lysaker, I have Oystein Hem, our CFO; Åsmund Fodstad, our Chief Revenue Officer; and Christine Arnesen, our Head of IR. Together, we'll take you through the highlights of the second quarter and what we're focusing on.

Standard disclaimers apply as usual.

Now to the highlights of the quarter. Over the last quarters, Pexip has been through a major transformation. This has resulted in a focused strategy where we drive technology leadership in the markets where we can be really unique and differentiated. It has also resulted in a more efficient organization and a significantly reduced cost base. Going forward, we will continue to optimize and improve our operations to ensure solid profitability, while maintaining growth capacity.

As for the first quarter, the results of this transformation are clearly visible in our Q2 performance. Q2 revenues came in at NOK 233 million for the quarter, which is 19% up from the second quarter last year. Our total annual recurring revenue base grew USD 0.4 million during the quarter and is now at USD 98.7 million. EBITDA for the second quarter came in at NOK 8 million, which is NOK 105 million improvement since the second quarter last year.

Cash flow. Positive cash flow. We added NOK 42 million to our bank account during the quarter, and our cash balance now is at NOK 508 million. We had a good start on the relationship and cooperation with Poly. This means we have high joint sales activities and marketing activities across all regions. The pipeline is developing positively and we have also closed the first sales.

On the technology side, we have launched direct calling from an MTR to another video endpoint during the quarter. We also launched SIP Guest Join officially, and we're in the process of piloting AI-powered translation functionality and other functionalities in cooperation with NVIDIA and some large customers as we speak.

We maintain our target of 20% growth in Secure and Custom spaces and an overall flat to positive development in ARR for the whole company in 2023. EBITDA target also remains unchanged at NOK 100 million to NOK 150 million for the year. On the cash flow side, as we have already reached our cash flow target for the whole year during the first half, we are increasing our annual target NOK 85 million to NOK 100 million for the year. This means we target positive cash flow also in the second half, but at a lower level than in the first half.

Let me take this opportunity also to quickly recap what Pexip is all about. Pexip is a technology company built on unique technology, technology that is increasingly relevant in today's world. We do transcoding or centralized data processing, and that means that we can install a full-fledged video collaboration solution on the server in the basement in any data center or sovereign cloud. No other provider in the market can do that today. We enable everything from business communication to ultra-secure government meetings, doctors' appointments and court proceedings.

Our proven and unique technology is also what attracts partnerships with some of the largest technology companies in the world. And as you know, we work closely with companies like Microsoft, Google, now NVIDIA, and others. This is also what has triggered the partnership with Poly, which I will say a few more words about. The partnership with Poly means that Pexip is Poly's provider of 3 new video infrastructure solutions that will replace their current RealConnect and Clariti solutions that they sell today.

The 3 products, Poly PrivateConnect, CloudConnect, and FedConnect will all be powered by Pexip and branded as powered by Pexip. For us, this means that our market share in Connected Spaces is likely to increase. Together, Poly and Pexip can now offer a competitive bundle as an alternative to Cisco. And in practice, it's only now Pexip, Poly and Cisco that offer interoperability solutions for Microsoft teams in the market today.

Within the Secure Meetings segment, we will significantly broaden our reach with this partnership with Poly. The market for self-hosted solutions is developing positively, and Poly is working with many very security-conscious organizations out there. So they will now be offered a Pexip powered self-hosted video solution instead of the Clariti solutions they have been offered previously.

In the government space in the U.S., we also see potential for growth together with Poly. And the recent FedRAMP and StateRAMP certifications underpin that to a large extent, and I'll get back to that in a second. All in all, there's a lot of opportunities coming out of this cooperation with Poly.

Also in the second quarter, we have been busy on the technology side. Our engineering team has been working long hours to keep our pace of innovation at a high level. And we have introduced new features into the market as we also did in the first quarter. I can't go through everything here, but let me give you a couple of Q2 highlights. SIP Guest Join, we introduced that to you already in the first quarter presentation. Now it is launched. It's a great new feature. It means that any Pexip Connected Spaces customer can now join any Microsoft Teams meeting regardless of whether the person that invites to the meeting is a Pexip customer or not. It broadens the usage area for Pexip substantially.

