Clavister Holding AB

STO:CLAV

Earnings Call Transcript 2021-Q4

[Jenny Ramkrans, Chief of Staff]

Good morning, everyone, and welcome to this Q4 quarterly interim report presentation. I'm Jenny Ramkrans. And with me today, I have John and David. Before we get started, I will remind you that after the presentation, we will hold a Q&A section. And you can already now ask your questions in the Q&A function or in -- during the Q&A session, ask your questions on your own by raising your hand, and I will let you in. But now over to you, John.

[John Vestberg, Co]

Thank you very much, Jenny. So welcome. Good morning, everyone. Again, this is our Q4 interim presentation. I'd like to start off with an executive summary in regular order, where we have a glance of the key highlights from Q4. To start with, we saw a strong sales uptake in the quarter, and we attribute this uptake on a few things, specifically the go-to-market investments we've made over the course of the year, but also the launch of new products in the quarter as well as our new business model. And this new business model, it's a subscription-based business model, which we launched early in the quarter. It has been well received by partners and customers. And as such, we believe the new model has a significant impact on our business. I'll get back to that in a few slides. As a consequence, as a result, our order intake grew by 39%, reaching EUR 44 million in the quarter, while our recurring revenues from recurring business grew by 43%. And for the full year of 2021, our recurring revenues are now representing 70% of the total revenue stream. And this is, of course, an important benchmark for the company, not only because it represents the outcome of a steady transition towards more recurring revenues, but also as we all know, it's an important metric in any modern software company. We saw that the order intake and the sales growth in the quarter was driven from a variety of solutions and came from a variety of partners and distributors, which is a good thing. This means that there is no single order or exceptionally large order in the quarter that skews the profile of the quarter. The 3 main solutions that were the growth drivers include our next-generation firewall solution, our identity and access management solution and our 5G security solution. And as I mentioned, a wide array of partners and distributors and end customers that contributed to the order growth this quarter. Net sales, recognized revenues in terms of net sales grew by 16% to EUR 36 million. The subscription-based business model causes a short-term impact, which is expected to net sales. And again, in another slide, I will talk more about the new business model and the implications, both positive and negative ones. Another key event in the quarter was our launch of a cost optimization program, and we're doing this to accelerate our journey to profitability and to positive cash flow. Moving on to the new business model. So as mentioned, it was launched in the beginning of the quarter. It is a strategic move. It's one of our strategic pillars for our growth journey. And it essentially means that we're moving away from a typical classical perpetual type of business to a business which is based on recurring revenues and subscriptions. So we will benefit from seeing long-term license revenues from our customer contracts rather than 1x fees, where as a consequence of that, we would be building a steady growing baseline of revenues where new sales will add to growth rather than us having to chase our own tail in order to keep up with our growth numbers. There are a number of implications coming from this business model. It's, obviously, quite complex to introducing new business model and a new licensing model, and it has quite a few implications and I think it's important to account for those. The positive implication is from an operational point of view where we will see lower sales costs for maintaining our customer relations and our customer retention. The reason for this is that we are employing a out renewal-based business, where basically our customers have to take an active decision to quit using Clavister products rather than the structure we had in the past where you have to actively choose to renew to use our products. This means that our sales and marketing and partner resources can focus on attracting new logos, new customers and new sales rather than renewing our customers' current business. As a consequence of that, we expect the churn rates to go down. And as a consequence of that, again, our evaluation and our assessment points towards a lifetime value of our recurring software business that will be increased in the excess of 40%, 4-0 percent. So it's quite a significant increase of contract value. This is probably the most important and individual significant reason why we decided to make this change to new business model. There are some