Smartcraft ASA

OSE:SMCRT

Earnings Call Analysis

Strong growth and strategic investments despite market challenges

In Q3, the company achieved a remarkable 29% increase in annual recurring revenue (ARR), supported by two recent acquisitions, though organic growth was only 10%. Revenue grew 32%, with a significant 94% recurring revenue share, albeit profit margins fell to 25% due to acquisition dilution and increased marketing expenses. With a strong operating cash flow growth of 58%, management expects ongoing efforts will stabilize churn, currently at 8%, and aims for 15%-20% organic growth. The outlook remains cautiously optimistic as improvements are noted in Sweden and Finland, while Norway continues to face challenges.

Overview of Recent Performance

SmartCraft continues to exhibit substantial growth, reflected in a 29% increase in annual recurring revenue (ARR) year-over-year. The growth is primarily driven by recent acquisitions of Clixifix and Locka, complemented by strong organic performance from new sales and upsells to existing customers. Organic growth itself stands at 10%, demonstrating the company’s resilience even in a challenging market environment.

Financial Health and Profitability

Despite a strong revenue increase of 32%, SmartCraft faced profit margin pressures, which declined from 33% to 25%. This drop in margin is attributed mainly to the integration of low-margin acquisitions (accounting for approximately 50% of the decline), combined with one-off costs associated with heightened marketing and branding initiatives. The company is strategically investing NOK 6 million more in development to position itself favorably as market conditions improve, which reinforces its commitment to future growth.

Operational Achievements and Market Strategy

During Q3, SmartCraft saw an impressive increase in operating cash flow, which rose by 58%. This demonstrates effective cash management and operational efficiency. The company also reported an increase in customer interactions, noting a 62% rise in sales meetings due to increased marketing efforts. Their marketing initiatives achieved a brand exposure increase of 41%, with sightings soaring to 44 million in Q3. However, the conversion rate from meetings to sales has declined to 35%, indicating a longer decision-making process in an uncertain market.

Churn and Customer Retention Strategies

Churn rose to 8%, marginally higher than the typical 6%, driven largely by bankruptcies within the customer base. Management is optimistic about reversing this trend as market conditions stabilize, and they are actively implementing strategies to improve customer retention and reduce churn, including transitioning nonrecurring revenue to recurring models to make purchasing solutions easier for clients.

Regional Market Insights and Future Expectations

SmartCraft operates across Sweden, Finland, Norway, and the UK, with varying market dynamics in each region. Sweden shows positive signs following three interest rate cuts, contributing to an 11% organic recurring revenue growth. Finland is stabilizing after a challenging start to the year, with project starts exceeding completions—a positive indicator for future growth. Conversely, Norway remains tough, while the UK presents mixed signals due to government initiatives aimed at building 1.5 million homes, countered by potential tax increases affecting the sector.

Strategic Growth and M&A Outlook

SmartCraft is committed to strategic growth through mergers and acquisitions (M&A). The company noted ambitions to further enhance its market presence, particularly in the UK, where it is developing a robust pipeline of potential acquisition targets. With a balance sheet that remains strong, SmartCraft is poised for both organic and acquisition-driven growth. The management has reiterated its medium-term financial targets, aiming for 15% to 20% organic growth in the coming years as they continue to scale their operations and realize synergies from acquisitions.

Earnings Call Transcript 2024-Q3

[Gustav Line, executive]

Good morning, and welcome to the SmartCraft Q3 presentation. My name is Gustav Line, and I'm the CEO of SmartCraft.

Today, we'll talk about the -- a little bit about SmartCraft to begin with, and then we'll take you through the Q3 highlights and financials. And as usual, we'll finish off with a summary and a Q&A, and you will have an opportunity to input any questions you may have in the web tool.

First, let me give an introduction to those that do not know SmartCraft that well. SmartCraft is a -- we deliver software to small- and medium-sized construction companies, and we basically solve some important challenges for them.

So let's look at some of those challenges. The companies in this part of the construction industry struggle with a high level of bankruptcies. They basically make -- hardly make money. There's also a high level of conflict between our customers and their customers, the end customer. There's a lot of conflict related to whether things have been built according to rules and regulations and whether people turn up on time and extra bills and so on. And there's also a high level of accidents and deaths. And about -- in the Norwegian market, 29% of all deaths at workplace is related to the construction industry.