Direct calling for Microsoft Teams rooms. This is the first Pexip-powered solution that increases the usage area for a Microsoft product. It adds new functionality to a Microsoft Teams room. AI is a big thing. AI-enabled features are improving the user experience and enable new functionalities such as live translation, gaze correction and noise cancellation. And we are working closely with NVIDIA to further take advantage of these technologies in Pexip's products today. And let me give you some more details on how we are doing this.

NVIDIA and some of our largest customers have seen a need to take advantage of AI technologies that they have otherwise been prevented from using since many of them are prevented from using public cloud services. So what we can now do is that we can pilot, we can do live translation based on AI technology without connecting to a public cloud service. And this is because Pexip's server side processing technology enables these AI features in private or sovereign clouds and even self-hosted environments. This is something that some of our large public sector customers really have been looking for as data privacy and control are their top priorities.

And the savings some of these organizations can get from reducing the use of human translators are enormous. The more common features such as noise reduction, gaze correction, screen composition optimization and so on are also on the road map. Recently, we launched a short video that gives some more details on what we are doing together with NVIDIA. And recently, we launched a short video and a blog post that gives more details on what we're doing together with NVIDIA on the AI side. The video is available on YouTube and through our website and on various social media channels. So take a look at that if you want to get some more insight into what we do here.

A few words about our business and our business areas. Our focus is really on 2 attractive markets where we see that we can take leadership positions based on the unique and differentiated technology that we have. We take a very collaborative approach to the ecosystem, and we aim to be partnering with leading technology players to complement their solutions and broaden the reach for Pexip's technology. I strongly believe that Pexip's market and technology positions have been strengthened during the second quarter within both Connected Spaces and Secure and Custom solutions.

Within Connected Spaces, the new features launched recently, together with our FedRAMP approval and Poly partnership, have solidified our position as a leader. We also understood this week that BlueJeans has communicated their withdrawal from this market, which can open up an opportunity to further increase market share.

Within Secure and Custom, the uniqueness of our flexible hosting functionality, the increased focus on data security, privacy and control, and of course, the new relationship to Poly give us a leadership position in the market that is developing very favorably. Let me illustrate the relevance of the secure and private solutions with an example from Norway.

In May, the Norwegian National Security Agency, NSM, published their updated security recommendations for Norway. This covered a lot of areas including cybersecurity and digital infrastructure. The recommendation with respect to avoiding public cloud services and instead establish national and regional data centers for data worth protecting is crystal clear. Norway is not unique in this respect. And there is an increasing awareness across countries on establishing secure and sovereign data services for public services. Several countries are issuing specific recommendations and regulations in this area.

Pexip has a unique capability to serve this market due to our self-hosted offering, allowing customers or Pexip to easily host multiple private and sovereign solutions.

In the U.S., our Government Cloud solution that was FedRAMP and StateRAMP authorized in Q2 is developing well. This solution allows U.S. government customers to use a Pexip provided cloud service called Pexip Government Cloud as a supplement to our self-hosted offering. The initial offering is focused on Microsoft's CVI interoperability within Connected Spaces, but we're working on adding more features and products to this cloud based on customer feedback that we have received.

The results so far are solid. We have already booked around USD 700,000 in new ARR under the FedRAMP, StateRAMP authorized products. And there is a pipeline of another couple of million dollars that we're working to convert going forward.

Since the second quarter last year, we have been through a major transformation. As a result, we now have a focused strategy and the cost base that is adapted to our revenues with the resulting positive EBITDA and positive cash flow. Q1 was strong in profitability and cash flow, and the same goes for Q2. Year-to-date EBITDA is up NOK 187 million to NOK 43 million this year, and we are on track to meeting our 2023 EBITDA target of NOK 100 million to NOK 150 million.

