Clavister Holding AB

STO:CLAV

Earnings Call Transcript 2022-Q2

[Jenny Ramkrans, executive]

Hello, everyone. Good morning, and welcome to Clavister's Q2 2022 Interim Report. And as usual, I have John Vestberg with us and David Nordstrom. And we will start with the presentation, moving over to a Q&A session [Operator Instructions]

John, should we get started?

[John Vestberg, executive]

Yes. Thank you, Jenny. And again, welcome, everyone. We will start with a summary of the quarter, the key highlights, if you wish, and some of those will be further elaborated on in sections during the presentation.

We had a lower order intake this quarter compared to the same quarter last year. This is mainly due to a very large single order in the comparative quarter last year coming from the defense sector. And we also see, and this is something we will elaborate on a bit later, the transition to the new business model is also impacting order intake negatively.

If we then look at sales, sales grew by 21%, so that is something we're pleased to see, obviously. And our recurring revenue element grew by 10%, which is in line with the transformation we're doing towards a more recurring business.

One area which saw particularly strong development was the Identity and Access Management business, and we'll talk more in detail about this in just a second and similarly within the defense sector, where we continued to see a number of very interesting activities and continued successes.

Our traditional firewall business also saw a good growth. We added more than 30% of new customer contracts in the period. And another important metric is the fact that we doubled the amount of hardware devices or hardware units shipped to our customers in the quarter. Our 5G security business saw a slower development in the period, and I'll get back to that as well. And finally, as a summary point, we continued to run our cost optimization program, which is progressing according to plan.

Moving on to the Identity and Access Management Solution area. So as mentioned, very positive development, which includes a continued strong sales and a healthy profitability. And I think most of you know that this solution business is managed through our fully owned subsidiary, PhenixID.

In the period and in the scope of identity management solution, we have a product called Signing Service/Workflow Service. A new version of this product was released in the quarter as well, and it sets a quite good benchmark for the type of business we are running within the area. This is a product that manages digital signatures. And I'm sure you've all seen or maybe been using other types of document signature systems. But this is a product that is compliant with EU and ETSI directives and uses strong factor authentication, including bank ID and so forth, to make signatures also much more compliant than what you typically find in other types of solutions.

One of the customers who has been integrating this new product quite extensively in their business is Region Stockholm and there is also a number of other Swedish public administration organizations who have started to use this product.

We have a change in the leadership in PhenixID as well, where Peter Laurén, the previous CEO of PhenixID, left the business early in the quarter. And Johan Edlund has been appointed as new CEO.

What we've seen so far is that our Identity and Access Management business with PhenixID has grown to become one of the leading suppliers in this area in -- especially in the Nordics area; Sweden, of course. But what we continue to see is that the strong demand for these type of solutions continue to increase and not only within the Nordics, which is, of course, the home base for our business so far, but also in other parts of the EU. We know that the digitalization and use of digital signatures is strongest within the Nordics, especially in Sweden, but other European countries are definitely picking up. So a very interesting future for this type of solution.

Moving on to defense. As mentioned, quite a lot of activities and successes within defense, starting with just a market situation. So we all know the tense situation in the world continues and defense budgets are rapidly being increased as we speak. And indirectly and directly, this drives additional demand for cybersecurity related to defense.

One marketing example of this is the very large trade show in Paris called Eurosatory. This is the largest defense trade show in the world. And we have the opportunity to present and exhibit at this trade show in June, where the solution was demonstrated for basically most of the major players in the industry. Most of them would be found on that trade show. And the response was already positive, good -- really good confirmation on the viability of this technology. Especially, the artificial intelligence component is something that is appealing to many of these players. We and the industry tend to realize that the future in cybersecurity includes the ability to be able to respond to zero-day threats and unknown threats. And here, artificial intelligence is a key mechanism.

Moving on to some current defense projects. As you probably know, we signed a major deal with BAE Systems for a major Western European military organization. This is for integrating our software into the Combat Vehicle 90, Infantry Vehicle platform or vehicle. And this project is progressing according to plan. We have been through both the R&D part of the project.

We have been through the pre-series part of the project. And we're now moving into series deliveries, and those are starting around year-end. And the shipments from -- or related to that project is done spanning over a 4-year period. And as a reminder, we're talking about approximately 120 combat vehicles being equipped with Clavister equipment.

We are also running a number of so-called proof-of-concept projects with other key players in the industry, and they follow a similar use case, similar pattern, so basically integrating software in defense platforms. Obviously, our ambition is to be able to transform those pilot or proof-of-concept projects into commercial integrations with yet additional platforms, so we're basically expanding our base.

