Exsitec Holding AB

STO:EXS

Earnings Call Transcript 2023-Q2

[Johan Kallblad, executive]

Welcome to this quarterly update for the second quarter of 2023 for Exsitec Holding. Thank you for joining. Talking now is me, Johan Kallblad, and I've been in this role as CEO of Exsitec since 2010. I expect this presentation to be around 15 minutes, and it is possible to ask questions via the Hand Raise function in Zoom or via the chat function.

So as usual, I will start off by making a short recap of our business, a reminder of what it is that we do. And after that, we'll cover our Q2 financials and a short market update and a recap of our priorities going forward.

So we exist to help medium-sized businesses in the Nordics use digital tools to improve their operations and we help doing this so they can focus on their own core business, which really is digital solutions and more often it is helping their customers. So digital tools can address areas like reducing financial administration through automation or use data for better decision-making and forecasting or adopting e-commerce or managing sales force.

We sell and implement around 20 software packages from around 10 software developers, and these are the primary software providers at this time. We have a revenue share partnership with these software providers where we market and sell their software to new accounts, and we make the customer successful in using the software over time. Our ideal customer uses up to 5 or 6 different components delivered through us, but the average customer is today only at just over 2. So there is a lot of work remaining in growing our footprint on existing customers.

The business model is built on 3 revenue streams. Our own sales and marketing is focused on selling software from the selection of third parties together with integrations between the software that we develop in-house. This is sold on a subscription model where you pay as you use, and this revenue stream is around 20% of net revenue for us. Just under 2/3 of our revenue is from professional services, where we implement the software and we make the customer successful in using it over time. We also do custom development and custom integrations where needed.

The third part of our business model is that we offer our customers a single point of contact support on a recurring fixed price model. In this, we can also take care of infrastructure and Internet access and IT security. We try to keep implementation projects relatively small, and we want to earn trust and scale our engagement with the customer over time where they also get a predictable cost structure with most of their running costs on a subscription model.

So I came on as CEO of Exsitec in 2010, and it took us a few years to set up this current business model and to reach scale, but since then we've had 10 years of solid profitable growth. And at this moment, we're just over 500 employees. We actually have reduced head count a little bit in the last 2 quarters with a specific reduction in the workforce on the e-commerce area, where we had a weak financial performance and also some reduction in overhead and the general focus on increased efficiency.

We defined our target market as medium-sized companies with at least SEK 50 million in revenue. We have around 4,000 active customers. And typically in a year, no 1 single client is more than 1% of revenue. There is no size limit upwards on where our model works, but we don't actively target the enterprise segment in our sales and marketing. We're happy to assist if they reach out to us with a specific need. So we do have quite a few large corporations as active clients as well.

An interesting thing we can do with the software components we work with is to combine them in a modular way, and we've created packages to fit different industries. These packages are often made up of the same foundational components with some industry-specific add-ons. All in all, the customers are spread through many different industries.

So talking a little bit more of what we've done in Q2 of '23 before moving into financials. I have communicated before that from the second half of 2022, we revised our priorities a little bit and decided that improved margins should be #1 before maximum growth. So that has been a key focus for us, working on stronger margins and operational excellence in what we have.

Also, we worked a lot on the business in Norway, and we're seeing very encouraging results from that operations. A somewhat unexpected statistic is the strong order intake where we actually saw a record number of new deals. It's a little surprising as we felt the market has been slowish, a little bit soft from Q3 of '22 up to Q1 of '23.

And lastly, a big internal undertaking was moving the business in Stockholm to 1 location from being scattered on 3 sites, and this is where the picture is from.

So let's dive into the specifics for financials in the second quarter here. Overall growth of 13%, organic growth of around 7%. Quarter, a little bit challenging in terms of working days with a lot of holidays, which affects our professional services as well as our customers. We've kept on prioritizing margin over maximum growth, and this means that we're taking out some businesses where we don't see a long-term profitable viability for us, primarily, that would be work done by subcontractors and custom consulting that doesn't contain product. Nothing dramatic really, just focusing on the things that we do best.

Profitability, I think, is the financial highlight of the quarter. EBITA is up from SEK 25 million to SEK 34 million, which means a margin improvement of over 3% to 18.2% margin in the quarter. Year-to-date, we're up 31% in EBITA, which is really nice since we have been able to cover for some things that are actually challenging, like a little bit worse calendar, change of the premises in Stockholm, more travel and kickoff activities post-pandemic, inflation.

Takes some time to change focus in an organization, but I think we were quite early on it in changing to prioritizing margin over growth last fall, which means I think we can also be well prepared for getting back into a stronger growth mode when the external conditions are favorable. So I've gotten a lot of questions on prices. We have not made specific price increases in Q2, but we are keeping up indexing on existing contracts according to the labor cost index, which covers the increased salary costs as well.

