Proact IT Group AB

STO:PACT

Earnings Call Analysis

Strong growth with stable margins, but service revenue declines offer caution

In the recent quarter, the company reported SEK 1.1 billion in revenue, an increase of 6.3% driven by robust system sales, which were up 17.6%. However, services revenue fell 4.7%, raising concerns. Despite this, annualized recurring revenue remained stable at SEK 1.7 billion, with adjusted EBITA reaching SEK 79 million, reflecting an 8.9% increase and an EBITA margin improvement to 7%. The firm maintains a net cash position of SEK 175 million, enabling share buybacks and dividends. While organic growth surpassed the expected 5%, delays in closing complex contracts for Managed Cloud Services may affect future prospects. The outlook remains positive, with expectations for a return to growth soon.

A Steady Quarterly Performance

In the latest quarterly earnings call, Proact reported revenues of SEK 1.1 billion, reflecting a healthy increase of 6.3%, with an impressive organic growth rate of 8.8%. The main driver behind this growth was robust system sales, which rose by 17.6% and 20.1% organically. However, the Services segment faced a 4.7% decline; this was mainly due to lower revenues in Managed Cloud Services and consultancy, indicating a mix of both broad market pressures and internal factors.

Annualized Recurring Revenue Trends

Annualized Recurring Revenue (ARR) stood at SEK 1.7 billion, showing a slight organic decrease of 2.4% compared to the same quarter last year. Notably, the company secured new cloud service contracts amounting to SEK 102 million in the quarter, a dip from SEK 119 million in the previous year. The challenges stemmed from longer sales cycles and contracting complexities within Managed Cloud Services, which may lead to temporary impacts on future financial performance.

Profitability and Margins

Adjusted EBITA was reported at SEK 79 million, marking an 8.9% increase year-over-year despite a SEK 9 million expenditure related to the company’s 30th anniversary celebration. The EBITA margin improved to 7% from 6.8% in the past year, bolstered by improved gross margins from 23.5% to 24.2%. The focus on efficiencies in service delivery has contributed to this positive trend in profitability, indicating the company’s operational resilience.

Strengthening Financial Position

Proact's net cash position significantly improved to SEK 175 million from SEK 80 million at the end of 2023, underscoring the strong financial performance and cash generation capabilities. The cash flow from operating activities totaled SEK 83 million, compared to a negative SEK 5 million last year. This robust cash position allows Proact to consider both share buybacks and dividends while maintaining a stable financial footing.

Regional Performance Insights

Analyzing performance by region, the Nordic & Baltics unit achieved revenues of SEK 566 million with an EBITA margin of 11.3%, well above the group target of 8%. The U.K. business grew 10.4% organically to SEK 170 million, despite a flat EBITA due to a revenue mix shift. The West region exhibited particularly strong performance with a 17.1% organic revenue increase, resulting in an EBITA margin of 4.4%, up from 2.3%.

Addressing Market Challenges

Management acknowledged that while the services business is experiencing short-term setbacks, particularly in Managed Cloud Services, they are confident it will rebound. The dip in cloud service revenues is largely attributed to timing and increased complexities in contracts rather than underlying demand. The management remains optimistic, projecting a return to growth in this segment as backlog contracts clear and onboarding of existing contracts progresses.

The Outlook Ahead

Proact is positioned well in a rapidly growing market, with expectations for organic growth to remain around the targeted 5% level. The company continues to invest prudently in the commercial side of the business, focusing on both sales and consulting to optimize scalability without necessarily increasing staffing substantially. As market conditions evolve, they foresee opportunities through mergers and acquisitions, enhancing their product offerings and reach.

Conclusion: A Stable Investment with Growth Prospects

Despite facing challenges in the consulting sector and some fluctuations in service revenues, Proact's financial health and operational efficiencies position it as a stable investment. The recent earnings report reflects strong sales in hardware and system solutions while maintaining a robust cash position. Investors might consider Proact favorably, given its adaptability in an evolving tech landscape and the management's focus on long-term growth strategies.

Earnings Call Transcript 2024-Q3

[Jonas Hasselberg, executive]

All right. Welcome, everyone. We'll just wait another few seconds so everybody can get into the meeting. We'll keep everybody muted for now. So just give us a few more seconds. All right. Let's start. Welcome to Proact Q3 Report. My name is Jonas Hasselberg. I'm here with our CFO, Noora as well. We'll take you through the presentation here.