accounting impacts. One is what we, obviously, saw already in this quarter, there is a short-term impact on recognized revenues. Reason is that we are distributing the total contract value over a longer time, and the initial delivery causes a negative impact. And that is also related to gross margins. So the first phase of deliveries of new customer contracts will see somewhat lower gross margins but that is then compensated for with very high gross margins throughout the remainder of the contract. And if you then combine that with the fact that we're extending or assessing that we're extending our contract with 40% in time, that will have quite a dramatic effect on gross profit as contracts are being built up over time. But these are the key implications. In the quarter, we also made a significant product portfolio refresh, specifically in our next-generation firewall solution. What you see on this slide, it's a range of new next-generation firewall products, which were launched early in the fourth quarter. They have also been well received, and they have been shipped to quite good volumes already. We are -- as any vendor in the electronics industry, we are working hard to make sure that we are not impacted by the COVID-19 supply chain issues. We have been able so far to keep up and to avoid large implications coming from that. But we're, of course, vigilant and making sure that we can source as much as possible. This new product portfolio or the refresh provides us with an increased competitiveness. It's -- it provides us with better price performance ratios, more connectivity options for our customers and a larger feature set that can be deployed in ranges from smaller sites through midrange sites even up to the most demanding data centers. A few highlights from the quarter in terms of businesses, starting with our public sector target vertical, where we saw a number of new -- both government agencies and state or publicly run critical infrastructure businesses, both in Nordics and in Germany. And this is a good proof point in our point of view that our focused efforts towards fewer verticals and limited geographies is yielding results. I would like to highlight one customer, just to give one example. It's a very significant law enforcement customer to Clavister that took a strategic decision in the quarter to extend and expand their business with Clavister. Within the service provider domain, we also have the benefit of adding several new service provider contracts in the period, ranging from larger Tier 1 mobile operator contracts down to smaller regional and even local service provider customers. So a good span of new contracts. A couple of examples, one being an Asian-based operator that decided to expand their security offering based on Clavister products. Another example is Latin American-based 4G, 5G operator, who is increasing their security posture with our 5G security solution. Within the defense segment, obviously, this is a long-tail business and lumpy business, as we know, but we are actively running a number of engagements. Those engagements are progressing according to plan, specifically with our larger engagement with BAE Systems. We are now approaching what we call the [indiscernible] phase. That means that product development has been completed, prototyping has been completed, and we're now moving into serious deliveries. And this is where the larger rollout of products are happening. As previously informed, we acquired Gothenburg-based AI ML vendor Omen technologies. And this acquisition was completed in the fourth quarter. We are currently integrating this technology stack into the larger portfolio of Clavister products. And meanwhile, while this integration is happening, we are conducting pilots and proof-of-concept deployments of this technology with a number of prospect customers, some licensing customers of the technology per se and some proof-of-concept customers on the integrated solution. Moving to the cost optimization program. And as mentioned, we see good momentum in our business right now. I mean, obviously, demonstrated by a strong quarter. But even more importantly, we see the buildup of the opportunity pipeline that, of course, has yielded result in the quarter, but also serves as the foundation for future business. Nonetheless, we also need to realize that we have a cash flow profile and liquidity, which exposes the company for an unnecessary financing risk. And this is dampening our possibilities to act freely, and it is preventing some of the business growth that we anticipate. So for those reasons, we decided to launch a quite significant cost optimization program in the fourth quarter. And obviously, we're doing this to mitigate the financing risk and to accelerate the journey towards profitability and positive cash flow. David will talk you through the details in this program in a short while. So with that, handing over to David.

