Micro Systemation AB (publ)

STO:MSAB B

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, welcome to the Micro Systemation Q3 Report 2019. Today, I am pleased to present CEO, Joel Bollö; and CFO, Henrik Bergentoft. [Operator Instructions]I will now hand you over to Joel Bollö. Please begin.

[Joel Bollö, Chief Executive Officer]

Hi, welcome to this presentation of MSAB's 9 months and 3 quarters results. Me here speaking is Joel Bollö. I'm the CEO for MSAB. And beside me here, I have my CFO, Henrik Bergentoft. Next slide, please. Short company background update. MSAB is an old company, we're founded in 1984. Since beginning of 2002, we've been pioneering the mobile forensic industry. We are 100% focused in helping law enforcement, intelligence and other type of governments that create the safer society, equipment with mobile forensic tools. We are a healthy company with almost 200 employees and offices in 17 different countries. We have had 14 years of consecutive profitable growth and average CAGR has been 17% for the last 5 years. Next slide, please. On the left-hand side, you see the figures for the 9-month period. There is a couple of things I'd like to highlight. For the 9-month period, sales increased with almost 3% and landed on SEK 223.7 million. The EBIT amounted to SEK 2.7 million. The difference is a direct effect of our investments in new markets and staff. Our gross margin is still on a very healthy level, above 90%. The cash flow for the period amounted to SEK 7.3 million. If we look at the figures for the third quarter, sales increased by 4.4%, amounted to SEK 93.3 million, which is the second best figures for the quarter ever in MSAB history. For those of you who known us for a longer time and are aware of our strong business model and high gross margin, you see that with the revenue, profit goes up as well. So for the third quarter, our EBIT amounted to SEK 19.9 million. And as for the first 9 months, we have a healthy good cash flow for SEK 13.5 million. Next slide, please. On the left-hand side diagram, we see the split of new sales and renewals. First, we see that the new sales have gone down a little bit. But let me come back to that one. The diagram that shows renewals show a strong and healthy growth in license renewals. This shows the appreciation our customers have in using our tools. If we look on the right-hand side diagram, we can see the split of what the new sales contains of. And still, we see that our strongest and core products show strength in continuous growth and new sales. The XRY Office product was launched in its first version already in 2003. The largest difference in new sales is Frontline businesses. Last year, we shipped good amount of Frontline in Q3. And this year, we do less. That said, I'm still convinced that the Frontline is to become much larger business for us in the future, more about that later into the presentation. Next slide, please. Here is the sales for different regions. We can see that they are on par or above last year. We can see that EMEA shows strength and do more than what they did in last year. Next slide, please.

[Henrik Bergentoft, Chief Financial Officer]

Now some further details and comments on the financials. Joel already supplied comments on the development and composition of sales. So I will move on to the next slide, which is cost of goods sold. The gross margin for the 9 months is at 91% as compared to 88% previous year. For the rolling 12 months, we have it at 90% as compared to 88% for the full year 2018. The improved gross margin is a function of a couple of orders last year containing more hardware than the usual average. With the current composition of sales, a 90% gross margin is what we expect, but may vary between quarters typically with sales of the Field Version solution. Other external cost increased for the quarter and the 9 months, as commented on previously, the main variable cost in this category is external marketing, where we are doing increased efforts to promote our brand and products. When it comes to external cost, I again want to highlight the implications of the introduction of IFRS 16, which means that lease contracts longer than 12 months will be recognized as an asset in the balance sheet and depreciated over the length of the contract. For MSAB, this has mainly meant that cost for office spaces now will appear in the income statement as the cost of depreciation, previously part of external cost. MSAB is still a very asset-light business in what traditionally is categorized as assets. Personnel cost is a direct function of the number of headcount, where the average for the 9 months is 185 compared to 149 last year, an increase of 23%, which more or less directly applies to the increase in personnel costs. The increased headcount is mainly in 2 categories: development and sales and marketing, hence investments clearly aimed at maximizing future growth. Cost of revenue combined, the 9 months now show a positive result, with the third quarter stand-alone demonstrates the leverage our scalable business model provides, where increased sales produces an operating margin above 20%. The MSAB business model has a high cash conversion, meaning that over time, operating cash flow varies with profit. For the first 9 months, cash flow from operation is positive at SEK 7 million compared to a positive result of SEK 3.8 million. Next slide. These 2 graphs show sales, operating profit and margin over a longer period of time. To the left, we see it by quarter, and main takeaway here is that sales fluctuate quite significantly between the quarters. Over the second half of the year historically always has been stronger. Main reason for this is that customers, to a large degree, place their orders at the end of their budget year, which for Europe mainly is in December and in the U.S. in September. This is clearly visible in this third quarter, which, from a revenue perspective, is the second highest in the history of the company. To the right, we see sales and profit in full year, a couple of comments on that. In 2017, the company made a record leap in sales and profit as a direct consequence of the strong sales. The company is now investing in the organization to enable the next level in sales. As in many cases, investment comes first and return later, temporarily putting the company at profit margins lower than historically and not representative of what the business is capable of generating in the longer term, shown in this third quarter that clearly demonstrates what the business is capable of. Looking back over the year, we can say that MSAB sales has not only fluctuated over the quarters, but also over the years. For example, sales were strong in 2015, with a slowdown in 2016 to really take off again in 2017. Therefore, I've said many, many times, we really emphasize to view of the MSAB business in the longer-term perspective. Next slide.