We are really proud of the turnaround we have done. The resulting focused strategy and profitable operation, together with an extremely competent organization, constitute a very solid platform to build profitable growth on. And building profitable growth is exactly what we plan to do.

Now I leave it to Åsmund to give you an overview of our revenues and sales achievements during the quarter.

[Åsmund Fodstad, executive]

Thank you, Trond. Let's move into sales, and good morning to us out there live. Let's look at the sales figures and some updates on the different segments.

It's, number one, great to be back to growth as we increased the total ARR base to USD 99 million in Q2. That is actually up from a negative minus USD 1.3 million in Q1 to a positive USD 0.4 million in Q2 '23. We also have a very good geographical mix, which continues with a strong development in the Americas. It's also noticeable that the first sizable order from the HP/Poly partnership also came from North America.

Let's look a little bit more in detail on the different segments that Pexip work and sell-in. So for Connected Spaces, number one, Pexip keep on winning major Fortune 500 logos. In Q2, we signed up the third largest telecom provider and the biggest gold mining company in the world. They basically choose Pexip for 3 major reasons. Number one, these large corporations have multiple technologies, complex environments and have the need to have the same user experience, no matter these different technologies. The Pexip solution resolves exactly that.

Secondly, we win with the best-in-class technology and the right feature sets to make multiple technologies and meetings simply work. We also see that through user adoption from some of these Fortune 500 customers, where they go from 0 to more than 30,000 meetings per month on the Pexip multi-platform solution.

And thirdly, our unique operation with Microsoft, we basically team up with them to win these large accounts to outcompete both Cisco, Zoom, and others. Our cooperation and unique certified solutions by Microsoft is essential when these corporations make their decision on which technology to standardize on.

Further on, like Trond also explained, we continue key innovation for Connected Spaces. So we stay ahead of competition, again, certified and in close cooperation with Microsoft.

Looking at Secure and Custom. These segments continue to be growth segments for Pexip with a 5% and 7% growth in Q2 and a 14% growth year-over-year. As in Connected Spaces, we keep on winning major logos with our Secure and Custom solutions. And very often, these 2 go very much hand-in-hand. And again, that's unique for Pexip. In Q2, we won significant logos and had large upsell both within healthcare and with different government agencies. These markets are growing markets and represent a solid future potential for Pexip.

It also confirms that Pexip has an established technology leadership position in the market. And as Trond mentioned, that lets us know also with the StateRAMP authorization. We keep on getting certified and get authorized by government body in these segments.

Deep diving a bit more on the breakdown of ARR and the different dynamics in these 2 spaces. So for Secure and Custom, strong upsell to existing customers for both Secure and Custom, that in a combination with very low churn results in a strong net retention rate of 104% for the quarter. Pexip are delivering as guided in this area, and we do see further growth in this space. For Connected Spaces, it is somewhat of a different dynamic. We have a strong new sale of USD 1.9 million to new customers, which also underlines that we have a unique solution for a multiplatform environment.

In Connected Spaces, we see that churn is somewhat higher, resulting in Q2 with a near 96% net retention rate, excluding the legacy areas. HP/Poly is starting to give results with a strong pipeline in this segment, and we have also seen the first PO just after 60 days after launch for Connected Spaces.

And with that, I plan to give it over to Oystein for more financial details.

[Øystein Hem, executive]

Thank you, Åsmund. Let me start off with the headline numbers.

As Trond outlined in his introduction, we're continuing to show a clear improvement in profitability with a substantially better EBITDA than the same quarter of last year. In Q2, revenues grew 19% to NOK 233 million. Around 14 percentage points of this growth is driven by a beneficial currency exchange rate, meaning that the underlying growth is around 5%. Quarter-on-quarter revenue is slightly down from Q1 due to lower software revenues, which is the same seasonality that we saw in 2022.