So basically, over the last years, there's been a high increase in documentation and need for reporting in order to beat these challenges. So it's actually become a lot more challenging to be a construction company because you also have a lot more paperwork to fill in. So what we do is to deliver solutions to have control of 3 things: people out in the field, the materials used in projects and the documentation that you need in each project. And when people are out in the field, we know they can actually report a number of hours. They can take pictures of the jobs. They can use a mobile phone to record the materials and fill in checklists and so on. And this information is then given to the people in -- sitting in the office on the web browser, and they can be in control of what's happening in the different projects in their company. So this way, we give good insight and control and people can actually sleep well at night because they are in control of the different projects in their business.

Today, we have a leading position in the Nordics, and we've had a very strong growth since we IPO-ed in June 2021. You can see that our ARR has grown nearly 30% over the last years. But maybe more importantly, we also had a very strong growth in adjusted EBITDA margin. And it's important to note that we've done 12 acquisitions over the last years. And most of those companies that we acquired come in at a very low -- with a very low margin. So this increase means that we actually raised the margin in the acquired companies as well. So today, we have 16 offices in the Nordics, but also now in the U.K., and we have more than 250 employees. And we think this is a good position to grow in existing markets, but also potentially in new markets.

The construction industry is being challenged by probably the biggest downturn for the last 30 years. And we are in a quite lucky position because the SME construction companies are mainly focusing on renovation. They are focusing on existing buildings and how they can sort of service maintenance and renovate existing buildings. And this market is actually bigger than the new build market and it's actually growing every year. And there are some nice things happening for our customers. There's a need to make these buildings more energy efficient, which is good because a lot of our customers are plumbers and electricians. So that's a nice drive for them. But not to forget, there is a massive -- this is a massive underpenetrated market. There is a need for digitalization. It's going to happen. And that's why the underlying market is actually quite good, although we are in a challenging position or the market is quite challenged at the moment.

When we look at the 4 countries we are in, I just wanted to give you a sort of really high-level view of the way we look at those markets. We see some positive signals in Sweden and Finland. In Sweden, there have been 3 interest rate cuts this year, and we can see that there is an improvement among our customer base and that we have some positive effects, most likely from that. We also see in the Finnish market that the construction projects that have started have now surpassed the construction projects that have been -- are being completed, which is also a positive factor for our position in Finland.

In Norway, we experienced a tough market. And at the moment, it doesn't look like there's any positive uplift in the Norwegian market. It's sort of continuing to fall. And in the U.K. there is a really positive thing that the new government wants to build 1.5 million new homes over the next 5 years, which is a massive increase. But on the other hand, they also suggested some pretty tough tax increases, which counteracts to a certain extent, this initiative. So there are some mixed signals. Some things are quite positive and some things are a little bit the way they have been for the recent year.

So to move on to the Q3 highlights. I'm pleased to announce that our annual recurring revenue, which is basically our holy grail has increased by 29%. Most of that increase or a majority of that increase is related to the 2 acquisitions we did in Q2 of Clixifix and Locka, but also a nice organic growth from new sales and upsells to existing customers. And also, there is a currency effect as well.

When we look at our margin, we have a strong margin, but it is down compared to last year. It's basically twofold. One is related to the 2 acquisitions we did. They have low margin. So the dilution from this acquisition sort of accounts for a little bit more than 50% of the down from 33% to 25%. The other half is related to some one-off initiatives that we have -- initiatives and costs that we see in Q3; basically, initiatives that we do to boost our position in the market and also some one-off costs that we have this quarter.

We also, this quarter, see that we have invested NOK 6 million more in development in order to sort of be in a pole position when the market turns. This is related to some new projects, not maintenance of existing solutions, but some new projects that we want to develop in order to be in a good position now that the market is like it is. And also, we think that could increase our competitiveness going forward.