We have a number of research activities as well, funded research activities, I would like to add, within the defense market or defense industry. One recent news that you might have seen is Clavister being part of a consortium which was recently granted EUR 25 million by the European Defense Fund. This consortium includes, apart from Clavister, really impressive companies, General Dynamics, Leonardo and 14 other companies. The goal or the scope of this project is to develop new technologies for autonomous vehicles. And our role is quite obvious. Of course, I mean we're delivering the cybersecurity components to these new vehicles. That project starts immediately after the year-end.

Also yesterday, we announced a proof-of-concept project here in Sweden. We were awarded by the Swedish Defense Material Administration. And for those of you who do not know FMV, they are the exclusive state-owned purchaser of military equipment for the Swedish defense. And they are managing as well a number of development projects to ensure that the Swedish defense is equipped with modern and high-end technology.

This project specifically is related to their space communication or military satellite communication, and our products will be used -- or our technology will be used to detect anomalies and thereby being able to detect threats flowing through military satellites. So all in all, very -- a lot of activities happening in the defense sector.

If we then look at our firewall business, and just as a reminder, our firewall business represents the majority of Clavister's business up until now. And as I mentioned earlier, we saw a very high volume of deliveries of firewall products in the quarter. So we doubled the amount of devices that we shipped to our customers compared to the second quarter last year. And we were able to add more than 30% of new customer contracts. So these are software license contracts that are recurring. So basically, this forms a new level of revenue baseline for the company, for this business.

We believe our assessment at least shows that the new business model that we have introduced is one of the strong contributors to why we see these growth numbers. We have essentially lowered the threshold for new customers to become a Clavister customer. And we see that the entire pricing model and the OpEx model which it entails is really appealing to many customer segments.

There is a flip side to the new business model. We have touched on this in previous reports, but we will repeat it as well. There is a short-term negative impact from the new business model both on order intake, as you saw in the report, and also on net sales. Reason being that we have deliberately set very low prices on the initial hardware.

The hardware is a delivery mechanism for the Clavister software and should have as low threshold for the customer as possible. So the prices kept very low. And we have moved then the majority or the rest of the contract value over to the recurring software element, which obviously means that we will be able to see longer contracts in the end or longer customer loyalty, I would say. And we would see total -- higher total contract value.

We have seen as well that the average contract -- the average initial contract lengths have been a bit shorter than what we've seen previously. And obviously, that means that the initial order value is lower. But again, the upside or the other flip side of the coin is the higher total contract value and more stable order intake levels over time. We don't get the lumpiness as in the previous model.

Moving on to 5G security. This quarter was a slower quarter in terms of 5G security business. We did not sign any new significant license deals. There were a -- there are a number of those in the pipeline, obviously, but no one that we were able to catch in Q2. However, we have then used the time well. We have our professional services consultants that have been working intimately with our mobile operator customers to make sure that the licenses they have acquired previously are now being deployed so that the software gets up and running and starts producing revenue for Clavister going forward.

And if you recall or have read up on the business model, the 5G security business model is very much attached to mobile data growth, which means that the more operators we deploy our software to and as those mobile operators are experiencing data growth, we will see an impact as well on our revenue generation.

We can also conclude, and I think you might have seen this from other 5G-related businesses as well, that the 5G mobile technology as such is definitely the fastest-growing mobile technology, that's without doubt. But the market penetration is still very early. I mean the dominant networks are still 4G and 3G.

So it's early phase, but we don't see any change in the reality of the cyber threats towards the networks. So the threats are real, and this means that the demand for this type of solution is still genuine. So we have good hopes for the solution, but obviously, the take-up rate has been a bit slower than expected.

With that, moving over to David.

[David Nordstrom, executive]

Thank you, John. So I will elaborate a bit further on more financial metrics, starting with order intake. And as John mentioned, we see a quite large decline in order intake in the period that is primarily explained by the fact that we don't have a large defense order in this quarter, which we had in the comparing quarter. And we will see and expect a lumpiness in order intake based on these types of deals.

Other -- another explanation is, as also mentioned, the transition to new business model. And to elaborate a little bit further on that, it is, of course, when the hardware component is cheaper, that has an initial impact on order intake as we basically charge less for hardware, meaning that we move more value over the course of the engagement. That is one part.

The other part is, also mentioned, the average contract length that is shorter in the new business model also contributing to better growth. And as you know, we are reporting according to IFRS. I will not derail into our accounting manual here, but as our engagement consists of parts that we deliver at a point in time directly when a customer orders, a contract and parts are distributed over the contract length.