On EBITDA, the majority of our costs are also in foreign currency. So part of the positive currency impact on revenues is balanced out by the negative impact on costs. The improvement in EBITDA is therefore mostly a result of the underlying cost reductions over the last 12 months, although the underlying revenue increase is also contributing positively. The EBITDA improvement is stronger than in Q1, although EBITDA is down from NOK 35 million in Q1 to NOK 8 million now in Q2. This is due to the expected revenue seasonality where typically Q1 and especially Q4 are the strongest quarters for Pexip.

In terms of operating expenses, we continue to realize cost reductions. And we have a reduction in both salary and personnel expenses as well as in other OpEx. The main driver behind this is the reduction that we did on cost in Q4 of last year. And we see now the impact of that having come through more or less in entirety. This reduction is partly offset by the impact of currency fluctuations.

On other OpEx, we continue to have a noticeable quarter-over-quarter reduction and a material reduction compared to Q2 of last year. This is mainly a result of lower sales and marketing costs as well as lower costs to consultants.

Looking at cash flow. The resulting cash flow is a net positive of NOK 42 million for the quarter, taking us to NOK 88 million so far this year. EBITDA, excluding noncash cost, is a key contributor to this. We also had an improvement in our net working capital, and we have reduced the level of overdue receivables so far in 2023. Our investment costs at NOK 9 million were also lower in Q2, mainly as a result of lower consulting costs in development.

All in all, we have overachieved our cash flow target so far in 2023, which is why we are increasing our free cash flow target from NOK 40 million to NOK 60 million to NOK 85 million to NOK 100 million. So far into the year, we are at NOK 82 million after the first half using our definition of free cash flow, implying that we do expect a neutral to positive cash flow for the second half. The seasonally lower cash flow in the second half is mostly due to revenue seasonality as we invoice more in Q4 and Q1, which we then collect in Q1 and Q2.

On cash outflow, we expect that to be at a lower level than it was in the first half due to our lower cost base.

Looking at the P&L in its totality, we have positive development on revenue, a positive development on cost of goods sold, salary cost and OpEx. On cost of goods sold, that positive development is despite of a significant increase in traffic on our cloud services. In total, these results give us a solid lift in EBITDA, also since we have lower restructuring costs now than we did in 2022. On reported EBITDA, the net improvement is NOK 132 million compared to Q2 of last year. This quarter, we also had a negative NOK 1 million in other gains and losses related to the termination of a contract, which will give us lower costs going forward. We continuously seek to optimize our operation, and I do expect some other losses related to this also for Q3.

This quarter, we also had higher depreciation due to one-off write-off of capitalized R&D tied to a discontinued product as we continuously focus our strategy and operation. Lastly, we continue to benefit on the financial income from the currency exchange fluctuations, as we collect cash at a higher exchange rate than what it was originally booked against. All in all, this gives us a net loss before tax of NOK 25 million.

And with that, I give the word to Trond.

[Trond Johannessen, executive]

Thank you, Oystein. Looking at our business overall, we are generally optimistic with a positive market outlook across the business areas. Market trends, particularly in the Secure and Custom area are positive and present opportunities for Pexip. The Poly partnership and FedRAMP, StateRAMP authorizations are expected to give additional positive momentum in the second half of the year.

For cash flow, we exceeded the annual target, as Oystein said, during the first half, and we have revised our annual target to NOK 85 million to NOK 100 million for the year. The other financial targets remain unchanged, and as explained in the presentation, we are on track to meeting them.

Finally, and as usual, we will shed some light on how we think about our ARR development in the quarter we're currently in, the third quarter, and our best estimate here is that we will end the third quarter in the range of USD 98 million to USD 101 million in ARR.

With that, the last point before we go to Q&A. On November 2, we will be back presenting our third quarter results. And now, Christine, I guess we have some questions. Hope we have some questions.

[Christine Arnesen, executive]

Thank you, Trond. Yes, we'll start with the questions from the analysts that are with us live. So we have with us Oystein Lodgaard from ABG. Any questions from you, Oystein?