[Joel Bollö, Chief Executive Officer]

Thank you, Henry. That was the figures for Q3. Let us move over to our market and businesses. MSAB has for the past year's been offering what we term as the MSAB ecosystem. Here you see an infographic of the MSAB ecosystem. One of the largest challenges in modern history police have today is to catch up and be ahead of the bad guys in regards of technology. In 99% of all types of crimes, there is one, or in many cases, several phones involved. There's few things, if any, that has challenged the police in general as much as the cell phone has. MSAB has a solution for helping the police adopt to this challenge and turn into an advantage for the police force. That is what we do with our MSAB ecosystem. It all starts with the lab, the experts that know the most of the most of the phones and other digital evidence of sources. What you see in the middle of the picture is the top-performing solution for the forensic lab, the MSAB Office kit. The office kit contains the most advanced equipment to be find on the market today. It is a kit for the experts so they can get out data from tens of thousands of phones, bypass security codes and also find deleted and hidden data. This is the XRY Office kit that we successfully have deployed for the forensic labs all over the world since 2003. Next slide, please. Even though XRY is a great success for the labs, it is not the end of the story. The police confiscate so much more digital devices than what the labs can handle. Therefore, we have provided solutions to help them out with this. There is 2 big areas for growth outside the labs. Both of these areas is a great potential for MSAB and our businesses. Next slide, please. On this picture, left-hand side, you see the kiosk and tablet, which is an easy-to-use platforms that are very powerful in their performance. However, it's safe and maintain the chain of custody. These solutions is what we define as a frontline solutions. Solutions for forces working in the frontline and closer to the crime scene than the lab. We have 2 examples of frontline platforms to the left. First is the MSAB Kiosk. The MSAB Kiosk has been instrumental in empowering many organizations worldwide to scale up their capabilities and decentralize their mobile forensic operations for increased efficiency. Eliminating delays and device processing backlogs with the Kiosk, nonexpert users can process most devices to free up digital forensic experts in the labs to focus on the most challenging cases. The other one is the tablet. The tablet, which is a solution for even more in fieldwork. The tablet can be tailor-made to organization workflows and configured for different levels of forensic ability to maximize the performance of the force. It offers control of forensic process in a lockdown environment to ensure the integrity and credibility of the forensic evidence. If we then switch over to the right-hand side of the slide, we see XAMN. The amount of data stored on mobile phones and other mobile devices is dramatically greater today than ever before. That makes the challenge of searching, filtering and analyzing that data more daunting as well. Our customers need to quickly find what they are looking for, even in a huge dataset, whether their mission is to gather a report, intelligence, prevent crime or quickly produce solid evidence. The powerful and intuitive tools in XAMN enables the fastest possible route for having raw data to finding an all-reporting digital insights.Next slide, please. To make it complete, our customers also need to be able to control their systems and make sure the investment is paying off. The XEC Director is that vital piece of the puzzle that let the police build, tailor and streamline a truly complete and effective mobile forensic system for their organization. It's a centralized management solution that lets our customers connect all their MSAB mobile forensic products into a network. XEC can control the whole MSAB system from 1 central location, pushing out watch lists and new software updates, assigning permissions, managing licenses, creating management information reports and monitoring processes and more. In short, XEC Director puts our customers in charge of a faster, more effective and much more flexible mobile forensic solution than any other out there. Next slide, please. All in all, what MSAB is offering is a smorgasbord of products, services and training that in the correct mix, makes every police force more efficient in their work with digital evidence. Next slide, please. End of the day, it's only the result that counts. So let me shortly walk you through a couple of slides that show how MSAB differ and what kind of intelligence we build into our solutions. We are here to make our customers effective in their work with digital evidence. Let's see how it all starts. Next slide, please. One important task for all police forces working with digital evidence