Going through the segments in a little bit more detail. Sweden, again, with a strong quarter, solid growth and earnings. EBITA margin is at the same level from last year. Weak performance in the e-commerce business led to us having to do a reduction in force here, and we had some costs associated with severance payments that we took in the quarter. feel much better now with the balance of demand and capacity.

Norway is still operating at a lower profitability, but good signs of a turnaround going from a negative margin of minus 3% in '22 to an 8% margin this year. It's all that we hope from, from the new management that has been in place for some time now. Also around the 10% growth. Forget 1 or more -- 1 or 2 more quarters of improvement, we should be on solid grounds moving forward here.

Denmark, keeps on doing a good job, has a decent growth despite divesting a business unit in Q3 of '22 that we didn't see a future in. Margins are improving here, too. So I'm quite happy with all the segments this quarter, to be honest.

The recurring revenue stream from software is a nice consequence of our business model, and that helps us having more stable results and cash flow than if we were only a professional services company. In Q3, we did divest our FlexPOS retail business in Denmark, which does reduce these revenues a little bit. And we have not made an adjustment for that in the graph, but several of our suppliers made price increases at the start of the new calendar year, which will help us throughout the year.

On the negative side, we do have the feeling that churn is a little bit higher this year than the last few years, with customers, for instance, looking over the license usage and removing unneeded users. It's not a big problem, but we're coming from a few years where churn was almost 0. So all in all, solid growth in this revenue stream, total growth of 22% year-over-year.

So I wanted to share a short update on the market conditions and our priorities. So the market in Q2, some unexpectedly strong sales numbers actually. I tracked 4 KPIs to monitor sales. How many leads do we generate? How long time does it take between a qualified lead and a sale? How many sales do we do in total? And what is the average order size?

So a negative KPI that's been going on for some time is that we have seen lead times increase, the time from lead to close deal, it increased in Q3 and Q4 of '22 and in Q1 of '23, peaking out at more than 50% longer sales cycle times than the historical average. We saw some encouraging signs actually very late in Q1, where lead time stopped getting longer, but they are still longer than the historical means. And this has been the case also in Q2 when we see the sales process just being 20% to 30% longer rather than the 50% longer that we had in Q4.

So throughout this slower period, we have been generating a lot of new leads. So now when the lead times stopped increasing, we are seeing something like a 30% increase in the number of deals with a 25% increase in the average deal size compared with Q2 of last year. So this is probably the best improvement in a quarter that I can remember. Total order intake is up more than 50%. We do not know way. It could be that some things that were stuck in a sales process just fell in the right place. But we are talking about some 400 deals here.

So it's not a single deal or a one-off that's -- or 2 that's skewing the metric. So we will track and get back with more info in the coming quarters as we understand if this is -- was a temporary improvement or if it's a change in the market conditions. But quite -- a little bit surprised, to be honest, and quite encouraged.

So looking at priorities for 2023. Overall, I think we are in a really good shape. We've taken actions to improve margins, and we intend to keep on doing this. There is still some improvements to be made, and I think we'll see the results going forward if we've done the right things. So there will be challenges, of course. We do have a lot to work with on developing existing accounts also.

So no changes in terms of strategy. We're executing on a business model now that we have implemented and refined for over 10 years. So the plan is to continue on a long-term profitable growth journey. The macro environment may be challenging, but we will mostly be restricted by our own execution. So all in all, a solid quarter, and we think we're in really good shape financially.

So lastly, I wanted to share an update on one of the prides of our organization, our trainee program. We are again getting back to record numbers, at least in Denmark and Sweden. In Norway, some work still remains on internal efficiency.

We were a little bit reluctant in committing new costs early on this year, and we were considering running a scaled-down version of the trainee program, but we felt we had such exceptional performance in last year's program and such strong sales numbers in 2023 that we decided to scale up after all. And all in all, there will be around 80 people that will start in the Exsitec trainee program this fall. I'm looking forward to welcoming these new colleagues in early August. Before that, I will try and enjoy the Swedish summer as best I can.

So that concludes the presentation. If there are any questions, please feel free to ask. It's always -- you can use the Hand Raise function in Zoom or the chat function. It's also always possible to send an e-mail to [e-mail], and we'll try and respond as quick as we can.

[Hampus Strandqvist, executive]

It doesn't look like we have any questions. So with that, we'd like to thank you for -- yes, we have. Now we have a question, let's see here.

[Johan Kallblad, executive]

I'm too quick in presenting.

[Hampus Strandqvist, executive]

Yes. Okay. I've unmuted you. You're welcome.

