Q-Free ASA

OSE:QFR

Earnings Call Transcript 2022-Q2

[Trond Christensen, executive]

Good morning, everybody. Welcome to this second quarter presentation from Q-Free. My name is Trond Christensen, I'm the interim CEO of Q-Free. Joining me online from a separate location is also our Chairman, Mr. Trond Valvik, who will say a few words later.

I will start this presentation today by recapping very briefly a little bit about what Q-Free is all about before we take you through the highlights of the quarter. Then we will go through the financials before we round off with a set of Q&A.

Q-Free is a world-leading supplier of intelligent transportation systems. We divide our solutions into Q-Flow, Q-Safe and Q-Clean. Q-Flow because we help traffic flow in our cities and on our highways. We help people spend less time in congested queues, being able to spend more time on their work and with their families.

Q-Safe, because we make traffic safer, about 1.35 million lives are lost every year in accidents. We generally think that our solutions help to reduce these numbers. And we also have Q-Clean because we help reduce pollution partially through reduced congestions but also by providing authorities with an opportunity to create funds from traffic solutions to make better cities and also through our bicycle and pedestrian monitoring solutions, et cetera.

We split our business into 2 main business areas, tolling focus on partially hardware, onboard units, tags and transceivers that are sold into tolling systems, turnkey systems that help both highways and cities to collect toll and monitor congestion and those kinds of things. We provide back-office systems to monitor these things, and we are 1 of the world leading suppliers in ALPR technology to recognize and identify vehicles based on their license plates.

Our second main division, traffic management. They focus on traffic signal monitoring and freeway monitoring through both hardware and software systems. And we also provide weigh-in-motion systems, traffic counting and classification equipment for monitoring traffic.

Q-Free has over the years provided numerous world-leading projects within these segments. These are just a few examples. I will not go through them in detail, but you can find a lot more information about this on our website.

Then we'll dig straight into the highlights of the quarter. There's really 5 main points that we want you to take away from today's presentation. For those of you who follow us regularly, you would have seen over the quarters that we focus more and more on creating a business model with recurring revenue. This change is definitely bearing fruits now. We see in current quarter, we have increased our annual recurring revenue to almost NOK 300 million, which is a growth year-on-year of 31%, so this is really picking up.

The other thing you see is that we continue to increase our order backlog. We continue to have a book-to-bill in excess of 1, and we are currently at almost NOK 1.5 billion backlog, which is more than 1.5 year turnover in normal terms for Q-Free. So this is very solid figures.

Even if we are, of course, under pressure from both increased inflation and a very tough labor market. We still maintained very good control on our OpEx space. Our operating expenses is more or less flat. So we have this under very good control, which is also significant condition to be able to generate good profit in the future.

As we later will see, we do not have a very big organic growth to our turnover. We are not too worried about that. It's 2 main reasons for our growth not to be very high on the top line level. Number 1 is the conversion to a recurring revenue model. This will, of course, affect our top line and also our EBITDA in the short run because it takes a little bit of time before you build the revenue base. As we have shown under the first 2 points, this is definitely happening, but it does kind of dampen a little bit on the growth on the top line. So we are not worried about this.

The other key factor is obviously the situation in the component market. It is rough to have enough components available. This is definitely hitting us on the top line. It's a temporary effect. We are not losing orders. We are not subject to fines. Our backlog is there. Our pipeline is there, and we're not losing out on it. So it's a matter of when and where. And this is the same situation, which is also affecting all of our competitors. So this is nothing unique to Q-Free.

The last point we want to make is that, yes, our working capital and cash situation is a little bit negative on the quarter isolated speaking. This is, in our opinion, by no means, a red flag or a yellow flag. We are consciously unknowingly spending cash with our suppliers and building inventory and building some working capital to ensure that we have available components in the future and thereby reduce the risk of any further erosion of our top line.

We have a very solid financial situation. We have good financing. So this is not a problem for the business moving forward. These are the main financial figures for the quarter. We came in at NOK 214 million revenue for the quarter, NOK 430 million for the half year. It's somewhat down compared to last year.

But again, if it had not been for the component situation, this would have been significantly stronger, and we are not worried about it, and it's also affected slightly by the annual recurring revenue, the change in our business model, where we can see that this is really picking up speed. We are increasing our annual recurring revenue by 31% year-on-year, which is really strong.

Our EBITDA comes in at NOK 32 million for the quarter, NOK 42 million for the first half year, slightly down compared to last year, but affected by some write-downs in Ukraine and the other issues I've already mentioned, we are fairly pleased with these figures. And the cash flow, it's slightly negative. We have also already commented on that one. It's related to securing inventory, securing components for the future quarters and is under good control. Once again, our order intake is good. We have a book-to-bill in excess of 1. And our order backlog is now close to NOK 1.5 billion, which is record levels. Once again, we had a good quarter with some very important key contract wins.

