Integrated Research Limited (IRI) Earnings Call Transcript & Summary

Hello, and welcome to the Integrated Research Limited Fiscal Year '23 Results Investor Conference Call. [Operator Instructions] I will now turn the conference over to John Ruthven. Please go ahead.

Thank you, operator. Good morning, and welcome to the full year FY '23 results briefing for Integrated Research. My name is John Ruthven, and I'm the CEO of IR. With me today is Matthew Walton, our CFO. I will open the presentation and then hand to Matthew to take us through a detailed financial review. He will then hand back to me talk through -- to talk through strategy and key priorities for FY '24. At the conclusion of the presentation, we will open the call for questions. This morning, we posted our results presentation to the ASX website, which we will be referring to during this call. You can also find a copy of it in the Investor Relations section of our website at ir.com. Moving to Slide 2. Integrated Research, or IR, as we've ever known, is a global software company providing performance and experience monitoring solutions for critical business systems. We have 3 product lines: Collaborate through unified communications and UCaaS, or Unified Communications as a Service; Transact, which sits in the payment space; and our Infrastructure product, the Hewlett Packard Enterprise or HPE nonstop environments, common to the customer use cases that we support, our complexity, mission criticality and scale. Slide 3 highlights the underlying strength of IR's business model, our customer base. These customers are large, well-known global enterprises in key industries, including technology, telecommunications, financial services, government, health care, higher education, retail and industrial services. Our customer base is long tenured on long-dated, noncancelable contracts with mission-critical requirements. I'm on Slide 4. CEO key messages. Reflecting on the full year, we had an improved TCV performance across all geographies and product lines underpinned by stronger renewal cycles and improved sales discipline. That said, we have work to do with our new business execution across both sales and product. We've trimmed our R&D expenditure and increased our focus on getting sales traction with products that have been developed in recent years. Across the board, we've exercised greater discipline in managing our cost base. Our 3-phase strategy continues, whilst we extend the execution phase to focus on getting business fundamentals right to full scale. In this process, we continue to refine our GTM or go-to-market model. Cash at bank was up strongly on the back of good collections discipline and a reduction in our DSO or days sales outstanding. That said, we expect the cash balance to pull back a little in the first half because of the seasonality in our business and the weighting of renewals to the second half. We have no debt and no debtor factoring was undertaken in the fiscal year. On Slide 5, we summarize our statutory results. The company achieved normalized profit after tax for the year of $2.6 million, excluding a noncash impairment charge resulting from impairment assessment forecast reflecting current trends in new business, renewals and expense growth. Statutory revenue for the period was $69.8 million, up 11% over the prior year. The strong performance was a consequence of improved sales execution, a larger renewal book and healthier external trading conditions. The FY '23 license renewal book grew by 10% or $4 million through price increases accounting for $3 million and term extensions accounting for $1 million. Cash received from customers totaled $76.3 million, up 1% over the prior period. The company continues to benefit from term-based noncancelable license contracts with a high-quality customer base, increase in cash receipts and increase in cash at bank, which continues due to strong focus on cash management. Now on Slide 6 and switching to pro forma results. The lead performance indicator, total contract value, or TCV, was $68.5 million for the year, up 21% on the prior corresponding period. We continue to report revenue on a pro forma subscription basis, which while a lag measure, we believe is more reflective of the long-term underlying performance of the business. Subscription revenues for the period were $68.3 million, marginally down as a result of lower new client sales and lost clients from FY '22 and FY '23. Revenue from testing solutions and services contributed to the period-on-period decrease in total pro forma revenue as the year has a large renewal focus. Pro forma EBITDA dropped 28% as a result of lower revenue and cost increases due to inflationary pressure and a one-off U.S. loan forgiveness in FY '22. Our cash conversion rate for the year improved to 101% as a result of the strong cash collection in the year. Moving to the FY '23 progress report on Slide 7. Before handing over to Matthew to provide an in-depth look at our financial results, I'd like to provide a progress update of source as we've done in prior periods. Critical to our turnaround is getting our largest geographic region in the Americas prime again. Whilst modest, TCV was up 5% pcp and heading in the right direction. Europe still continued its return to growth, up 18% pcp. APAC continued its strong growth trajectory, up 36%. Critical to our strategy is getting a return on the investment we have made in bringing new products to market and getting them into the hands of our customers. In this area, we are behind plan, and we're taking steps with both our GTN and sales execution to address. Whilst we've achieved some early wins, momentum is slow. Our Transact portfolio continues to achieve high customer retention and contract terms close to 5 years. By contrast, Collaborate retention rates are more challenged and contract terms closer to 3 years. The challenge of vendor tools and customers' cloud migration continues and has placed pressure on our Collaborate renewals. Through the second half of FY '23, we reset our product and development strategy to align to customer-driven demand and near-term opportunities. The reality is this is smaller pieces of work, and in many cases, more of a co-development approach, working closely with customers on specifications. It has also resulted in increased innovation on our on-premises or server platform. Our balance sheet remains debt-free with an improved cash position at the end of the year, part of our drive to improve our overall working capital position. I will now hand over to Matthew to take us through a detailed review of our financial performance.

