Micro Systemation AB (publ)

STO:MSAB B

Earnings Call Transcript 2019-Q4

[Operator]

Ladies and gentlemen, welcome to the Micro Systemation Q4 2019 Report. [Operator Instructions] Today, I'm pleased to present CEO, Joel Bollö. Speaker, please begin.

[Joel Bollö, Chief Executive Officer]

Hi, and welcome to this presentation. Today, we will give a short brief of the company and then a deep look into the figures for the fourth quarter and the full year of 2019. We will also give you a brief of the solutions we are offering. We, who are presenting here today, is myself, Joel Bollö; and on my right-hand side, I have my colleague and CFO, Mr. Henrik Bergentoft. Next slide, please. MSAB is the global leader in digital forensic technology for mobile device examination and analysis. We have offices in 17 countries, covering 5 continents as well as a network of distributors across the globe. We have been involved in communication since 1984. For the past 17 years, we have had a dedicated focus on mobile forensic market. That means that we enable and decode data for digital devices that our customers for any legal reason need to investigate. We develop, train, support high-quality, easy to use mobile forensic solutions that empower our customers to make them successful in their missions. Together, we make the world a safer place. Our tools and services enable them to secure evidence and intelligence from the different types of digital devices, including mobile phone, SIM cards, tablet, drones, GPS devices, smart devices and much more. We serve law enforcement agencies as well as correctional institutes, intelligence agencies, tax authorities, border control agencies, military agencies and a few others. Our technology is used in over 100 countries, and that is great. But what is more important is the difference our solutions do for customers every day. MSAB has grown every year for the last 15 years and employs close to 200 people worldwide. We have a AAA rating with 0 debt. Next slide, please. On this slide, we see the figures for both full year and for the fourth quarter. The sales for the full year landed on SEK 307.6 million, slightly above last year. The EBIT landed on SEK 6.2 million. That means that the EBIT margin was 2%. Cash flow from the operating activities amounted to positive SEK of SEK 17.7 million. For the fourth quarter, sales landed on SEK 84 million and EBIT amounted to SEK 3.7 million. Let's now dive deeper into what's behind the figures, so we can get a better understanding on why I am convinced that we are doing the correct things. Next, slide, please. On this slide, we see 2 different graphs. On the left-hand graph, which shows the split between new sales versus renewals. If we start to look at the renewals, it shows good increase of license renewal sales. This confirms the very high churn that we have. This is an outcome of the great improvements we have done into the product every year. I'm proud to say that we have done significant improvement in our products during 2019. The feedback has been phenomenal, and we will continue to do good things even better during 2020. The new sales is slightly lower than last year, so let us have a look into what the new sales consist of so we get a better understanding of what is good and what we can improve. In the graph to the right, we see new sales and what different product segments we are selling compared to last year. The Frontline and Field Version's business is lower than last year, while both training, office and what we term as other businesses continue to grow. So what conclusions can we make out of this? Well, for those of you who know us for some time, you know that our original and core product is the office version. The office version is what we mainly offer to the forensic labs, and that one is just continuing to grow year over year over year. While some of the new product segments do not take off as much as I would like have -- to see. With a gross margin with -- over 90% and a good growth of the office, together with the increased revenue of license in Europe, this shows that we are the leader in the segment of mobile forensics to the forensic labs. What we have invested in for future growth is Frontline and XAMN. Those investments have yet not taken off, and that is what's impacting the result for 2019. That said, I know there is and I see a strong demand for both Frontline and XAMN solutions. It's just a matter of time before we see it takes off and the results for the investment in these segments. Next slide, please. Here, we see the split between different regions. There's no surprise when we match this diagram to the figures for 2019. What this graph shows is that we have good potential for continued success in Asia, but the largest potential for growth is in North America. I will make sure that North America will become much larger than it is today. Next slide, please.