In the United States, in traffic management segment, we had a very important first contract with a statewide ATMS customer, where we are now actually hosting the entire solution for the client. This contract was very important as a breakthrough deal on a new business model that will also positively affect the opportunity to get similar deals in other states.

The contract isn't extremely long. That is for legal reasons, but we have very strong faith that this will be, in effect, a very long-term contract that will be renewed multiple times. So this will also help to build our recurring revenue base in this segment. This contract, we have not yet started recognizing revenue. So this will have effect later this year.

In Chile, we won another important tolling contract. We are delivering all the roadside equipment for the San Antonio, Santiago Highway. This is a combination of project revenue on delivering the equipment itself and a long-term 5-year service and maintenance contract. We have already earlier this year, won a back-office supply for the same project. So this definitely brings us even 1 step further in making a very good stronghold in the Chile market.

And also on the last day of the quarter, we got an extension for the service and maintenance contract for Ascendi in Portugal. It's NOK 148 million recurring revenue contract over a 5-year period. This is an extension of a contract or the renewal of a contract that we already have.

It's related to the same project that we are currently in the process of exchanging all the physical roadside equipment, so this contract is a very good example of a long-time customer of Q-Free, once again, selecting Q-Free to do the replacement and to do the extension of already in the existing work, showing that they're very happy with the solutions that Q-Free has provided over multiple years.

Then we have a few comments on changes in management. So I'll let our Chairman, Mr. Trond Valvik comment on that. And if Trond can hear me, I think he is still on mute.

[Trond Valvik, executive]

Good morning. My name is Trond Valvik, as Trond just said, and I'm Chair of the Board in Q-Free. And I have to give you a short update on the conclusion of the CEO recruitment process, but first, I want to use the opportunity to underline and express my satisfaction on an important operational development for Q-Free. As Trond Christensen just has presented, I'm very pleased to say that Q-Free is delivering on our goal to transform the business model and showing a massive growth in recurring revenue.

Given this transformation, we are able to deliver quite a strong quarter in terms of margin despite component shortage resulting in another soft quarter in terms of revenue from projects and product sales. This quarter, then hopefully gives an indication of what the transformed business model will due to the robustness and stability of the underlying business in Q-Free going forward.

This makes me quite optimistic for the future. And another thing that makes me optimistic for the future is that after a thorough recruitment process during the last 6 months, we announced on the 30th of June, Thale Kuvås Solberg as future CEO and President of Q-Free.

As mentioned in the press release, at the 30th of June, we are very confident that Solberg, together with the rest of the Q-Free executive management, we'll be able to capitalize on the restructured growth platform we have and scale the business in the years to come. Solberg has a proven track record on global business development with focus on with growth, recurring revenue business models and sustainability. So that should hit Q-Free really well.

She comes from a position as Chief Delivery Officer in Volue, which is a listed international technology company based in Norway and she also has experience from JPMorgan, Ernst & Young Advisory and various executive positions within banking. Solberg is also a trusted board number in listed and private companies in various industries and she holds a masters science from the Norwegian School of Economics and University of Southampton.

With that, when Solberg will assume the position is still not finally decided. But at the latest, she will start at 1st of January. Throughout the process, we have had many good and highly qualified candidates. And we are glad to see that Q-Free is viewed as an attractive employer both in Norway and abroad. But given both the company's roots and DNA and the company's future global prospects, I feel very confident that Solberg is a good match for Q-Free and the right leader to take the company to the next level.

As indicated in the Q1 presentation and as communicated in the press release 30th of June, we are also very happy with the interim solution that we have in place with Trond Christensen acting as interim CEO until Solberg is in place. And further, Arne Kristian Hoset has taken on the function as interim CFO in the same period. Hoset joined us back in 2019 then as Group Financial Director.

In the Q1 presentation, I gave the Board's view on some of the market dynamics in the ITS sector and potential external market interest regarding Q-Free and the Q-Free share. And as stated in the last presentation, we are very pleased to observe both through a good order intake and through the general market standing that Q-Free is viewed as a player with leading technology in our segments, which again puts Q3 in an attractive position as a good platform for future growth, both organically and as a platform or a vital part in a consolidation with smaller or larger players in the ITS market.

Now with the new CEO recruited, we are also building a management team and a management platform to support future growth, both organically and inorganically. Together with the new management, the Board are eager to execute on existing plans and to lay out new ambitious plans for the company going forward.