Before we start, I'll just let everybody know -- I want to let everybody know that we are recording this session, and it will be published on our website after the session. And we'll make sure that there's room for questions at the end. But until then, we will keep everybody muted so that you can hear us okay throughout the presentation.

Good. So good morning again, and welcome. Here we go. I'll start with just a couple of introduction slides. Most of you know us quite well. Proact is a tech company, a European-based tech company. We help our customers to secure and manage their business critical data and business critical applications. We just turned 30 years old, which we're quite proud of. Not all tech companies survive that long. We are based in the countries you can see here on the map. We're divided into 4 different business units: Nordics & Baltics; Central with Germany and Czechia; West with Netherlands and Belgium; and U.K. with U.K. And we have about 4,000 customers. We employ almost 1,200 people. And those people are very, very skilled, which is an important part of our success, of course.

Here power, roughly distributed. Also in terms of the revenue and the employees, you see the 4 regions I just mentioned. A couple of things to highlight here is that we deliver our cloud services out of 4 delivery hubs, one in each region. So there's 1 in Sweden, 1 in Germany, 1 in Netherlands, 1 in the U.K. And this enables us to both be very close to our customers, but also standardize and build scalability into our delivery capabilities in our cloud services, which is very important to us.

We also run Security Operations Center out of 2 locations, one in the U.K. and one in Germany, which enables us to do 24/7 monitoring and security incident handling for all our customers across the regions. So while we're highly decentralized and highly local and very close to our customers, we also build scale through those delivery centers and the security operation centers.

We run -- excuse me, we run 4 main revenue streams. As you can see here, the numbers here are based on the full year 2023 systems. So where reselling of hardware and software is still the biggest revenue stream for us and continue to grow. It's a very traditional reseller business, but obviously it's mission critical hardware solutions we speak about here. So they're quite -- quite important and quite niche, if you will, for our customers in the sense that we only do the types of solution that we're really good at.

Support Services; so this is an add-on service to the systems, helping customers to keep those systems running. There's a quite high attach rate here and these are typically contracts running throughout the lifecycle of the actual system solution.

Third, Managed Cloud Services, very important. This is delivering the same type of infrastructure, functionality and tech service but as a service so customer buy it on a contract instead of owning and operating the equipment themselves.

And last and least, Consulting Services. Anything from strategy, transformation, onboarding, migration, design, education. So a broad range of consulting services that helps customers to modernize and drive their infrastructure evolution.

A couple of key areas that we just highlight in terms of skills. It's not complete in any way, but those are relative in terms of -- or important in relation to key trends. Security solutions, I touched on already with our operation centers. We have great skills around what's called cloud native, so enabling customers to rapidly develop their own applications and speed up application development significantly, AI infrastructure in a number of different flavors. And last but not least, a lot of skills around Microsoft both in terms of the workspace as well as their cloud services. So skills wise we have a broad range of skills and also services.

Just want to highlight this, maybe a little bit of bragging almost, but we did celebrate our 30th anniversary here recently and I want to highlight that for 2 reasons. One, we have a fantastic culture in this company and great employees that bring all that value and all those skills to our customers. We spoke a lot at the celebration around our purpose and mission and our core values because they truly unite the company here. Even if we're -- we've grown through acquisitions and we exist in many different companies -- many different countries, excuse me, but when we do come together like this, we all realize that we are definitely running on top of the same foundation in terms of values and mission. You'll see if you read the report carefully that the cost of the celebration is covered here in the Q3. So the EBITA results is including the cost of the celebration.

Key trends in the market, just want to highlight a few things. Clearly the business driver is the underlying driver for everything we do. We are helping our customers with their business development. All sorts of use cases we see our customers doing, they deliver software as a service and need reliable infrastructure. They may be running healthcare systems where there is super sensitive data and all their patient records needs to be digitalized. They may be running AI use cases to improve the productivity of their own processes. Most of what we do is underpinning the critical mission and the business development activities of our customers.