[David Nordstrom, Chief Financial Officer]

Thank you, John. So looking at order intake, we saw, as John said, order intake increase of 39% year-over-year. It's driven by a strong momentum in our underlying business and definitely supported by the rollout of our new subscription-based business model. And just saying something about that, I would say that we are now delivering our high-end cybersecurity solutions in an attractive and competitive pricing where our customers see payments and cash flows as they consume and use the service, and we have lowered the threshold for investing in our solutions, and that has, in general, been very well received by the market. And by adopting this profile, yes, we see some impacts early on cash flows and net sales generation. But we built a much stronger platform for good cash flows and a stable revenue-generating platform over time. So we strongly believe in this shift, and we're glad to see that the market does so as well where we drive more order intake through this change. Looking at net sales then, we have some impact by FX. So if we subtract that, we have an FX adjusted growth of 13.2%. And if we exclude FX effects, our growth is 16.5%. And just looking at the delta here of order intake growth of 39% and a net sales growth of 13.2% adjusted for FX. What that says is we have an order intake that will come into play and generate more net sales growth as we move through time. And just adding a bit more to what John said before, one very important change in our new business model compared to the old is that in history, a lot of the value of our offering was associated with the hardware platform. So when we sold a contract in the past with an associated firewall, we recorded lots of net sales early in the contract because the -- a big portion of the value was associated to the hardware. This is now changed where the hardware only have more or less -- we will sell it more or less at cost, meaning, of course, that when we distribute our hardware and software component to a customer, what we record as revenue upfront is lower because more of the value is attributed to the software component and is then recorded over time. So this is a big change, which one needs to take into account when looking at our net sales performance. This means that we will have a much stronger net sales support over time for -- from the contracts that we are winning. Looking at recurring revenues, repeating what John said, a strong uptake where we keep delivering on our strategy to build a more robust P&L going forward, where more and more of our net sales is attributed to recurring revenue contracts, and we see, of course, the transition to our new business model accelerates that where we grow with 43% in the quarter, ending on 72% of recurring revenues compared to 58% in the corresponding quarter. Some words on other revenues. And what I would like to emphasize here is that we're seeing that we are now back to more normal levels. Those spike during 2020 due to one-offs and to a large degree related to different COVID-19 impacts where other revenues soared. And I would say that the levels that we're seeing now is more normal to our business. I think that's what we want to comment here really. Looking at COGS, some increase, but that's to a high degree, due to the strong order intake and the corresponding sales growth. We see that we maintain well above our target of 80% of gross margins. And of course, periods of high growth have an impact on margins. And as we keep rolling out contracts after initial rollout, the margin is significantly higher and will support gross margins going forward. But growth will have an impact on margins. Underlying OpEx increasing somewhat in the quarter when we remove nonrecurring costs in this year. What we see here, those 3.4 billion is representing the first part of our cost optimization program where we have set out to reduce number of FTEs. And have a first part of cost restructurings in recorded with a P&L effect in the quarter. In the corresponding quarter, we had different nonrecurring elements as well. So if we adjust for that, we see a slight increase in OpEx. As I said, we have launched a cost optimization program with the aim to well significantly reduce our run rate cash OpEx. And this program, the activities in the program will run until Q3 2022. And we will see the full impact on cash OpEx during the fourth quarter. We will talk a bit more about that as we go through the presentation. Financial items. The impact on cash flows keep to be stable around EUR 1 million or a bit below. And the remaining amount is, as you know, noncash related to costs for the EIB warrants, long-term interest to the EIB loan, but -- and also finance, FX revaluation effects of the loan as the EIB loan is in euros. And as you know, our recorded P&L is in SEC. So you will always have FX impact here, creating some volatility in that number. Some words around the balance sheet and cash flows. We see an increase in CapEx investments in the quarter. It's driven by continuous investments in the SASE solution, the cyber armor solution who is nearing production phase and of course, the acquisition of Omen Technologies and with that corresponding subset of AIML IPRs. So these factors contribute to the growth. And we have a slight increase in [ annotations ] then due to continuous buildup of tech investments. Cash flows before working capital changes, some improvement here with a somewhat reduced cash burn in the period. We will -- our aim is to improve that with -- which is one of the reasons of the cost optimization program. Cash flow after working capital changes, what we see here in both on operating receivables and operating liabilities is that growth have an impact. So the impact of operating receivables is a negative impact of EUR 16.9 million, where the absolute majority EUR 12 million is account receivables that will be paid during Q1. So it's a -- say, then a short-term negative impact by -- driven by positive effects of a growing business. And we see a corresponding uptake in operating liabilities. So -- and I will -- yes, everything I would say is related to growth. So nothing really that stands out. So it's more a general growth there. And just repeating a message that we have had during this year is that during the 12-month period, we have burdened cash flows with nonrecurring payments of EUR 29 million. None of those are attributed to the fourth quarter. But looking at the full year effect, we have repayments of COVID-19 support. We have had the payment of fees related to the 2020 cap rates and the final down payment of an IPR Board in 2020. So of negative cash flows of during 2021, EUR 29 million of that is related to 2020 and a small increase of FTEs as part of investments in tech and go to market. And we anticipate the FTE number to decline as we move through the cost optimization program during 2022. So some words on that. During late Q4, we launched this program with the aim to accelerate the earning to profitability and positive cash flow. We believe in growth in our business in order intake and in net sales. But we also see a need to reduce our costs and our negative cash flows by having a very strict review of our entire cost base. The goal is to reduce cash OpEx with 20% from the 2021 exit run rate level. We mainly focus on managerial and administry resources where we look at reorganizing the organization where we can reduce managers where we can reduce admin support by structuring our teams in different ways. So -- and then, of course, looking at all our contracts, all our spending in all parts of the business to have a very structural approach to reducing our spend. And we believe that this will have a significant impact on cost and on cash flows without jeopardizing our go-to-market engine, we see more investments there to drive more growth. And we are committed to safeguard our IPR investments because that is the mechanisms to create future growth and future shareholder value. So the program is not aiming to cut our sales capacities or our product development capacities, but rather streamlining the organization where we cut our cost levels in all other areas. The positive P&L impact and the corresponding cash flows will start to materialize in Q1, but we will -- we anticipate to see P&L effects first. And then there will be somewhat a lagging effect on cash flows as, for example, as the number of FTEs reduce, and salary payments then will correspondingly reduce with that. And as said, the program will run until Q3 2022 when the activity side of it, at that time, we expect that all activities related to the program will be concluded and the full cost savings will be realized during the fourth quarter. So it will be a buildup of cost saves as we move through the year. Material post-closing events then, some words on the -- what the Swedish government has done related to COVID-19 support program for business that will -- some of these programs will be strengthened and prolonged as the COVID-19 pandemic keeps impacting businesses. One such program is liquidity support through deferral of tax payments related for staff-related taxes and VAT. And we have previously used this program, but we repaid it in full during 2021. And by using the possibility to request deferral of tax payments, again, Clavister's cash position will be significantly improved during 2022.