[Karl Norén, analyst]

Can you hear me?

[Hampus Strandqvist, executive]

Yes.

[Johan Kallblad, executive]

Yes.

[Karl Norén, analyst]

It's Karl here from SEB. So congrats on the strong results, looking good here. I'm just wondering a bit on the order intake, it sounds quite bullish, I must say. So I'm just wondering when we will see that in the revenue growth, again, because I think revenue growth is a bit maybe lower than what we're used to and what it should be over time in Exsitec. So just curious to hear your thoughts on that.

[Johan Kallblad, executive]

Yes. We were actually -- first, to comment on the sales numbers, on the overall revenue. Since we know that we take out some of the things that we don't think add much, like the low-margin operations that reduces revenue, but it doesn't reduce earnings. So we have actually, in some areas, chosen not to keep up doing some revenue-generating work that does not produce margins for us. So it's a little bit by choice, the lower revenue. So I'm not actually worried about that in the short term. But it's a good question.

So typically, when we look at sales numbers, we try to -- most of the revenue that we sell in the professional services side is realized over a 6-month period after the sale. So typically, it's a little bit slower after the summer because if we sell something late June, we won't start delivering probably until September or -- it should be August. I wish for August, but it's usually September and sometimes October. So it's a few months between a sale and professional services revenue, 1 to 2 months typically, and then the project goes on for up to maybe 6 months.

The revenue stream from product is -- what we look at in order intake is the 2-year product revenue, so -- and actually, most customers are customers for 10 years or 15 years. So it's actually even understating the long-term revenue, but it will -- before it's a significant product revenue, you should expect it to be 3 to 6 months on the license side and maybe 2 to 3 months on the professional services side.

[Karl Norén, analyst]

Yes. So then I have a question also on the growth, again, maybe on the top line growth because I think organic growth was at 7% in the quarter. And if I just look at the different -- kind of the revenue split, it seems like consulting grew a bit faster and the main -- lower sales year-over-year is related to the other parts. Is that anything -- I think that is down...

[Johan Kallblad, executive]

Yes, yes. And that's mostly in this FlexPOS business that we divested in Denmark. There were some hardware sales and other things that we -- that's one of the examples of revenue streams that doesn't produce much value for us. It's, for instance, reselling hardware and we've tracked as other revenue. So it's not the focus of ours. So we try to get that...

[Karl Norén, analyst]

You said the core underlying organic growth is probably maybe 10% around there...

[Johan Kallblad, executive]

You have to do -- that's a very hard thing to calculate. I mean -- but one thing that is -- that I wrote about in the report is that we actually have -- for instance, we have a negative 30% growth in an acquired unit that we acquired last year that does e-commerce. That's very unfortunate. It was a bad timing on our decision to do the acquisition there. And we cover those negative 30% with other organic growth.

So I think in a steady state, looking at the business as it is, I think it's fair to assume somewhere above 10% growth that should be supported by the underlying market. But then we've done -- we try to get rid -- again, we try to get rid of things, like things that -- if we have product delivery or consulting deliveries that are purely done by subcontractors, it's better that's not a part of our P&L sheet. And same thing, if we have hardware deliveries where we add very little value to the hardware, it's also nothing that we want.

So we try to clean up the P&L a little bit, and I know it's going to be a few quarters where it shows as a slower growth. I think Q1 and Q2 and then sometime Q3, Q4, we should be done with that is my expectation.

[Karl Norén, analyst]

Yes. Sounds good. And then on the -- you write that you had taken a direct cost of SEK 2 million, I guess, maybe to fire some persons in the e-commerce business. Is that adjusted for in the adjusted EBITA figure?

[Johan Kallblad, executive]

No. So adjusted EBITA is that -- we have not changed -- so no. And that is -- I mean to some extent -- and it shouldn't be, I don't think -- that happens. Sometimes you end up with the wrong competence mix and then you need to do adjustments. And then you should take that over the results. So we think -- we discussed that back and forth a little bit, but we felt that this was the honest way to do it.

But we still wanted to talk about it because you may get the feeling that our salary costs are increasing more than that they actually are because we have some severance payments that are actually going to be paid out in the months ahead, but we take that cost right away. So you may get the feeling,, if you deep dive in our results, that salaries are increasing more than what they have been. But it's not a huge thing, all in all, but we decided to take that throughout the August quarter and not do an adjustment for it. It's a part of the people business that this sometimes happens, too.

[Karl Norén, analyst]

Yes. It's just that a lot of companies have differences in how they do with adjustments, et cetera. So I just wanted to check that, but that's good and clear. Just the last one is on Norway. I missed the beginning of the call a bit, was on another call. So just curious to hear your thoughts on Norway. And have you seen -- have we seen a clear turnaround there now and are we confident that...