Data is growing very rapidly, partly because of AI or probably accelerated by AI, but that's obviously a core and the legacy of Proact is all around data. So this is good for us, but also has the drawback of cyber threats. So the more data increases, the more value there is and the higher the risk of cyber threats. So while it's a business opportunity for us, it's also a negative trend, of course, in the marketplace.

Sustainability increasing in importance very rapidly. You've all seen some of the statistics. The IT business in general is definitely a big consumer of electricity. As we move into AI and the high performance compute platforms needed for AI, that need for electricity is multiplying drastically, 5 to 10x more needed than on a normal platform. So for us this means a lot of work around highly energy efficient platforms, super efficient data centers only running on renewable energy to make sure that we can help our customers be sustainable.

And then last but not least, the technology trend around cloud. So obviously all these types of solutions we speak about here are cloud-based, but there's different flavors of cloud which we call hybrid cloud and that's very important. Not every -- there's not a one-size-fits-all for our customers in terms of cloud, but they really do a lot of cherry picking and we want to be able to help them with all of those different variants.

So these are all 5 key drivers that are driving the growth for us. And when we look at the market, in particular core markets here, we think the market is accelerating as we look into the maybe the tail half of this year and going into the next few years. This is from external analysts. So we think both the cloud business as well as the traditional businesses are -- well, the total business is growing, accelerated by cloud, of course, but still a healthy business also in the non-cloud segment. So a good trend for us when we look at the growth opportunities going forward.

I touched this already. What we do for our customers? There's a number of use cases that are all very critical. So we are working very closely to our customers, not only on the tech side, but also on the business side. And you see the somewhat complex snake, as we call it, on the right-hand side in terms of how we help our customers. We engage early, really try to understand their business needs and how technology can enable those business needs. We help them design and migrate and transform their IT infrastructure to be modern and then we run it -- deliver to them, or even run it for them through a hybrid cloud solution. So we have a very broad and business-driven engagement with our customers to make sure that the technology is truly helping the business.

A couple of new services we've released and made available over the past couple of months. Just very quickly on the top left, we have AI enabled our core cloud services. So these are tried-and-true services we have in our portfolio already. They are secure, they've been tested in real life for many, many years. But now we've added the AI capabilities through the Nvidia hardware and software components so we can do generative AI workloads on top of our existing cloud platform. So this is great, and a good natural extension of our existing portfolio.

And on the right-hand side, what we call sovereign cloud. So again taking our existing tried-and-true technology, but make it available in a way that is very secure, not only technically but also legally in terms of jurisdiction and geography to customers with extra high security requirements. Financial sector will be a very good example of this where they need the infrastructure and the data to be very secure from a technical perspective, sometimes not even connected to the outside world, but also from a jurisdictional perspective.

And then a third product we've also made available recently is what we call a Cleanroom product. This is in our security portfolio. This is a product that enables customers to recover after a ransomware attack or any type of attack. So -- and as you may know, ransomware attacks, you don't know typically how long before the actual attack, how long before did the attackers penetrate your systems. That could be many quarters before the actual attack happens. So they may have been lingering in your systems for many, many months. So when you recover your system, you don't know if you bring back in then the old ransomware software, even if it's restored from a backup.

So the purpose of this solution here, the Cleanroom solution, is to restore a customer environment fully in a production environment, but it's disconnected from the outside world. So you can actually run your complete environment in a Cleanroom and validate that everything is working the way it works, the way you expect, and that it's free from any ransomware or malware.

So these are just 3 examples of how we evolve our portfolio, leveraging, of course, existing products and services we have and evolve them to meet our customers' needs in terms of, in this case, AI and security. So those were just a couple of highlights in terms of the company in general and also what we've done from a portfolio perspective since we met last.

If we then turn to the numbers, I'll just quickly run through them and then I'll hand over to Noora to go a little bit deeper. Good growth in the quarter driven very largely by our systems, also strong organic growth. Organic growth was almost 9%. Good cash generation as you're used to when we look at Proact. EBITA, also good growth, almost 9%. And as I mentioned already, that includes taking the costs of our celebration, which was almost SEK 9 million on top. So if you add that back, a very good EBITA growth year-over-year.