is to keep the chain of custody. One obvious part of that is integrity of data. Data that has been extracted shall be secured from altering or changing, not even by mistake. Therefore, MSAB has developed a forensically secured file format that makes it impossible to alter and extract the data. Of course, the police can make subsets to be able to carve out information, but the court can always ask and have the original untouched copy of the initial extraction. All of this is due to the unique XRY file format. Once the data is contained in the unique XRY file format, it's easy to view it from different types of angles, comparator and filter in any way with a powerful XAMN tool. Next slide, please. It all starts with the smallest with XAMN Elements, which is a tool for the experts. The user can carve out hidden and even deleted information. For expert, this is a real blessing. XAMN Elements help our customers make sense of extracted data. It lets them dive deeply into the hex data with full search and capabilities, even across different datasets. They can also identify, investigate and validate information more easily. Furthermore, it lets the manual reconstruct data, allowing users to carve out exactly what they are looking for. But for those who might not carve out data all days, they can use XAMN Spotlight. Next slide, please. Here we see XAMN Spotlight. Spotlight is a tool that, what you see is what you get. Spotlight let our customers view images by categories, such as drugs, weapons and people, enabling faster searches of large volume of images, and they can also focus their searches by geographic locations and other time-saving options. Next slide, please. XAMN Horizon can handle 1 or many different phones at the same time. Horizon builds up different views of the content from the phones, geographic view, time-line view and connection view. These new views enable our users to discover and investigate data from new and exciting perspectives. They can zoom in and out to focus their analysis on any point in time using the time-line view. The geographic view let them navigate data by location, find places of interest and investigate the data connected to those places, such as calls made or received, pictures taken and much more. And finally, used incredibly powerful connection view to discover and investigate the interactions between different devices, owners and accounts. Next slide, please. With all good things you can do with XAMN, we take it even further, we know that our customers have less and less time to spend on each device. We have invested a lot in our next powerful capability. Next slide, please. XAMN AI is probably the most efficient, smart, tactical analytical tool on the market today. With its powerful features, the user only need to know what type of crime the suspect are in for. Simply click on the bottom or what type of crime the user want to investigate and boom, XAMN AI present relevant evidence. The more the user use XAMN AI, the more precise the result will become over time as it learns what to find. Next slide, please. XRY supports the extraction of data from tens of thousands of mobile devices, profiles and apps, but there are always some devices that we know how to get access to but for various reasons are difficult to implement into our standard XRY Office product. With Access Service, MSAB forensic experts use advanced forensically sound techniques to extract and decrypt the data from the most complex devices. Evidence that would otherwise be unattainable and which could mean the difference between solving a case or not. These new services have proven track record of success in a number of critical investigations. It also improves the trust for MSAB as a leader in mobile forensics. Next slide, please. Now we've seen sample of what great products we are offering and as for the company, we see many more growth opportunities, not only through our great and new products. There are 4 main areas for growth: Customer growth. We are very strong within the police. That said, we see other verticals that can be as big potential as the police that we have the same and similar type of needs. Geographical growth. We continue to increase our presence in different countries. We've seen the success of having our own boots on the ground. Therefore, we will look into both strengthen our presence where we are, but also find new regions and countries to hire our own MSAB staff. Product feature. There is so much going on, that we will never be finished with new opportunities and features. Now when 5G is slowly starts to roll out, the capability in 5G is to have 1 million connected devices per square kilometer. And last but not the least, we see that MSAB is so strong in our area that there are big interest being a partner with us, and we believe that working with selected partners that complement what we are doing will increase our businesses even more. Next slide, please.