If then contracts are shorter, that means that you have the corresponding impact also on net sales. But over time, this will generate bigger revenues for us and also stabilizing order intake. But during the transition phase, we expect this -- to see this type of impact, and also then a slower inflow within the 5G business. And there, we typically see larger order sizes. And when that have a slower progress, we will then have a corresponding impact on order intake.

And then looking at net sales, we see a good growth. If we adjust for FX, that growth is 16%. And the main drivers here are, of course, that we have been able to ship more than -- 30% growth of number of software contracts, meaning that we are broadening the installed base. And we're also shipping 98% more of number of hardware appliances.

And to read into these figures, I would explain that, of course, the growth of contracts means that we have a growth of appliances. But we're also shifting business model with new contract types associated with new hardware platform. So the fact that we see much more appliances sold than new -- totally new contracts means that there is an ongoing migration from all platforms, all contracts over to the new platforms, new contracts, which has a higher degree of recurring revenue.

So this is -- the delta there is primarily explaining an overflow from the old to new business model, and hence, we can expect to see a larger appliance growth than a net growth of contracts. And this is then the -- and also, we see growth in net sales that we have support from deferred revenues from a growing installed base. This also translates into keeping the trend with growing recurring revenue. So this continues also in this quarter.

Looking at margins, we see a quite clear decline in our gross margin. We have been seeing that as we have been transferring to our new business model. This has been expected, and we've been communicating this as something to expect when moving into the new model. The main driver here are, I would say, 2 things. One, of course, a much larger volume of appliances means that the COGS factor increases as a shared product of the fact that we ship much larger volumes of appliances.

In the new model, as said, we are removing thresholds to become a Clavister customer. One such large threshold that we identified historically is this historic steep price of hardware. And then to build a better platform of software growth, we have reduced the price point of the hardware, transferred that to the software, meaning that the initial impact is negative on margins. So I think that is the main explanation, larger volumes at a lower initial price.

Looking at OpEx, we are on track from an OpEx perspective, but we have, in the quarter, restructuring cost of SEK 2.6 million related to further redundancies in the cost optimization program. Our primary aim is to reduce staff by finding ways of -- it doesn't go to layoffs, but in certain cases, we also need to use that as a tool, which comes with an associated restructuring cost.

And we had a release of reserves in the comparing period. Those of you who remember, a couple of years back, we closed our R&D site in Umea. We had a contract for that Umea office, which we successfully managed last year to close down early, which meant that the corresponding reserve of SEK 2.8 million was released in Q2 2021.

So if you adjust for these factors, OpEx is SEK 44 million in the period compared to SEK 45 million for the corresponding period. Our view is that the cost optimization program is on track. We will talk about -- a bit more of that when it comes to the numbers.

FTEs on the next slide and financial items. We have a -- as you see here, the items impacting cash flows remained stable, around SEK 1 million, and the remaining amounts are noncash. And the largest part here is especially related to FX effects on long-term debt. As you know, we have -- the majority of our debt is in euros. And when the SEK deteriorates, we will have then revaluation effects that can be quite large in a quarter.

And again, comparing to Q2 last year, those revaluations then were positive. And in this quarter, they are negative. The other big parts there are the warrants to EIB and the long-term interest to lenders who also builds up the financial items, but they are noncash in the quarter.

Then some balance sheet and cash flow metrics. Looking at CapEx, that have decreased a bit in the period. That has a couple of different drivers. One such is that we have a high ratio of maintenance and research in the period. I mean it is related to what we see in defense, which is a bit research-heavy before we get into more of a development mode. And we have been working with improving efficiencies in our software. And we have then seen a higher degree of maintenance rather than new product development.

In the cost optimization program, we have a lower number of FTEs, which means that the cost for R&D is a bit lower. But we have also, within the program, looked at where in the company do we have resources that can be used in a different way, in a more customer-facing way and in roles which is more demand generating. So we have also moved some resources from development activities to more commercial-oriented roles. That is also explaining the decrease here.

Looking at depreciation and amortization, have increased slightly, and the reason for that is that, historically, for a couple of periods in higher levels of CapEx investments, and hence, amortization is then slightly increasing.

Cash flow and looking then at what is the primary explaining factor for the weakening cash flow before working capital changes, and that is the increased COGS. We have significantly larger volumes being shipped at a lower price point, which has an impact on cash flows. And we have also then some effects from these challenges that we see on supply chain which we are managing, but it has impact on price. And we believe that we can offset that price to a quite large degree by increasing our prices to customer, which has taken effect from July 1.