I think the only thing we are a little bit unexcited about or unhappy with is that we have a bit of a decline, about 2% organically in our services business. ARR, recurring revenues is flat organically. But we had a bit of a decline in our MCS business. We're not super worried about it. It's a little bit of a timing effect. It's been a little bit slower in terms of closing new contracts. Contracts are expanding in scope, they are expanding in complexity and therefore they take a little bit of a longer time, which means takes longer to onboard and we get a small dip in our MCS revenue. As I said, we're not happy, but we're not super nervous either about it. But it's maybe the thing that could have been even better in this quarter.

Good. With that. I'll hand over to you, Noora.

[Noora Jayasekara, executive]

Thank you, Jonas. So, on this slide, revenue in this quarter reached SEK 1.1 billion, an increase with 6.3%, of which 8.8% organically. The improvement is driven by strong system sales, as you can see, which is up 17.6% and actually 20.1% organically. As Jonas mentioned, the Services business decreased with 4.7%, 2.3% organically compared to Q3 2023 due to lower revenue in both Managed Cloud Services and consultancy revenue, while Support Services remain flat.

Business units, Central and West stand for much of the increase in this quarter as well as U.K. Thanks to good system sales. Nordic & Baltics remained stable with some changes in product mix, which we will come back to. Services revenue accounted for 45.5% of total revenues, a slight decline compared to last year driven by the good system sales in this quarter. And as previously mentioned, the system business is a bit volatile with large deals in individual quarters impacting the mix.

On the next slide, we have our annualized recurring revenue that amounted to SEK 1.7 billion in the third quarter, a decrease with 2.4% compared to Q3 2023, organically, though ARR was flat. This quarter was still affected by lower Support Services primarily in the U.K. and longer sales cycles for complex deals in Managed Cloud Services, as Jonas mentioned. During the quarter, we have signed for new cloud services contracts amounting to SEK 102 million, a decrease from last year's SEK 119 million.

On the next page, adjusted EBITA amounted to SEK 79 million, an increase with 8.9% compared to the same period previous year where business unit Nordic & Baltic stands for the majority of the increase. The improvement is driven by increased revenue and improved gross margin from last year's 23.5% to 24.2% this year, coming from increased margins within system sales as well as continued efficiencies within services delivery. As a result of the higher gross margins, EBITA margin increased to 7% compared with 6.8% last year. And as mentioned by Jonas, this quarter includes circa SEK 9 million cost related to the 30 years celebration.

Further to cash flow and net cash position on the next slide. Our net cash position in the end of the quarter landed at SEK 175 million compared to SEK 80 million at year end 2023. Our strong financial performance has enabled both share buybacks and dividends still leaving us with a stable financial position at quarter end.

And some more cash flow on the next slide. Cash flow from operating activities amounted to SEK 83 million. Total cash flow in the quarter was SEK 42 million compared to minus SEK 5 million last year.

And some details from our business units starting with Nordic & Baltics on this slide. Revenues landed at SEK 566 million in the quarter. EBITA increased with 12.4% to SEK 64 million, resulting to an EBITA margin of 11.3% being well above the Group target of 8%. Business unit Nordic & Baltics continues to deliver stable results in the third quarter.

Further to business unit U.K. on this slide. In the U.K., revenues increased to SEK 170 million, an organic increase of 10.4%. The increase is driven by good system sales. EBITA remains flat at SEK 3 million, corresponding to an EBITA margin of 1.6% due to revenue mix shift leading to lower gross margin.

And on the next slide business unit West. Revenue in West increased organically with 17.1% and landed in at SEK 216 million. This quarter system sales are driving the improvement. EBITA increased from last year's SEK 4 million to SEK 9 million this year, a margin improvement of 2.1 percentage points to an EBITA margin of 4.4%. The improvement is mainly driven by good cost control and volume increase.

And business unit Central on this slide. Revenue increased with 16.9% to SEK 210 million. The organic growth was 21.2%. The increase, although compared to a somewhat weak third quarter last year, is driven by some large system sales -- system deals, also in this quarter. The services business was down with 10.8%, 8.1% organically. EBITA landed at SEK 6 million, corresponding to an EBITA margin of 2.7%. The improvement in EBITA is mainly attributed to the increase in revenue.

And on the next slide are financial targets. In the quarter, our organic growth reached, as mentioned, 8.8%, which is slightly above the long-term financial target of 5% of organic growth and additional 5% growth via acquisitions. Looking at total growth comparing last 12 months to full year 2023, we still have a way to go where we haven't made any acquisitions during a slow M&A period in the markets. EBITA margin in the quarter was 7% and last year -- last 12 months sum up to 7.3%. So we are definitely closing in on the long-term target of 8%.