So to summarize, the status and conclusion are the same as it was last quarter. We are quite happy with the position we are in as is, but Q-Free follows the market closely, and we will continuously evaluate and consider taking part in structural opportunities if and when they should arise.

So I think that's from my side for this presentation. Thank you.

[Trond Christensen, executive]

Okay. Thank you, Mr. Valvik. We'll then dig into the financials of the quarter. As already mentioned, we have a slight drop in revenue for reasons already mentioned. But again, we would highlight that the recurring revenue is an increasing share of our total revenue, and that's the part of our revenue, that's really growing. And that's a desired change in the Q-Free model. We want to have a larger proportion as recurring. So that's good news.

We have a very strong gross margin this quarter of 68.7%, which is a steep incline from before. We are not too focused on gross margin itself because this is very much driven by product mix. This quarter, we had very little product sales due to the component situation, which generally gives us good profits but at a lower gross margin, while we had very good software sales, which give a higher gross margin. So this is very much up to product mix.

What is important to highlight is that we are actually keeping our OpEx level slightly down on the quarter, almost flat on the half year, which is a clear indication. And it's been very stable for a very long time now that we have our cost base under good control. And even if we are continuously looking to expand our footprint and consider going into new markets, we are trying to do this at low level cost models, where we don't build that cost base ahead of entering a new market. So this is really working out.

So we ended this quarter on EBITDA of NOK 32 million, which is slightly down from same quarter last year, but still at an EBITDA margin of almost 15%. Again, our revenue is slightly down, said many times already, but I will repeat it. Two reasons. Number one, the changing business model, where we're moving to more recurring revenue that makes us -- that reduces our project revenue as we are installing systems but it will give us a long time revenue in the future. So in the short run, it hurts our top line. But in the long run, it creates a better Q-Free with less risk to the shareholders.

And in addition to that, the component situation has, at all times, of course, a significant impact on our top line. This is the part that we really want to emphasize. Annual recurring revenue has grown by 31% year-on-year from last year and is now close to NOK 300 million per year, which is close to or actually slightly in excess of 1/3 of our turnover.

So again, this helps reduce the risk in Q-Free and creates long-term value and more predictability to our future earnings. And we still have a lot of contracts. We listed a few of them on the right-hand side, where we have the contract, installation and setup is in progress, but we have not yet started recognizing revenue on this contract, which will help build a continuous growth in our annual recurring revenue.

These are the details on the segments. Both segments are lagging a little bit on turnover for the quarter compared to last year. Tolling is more affected by the component situation, and therefore, the slowdown in turnover is more visible there, and it's perhaps also tolling where we have seen the last half year that we are spending a lot of resources on building systems to prepare for customers that will start generating long-term recurring revenue in the second half year.

Our EBITDA is slightly down on the quarter but we have a very solid EBITDA margin of 15%. So again, this is a part of the transition in business model that we are currently in. And as annual recurring revenue keeps adding on and the component situation is normalizing, this will improve further.

Yes. And both segments are slightly down on EBITDA this quarter as for margin, but traffic management actually had a solid increase in EBITDA compared to last quarter, mainly due to a few very solid software contracts that was executed by our team in the U.S.

Again, our order intake is very good. We have a book-to-bill in excess of 1 for the third consecutive quarter. First quarter was a record-breaking order intake with more than NOK 0.5 billion, but second quarter was also good. So we have now almost NOK 800 million in order intake during the first half year and still have a few contracts that have been awarded us but has not been made public because the contracts, et cetera, are not yet signed and a very solid pipeline that makes us very confident that we will continue having a very strong order intake forward.

That gives us an order backlog of almost NOK 1.5 billion, which is very solid and is a very good foundation to keep building the future growth of Q-Free. And in addition to this order backlog, we have quite a few frame agreements that we are confident will give us some good orders in the future, but we do not count frame agreements in our order backlog, we only count it when we have specific contracts or specific purchase order.

And as you also see on the right-hand side, a lot of this backlog, more than NOK 1 billion is from 2023 onwards. So that gives us a very good baseline and a very low risk on the future business of the company.

Yes, cash a little bit down. Interest-bearing debt a little bit up. Again, we are building inventory, and we are paying a little bit to suppliers to secure the situation on the supply chain area. We are doing this or to reduce the risk of loss of turnover due to the supply chain situation. We cannot eliminate that risk, but we can affect it. And that's what we are doing. And we are solid -- extremely solid financially now. We have very good financing. So we are willing to spend this cash to reduce the risk moving forward. It's not a problem for us.