And looking at then cash flows, when we look at the balance sheet impact, we have a somewhat improvement of our cash flows but negatively impacted by a strategic buildup of inventories. And we have -- we made a strategic decision to -- even though it's negative from a cash flow perspective, to build larger inventories because we have seen challenges with the supply chain issues that affects many businesses and also the firewall business. And we want to avoid a situation where we are unable to uphold deliveries because of a shortage of inventory.

Now we have no such shortages. We have been building inventory in all our appliances to make sure that we can deliver and to have a stability to deliver, and we're pleased that, that has been a successful endeavor but with an impact on cash flows. And that is roughly SEK 2.5 million in the quarter.

Looking at FTEs. We have -- we're seeing a large decrease of the number of FTEs in the quarter, down from 133 to 119. And reason for that is, of course, the cost optimization program. In Q1, we saw some impact, but the majority of the levers identified during the beginning of the year happened in Q2. This is partially offset with a short-term increase of external consultants because in certain areas, to uphold deliveries, we need to have a short time increased reliance on external consultants. But that is, on the other hand, easier to reduce when we have the ability to do so and with more precision than looking at our own staff.

So that's a short financial summary. So over to you again, John.

[John Vestberg, executive]

Thank you, David. Then we round off with the outlook looking forward, and we maintain our outlook compared to the previous quarters. So just to repeat and to remind again, the transition to the subscription-based business model has an initial impact on net sales. So we keep our outlook for the net sales growth to moderate for this year.

Looking forward after this year, we will obviously arrive to a point where the effects start to normalize, and then our ambition is to grow net sales with an average of 20% over 3 years. Following the effects of the cost optimization program, that has an impact on cash OpEx and, of course, then on cash flow and EBITDA. And we see those effects already in 2022.

[Jenny Ramkrans, executive]

Yes. Thank you, John. Thank you, David. Should we move over to the Q&A then? [Operator Instructions]. I will give you 10 minutes. Actually, we have [ Vidal ]. [ Vidal ] can you hear me? So [ Vidal ] you have to approve the request. So we move forward until we have [ Vidal ] back again.

John and David, you talked a bit about the BAE contracts. Could you actually elaborate a bit? What is the outlook of Clavister in regards of the new contracts and opportunities for BAE? How can Clavister be a part of that? How does it work?

[John Vestberg, executive]

Absolutely. Absolutely. Yes, so as a reminder, BAE is one of our partners in the defense industry. And back last year, we signed a framework contract -- or previously, we signed a framework contract with BAE that integrates our software into the defense platforms or the vehicle platforms they are building. They have a number of their products or their devices or their vehicles operating in several European countries, of course, including Sweden and Holland, Norway and so forth.

What we've seen just in the past 6 months -- over the past 6 months is a very strong inflow of businesses -- new businesses for BAE Systems for various types of vehicles. Some of those new businesses are in shortlisting process, which means that we are -- BAE are working with end customers to finalize and formalize contracts. And obviously in this type of industry, it's many, many months of contract negotiations due to the sheer size of the contract and the complexity.

What we have stated in the report as well is that we, of course, have a lot of expectations to be part of more business coming from BAE. But until those type of contracts have been formalized between BAE and their end customers, we are not in a position to explore more or to tell more. So as soon as they have been concluded, we can come back with more information.

[Jenny Ramkrans, executive]

Perfect. Thank you. And we seem to have [ Vidal ] with us right now, right? Go ahead, [ Vidal ].

[Unknown Analyst]

Do you hear me now?

[Jenny Ramkrans, executive]

Yes. Perfect.

[Unknown Analyst]

Very good. That's nice to hear about PhenixID's development second quarter. Question, how much of the Clavister sales represents or comes from PhenixID? You have close to SEK 35 million, but how much comes from Phenix?

[David Nordstrom, executive]

Yes, that's a good question. And we -- in the report, we don't disclose individual parts of the business, but still to talk about Phenix, I would say that the Identity and Access Management part is roughly 1/3 of the group's total sales. Order intake might fluctuate, so I think let's talk about net sales because that's more normalized. So roughly 1/3. And I would add with good margins and a good profitability, so that's a very important part of our business, which is -- which we are very proud of.

[Jenny Ramkrans, executive]

Do you have more questions, [ Vidal]? No? Okay. With almost the entire PhenixID team leaving by the end of 2022, could you give some information on how this may affect the ability to keep providing software to support innovation within the IAM domain?

[David Nordstrom, executive]

I would say that, that's -- it's a good question, and let's answer that. And I think John and I could try to answer that collectively. Our view is not that the majority of the team is leaving by end of 2022. We have a change of leadership, as we say in the report. Peter Laurén, who was the former CEO of Phenix, who has done a very good job in building up that business, has left us. And we have a new CEO running the business.