[Henrik Bergentoft, Chief Financial Officer]

Now a couple of words on the MSAB business model. On the graph on the right-hand side, you see the gray bars, showing our revenue from license renewals over the year, which the trend line shows is over time ever increasing. This is a consequence of the fact that most of our customers renew their license. This also means that with every new sale, we do in a year adds another potential license renewal revenue the following year. The line shows the proportion of renewal revenues related to total product sales, [ as shown only ] about 50% of our revenue is actually recurring. The core of the MSAB business consists of selling a license with the rights to use our software. This license is usually sold for 1 year, but could be up to 3 years. When the license expires, the customer will in most cases, renew their license, generating a recurring revenue. As long as the customer has a valid license, they receive support but most importantly, the right to download all of the updates that we constantly do to our products. These updates are a reflection of the constant flow of new phones and new and updated apps. Hence, the possibility to update and always have the latest capability, is a great driver for customers renewing the license and giving us the very healthy recurring revenue. A scalable business model with a constant increase in recurring revenue is a solid foundation for the company to build on. This indeed gives us the comfort to have a long-term perspective on our business when we build an organization to stimulate and maximize the great growth potential we see in this market. Next slide.

[Joel Bollö, Chief Executive Officer]

Last but not the least, what we are working for is to create the safer society and what we should do is to make our customers heroes. If we make our customers heroes and treat them as heroes as they deserve to be treated as, they will continue to buy more stuff from us and more products and as we help them, we do it for a good reason. So they can continue to make our society a safer place. Thank you for listening.

[Operator]

[Operator Instructions] And our first question comes from the line of Viktor Högberg from Danske Bank.

[Viktor Högberg, Analyst]

So could you talk a bit about more -- a bit more about the pipeline and new markets you've entered, Japan and India?

[Joel Bollö, Chief Executive Officer]

This is Joel. No, I cannot talk about the pipeline because that's a little bit of a forecast. But what we see is that boots on the ground gives results. That said, it takes time to develop the market. And Japan and India is progressing good, even if it's from some small numbers. We believe that we will do at least in India this year, a record high revenue from our establishments in India.

[Viktor Högberg, Analyst]

Okay. So we know that Frontline solutions, that their sales is lumpy, but what could we expect from here? And maybe not short term, but for 2020, '21, do you see anything? Or do we just -- or we are just waiting for the hockey stick or -- what to expect? In terms of timing?

[Joel Bollö, Chief Executive Officer]

What to expect? Yes, I don't want to commit myself to any timing, but we know and see -- and we've also seen in the past, both 2017, 2018, that when the strong final order comes in, they give you a high number on that revenue. So I'm convinced based on the work we are doing that Frontline will have a greater portion of our revenue in the future. If that shows in Q1 or Q3 next year that's -- actually, I don't know when it's going to happen, but I'm convinced we are going to see much more Frontline businesses in the future.

[Viktor Högberg, Analyst]

Okay. So in terms of organic decline in Q3 last year, you had a large order, in the previous Q3 a large order as well. But the organic account was only 1% here in Q3. Would you say, have we seen the worst in terms of organic declines? Do we have that behind us or?

[Joel Bollö, Chief Executive Officer]

We believe in long-term growth. I don't know. I mean, we are -- when you say decline, it's -- I mean, we can see that as you said, we have some large order last year. And you can see that we, well compensate for that with the ongoing business, which means that we have a good revenue coming in from our core products as the XRY Office kit.

[Henrik Bergentoft, Chief Financial Officer]

And this is Henrik. Just adding also I think in this context, it's good to also look at the gross profit because actually, the gross profit is more or less what would be considered the true growth, so to speak, because last year there were significantly more hardware included in our deals and that is not necessarily the core of what we're doing. So if you look at that line, you do have a couple of percentages of real growth, regardless of the positive currency effect. Just as a nuance to the question on growth there.

[Viktor Högberg, Analyst]

Okay. And let's see here. In terms of hiring, when do you expect the net hiring to come down, the growth in -- or the expansion in the organization? Are we getting close to that? Or do we have some -- a couple of quarters ahead with an expansion in the number of employees or is it tailing off now?