We're pleased to see that our operating cash flow increases by 58%. And we see that our churn is slightly up to 8%, which is a little bit higher than it was last year and about 6% would be probably our normal churn in a normal market. So this rise from 6% to 8% is largely related to bankruptcies. So we expect when the market gets better that we get back to a more normal level. So like I said, we are in a market that is quite challenged. And we want to invest in marketing in order to sort of really be in a strong position. So we have invested more in marketing this quarter than we did last year. But we also invested in a branding project in order to have a more -- can I say, a more stronger voice, we can sort of consolidate some of our communication from our different solutions to have more of a consistent and visible voice in the market. This is a project that we invested in, in Q3, which will be good for the company going forward.

So the investments we've done in marketing has, in total, given us a 41% brand exposure, which basically means that we've been seen 44 million times in Q3, which is quite a high number by all means. That creates more inbound leads, which means that more customers knock on our door to say, look, I really find this really interesting. Can we have a meeting? So we have a 62% increase in sales meetings, which I think is quite nice to see that there's a lot of interest in the market for our solutions. It means that they fit the market well, and there is a lot of interest in the market. But we do also see another thing is that the conversion from those meetings to sales is at 35%, which is by all means a good number, but it's actually down 15% to what it would be in a more normal market, what we've had historically, where it's been about 50%. And that means that -- the customers that we meet, we don't lose those customers. It's just that the sales processes take longer time. There's a longer lead time for them to make decision. They are quite unsure about the future, so they are also a little bit hesitant to make investments, which means again that we are, to a certain extent, building up a nice pipeline going forward as these customers really sort of sitting on the fence haven't really made a decision.

And when we look at the start of Q4, we can see that our biggest brands actually have a very nice start on Q4. And of course, it's early days. Q4 is still a lot more to do, but we have a good start on the fourth quarter this year.

So we also acquired the solutions, Clixifix and Locka in second quarter. And I just want to give you an update of what we do to position ourselves to be able to grow further with those solutions. And Clixifix, which we acquired in May, we regard Clixifix as a platform for growth in the U.K. We're pleased to see that they have an organic growth or a recurring revenue growth of more than 30% in the third quarter and also that the EBITDA CapEx margin has gone from negative to double digits in the same quarter. And at the moment, we are looking at some of the Nordic solutions to see how they could fit the U.K. market together with Clixifix. So this is a project we're looking at. And we're also developing a list of potential acquisition targets as we think we could do a lot more in the U.K., and we want to do it both organically and through acquisitions.

And then we have Locka we acquired in April. It's slightly different compared to Clixifix in the way that Locka is actually sort of included and integrated into the Swedish organization, which means that they benefit from the practices and the marketing and everything we do in the Swedish organization and being part of a larger group. The main focus in Locka is to shift revenue from nonrecurring to recurring revenue as they came in with 50% recurring revenue, we want to see how we can raise that to the company average where we should, for the group, have an average of about 95% plus in recurring revenue.

So there are some key takeaways. We have continued strong growth and high margins, although we have wanted -- that we have done some investments and some initiatives in the third quarter. And we have a very strong cash flow despite a challenging market. We do see some positive signals, although there are some mixed signals in the market, where we see definitely some positive signals in Sweden and Finland. And we also see that sort of pushing and spending money on marketing and sales activities creates a lot of buzz, creates a lot of interest, which we think is very good for the company, both in the short term but also in the longer term.

And like I said, we are investing quite a lot more than we have in the past in solutions for the future. And that should put us in a good position when the market turns. So both the development and the branding project is quite exciting in order to build extra momentum going forward.

So with that, I want to give the word to Kjartan and take us through the financials.

[Kjartan Bo, executive]

Good morning. So let's look at the financials. So we have still a high growth in ARR, 29% year-on-year. Organic growth is 10%. And Q3 is a seasonally slow quarter when it comes to new sales. And we still have a high level of churn and downgrade. So that affects our organic revenue for the quarter. We focus on, as Gustav said, transitioning nonrecurring revenue streams to ARR and recurring revenue. This has, of course, a potential growth tailwind for us as we grow ARR going forward. But also it puts a bit pressure on total revenue as we lose the revenue of the nonrecurring immediately.

When we look at revenue, of course, still high growth as well, 32% overall with now a 94% recurring revenue share. And as Gustav said, we have invested on the profitability for the quarter. We declined the margin to 25%, where 4.4 percentage points is dilution from acquisitions. The rest of the decline, roughly 4 percentage points is certain one-off items. We have done marketing more than we had planned. We see when we can do marketing activities to boost our position, then we wish to do so. And this is true for Q3.