And there are some changes in the team, but looking at PhenixID, we have a strong performance so far this year. And we are very confident of the team and the team's ability to keep producing high-quality products and services and also supporting our customers and driving good sales. So I would not agree with the statement that a majority of the team is leaving. There are changes in the team, and my belief is that those changes are fully manageable.

John, do you want to add something to that?

[John Vestberg, executive]

No, I agree. And for the entire business, for Clavister and PhenixID and all the various solutions, we keep on adding competence even though we are in a cost optimization program that also entails that we are increasing our competence density as well. We are recruiting and we see levers happening throughout the organization at all times. PhenixID is not an exception to that. And we have good talent across the board. And if there are levers, we replace them with as good talents.

[Jenny Ramkrans, executive]

Thank you. I would like to move into the 5G security business. You state that there is a slow development of the 5G security business in the period in the report. Should we worry regarding the 5G business and the relation with Nokia?

[John Vestberg, executive]

No, you should not. The relationship with Nokia as being one of our 5G partners, of course, the most important one, to be honest and transparent, that relationship is very good. We are expanding our activities with Nokia. We are deploying more software. We have a larger installed base and so forth.

But as David mentioned as well, the larger orders coming from 5G are typically fluctuating and 1 quarter without large license deals is 1 quarter. And we've built a strong base, but we will, of course, expect more. We are expecting more. And I think the entire industry has been somewhat disappointed about the slow take-up of 5G in general.

And of course, security is then also affected by slow take-up rates. But that being said and as I mentioned, the 5G technology as such is the most fast growing but from low numbers initially. So yes, we have all the reasons to be -- to still be looking forward to good business with 5G, and we maintain absolutely good relationship with Nokia.

[Jenny Ramkrans, executive]

Thank you.

[David Nordstrom, executive]

Yes. And adding to that, our control over when order happens is, to a quite low degree, controlled by Clavister. They are controlled primarily, of course, by the end customer who runs the process and then, of course, Nokia as the dominant partner and then by us, which means that there will be fluctuations where certain quarters are slower and others have -- happens more in other quarters. And I think that is to be expected. And of course, then the aim from our side is to lift the total volume and -- of number of deals and the size of the deals, but we will always have fluctuations between quarters.

[Jenny Ramkrans, executive]

Yes. Question coming in, Irdeto, what kind of business is it?

[John Vestberg, executive]

Yes. So Irdeto is a niche system integrator. They have activities in different kinds of end user segments, but their focus is, to a great extent, on what we would refer to as critical infrastructure customers. So that would include telecommunications. It would include transportation and similar businesses. So they are our latest larger partners signed, and we are actively working with them on a number of potential projects, which we hope to be able to get back to you within short time.

[Jenny Ramkrans, executive]

Thank you. What are you most proud about, John, in this report?

[John Vestberg, executive]

I think I'm most proud of the fact that with -- I would say with the exception of 5G, where we had higher hopes for the quarter, but with the exception of that, we see all the other solution areas moving forward, some of them very strong and some of them strong. And they are doing so in a period where we, at the same time, are managing our cost base quite aggressively, and we're running tough cost optimization program. And that is a balanced act that is not always easy, so I'm happy to see that the business is evolving despite cost optimizations.

[Jenny Ramkrans, executive]

Thank you. I have one last question, and that's for David. What would you highlight in this report if you would highlight something?

[David Nordstrom, executive]

I think -- I start where John left off. And I think we are reducing our number of FTEs, and that is challenging for any organization. And we see good momentum in the organization despite that. And I'm very glad and also very grateful to our staff that, that is the case. And I see that we set out with an ambition when our -- launching our new business model. We did that as we saw challenges in growing our business in the way that we want it, and I see then that we keep growing recurring revenues, which are very good for us in the long run.

I see that we ship much, much more appliances. I see that we have, in a challenging supply chain market, been able to secure our delivery capacity. And I think anyone, who's in the industry or similar industries where you rely on semiconductors, can acknowledge that, that is quite an achievement to secure that at good price point as well.

And the fact that we are shipping much more new contracts and building a bigger and broader contract base based on predominantly recurring revenue, so I think we are setting the foundation that we aim to do. So I think I'm very pleased with that. I'm sorry for the quite lengthy answer.

[Jenny Ramkrans, executive]

It's good. It's good. I think with this, I would like to conclude this Q&A session. Thank you, David. And thank you, John.

[John Vestberg, executive]

Thank you.

[David Nordstrom, executive]

Thank you, Jenny.

[John Vestberg, executive]

Thank you, everyone.

[Jenny Ramkrans, executive]

Thank you, all the audience. Thank you.