[Henrik Bergentoft, Chief Financial Officer]

Thanks, Joel. I will now provide some further details and comments on the financials for the full year and Q4. Joel already supplied comments on the development of sales, so I will move on to the next slide, which is cost of goods sold. To add some flavor to that row, it is worth highlighting what the company's core business is, which is developing and selling a software, meaning a very scalable business model. However, the software comes with some accessories and runs on different hardware platforms, which combined make up the cost of goods sold. The gross margin for the full year is at 90% as compared to 88% previous year. The higher gross margin is a result 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 for the quarter is slightly lower than last year, but higher for the year. The main increase in also the variable cost in this category is external marketing, which varies between quarters, depending on the degree of activities.When it comes to external cost, I 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 costs for office spaces now will appear in the income statement as a cost of depreciation, previously part of external cost. MSAB is still a very asset-light business in what traditionally is categorized as assets. The personnel cost is a direct function of the number of headcount, but the average for the year is 189 compared to 157 last year, an increase of some 20%, which explains 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 for MSAB. The MSAB business model has a high cash conversion, meaning that over time, cash flow varies with profit. For the full year, cash flow from operation is positive with SEK 17.7 million, ending the year with a cash position of SEK 64 million. Next slide, please. These 2 graphs shows sales, operating profit and margin over a longer period of time. To the left, we see it by quarters. Main takeaway here is that sales fluctuate quite significantly between the quarters, but with a clear pattern, and the historical pattern is that 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. To the right, we see sales and profit in full years. Looking back over the years, we can see that MSAB sales has not only fluctuated over the quarter, but also over the years. Therefore, as said many times, we really emphasize the view of the MSAB business in the longer-term perspective. The investments that MSAB are making in the organization is aiming towards just that, growth in the longer term. Next slide, please. A couple of words on the MSAB business model. The graph on the right-hand side, there you can see the gray bars showing our revenue from license renewals over the years. As the trend line shows, it's over time, ever increasing. This is a consequence of the fact that most of our customers actually renew their license. This also means that with every new sale we do in a year, we add another potential license renewal revenue the following year. The line shows the proportion of renewal revenue related to total product sales. As shown, over 50% of our product revenue is recurring.As long as the customer has a valid license, they receive support, but most importantly, the right to download updates that we constantly do to our softwares. 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 in the software is a great driver for the customers renewing their license, giving the company its recurring revenue base. All combined, MSAB has a product and business model that is scalable and contains a large share of recurring revenue streams. This solid base allows the company to have a real long-term perspective on how we build and invest in the organization to generate future growth. Next slide.

[Joel Bollö, Chief Executive Officer]

