4C Group AB (publ) (4C) Earnings Call Transcript & Summary

Okay. I guess we are live, and we kick off the interim report for Q3 for 4C Group. So welcome all. I'm Magnus Bergqvist, I'm the CEO of the Group.

Yes, Anders Nordgren, Group CFO, I will be presenting the Q3 figures. And like in previous webinars, we will end with a Q&A session. So please feel free to add or submit your questions in the chat, and we will pick them up when we move into that section.

Thank you, Anders. Okay. I'd like to start by giving some highlights of Q3. So as we closed the third quarter of 2023, we experienced the quarter far from our expectations, which led us to issue a profit warning on October 10. This is very unfortunate, and it's the result of us not being able to convert, in this case, 12 significant contracts that we were expecting. It has been very frustrating to have this experience in so many of our contract negotiations in the same quarter, which leads to an unwanted quarterly volatility. This has especially impacted our North America and Nordic segments. I will later on come back with more details and more in-depth explanations about the reason of these delays. But the main message, however, is that all of these customer engagements are very positive. No contracts are canceled, and we expect to convert them in coming quarters. Our net sales reached SEK 49.1 million, generating a negative EBIT of SEK 34.2 million, which is clearly far from expectations. Anders will cover more financial details later in the webinar. On the positive note, we are experiencing a strong pipeline growth in all regions and noticeable is the growth in our new geographies, for example, Asia Pacific. Worth highlighting in Q3 despite the overall performance was the continued strong results in our international segments with, for example, key new contracts within the U.K. Ministry of Defence. Since our IPO, we have invested according to plan to set a foundation for future growth. We have expanded our sales force. We have invested in brand awareness, especially outside of Nordics and U.K. and we're seeing effects of this in an increasing pipeline. Another key investment area has been our R&D organization to enable us to accelerate the transformation of our software to more modular-based scalable architecture and to increase the launch of new products, we have mentioned this before in the spaces like individual training and climate resilience. And going forward, our focus is to optimize and secure return of these investments, and we do not anticipate large new investments and increases in our cost base. Our overall expectations and belief is that we will come back strong. We have initiated several actions to secure this. We have announced new leadership in North America. We have hired a new president with a strong background and a vast network, and we're also expanding our North America Board during Q4. We've added several strong sales leaders with a proven track record. We've done that in Sweden, Finland, U.K., Australia and in North America. And as a company, there is an increased focus on conversion of our pipeline. In group management, there is a clear focus and attention to ensure the conversion of all these delayed contracts. As several of these are more complex in nature, we're optimizing our plans to shorten the process and to achieve a successful conversion. But before handing over to Anders, I want to give you some more details on these contracts. The largest challenge and deviation to our expectations has been low revenue in North America. We were expecting major call-offs of licenses and extensions during Q2 and Q3. Currently, we, as a company, are operational in several programs, both with the U.S. Army and U.S. Marines. These programs are led by large prime contractors. And the reason for the delayed call-offs is outside of 4C control and it's difficult for us to impact. All of the programs are ongoing, but due to U.S. defence budget delays and ongoing negotiations, only interim contracts have been awarded in the third quarter, and that is the reason also for the very low revenue. The outlook in these programs is, however, positive, but the timing is still uncertain. Looking into 2024, we are optimistic as 4C is now involved in multiple new bids to support our growth in the region. Another important milestone is for us to obtain facility clearance status from the U.S. government. We are in the final stages of this process. And this will enable us as a company to bid and deliver classified contracts directly with the U.S. government without going through prime contractors. Moving over to Nordics. In Nordics, the challenges have been more unexpected. We have previously announced long-term commitments from our defence customers in the region. And currently, there is a positive outlook as increased funding is available, but there has, in most countries, with major delays in the customers' ability to finalize these call-offs. The reason we are given for these delays is the lack of resources in combination with an increased attention on the need to process and the Ukraine conflict. Our expectations and feedback from our customers is that this situation will be resolved shortly. Finally, the corporate and public part of the business, as announced and said in our Q2 communication, this has not evolved as expected. The uncertainties in the overall business climate is clearly impacting this. And there is an increased, I would say, carefulness in committing to new software investments. However, as we are seeing an increased number of potential contracts, we expect a larger proportion of corporate and public top line in the coming quarters. We're also very confident in our offering and the feedback we are getting from our customer base as they upgrade to our new solution is very positive. As a proof of that, it has also resulted that we have no churn in public and corporate during Q3. So I'll come back later. And by that, I hand over to you, Anders.