And as I said, still very strong 48% equity ratio, basically rock solid balance sheet, no issues on that. Interest-bearing debt, it's down year-on-year, a bit up in the quarter, but we are still at a very low leverage ratio and very solid financials. Those of you who have followed us for some time, have seen this slide before many times by Hakon, our previous CEO. We are now done with focusing our business on the business areas that we really want to excel in.

We have more or less finished the phase where our main focus was to build our presence in the existing core markets. We have won important new contracts in many areas in the U.S. in traffic management, in Norway, in Portugal, in Sweden, numerous places to make sure that we have a very strong presence where we already are. And we are now in the phase where we're trying to scale our solution to be able to take even further contracts in both existing markets but also to make a low-cost entry into new markets.

And we are trying to do this by making our solutions more kind of off-the-shelf or more standardized. We will never be able to 100% standardize our solutions, and that's not an option either because our main option is to deliver what the customer wants, but we think that we can reduce the cost. And perhaps even more importantly, we can reduce the risk, both for Q-Free, but also the customer by using more standardized platforms, doing things that we have done before, but with some level of adoption and tailor-making to increase our delivery capacity and to reduce the risk and to increase our profits from this solution.

And we have come a long way on this, both on the way we deliver our solutions but also on how we develop our systems and have a basis, which is the same for everybody and then having add-on solutions where that is needed to meet customer requirements.

And as we move forward, we see that there's a lot of new potential markets opening up for us. This is also a slide that a lot of you have seen before. What we see now is perhaps especially France is starting to become very interesting. There's a lot of new contracts coming into the market that Q-Free is considering taking a part of, but also the other countries here are of interest, and we keep monitoring and keep looking and is definitely working together with partners and others to continuously monitor the opportunities in these markets.

Yes, I won't comment too much on this. This is all also a continuing story from Q-Free. We now try to increase focus on getting the right commercial resources in place. We have improved our solutions a lot. We have improved our delivery capacity a lot and now we need to put more focus on making sure that we are able to reach the customer, get it to -- get the message to the market and make sure that we get the contracts.

As we've seen from order intake, we are getting it, but we think that we can scale that up even further. We have onboarded a lot of new key employees with a commercial background that will help us do that. And we're confident that we will see the result of this in the coming months.

So that's the key message we basically had for you today. We are now open for Q&A.

[Trond Christensen, executive]

We have a couple of questions in already. They are both related to the supply chain situation. It goes on how we think the supply chain and components shortage will affect the third quarter. And if what we have done on inventory and payments will kind of counter affect that in full. And to what effect the component situation will affect our gross margin?

Well, it's a mix of things. We do think that the situation will improve in the third quarter. Our prognosis for supplies indicates a good improvement, especially in the tolling division for both the onboard units, which are pure product sales but also for cameras and other equipments that are affecting our project revenue.

So yes, this is expected to improve in the third quarter. The increase that we are doing in inventory and supplier payments. It will not automatically eliminate all the risk. The situation is bearing a lot from day to day, and it's a huge effort by our supply chain departments and all other parties involved in keeping up with this day to day. And it's rather surprising sometimes what kind of situation that can affect us.

In the beginning of the supply chain issues, it was mainly microprocessors and those kinds of things that were affected. But what we are seeing today is that transportation issues and other issues makes it very unpredictable. And from time to time, there are rather small not so important components that are keeping up some deliveries, but that's enough to stop the delivery if we are missing 1 small component.

So the things that we are doing on inventory and otherwise is definitely reducing the risk, but it's not eliminating it. The margin is to some extent affected, yes, because the prices are increasing. But I would say not significantly. And over time, we expect that it will be possible to regain those expenses in the marketplace. So it's difficult to predict 100%.

We also have 1 question related to backlog. The comment is that it looks extremely strong on pulling but it's slightly lower visibility or long-term perspective of traffic management. I think the opportunities we have in traffic management is by no ways any weaker than what we have in tolling. But it's different sales processes.

For our part, it has also been affected by the war in Ukraine, where we had a lot of ongoing negotiations, ongoing contracts. These were obviously stopped when the war broke out. We are seeing very positive signs from Ukraine. That's a tough people. They want to come back. They have actually started paying us a little bit of the money we had outstanding when the war broke out, and they are giving us very good signals to wanting to restart their projects, but that's, of course, lack of visibility on that part.

But also we see that in the traffic management segment. It's kind of a shorter time span from -- we sign a contract until it's actually delivered. So we currently do not have the same very long-term order backlog in traffic management. But we think that, that will change in the future as we also in traffic management, move to more recurring revenue, so that will also improve in the future is our opinion.

Okay. That's all the questions we have for today. So then I would like to thank you for your attention and wish you all a good and hopefully well deserved summer vacation, at least for those of you here in Europe. Thank you very much.