[Johan Kallblad, executive]

Yes. I reported -- not sure if you remember, I reported already last -- actually after Q4 that we saw some encouraging signs and then we had a better results in Q1. And now in Q2, the market -- as you can see there, we went from a negative 3% margin to a positive 8% margin. So that's an 11% margin turnaround in 1 year. And it's been now, this is the third quarter where we actually are encouraged by the movement.

It's still early. But I do think -- I'm a lot more confident than I was 2 quarters ago. So we're feeling pretty good. And actually, we were a little bit lucky here or -- in that Visma, it's 75% of the business in Norway for sure. It's working -- 80% maybe is working on the Visma product line. And they released a new version of a legacy software, where we have a large customer base. So it's a lot of conversion projects going on.

And actually, we've only converted, I think, less than 5% of our active customer base. So I think this -- assuming that we keep having the strong interest in the market for doing this conversion. And so far so good. We have about 15 customers live. Assuming this continues, and it should, then we should have a good solid -- I mean we should have 3, 4 years of nice conversion works, evening out -- giving us a solid foundation for a reasonable growth over the last -- over the coming couple of years. So we're feeling a lot better about Norway.

[Hampus Strandqvist, executive]

We've also got 2 questions through the chat. So the first one is what you believe are the possible margins Exsitec can reach in midterm and long term in Denmark and Norway?

[Johan Kallblad, executive]

Yes. This is a good question, and I can only look at some -- I will choose to answer that vaguely. It's -- in Denmark, we have the need to do -- to invest a lot in growth and trainee programs and people. And that will take -- that will limit the margin a little bit. But there is no reason for why the margins should be lower than in Sweden now because now we've changed the set of offerings that we have in Denmark, to be the same softwares that we work with in Sweden. So it's much more aligned with Sweden. And it's no difference if we work on the same sort of vendor agreements and we have the same sort of revenue share agreements and so on.

So there's no structural reasons for why margins should be lower in the long term. But it will be -- before we're at 20% margins, so I think there will be -- I think we should be happy if we see -- the coming 2 years, if we see a 15% margin from Denmark, that should be nice and encouraging because we do want to invest in hiring new people. And it's a relative higher number of new people and new sales and new offerings there. So it will take some time in Denmark.

Norway, this may seem to be counterintuitive, considering that we've had such bad performance over the last couple of years, and it's now going to an acceptable performance. We still see no structural -- I've been asked this for 1.5 years or 2 years. We still see no structural reason for why margins should be lower in Norway actually. So we've had an internal culture problem around cost and efficiency and so on. As we keep on working through that, if the management keeps on working through that and we get to a similar culture that what we have in Sweden, we actually expect it to align to the Swedish levels faster rather than slower.

So in my most positive projection, we're only a year away from having the same margins in Norway as in Sweden. But I've been disappointed in Norway before. So I'm not making that as a solid prediction. Does that make sense? Is that clear or vague enough?

[Hampus Strandqvist, executive]

So the second question we've got is regarding the software kickback that you get, how does this work? Do you get a recurring kickback during the whole time that a customer uses a specific software or for a limited time?

[Johan Kallblad, executive]

Yes. So we don't talk so much about kickbacks and kickback structures. It's -- we try to have more of a revenue share partnerships where we -- sometimes, it's we that invoice the customer, sometimes it's the software vendor that invoices the customer, but -- and then we share the money. So we share the money over the lifetime of the customer's usage, as long as we keep on providing value. There are some exceptions, but they are not a significant portion of our revenue because typically, we only sell and market software where we have a long-term revenue share with the vendor.

That limits us. I mean there are a lot of softwares that we don't sell because they don't have attractive partner programs and attractive revenue share models. So I would say, 95% of -- or probably more, probably 98% of the software that we sell, we have a long-term revenue share partnerships. And then there are some things on the side that -- where we are so small that we can't define. Maybe you sell a really large and really popular set of software from a large vendor with their own -- where we don't have like a strength in negotiation and then it might be different, but that's not a significant portion of our revenue. So...

[Hampus Strandqvist, executive]

As it is now, we don't have any further questions. So we'd like to thank you for listening to the call. And we wish you all a good summer.

[Johan Kallblad, executive]

We can give 30 seconds, if someone needs a clarification on the follow-up on the chat because I was not sure if I was clear enough.

Yes. I assume we were clear enough. You can always send an e-mail to [e-mail], and then we'll try and get back to you and clarify.

[Hampus Strandqvist, executive]

Thank you for listening in.

[Johan Kallblad, executive]

Thanks.