[John Vestberg, Co]

Okay. Thank you, David. Before moving into the Q&A session, then just a few words on our updated outlook when we now move into the new year. Key to start with is, again, to emphasize that when we now have moved into our new subscription-based business model, as previously mentioned and indicated the net sales recognized revenues from our business will have a short-term negative impact. And as such, we expect the 2022 or 2021 net sales growth to be somewhat more moderate as a consequence of that. Then as we're normalizing the effects from this transition, we believe that the average net sales growth can increase to an average of 20% in the years 2023 through 2025 on a CAGR level than averaged growth level. As a consequence of the cost optimization program and the growth in combination, we believe that we will see a significantly lower run rate cash OpEx and that the impacts, the positive impacts are being seen already on cash flow and EBITDA during this year 2022. So that's our updated outlook. And with that, moving over to Q&A.

[Jenny Ramkrans, Chief of Staff]

Yes. Thank you, John, David, for a good presentation. Let's see. Let's get started. I will start with the [indiscernible]. How do you see the company's liquidity situation for 2022?

[David Nordstrom, Chief Financial Officer]

Yes. That's a good important question. We -- as we say in the report, we end with a cash position of EUR 50 million. We are running a cost optimization program to reduce our cost base during 2022. So that will have an important support. And as we said in material post-closing events that we are -- we plan to use the possibility of deferral of tax payments during 2022 and expect a significant positive impact on our liquidity due to that. And we, of course, look at other options and other possibilities of strength and liquidity if need arises.

[Jenny Ramkrans, Chief of Staff]

Before I move forward with the questions, I will remind everyone that you can use the Q&A section to ask the questions or you can raise the hand, and I will let you in and ask the questions to John and David on your own. I prefer the last one since it's more nice to hear your voice as well. One more question. Why do you implement the cost optimization program? And what are the most important objectives you want to achieve?

[John Vestberg, Co]

Right. So I can answer that. I mean, obviously, we are a growth business, and we have invested in go-to-market and in our product development activities to drive growth and to build up a larger market share and through that fulfill our objective of building a larger cybersecurity vendor in Europe. Obviously, at the same time, we have a cost level which is quite high. And at times, we need to review our P&L and review our cash flows to make sure that we can sustain our investments in growth engines. So to that extent, it's a natural review that we're doing. It's quite significant, though, and we do that to make sure that we can mitigate and reduce as much financing risk as possible for the company.