Additionally, we have done a branding project, and all of this is roughly 50% of the 4.1 percentage points. The rest is related to onboarding the acquisitions. We have some overlapping system costs, et cetera, and we have also some increased losses from customers.

On the capitalization side, we have capitalized more in Q3 than we did last year. We have invested more in development projects to be in pole position when the market turns. And we see we had a lot of resources available in Q3, not on vacation. For the year, we're still expecting roughly 9% or just above.

In Sweden, the market is quite stable from before. We do see some positive signals, and we have had 3 interest rate cuts, which is starting to materialize on the pipeline. We have an 11% organic revenue growth -- recurring revenue growth. And the EBITDA declined in Sweden as well, but it's very much related to Locka. As Gustav said, Locka is focusing on transitioning nonrecurring revenue to ARR.

In Norway, the market is still quite challenging. We see that we have a strong performance when it comes to new sales, but our growth is hampered by increasing churn and downgrades. The markets are tense, and we expect it to be improved going forward as well. And hopefully, we can see some interest rate cuts here. We see an improvement in the EBITDA margin as we have less development capacity needed on existing solutions.

In Finland, we see an improvement. We saw in the first half of 2024, a negative 6% growth. It stabilized from Q1 to Q2. And now going into Q3, we see an improvement close to 0. So we're at 0.7% negative growth. ARR growth is trending upwards and churn is trending downwards. And we see several positive marketing signals. The initialized construction projects is exceeding the project completions. It was the first quarter in the Q2 for, I think, since 2021. But we still see the trend continuing in Q3. So as we have a project-based revenue model, it implies a growth tailwind when the market turns.

On the cash flow and balance sheet side, we still have our very strong position. We are still cash positive every quarter, and we have a very good growth in Q3, 58% growth in operating cash flow. On the balance sheet, there are less changes. We are very stable. We're still net cash positive, and we have a net working -- negative net working capital. Currently, we hold roughly 2.2 percentage points of own shares, of which a small amount, roughly 180,000 shares is still owed to the owners of -- sellers of Clixifix. So Gustav.

[Gustav Line, executive]

Thank you, Kjartan. So to sum it up, we are very close to our customers and some of the initiatives and development projects that we have is really done in close relationship with those customers. We will continue to work with marketing and sales excellence, continue to work to create bus and build solid customer pipeline. And also, we will continue to see how we can automize and do more self-service in our business. We think there's a great potential to do more and also include AI in that work. And hopefully, I'll be able to tell you more about that at a later stage. We have some projects going on in that area. And we will use our flexible business model to keep the cost level down.

This quarter, we decided to spend a little bit more in order to be more competitive going forward, but we could have chosen not to, which would have kept a higher margin, but we decided not to. And then also, we will continue to do M&A as we have a strong balance, and we think it's a good way to grow the company in addition to organic growth.

So we reiterate our medium financial targets of 15% to 20% organic growth, and we do expect the margins to increase as we synergize and scale the business.

And with that, I would like you, Kjartan, to join me, and then we will open up for Q&A.

[Kjartan Bo, executive]

Thank you very much. There are still -- there's still an opportunity to post questions in the webcast player, but we have several already in the inbox.

So first question, do you think we have reached peak churn now? Or are there any reasons why churn may go even higher from here?

[Gustav Line, executive]

Yes. It's a good question. I think it's really difficult to predict. We have seen churn being around 8% the last quarters. We do work hard to keep churn down, but it's really difficult to predict if companies are going to go bankrupt or not. So I would hope the churn doesn't increase more, but I can't promise anything. I've learned one thing in business, not to promise anything in the future.

[Kjartan Bo, executive]

There's one question on the cash flow. What were the drivers of the positive cash flow -- cash inflows from working capital items this quarter?

[Gustav Line, executive]

Well, we -- in general, the major driver of cash flow for us is deferred revenue. So we invoice in advance everything between 1 and 12 months in advance. And the deferred revenue is what's driving net working capital and cash flow.

[Kjartan Bo, executive]

Thank you. Are you planning to extend any of the initiatives to increase scale and synergies into Q4? If so, should you -- could you give some flavor of the scope?