As I previously mentioned, we are actually in a net cash position, meaning that we are well below the set level of 2x EBITA in leverage. Return on capital employed is at 21.1% for the last 12 months, well above the target, which is 20%.

And this concludes the financial overview of a good third quarter. Back to you, Jonas.

[Jonas Hasselberg, executive]

Yes. Thank you, Noora. The summary is easy. Good growth continued to be strong organically and above what we would have expected. As Noora mentioned, we typically plan for roughly 5% organic growth. EBITA development also good in particular considering the one-time costs of the celebration. Very strong financial position and we are as always, very positive about the market outlook. We are positioned very well in a market that's growing quite rapid, so still positive about the future.

So with that, we've gone through the slides. We'd be happy to open up for questions. You know how to do it. You either unmute yourself and scream or you raise your team's hand, however you feel comfortable. Wilhelm?

[Operator]

Wilhelm.

[Jonas Hasselberg, executive]

Go ahead.

[Wilhelm Gruvberg, analyst]

Yes. This is Wilhelm from Alcur Fonder. Just a question on the balance sheet and the really strong cash flow with this recurring revenue base that you have and very strong cash flows and a big net cash position. You have announced that you will do some buybacks, but it's really been quite shy of volumes. Is there something that makes you avoid the buyback? Or is it like you have a very good pipeline of M&A? Just trying to understand.

[Jonas Hasselberg, executive]

Yes, it's a couple of different things that all kind of add up. But we said before, I think we're quite clear, we'd rather do M&A than buyback. So you're absolutely right. We want to keep our gunpowder for M&A. We've also started the buyback in July, and it was only -- not too many months of activity before we get into this quiet period. And then we also try to balance a little bit when and how we buy, considering our own share price, not that we're saying that we're overvalued, but we want to be smart about when and how we buy. So there's a couple of different things that are just balancing out when and how we do the buybacks.

On the M&A topic, we definitely see a better activity in the market now than we did last year. And frankly, also at the beginning of this year, we thought maybe the M&A market would open up a little bit earlier this year. It's been a little bit slower, but good -- good activity. And I think valuations are starting to harmonize again as I think it's been a slowdown in the market in general, and maybe interest rates that are coming down is helping as well. So that's positive as we look forward. Good. Daniel?

[Daniel Thorsson, analyst]

Yes, Jonas. And I'm very sorry if you have already answered this one, but I had 2 other calls coinciding with this one. So I shoot my questions anyway. The first one is on cloud revenues here organically down 1% year-over-year. What was the main reason for that? And is that the trend that we should expect ahead as well, or any feelings for Q4 here?

[Jonas Hasselberg, executive]

No, quite the opposite. We should expect this. It's a bit of a timing effect, frankly. So a couple of different things happened at the same time. We had a little bit of a slower TCV during the last 2 quarters, largely because we see that the sales cycles are long. Maybe quite likely, people are still a little bit concerned with where the general market is going. Consumption hasn't really picked up. Economy is still in some sort of waiting mode, but also that our contracts are becoming more complex. And I mean -- I don't mean the legal contracts, I mean the scope of our contracts, the types of services we're delivering. So obviously our customers are more accurate, more particular with the contracts.

And then onboarding of some of the contracts we've done in the past also being complex, takes time. So it's mostly timing effect of closing deals, in particular during summer times with onboarding of previous deals. So we continue as always to be positive about our clouds. We're not happy with the dip, but we would rather have a continuous, of course, growth. But it's more of a timing effect than anything else.

[Daniel Thorsson, analyst]

Yes. So it's reasonable to expect that to come back to growth relatively soon, I guess.

[Jonas Hasselberg, executive]

That is correct.

[Daniel Thorsson, analyst]

Yes. Excellent. And then second one on consulting revenues, they were down here in Q3 year-over-year. Is that the market thing? I mean all the IT services companies have a very hard time out there? Or are there any company-specific reasons for that?