[Øystein Lodgaard, analyst]

Congratulations on a solid report today. So I wanted to start with a couple of questions on the Connected Spaces segment. A couple of days ago, news broke that BlueJeans is likely be shut down. They, of course, have been a smaller competitor in the CVI space, but there has been a pretty a big shift in the cloud video interop market now with going from 4 to 2 players in a relatively short while. Can you say something about how you expect that to change things for you?

[Øystein Hem, executive]

I'm happy to take a stab at that. I think short term, this means that there are quite a few customers out there that now have a provider that has notified them that their product is going end of service in a reasonably short time. And so for us, this is an opportunity to be out there and help those customers and help our partners in transitioning over to a solid long-term product, which we can provide. So I think short-term, this is an opportunity for us in terms of grabbing some of that market share over the coming few quarters.

Then in the long term, I think with Pexip and Cisco being long-term specialists in this field with, to be fair, Pexip having this as our core focus, which is somewhat different, gives us a good position to continue to sort of be that technology leader and stay ahead of competition now that it's basically a 2-horse race.

[Trond Johannessen, executive]

And I think also it underlines the importance of the partnerships that we have been working hard to establish. The way we work with Microsoft, the way we work with Poly, it's giving a strength to our solution and our market approach that is different from what you will achieve stand-alone.

[Øystein Lodgaard, analyst]

Okay. And maybe you could give some update on the progress with Poly. You've now been working with them for a few months. When do you expect to start to see revenues come in? How do you see the potential there? Is it, let's say, bigger or smaller than you originally thought?

[Trond Johannessen, executive]

I can start. You can fill in. I think from a pipeline point of view, as we mentioned during the presentation, I think we are seeing a stronger pipeline development than we had -- and a faster buildup of pipeline than we originally expected. We have already closed the first 3, 4 deals that we have in our books, but the conversion of the rest of the pipeline is naturally going to take some time. This has to do with the end of sale of the current Poly solution wasn't until the end of last month. So it's only been now a week plus where actually the Poly sales force has had only the Pexip Poly solution out there to provide to the market.

So we do expect it will take some time to convert this pipeline into real orders. We're working -- particularly in the public sector, as you know, the sales cycles are longer than in the private sector. But the solidity and the quality of the pipeline that we have, I think, is stronger than what I expected.

[Åsmund Fodstad, executive]

And if I can add, I think you're answering it in a good way. We have never seen such a pipeline in such short period of time, and it's all tangible, it's existing customers, right? So we don't necessarily build them up. But again, to your point, we have long sales cycles. We've never seen a PO after the 60 days with the corporation. So it's easy to get excited, which we are, but we need somewhat more time to see how much are we able to kind of close before being able to kind of be even more optimistic about the partnership that is developing really, really well.

[Øystein Lodgaard, analyst]

Very interesting to hear that the pipeline is building faster than you originally thought. And lastly, on the Connected Space segment, there was, if we go a bit back, Cisco and Teams and Microsoft, they launched the opportunity to run Microsoft Teams natively on new Cisco hardware. Have you seen that impacting your business to any degree yet? Or do you have any comments on that?

[Øystein Hem, executive]

I think if I was to add a comment on that, I would say that we definitely see a fair number of customers opting for Microsoft Teams Rooms, but that's not -- I wouldn't say that's accelerated now after the Cisco Microsoft Teams announcement. And on the existing base, the impact so far hasn't been noticeable. So, so far, we don't really see a big impact of it. But we continue to see a fair number of customers that opt from Microsoft Teams Room as well as a fair number of customers opting for SIP endpoints.

[Åsmund Fodstad, executive]

And we see that also versus maybe the last 2 years where it's been a massive Microsoft wave, if I can put it that way, but also in the meeting room space is that also the multiplatform, which basically means keep your already investment, make sure that the meetings rooms are the same, no matter if they are MTRs or SIP endpoints, resonates a lot with large government institutions and also the biggest enterprises. So it's a somewhat different picture on a positive note for Pexip.