Thank you so much, Henrik. And now we will go in and look to the products and what we are offering. This is our main offerings, a complete set of products and services, so our customers can maintain the chain of custody. We offer very strong platforms that make it easy for our customers to extract, decode, analyze and manage the investigated data and still maintain the chain of custody. The offers we have is a number of different products that can be run on different platforms, platforms that can be either turnkey as well as open. The solutions we provide have never been stronger, and that is one reason I believe that in the future, we will see the outcome of the investments that we have done. Next slide, please. Frontline is one of the areas for future growth for MSAB, and therefore, it's important that we keep the lead in this area. And yes, to the best of my knowledge, we have deployed most number of kiosks globally so far. It's not the question if Frontline business is going to take off. It's more about when. I am proud to show you the latest version of our kiosk. It is MSAB Kiosk Mk III. This is the most advanced kiosk on the market today. We have improved everything with its pioneering design, faster software, larger storage and 21% bigger screen. It will attract a whole lot of new users.MSAB Kiosk offers the proven power of XRY mobile forensic software through a turnkey terminal that is simple enough for anyone to use. The kiosk has an easy-to-use touchscreen interface that guides the users through extractions with MSAB unique step-by-step technology according to a predefined workflow. The workflow can be customized to organizations' unique needs and requirements. It is designed for operational Frontline users where mobile data recovery and analysis is an important part of their responsibilities, empowering them to quickly perform extractions successfully. The MSAB Kiosk been instrumental empowering many organizations worldwide to scale up their capabilities and decentralize their mobile forensic operations for increased efficiency. With the kiosk, nonexpert users can process most devices to free up expert time for the labs to focus on the most challenging cases. Next slide, please. With XAMN, our customers can overview the data more simple than ever through a special filtering to you suggesting to do one click, and boom, XAMN will show the result. XAMN can give an immediate overview of the connections between different people of interest and help to discover additional individuals that may be relevant for the investigation. The geographic view lets 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, much more, synced to everything that is geo-tagged.The chat view lets them track chat threads from all different types of chat apps, but not only doing that, they can combine different chat apps, so they can see and find if they try to hide chat apps between different applications. They can zoom in or out to focus on their analysis to point by time using and using the time menu. And also, they can use incredible powerful connection view to discover and investigate interactions between different identities and accounts. It has also built-in picture recognition filter, so the user can XAMN, find any type of pictures that are of interest. With all of these features and functions and now also simple to use, I foresee a tremendous growth in XAMN for the future. Next slide, please. With MSAB Access Services, our experts use advanced techniques to access the data in selected mobile devices that goes above and beyond what is currently supported in our XRY product. This is data that otherwise will be unattainable and which could mean the difference between solving or not a case. These new services give our customers access to data from the latest models and chipsets by using advanced security bypass, extraction and decryption methods.As new phone models enter the market, we constantly develop and refine new methods to unlock devices and decrypt data. MSAB Access Services are delivered using forensically sound techniques and with a written documentation of all steps. There will always be devices that have not yet been able to or, for other reasons, not want to add into the product. Those devices can be sold with Access Services. These services has not only been very good and appreciated by our customers, it also generates good revenue and build our brand. We have a constant increase for these services. Next slide, please. What is very important for our customers is that we -- to get -- is to get the data. And as I've shown in the previous pictures is that we have a number of different ways to do that, either through a product, Kiosk, Tablets, Office and Access Services. So getting into the data is very important, get the data. Therefore, we constantly add new devices, and we focus on the most and biggest brands. And I say that MSAB shall be the #1, in one way or another, getting data from these or from different type of devices, latest ones, old ones, the most common one, but not only phones, also all the different types of apps. Today, MSAB is close to support 30,000 different device profiles. Next slide, please. Last but not the least, we need to know who we are working for, and we need to treat our customers very well, and we do that. You can see that by the high churn, the high renewal rate, and we will see it in the future growth of the new markets that we are entering -- segments, I would say, product segments. But as long as we treat our customers as heroes, and they should be treated heroes, they will be very pleased and they will continue to buy. And if we make them successful, they will continue to buy our products and invest in MSAB solutions. Thank you for listening.

[Operator]

[Operator Instructions]

[Henrik Bergentoft, Chief Financial Officer]

Okay. Thank you. We have received the following questions, and I will read them out and Joel will answer most of the questions. So question number one is, given the investments done during the past 2 years, when should we see the benefits in terms of increased sales growth and what is the visibility to growth?

[Joel Bollö, Chief Executive Officer]

Well, great question. And well, it's different on different markets. As I said in my presentation, there is different products that we're selling different from. But if we start to see where we came from or we've been doing good and great for the past 18 years, it's sort of the office kits to the forensic labs. That's where we continue to grow. It's a very healthy business with a high churn. We increased the special phase of the office kit. What we see for future growth potentials in Frontline and XAMN is more for the mature markets where we already have deployed XRY Office to the forensic lab. So the new sales and the growth for that -- in those areas is in the new product areas, and you can see that those have not overlapped. So it has not taken off yet, as I said during our presentation, in the Frontline and XAMN business. That said, we see, without giving any forecast, that the demand is out there, where it's taking maybe slightly longer time than we would like it to be. But it's no question or no doubt about that the customers' demand for doing something to adopt these digital challenges is out there, and we have proven evidence from several customers in Europe and North America, success by deploying Frontline. So I'm convinced there will be many, many more to follow in this type of business.

[Henrik Bergentoft, Chief Financial Officer]

Right. Next question. What's your assessment of market growth and your relative market share during the past years? Are we winning or losing?

[Joel Bollö, Chief Executive Officer]

Well, that is hard to say because market growth -- there is no -- this is a niche market still, and there's no one measuring this. We have also to understand what markets we are acting in. I would say, there's a definite increased demand in this market. There is a huge potential -- untapped potential for growth in this market. And we are definitely one of the leaders in this and not losing market shares, especially not if you look on the core where they're coming from in the forensic labs and getting the data of these devices. I would say that we -- if not the one, we should be the best one to extract and analyze data out of these devices for the future.