[Jonas Hasselberg, executive]

No, there's definitely a slightly tougher market for consultants. We're also lower on consulting. We haven't staffed up our consulting teams to the level we planned for, for that very reason, for the market reason. So I think, yes, it's -- there are some market reasons but the good thing is we don't sit with a lot of bench warmers, as we would call them. There's not a lot of people in our consulting staff that are not active, not billable. But on the top line, you have a negative impact.

[Daniel Thorsson, analyst]

Yes. So the utilization in the consulting revenues are still good?

[Jonas Hasselberg, executive]

It's still good.

[Daniel Thorsson, analyst]

Yes. I see. And then I have a question on the gross margin here. The system business drove the growth here in the quarter while gross margin was still up slightly versus last year. Were there any positive one-off deals on the system side? Or is this a good underlying trend to expect ahead?

[Jonas Hasselberg, executive]

No, I think it's thinking back on the list of deals. So you're asking me, I'm doing a real-time analysis. That's dangerous. No, I think it's more -- there's not one deal that sticks out as we've seen some other quarters. So I think it's a good mix in terms of the systems portfolio or the system deals. Just rather that we -- as you all know, we work quite hard on efficiencies and working up our margins and we see the positive effects.

[Daniel Thorsson, analyst]

Yes, I see. And then finally on the cost side here going into 2025, will you be a bit more forward leaning, investing in cost? Or will you continue to be prudent as we now see your growth picking up?

[Jonas Hasselberg, executive]

Well, we're always prudent, of course. But if there are areas we would invest, it will be on the commercial side, so sales and consultants. Those are the areas where we would want to invest. I think we're quite good and quite okay in our admin and our operations costs. So -- and you've heard us say this many times, we want to build scalability into our operations. We can bring in new customers, more volume into our cloud and support services without having to add a ton of more people. And I think we are in a better shape there now. So if we do investments, we will do investment. It'll be primarily in driving our commercial agenda and the consulting business.

Any other questions?

[Unknown Analyst]

Yes. Can you hear me?

[Jonas Hasselberg, executive]

Yes.

[Unknown Analyst]

Yes. Sorry to barge in. [ Christoffer ] here from DNB Markets. Just wanted to pick your brain on these incentive scheme changes at Microsoft from January of next year. So first of all you're primarily doing CSP given your SMB focus and do you see any upside to that as I think they will increase rebates for CSP next year?

[Jonas Hasselberg, executive]

There may be. I think we're quite careful with running our business off of Microsoft incentives. And the reason is exactly the reason you bring up. They change year-by-year. So our business model is primarily driven by 2 things when it comes to Microsoft. Number one is we try to do as little licensing as possible. So just licensing Azure or Microsoft 365 is not our core business. It doesn't mean we don't do it. We do, do it, but to the minimum extent possible. And then the second piece then is that we try to make our business off of our own services on top. So we do security services and/or running all the workloads on behalf of our customers on top of the public cloud. So our own cloud services on top of Microsoft is more important to us and they're unrelated to the licensing schemes. So those are the reasons why it may have a positive impact. But that's not what we build our business models on if that makes sense.

[Unknown Analyst]

That's great. But just to be clear, you primarily own the licensing CSP oriented or yes, or maybe you don't disclose the split?

[Jonas Hasselberg, executive]

We don't disclose the split, and I don't even have it in my head. So...

[Unknown Analyst]

That's okay.

[Jonas Hasselberg, executive]

Yes, [indiscernible] I'll have to make it up, which is not a good answer.

[Unknown Analyst]

[indiscernible] here. Congratulations on your 30-year celebration.

[Jonas Hasselberg, executive]

Thank you.

[Unknown Analyst]

Yes. I had a question about that. The SEK 9 million cost, why didn't you -- why don't you consider that a non-recurring item?

[Jonas Hasselberg, executive]

We always try to minimize the non-recurring items. We try to run a stable operations that is predictable. I know it was really on the verge, but that's kind of the general philosophy we have. We try to do as little non-recurring items as possible. Keeping a good culture and engaged, happy employees is part of the business. Obviously, now all the cost happens in 1 quarter. I totally recognize that, but that was the rationale behind it.

Good. Feel free to reach out to us if there's any more questions coming after this call. As mentioned, the recording will be available on the website. The slides and the report is already available there. If there's no more question, we wish you a great Friday and a happy weekend, and we'll see you in February.