[Jenny Ramkrans, Chief of Staff]

Moving backwards, what is the cost related to the optimization program in Q4 2021?

[David Nordstrom, Chief Financial Officer]

We have recorded a restructuring reserve of EUR 3.4 million in Q4 related to this program. And that relates to expected redundancies of the program of a -- and that part of the process is currently running. And when the interim report was made, our best assessment at that time was that the cost will be EUR 3.4 million, and that's then recorded in the period.

[Jenny Ramkrans, Chief of Staff]

Moving to cash flow situation again. Will you be able to achieve positive free cash flow without additional liquidity?

[John Vestberg, Co]

When everything is a factor of our growth, obviously, and how well our business develops over the course of the next period. We have an ambition that we should reach positive cash flow as soon as possible and avoiding going to the capital market. We can never promise that no business can do that, but I think the changes that we're implementing now is our testament to really driving the business as effective as possible without using external sources. So that's the answer to that.

[Jenny Ramkrans, Chief of Staff]

You talked about the subscription-based business model. How is the gross margin affected in the transition to the new model?

[David Nordstrom, Chief Financial Officer]

From a long-term perspective, the impact of gross margins is -- we believe that to be very positive as more of the value -- the contract value will increase as a consequence of the shift. And as we have very high margins on our software, the transition to where we transfer more value to the software, that will mean that we increase our revenues over time with a positive impact on margins. But if you look on it only in the short-term perspective, there are 2 effects. First, we believe that the new business model will drive more growth. And as we grow, the initial impact on margins is negative because in the rollout phase, we all -- well, not always, but to a very high degree, have a hardware element. And when we roll out hardware, the margins are lower. In the new business model, we have lowered the price on the hardware component and raised the price on the software component that is generated over time. So the initial impact of both growth and the lower hardware price in the new business model will have a short-term negative impact on margins. The long-term effect is, however, deemed to be quite positive or very positive.

[Jenny Ramkrans, Chief of Staff]

And we have a raised hand. Thank you, David. Oscar, I will let you in. Are you in, Oscar? You are muted.Let's do another question before that. John, what are you most -- what are you most proud about regarding this report?

[John Vestberg, Co]

I mean the growth -- the strong growth in order intake and recurring revenue and the associated net sales growth is, of course, a very positive sign. More importantly, I would say that the fact that this growth comes from such a wide array of partners, distributors and end customers and where we really don't see any single deal that sort of disturbs or skews the numbers in the quarter. I think that's solid. That's really good. Also that the growth and the sales comes from our main solutions and where all of the solutions contribute to growth. That is also a very positive sign. It means that our investments that we made in the very solutions are yielding results.

[Jenny Ramkrans, Chief of Staff]

You published the first order where you mentioned Nokia as a customer specifically, has the relation with Nokia intensified recently?

[John Vestberg, Co]

Yes, correct. So you're referring to the press release that we published recently that announced a deal together with Nokia in Australia. It is true that we have intensified our work in the 5G area, not only with Nokia, but with other partners as well. We are moving into a situation, I think we have explained or announced this before, where initially Clavister Solution or Clavister Technology was part of Nokia's 5G or to some extent, 4G core network blueprint. The difference today is that we have expanded also into other areas outside of the 5G core blueprint. So we are engaged in deals, for instance, with what we mentioned in that press release with a railway operator, which is, obviously, an enterprise type of business customer to Nokia. And through this increased level of engagement, we are not always, but to some extent, more -- can be more open with our relationship and use also the brand name Nokia in another way, which we were prevented to do before.

[Jenny Ramkrans, Chief of Staff]

Thank you, John. Could you elaborate a bit about what you currently see in the M&A market? Are you looking at any targets? And what kind of targets would that be?

[John Vestberg, Co]

Good question. Yes. As you might remember, we have in our growth strategy, one of the growth pillars or key pillars is M&A. We just recently completed the M&A of -- or the acquisition of Omen Technologies and the integration work happening there. We have a long list of various type of potential target acquisitions. We have, obviously, to realize that we're still a small company and we have limited bandwidth to engage in too many acquisition discussions or events at the same time. So right now, our focus is to complete the integration work with the acquisition of Omen. And then we keep on monitoring potential targets. And if there is a good match that services, of course, we are ready to start engaging on that.