[Henrik Bergentoft, Chief Financial Officer]

Good. And next question is, how much of the stated growth investment is going to the R&D needed to keep offering relevant, i.e., it's more of an OpEx type of nature?

[Joel Bollö, Chief Executive Officer]

Well, it's a great question. And this blurs a little bit into each other since we are on a market where technology -- probably one of the markets where technology moves the fastest forward. I mean we're talking about Samsung, we're talking about Apple, we're talking about Huawei. These companies are developing is what we are catching up with, so of course, a lot of the investments that we do is to maintain our leadership in this area. But that said, it in the same time opens up for new business opportunities. So there is no clear silos in between what is maintaining and renewing. What will attract new feature functions is also what maintain and keep the high churn that we have. And as I said in my presentation, we've done great -- very good steps forward during 2019, and we start to see an increased feedback for that -- an increased positive feedback for that. And hopefully, we will see the result of that even more in 2020. Thank you.

[Henrik Bergentoft, Chief Financial Officer]

And just a comment how this is reflected in the financial statements. As you can see, we have no immaterial assets, meaning that we are not activating any development work, which naturally is an indication of the vast part of the efforts made are to maintain and improve existing products and not developing entirely new products. Next question is, what is the future margin we should model and future growth we should expect?

[Joel Bollö, Chief Executive Officer]

Well, I mean, we don't give any forecasts in general. So specifically so -- but I can talk more in general terms. But I would like to highlight. I mean we have a very strong business model. When I say that we have a very strong business model, we have to remind and I have to highlight that we have a gross margin for over 90%, which means that the operating margin is a direct effect of our sales, of course. But we have a fixed cost, and we have chosen actively to do investments, and we foresee that we will harvest from those investments in the future. So the investments we've done during 2018 and 2019 will not be as high until we see that the -- in the future, until we see that the sales takes off. I think we have a great platform to hit the market, both in Frontline and the office and as well in XAMN area. Do you have anything to add to that one, Henrik?

[Henrik Bergentoft, Chief Financial Officer]

No, nothing, nothing to add in that area, I would say.Okay. Thank you. And next question is when, in time, would you go back to the past level operating expenses, if orders does not materialize? And that's interpreting, if we will not see growth, are we going to adjust operating expenses accordingly?

[Joel Bollö, Chief Executive Officer]

Well, if I look for the future, I hope we will never come into that situation. But that said, I will also note that this company be a nonprofit company. I mean we have a high gross margin. So if we have revenue of over SEK 300 million, that means we have SEK 270-ish million in gross margin to harness. So I will not predict anything, at least say anything about that here. But long term, we should not be, and there's no reason for us not making money short and long term.

[Henrik Bergentoft, Chief Financial Officer]

Next question is, what can be done by MSAB to speed up Frontline solutions adoption among customers?

[Joel Bollö, Chief Executive Officer]

Well, there's a lot of things going there. And I would -- competition-wise, this is an open forum, which anyone can listen into. So I would not prefer in this one, not going to details about what we can do. But there are things we're doing, and there's, of course, more things that could be done. But we -- with the resources we're doing, I think we'll do the right things, and we will see the outcome of that.

[Henrik Bergentoft, Chief Financial Officer]

And related to that, if we would ask your competitors, would they be seeing Frontline solutions growth by now?

[Joel Bollö, Chief Executive Officer]

Well, I would say, if we look at -- I'm pretty sure about this. We see this that so far, MSAB have deployed, and we should continue to do that, most number of kiosks globally -- I would say, Frontline solutions globally. So no.

[Henrik Bergentoft, Chief Financial Officer]

Good. And as of now final question is a specific question on India, and how the progress is going there?

[Joel Bollö, Chief Executive Officer]

Well, we don't comment any specific countries figure-wise, at least, but I can say that the progress in India is doing good.

[Henrik Bergentoft, Chief Financial Officer]

And that was actually all the questions we have received. But I want to encourage anyone who has more questions to address them either to me or to Joel directly after this call.

[Joel Bollö, Chief Executive Officer]

Okay. So thank you for listening. And yes, we take it from there. Thank you.

[Operator]

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