[Joel Bollö, Chief Executive Officer]

I don't expect us to stop hiring, if we don't see that we don't have any future growth for the business. So my answer is that we are going to continue to hire new people, but that -- in how many over time we hire, that might vary. We don't have a specific number that -- where we will stop hiring. This is something that we make decisions on ongoing so to say.

[Viktor Högberg, Analyst]

Okay.

[Joel Bollö, Chief Executive Officer]

And it's based on the opportunities and the ongoing business.

[Viktor Högberg, Analyst]

Okay. And so looking at the OpEx level here in Q3, we have some vacation effects in Sweden and that's the main part of your employee base. But looking at the other external costs, they were at least lower than what I had expected. Is there something special here that affects the cost level in Q3 other than being a vacation quarter or is it something else?

[Henrik Bergentoft, Chief Financial Officer]

Well, thanks for the question, Henrik here. No, I would say it's more what you say, the vacation effect. I mean, for one thing, you have that on personnel cost, obviously but also the external marketing activities really on a global perspective, is lower in Q3, and I believe you also commented on that in Q2 was significantly higher. So I think the, sort of, trend line hasn't changed. But there's a seasonality in where these events occur.

[Viktor Högberg, Analyst]

Okay. In your report, you report on an aggregated basis, the new sales and licenses. Here we have the numbers for January to September. When I back it out, looks like the decline in new sales is quickly coming down from I think, high double-digit to just a single-digit decline here in Q3. Is that correct? And if there is something you can say about the new sales trends there, what your clients are saying or what you're seeing?

[Henrik Bergentoft, Chief Financial Officer]

Well, thanks for that question. That's the purpose why we reported on an aggregated level, because it's much easier to view MSAB in a longer-term perspective. So I would say, it's not wise to draw any conclusion based on single quarter numbers. But I mean, what we have said this year is that new sales is slower than last year. And what we are sort of lacking are the bigger Frontline deals that we definitely are discussing with customers, but we haven't received the orders yet. And as Joel said, it is difficult to commit when that's going to happen. But it is also important to point out that new sales is by definition 0 January 1 and something that will build up. So it's not that we don't do new business, but we haven't done these fairly big deals that we did the last year. And meanwhile, license renewals is ticking on, showing that, that current customer base is happy with their products, and they are renewing their licenses.

[Viktor Högberg, Analyst]

Okay. And regarding new sales. Can you comment something about competition -- the competitive landscape, has it changed during the summer and this autumn, could you talk some about the Cellebrite and their new ownership structure? And if that has changed something in the market? And are there some contracts that you've lost out or that you know that you've lost out on or that you know that you have won, just to give some color on the competitive landscape?

[Joel Bollö, Chief Executive Officer]

I mean, the -- this is Joel. The competitive landscape has not changed and the ownership hasn't made any big difference for us. And it's a smaller portion of Cellebrite that's been sold out to this venture capital company. So in that regard, it hasn't changed. What we see is -- and as I mentioned in my presentation, we are catching up. And I also say in my wording, phone by phone. I mean, one of the core values is to get into these different devices. And my goal is that we should be the #1 in getting access to these devices globally, and we are taking phone by phone and making great success on that. So we also meet other type of competitive landscape, but that's more for a reason that we expand our business in now also to the smart analytics. We don't see it in the figures, but we definitely do great success -- great progress in activities on the market in regards to that as well.

[Viktor Högberg, Analyst]

Okay. Just a last question. Upcoming Q4 report. Is there something to be aware of in terms of comparables or upcoming contracts or contracts that you won last year or something like that? Is there anything to be aware of?

[Henrik Bergentoft, Chief Financial Officer]

It's Henrik here. No, I wouldn't say there was nothing particular in [ Q3 ] last year to consider when comparing the coming Q4.

[Operator]

[Operator Instructions] And as there are no further questions. At this point, I will hand the word back to the speakers for closing comments. Please go ahead.

[Joel Bollö, Chief Executive Officer]

Okay. Thank you for listening and attending. If you have any further questions that you might find afterwards, feel free to contact us through e-mail or phone. Thank you for listening.

[Operator]

This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.