Thank you, Magnus. So if we take a more detailed look at the financial performance during the third quarter, you can see that we delivered SEK 49 million in net sales, a negative growth compared to the same period last year where we delivered SEK 81 million. When the revenue is broken down by revenue stream, you can see that it is within software revenue or software revenue is the prime reason to the weaker performance during the third quarter. The other 2 revenue streams, expert services and software-related services are either on the same level or slightly above last year's quarter. Important to note is that Q3 is the weakest service quarter due to vacation period. On the rolling 12, we see a negative trend at the moment, a development we aim to turn around to a positive trend coming quarters when delayed deals are converted. Taking a closer look at our segments to the left. We can see negative development in both Nordics and North America, while international continues to deliver strong numbers. International delivered SEK 25 million in the third quarter and is showing significant growth, both for the quarter isolated, but also on a rolling 12-month basis. And this is not only driven by the geographical expansion, but also within already established markets. Nordics, delivering SEK 17 million, a weaker quarter where we had higher expectations, especially linked to the clients or programs that Magnus just referred to. North America delivered SEK 8 million, which also was below expectations, and the revenues in Q3 are more or less bridge contracts that has been established until the permanent rollout is contracted. Moving over to the right side or right part of the slide and the customer vertical. It is within the defence vertical, the majority or the largest delayed deals are found. Looking at profitability. The effect from the lack of software sales in the third quarter had significant impact on our EBIT and profitability. On a rolling 12, we also are on negative numbers, something we expect to turn around as we convert the delayed software deals in the coming quarters. When we are on this slide, I just want to take the opportunity to comment on the cost development. Magnus touched upon it already, but it is an area we are evaluating and monitoring closely. But during the third quarter, most of the investments announced in connection with the IPO have been completed. Investments that have been largely allocated to geographic expansion, sales resources, sales activities and improving our offering. We have now come to a point where the focus will be on return of investment and to ensure we see full effect on these investments. This, at the same time, as we optimize our support functions. Therefore, I don't expect to see that our cost base will increase significantly moving forward. Also I would like to take the opportunity to comment on cash and cash development. The cash flow is weaker both in Q3 isolated, but also for the first 9 months. The decline in cash relates mainly to a combination of the delayed contracts, investments in the organization and repayment of tax debt. And important to note is our highlight is that we, and many procurements agreed to fixed payment plans, and this is mainly due to customer budgets where the investments are spread over a longer time period, and this is more common within the defence vertical, but we have guaranteed contracts and the military customers are always paying according to established and agreed plan. We're, of course, monitoring it. Our assessment is that the delayed contracts will be signed and converted to cash, something that will improve the cash flow going forward. So summarizing and taking a look at some key guys, we see that the financial position remains solid even though the weaker performance during Q3. Net debt remains negative. Net working capital had a positive development during the third quarter, coming down from higher levels in previous quarter and annual recurring revenue continues to increase based on new contracts signed during the third quarter. So that, I believe, concludes my part.

Thank you, Anders. Before going, and I see that there are questions coming in. But before going to Q&A. So to summarize Q3, it's clear that Q3 has been disappointing and far below expectations. We have experienced delays in several large new and existing customer projects. But none of these contracts that were forecasted in Q3 have been canceled or lost, and we expect to convert them in coming quarters. We have, as said, concluded most of the growth investments, and I see there are some questions coming into this outlined in our IPO and are now working hard to optimize and realize a strong return on these investments. We have taken the actions to strengthen our sales team and leadership, as mentioned, with an increased group management attention of being more short term in converting the delayed contracts. And thank you for listening, and we will move over to questions, Q&A.

Yes. So as expected, I see a couple of questions coming in. So let's start. Can you give more details on what full year revenue loss you anticipate from your delayed contracts?

I cannot give a specific full year outlook. I can, however, say that most of the contracts, like always is a mix of software licenses, development and implementation services. The license part is not impacted if signed this year because it's the same value. The services and the development services will though be lower based on the timing of when we sign these contracts as they are recognized based on rate of completion.

Yes. Okay. Next question. You mentioned 12 delayed contracts. Can you give more details of the size of these contracts?

I cannot go into the individual contracts, but I can say that the contracts -- the 12 contracts that I referred to have an individual order value. So we need to separate order value between SEK 5 million up to the largest one being SEK 70 million. In total, it's worth order value-wise, SEK 200 million. The full year revenue impact depends on the, as I said before, on the composition of these contracts. The estimated full year revenue impact when signing these contracts is approximately SEK 70 million. I can take another question here. Is there any difference in the ability to get paid in the U.S. between 4C and the prime contract, that's a good question. No, there's no difference. There's normally a month delay. We invoice the prime contractor who gets paid by the U.S. government and then subsequently pay us. So we have no experience of any risks in getting paid in the U.S.

Can we expect this high quarterly volatility in the future?

Also a very good question. We communicated during the IPO that we have a large variation between quarters. 4C should always be evaluated, especially in a rolling 12 months. If you go back to Q4, I think '21, we experienced a similar effect. If I remember correct, approximately 40% of the full year revenue in '21 was allocated to Q4 due to delayed deals. In 2022, we have been able more to balance this over the 4 quarters. Q3, as we are closing now, has been extreme. That's not at all according to our expectations. We were faced with so many extensions and renewals in the same quarter and experienced the delays that are referred previously. Of course, as a company, we will do everything to avoid that type of volatility. Also, as our top line grows more than cost in the coming years, this will have less effect on short-term profitability. That's a very long question. Let me see here. I think that is covered. Have you seen any change in behavior from customers positive or negative so far in Q4? I'll stop there. No. We have not seen a big change now in Q4. As we said, we expect to convert the contract. Do you see a risk that these delays will end up as cancellations? There's always a concern but in these cases that I'm referring to, I am very confident in our ability to convert most of these contracts. And the reason for my confidence is verbal and written confirmation from our customers of their intent to end up in contracts with us. You highlighted that most of the investments announced in the IPO are now completed. What is outstanding and what are the associated costs? Well, yes. As I said, most of the investments, the large investments we have done are in place. But there are clearly -- we have a growing business in Asia Pacific. We hope to announce new contracts down there soon. And of course, we need to invest in delivery personnel to be able to manage a growing business in new geographies. But when it comes to group overall cost, when it comes to investments in new software development and R&D, we do not see that we need to expand in those areas.