[Gustav Line, executive]

Maybe you can throw some more light on this, Kjartan. But in general, what we mentioned is that there were some initiatives that we have done in Q3 that are one-off initiatives. So that's basically what we don't expect those to go into Q4. I don't know if you want to.

[Kjartan Bo, executive]

Well, we -- if we look at the marketing initiatives we have done, we can divide it in 2. We have one group brand project, which is isolated for Q3 that will not be continued, that is finalized and will not come back in Q4. And then we have some marketing activity increases, which is -- when we see an opportunity to take a good position to make a higher impact, then we wish to do so regardless of declining the margin. We don't have plan to do this in Q4. But if we see a good possibility, I can't rule it out either. The onboarding, as I said, with the system overlapping, et cetera, that will possibly be some more in Q4, but it's a very short-term initiative.

[Gustav Line, executive]

Thank you.

[Kjartan Bo, executive]

Then there's a question on the market development. There are -- one question goes on the Norwegian market, where there is an absurd backlog for small craftsmen being slim moving into Q4. Can you comment on your discussions with these clients and the churn in Norway in particular?

[Gustav Line, executive]

Yes. I did talk about the number of meetings we have and the strong interest we see for our solution, which is higher than it has been in the last years, even higher than what we had when the time market was normal -- in a normal market back in '21, '22. So we see a high interest, but we also see that sales processes take longer time. So from our point of view, we have a nice pipeline of existing customers, which -- sorry, not of existing -- of potential customers. And actually, what I mentioned is that we see a good business activity at the beginning of Q4, which also means that we have a good strong pipeline for Q4. Whether this is reflected in our customers' pipeline, I wouldn't know, but at least from the interest we see from the market, it looks okay. But again, it's uncertain times. And especially in Norway, things are a little bit more shaky than it is in the other 3 countries.

[Kjartan Bo, executive]

Thank you. A question along the same lines for Sweden. I don't know whether you have some more granularity for Sweden, which data points do you track there to tell if the market is improving?

[Gustav Line, executive]

Well, we have -- especially Bygglet, which is our biggest solution in Sweden and accounts for a lot of the revenue. They have a lot of -- they really have a lot of customers, and it's quite -- I would say, having followed Bygglet for many years, we can very much see the market trends in the interest from our Bygglet customers because -- and also the decision times from when we meet the customers to when they make a decision is quite short. And the interest for Bygglet at the moment is, in my opinion, very positive. There seems to be a lot of customers that knock on the door and a lot of customers that want to know more. And it's much more positive than what you would assume when the market is as depressed as it is. So whether that is a result of our excellent marketing activities or sales activities or whether it's a view on the market that the market is improving, I'm not sure, but maybe there's a combination of both.

[Kjartan Bo, executive]

Thank you. One question on Clixifix in the U.K. How has the financial performance been since the acquisition in terms of revenue growth and margins? I believe you touched upon it, but maybe you can elaborate further.

[Gustav Line, executive]

Yes. We don't have Clixifix or U.K. as a separate segment as we only have one solution in the U.K. But we wanted to give you some flavor on what has happened and how the development has been. And we're pleased to see that the organic or the ARR growth has improved more than 30%. So there is a growth of more than 30%, not improved, it is a growth of more than 30% and that we have changed from minus margin to plus double-digit margin in Q3. So I think it's really nice to see that not only -- can this be a great platform for growth, which we think it is. We like the people a lot. We think the company is really great, but it's also growing nicely on its own, which is really good. So let's see how we could sort of add some more companies and do some acquisitions in the U.K., and we think it can be really exciting.

[Kjartan Bo, executive]

Thanks. On M&A and this quarter's P&L, it had a significant effect, obviously, on the P&L. Is it possible to say a little bit about Q4? How do you expect this to develop into Q4? Could we see another quarter with higher effect sequentially, especially considering the transition from nonrecurring to recurring revenue?

[Gustav Line, executive]

I would -- well, first of all, we don't really guide on the short term. But looking at Q3 and we had a higher decline in Q3 than in Q2 from the acquisitions. The dilution were greater. We are not expecting it to be further declining due to acquisitions, 4.4 percentage points, which it is in Q3 would be -- I would assume to be the bottom point. And partly, this is because Locka, which has 50% recurring revenue share, had a natural decline in nonrecurring revenue during the summer holiday. When we go into Q4, without such a long period of holiday, the nonrecurring revenue would likely be higher, although, of course, we try to transition it, but we can't transition it that fast. So yes, likely, we would see not as high dilution in Q4.