[Jenny Ramkrans, Chief of Staff]

Moving back a bit to the service provider area. Could you give some color on the development on 5G security market? How has it developed during this quarter? And what do you see in the coming quarters?

[John Vestberg, Co]

So we -- as we mentioned in the report and also in this presentation, we are adding more and more service provider contracts. And I think one important and positive development is that in previous -- perhaps not in previous quarters, but in previous years, the service provider sales has been very much focused on the Tier 1 mobile operators with long lead times and quite long tail business. That is still a business that is growing. We're adding more and more 5G operators to the portfolio. But we're complementing that, and that is especially what we saw in the fourth quarter, a scenario where also smaller service providers and not only mobile operators, but managed security service provider, Internet service providers or other types of service providers are turning to Clavister for their security needs. So it becomes a broader and more diversified service provider sales for us, which is good. It reduces risk and it sort of reduces lumpiness from the business. But the sort of original or underlying 5G-related sales is increasing, that is for sure.

[Jenny Ramkrans, Chief of Staff]

Moving into different focus markets, defense. Can you please comment on potential follow-up deals with BAE Systems, anything possible in 2022?

[John Vestberg, Co]

So what we're doing in defense is twofolded. One is, of course, us delivering on the contracts we have and the engagements we have. That is a big undertaking, but also, of course, a very fruitful one with high volumes committed to the business. In parallel to that, we have committed sales resources to drive additional defense opportunities. And there is an interesting opportunity pipeline. Everyone knows that defense contracts and defense-related business is high-risk, high-reward super long tail. So compared to other types of businesses, we don't have the volume or the spread. It will be a few orders, but very large ones, obviously, as demonstrated with the initial orders we've seen. There is a pipeline of such orders. It is obviously related to government, defense budget spending so and so forth, which is very much outside of Clavister's control. So while there are opportunities that could materialize in 2022, it is a little bit too early to say if they will do so. But we're tracking the situation. We're engaged in tenders and we, of course, have good optimism to see that those turn into business. And obviously, as everyone knows, with the current geopolitical situation, it could be safe to assume that defense spendings in general will increase rather than decrease.

[Jenny Ramkrans, Chief of Staff]

You were mentioning a strong sales bundle. Can you share some details on it? How has it changed your -- how has this changed year-over-year?

[John Vestberg, Co]

It has been a continuous buildup. So as in other -- as in any sales activity, we need a large funnel to drive order intake. It's purely a numbers game. We have an internal target, which we're not exposing to the outside, which is significantly high. It is a very strong funnel target we have. We have reached quite well advanced on that target already. We have more to do. We -- and that's the reason why we have now a dedicated go-to-market team, which is driving new opportunities. So it has been developing well. And obviously, with the lead times to close deals, the Q4 order intake is a result of a built-up funnel over the year.

[Jenny Ramkrans, Chief of Staff]

David, what would you highlight from the report, if you would highlight something?

[David Nordstrom, Chief Financial Officer]

I would highlight the fact that we set out to do a certain amount of things, and we have done that. We set out to drive more growth by implementing a recurring revenue-based business model. It has been implemented and it's driving growth. I think that's one important thing. We saw that in order to be successful in driving more growth, we needed to have a stronger focus on our key markets and key verticals. We've implemented that and implemented a new stronger sales leadership to drive that investments in an overall marketing organization to support that with good messaging and good support in our business. So -- and keeping -- keep up the transition to more recurring revenues. And I think we can proudly say that these activities has been performed, and we believe that, that will drive more growth going forward. So I think that's something I would like to highlight, delivering on what we set out to do.

[Jenny Ramkrans, Chief of Staff]

With that, there's no further questions. So you want to say something in the end, John?

[John Vestberg, Co]

I mean just concluding on thanking for the support, and we remain committed to build a good business, and that's why we're here.

[Jenny Ramkrans, Chief of Staff]

Thank you, everyone, for participating today. I will upload the presentation afterwards this.

[John Vestberg, Co]

Thank you.

[David Nordstrom, Chief Financial Officer]

Thank you.

[Jenny Ramkrans, Chief of Staff]

Have a great day. Thank you.