[Øystein Lodgaard, analyst]

That's good to hear. And the last question from me is on the guidance for Q3, guide for rather limited ARR growth in Q3. Is that driven by some seasonality or any other factors impacting that?

[Trond Johannessen, executive]

I think the guiding range, we have been trying to give an as accurate picture as possible. But you know, we are working on some relatively large deals every quarter. And if they swing into the quarter or out of the quarter, it makes a big impact on this actual delivered number. That's why there is a range. The range now is higher than the one we presented for the quarter we're in. So we're kind of signaling a modestly positive outlook in that respect. But to be more accurate than we are now at this point is difficult.

[Christine Arnesen, executive]

We have also received a few questions via e-mail. So first question. What is your perspective on artificial intelligence, AI. Do you believe it could potentially impact subscription growth negatively? Or do you see it as having a positive influence on the videoconferencing industry?

[Trond Johannessen, executive]

I will start and you will help me. AI is impacting every industry and every technology company out there. Video is, of course, well catered to take advantage of many of these AI features, but in some cases, it comes at a cost, right? Just having AI functionality available, having this learning AI and engines running requires a lot of data. Many organizations are very concerned about how their data is being used to train AI engines. And even if it gives better functionality, what is actually happening to the data. And the awareness around this is increasing every day.

And that's why, at Pexip, we try to let organizations take advantage of AI technology and still maintain data privacy and control. And this is really, it's a balancing act. And that's why, we together with NVIDIA and together with some very large customers in the public sector, try to find ways to balance this and make solutions work to make AI technology available to these organizations. In general, AI has a lot to provide to video conferencing and collaboration, no doubt about it. But it's this balancing that's important.

[Åsmund Fodstad, executive]

And I think, again, it speaks to the Pexip's uniqueness, right? That also artificial intelligence really fits well into solutions that we already have, especially in Secure and Custom. We're also easy to get excited on, as an example, which we are demonstrating these days on translation services and so on, where you actually prefer to have a video meeting versus a physical meeting, not only because of the cost savings, but it's actually a better meeting. So it speaks well to the potential of video going forward.

[Christine Arnesen, executive]

Can you also comment on the criticism against Zoom and the challenges with AI on privacy?

[Åsmund Fodstad, executive]

I guess it's exactly that point, right? I mean, of course, Zoom is trying to make the best possible functionality for their users and customers. But to do that, they need a lot of data and some organizations are concerned about the way that data is being used. And this is a problem we're trying to solve with our more closed solutions.

[Christine Arnesen, executive]

Last question via e-mail is regarding the FedRAMP approval. So how does the company capitalize on this? We are the only approved video solution as of now. Does that mean that everyone with a certain level of security must switch to Pexip, or are the big players forced to bundle Pexip solutions into their system?

[Åsmund Fodstad, executive]

So the way that FedRAMP works today is, it's actually a sovereign cloud, number one, for North America currently, which means that any government agency within the U.S. can use the Pexip solution. Number one, we're the only one with that FedRAMP authorization with Microsoft CVI. They don't have to, but there are also quite some of the government institutions that have regulations, so it's actually forcing them to use these kind of communication solutions. So it's a mix, but more and more of them are going that way, again, because of sovereignty and because of privacy and security.

[Trond Johannessen, executive]

And of course, it's the whole -- the market is connecting to Teams meeting, basically, right? And all these -- in the government organizations in the U.S., they have all these video meeting rooms, all these SIP based endpoints that they want to connect to Microsoft Teams meetings with. And now the only secure way they can actually connect to Microsoft Teams meetings is by using Pexip interoperability functionality on those SIP endpoints. So we believe that, that market is there and it's going to be growing for us going forward.

[Christine Arnesen, executive]

Thank you. I think with that, we conclude the Q2 presentation. Thank you very much.