[Kjartan Bo, executive]

Thanks. One question on the way you are now transitioning the acquired companies. What is the initial feedback from customers when you transition them from a pay per use to a recurring revenue model?

[Gustav Line, executive]

Well, basically, we take away the nonrecurring is basically initial setup fees, installation fees, training fees, support fees, all of those things that we think should be included in the monthly fee. And to take away that one-off initial cost reduces the hurdle to buy our solutions. So the feedback from like the U.K. team, for example, is very positive. They think this is a great initiative. It's easy for the customers to make that decision because it's not an investment decision. It's just something that goes below the line as an operating cost. And that's what we want to do is to have great solutions that are easy to use, easy to buy, easy to understand. And also that is just an operating cost on the same line as a lot of other operating costs that you approve every month, and it's not a big investment that you have to make and a big decision that has to be on the board of directors to take that decision because we don't think that's the way our software should be bought.

[Kjartan Bo, executive]

Thank you. Can you comment on the increase in average revenue per customer? How much was driven by M&A?

[Gustav Line, executive]

Well, a lot is driven by M&A. In Q2, Clixifix was a part of the quarter in 2 months. In Q3, it's part of the full quarter. So with a high revenue, average revenue per customer, that, of course, drives the group average as well.

[Kjartan Bo, executive]

Thank you. How much R&D and marketing growth investments are in the P&L, if any?

[Gustav Line, executive]

Marketing and growth investments in the P&L. All marketing, all growth investments are in the P&L. The only thing we have adjusted for is acquisition costs.

[Kjartan Bo, executive]

One more question on U.K. and the market. In the U.K., housing building starts are coming down significantly, which will drag completions very soon. How do you see this development? Has Clixifix taken any measures to address this?

[Gustav Line, executive]

Like I mentioned, there are a concern in the U.K. that there are too little -- well, there's a lack of housing and the labor government has an ambition to really speed this up dramatically by building 1.5 million new homes over the next years. And there have been initiated quite a lot of investments and initiatives to make this happen, but there's also -- like I said, there are also things that are working a little bit against this because they're raising the insurance tax for companies and also raising the capital gains tax, which is also not really working in that direction. So I think all in all, this should be positive for the industry because there are a challenge that there are too few buildings -- too few new construction projects started. So this is a concern that is definitely something that everyone knows about and they are trying to beat. So yes.

[Kjartan Bo, executive]

Thank you very much. There's one final question. And just to remind everyone, if you want to post any more questions, please do so now. We'll take the final one that we have, which is related to M&A.

Could you provide an update on the M&A pipeline, specifically with such a tough market? Are valuations coming down, making M&A more available? And finally, are you considering larger transformative acquisitions as well?

[Gustav Line, executive]

I think there are more potential targets that we are in dialogue with over the past year, I would say, due to the changes in the market. And for the companies that are not doing so well, valuations are coming -- definitely coming down. For companies that are doing well, I would say the valuations are -- expectations are fairly high still. We are in dialogue with quite a lot of companies. So it looks, in that respect, quite promising. And we are building a pipeline in the U.K. as well that we think is going to be interesting to dive into. When it comes to more bigger, sort of, really bigger acquisitions, we have been quite good at doing smaller acquisitions, and that's something that we have done, I think, with a great success. And we might do bigger acquisitions, but I think also it does always come with a slightly larger risk because then, of course, there's more politics, there's more bigger changes to be done and so on. So I wouldn't rule it out, but I think we are more likely to maybe make smaller acquisitions, meaning up to sort of 50 companies with about 50 employees and so on.

[Kjartan Bo, executive]

Thank you very much, Gustav. There are no further questions from the webcast now.

[Gustav Line, executive]

All right. In that case, I would really like to thank you for joining in. And again, we are very proud that we are growing in a tough market. We have a 29% annual recurring growth, but also remember that we have a 10% organic growth, which is quite okay, not where we want to be, but it's still quite good considering the market.

So thanks a lot, and have a great day.