Thank you, John. We're now on Slide 9. Slide 9 shows the linkage between total contract value, statutory revenue, pro forma revenue and annual recurring revenue. It's worth unpicking these for a moment. Total contract value, the black line, is the total value of revenue-generating contract written in a year. This includes software license and related maintenance, cloud, testing and consulting services revenue. TCV is a function of the term of the contract and annual value of the contract. For example, TCV can reduce significantly if the term is reduced even though the annual value of the license subscription has increased. Statutory revenue, the red line, is revenue recognized per the accounting standard. This has strong upfront revenue recognition with less revenue recognized over the life of the contract. As a consequence, there is strong alignment with TCV. Pro forma subscription revenue, the middle blue bar, is the license and maintenance revenue from the contracts spread over the life of the contract. It's a nonstatutory and unaudited view that we believe better represents the recurring nature of the contracted revenue streams. Pro forma revenue, the left purple bar, is performance subscription revenue plus other nonrecurring revenue streams, typically professional services and onetime through testing services. Recurring revenue, the gray bar, is the annualized end-of-period subscription revenue and this represents the ongoing recurring value in the revenue stream. This chart highlights that while there is more volatility in TCV and statutory revenue, there is more consistency in the revenue streams over time is represented by pro forma and annual recurring revenue. Two key points to address in this slide are the convergence of TCV and statutory revenue, which is driven by the shift to SaaS with less upfront revenue recognition. And secondly, the recent stability of performance/ARR compared to the volatility of the lead indicators of TCV and statutory revenue, which shows that the growth of pro forma and ARR occurs as new clients TCV are added to the renewal base. The renewal base is extended through price increase, and this offsets any lost revenue through applied exits and downsell adjusted for any foreign exchange movement. We'll turn now to Slide 10. Slide 10 presents our TCV, statutory revenue, pro forma subscription revenue and annual recurring revenue by geographic region and by product set. This slide should be considered in conjunction with more detailed slides in the appendix. Points to highlight include the Asia Pacific chart clearly shows consistently strong pro forma and ARR growth of 9% on a 5-year CAGR. The Asia Pacific growth was across all products and new business and renewals, improving Collaborate renewal period, including a significant growth in the contract term. New Transact sales will grow future pro forma revenue and ARR, and new leadership in the Americas and Europe is driving license TCV growth. We turn now to Slide 11. This slide focuses on the key metric underpinning value, namely the change in the components of recurring revenue. Total ARR, or annual recurring revenue, declined by 1% to $67.5 million. New logos in Collaborate and Transact, upselling Collaborate from new capacity and price increases and favorable foreign exchange were overshadowed by the loss of clients and downsell price reductions in Collaborate. Collaborate is experiencing headwinds in all geographies. Further information is in the appendix. We turn to Slide 12, operating costs, excluding the impairment. Turning to Slide 12. IR has continued to manage costs tightly. While costs have increased 2% on the prior period, this is down 5% in the increase that we had at the half as a result of inflationary pressures offset by managing our headcount. National attrition continued through the period as the market for technology staff was competitive. And pleasingly, IR was able to replace all critical roles quickly with high-caliber candidates. Our innovation agenda continues as illustrated by the left-hand chart. The jump in product and technology expenditure primarily reflects a lower level of capitalization as we reset our investment in our cloud platform, balanced with customer-driven solutions focused on near-term opportunities. As covered in the first half, the sales and marketing, while our headcount is lower than in FY '22, this is offset by increased travel costs as customer face-to-face meetings and marketing events have returned and some upward pressure on remuneration. The company's general and administration expense increased with costs incurred in retaining and recruiting staff in the competitive market. Slide 13 will look at the full year performance review and some further key metrics. The additional metrics in this slide underpinning value the level of recurring revenue, the contract length and the proportion of new business to renewals in the period. Recurring revenue was nominally increased as a proportion over the prior period. If we normalize for the same level of testing and services revenue, nonrecurring would actually consist -- recurring revenues consisted 86% of pro forma revenue. Contract length has improved over the prior period with the average length of the contract written in the year increasing to 3 years, up from 2.6 years in the prior corresponding period. Renewals dominated the year with $41 million in renewed TCV, up from $25.5 million in the prior year. If we turn to Slide 14, net cash flow analysis. Cash flow is illustrated in this slide with cash at bank increasing $6.3 million or 51% over the year. Significant focus was paid to collecting the long overdue balances, and this is highlighted in [ Note 11 ] of the accounts with receivables past 60 days due being less than 20% of the prior period. Cash paid to employees and invested in development reduced compared to last year. Finally, FY '22 cash included the repayment of $5.3 million of borrowings. The company believes we have appropriate cash reserves to manage the cyclical nature of our business. Slide 15, EBITDA cash flow bridge. While the company had statutory EBITDA of $12.1 million, $1.6 million of cash was generated from operations. The primary drivers of this difference are overtime revenue and cash conversion compared to statutory upfront revenue recognition, combined with improvements in working capital is $0.6 million as a result of improved collections offsetting historic debtor factoring of $2.7 million, which concludes in December, and income tax paid. We should emphasize the company is not factoring any receivables and the current factoring completes in December 2023. We turn to Slide 16. The balance sheet shown on this slide shows a 31% decline in net assets, a result of the $31.8 million impairment of goodwill, intangible and other assets. Cash and trade receivables increased $1 million on the prior year, while payables are down $2.2 million. Receivables remain a strong source of cash flow in the current and future years. The company remains debt free. I'll now pass back to John for the rest of the presentation.

Thank you, Matthew. Moving to strategy on Slide 18. Our 3-phase strategy of innovation, execution and scale remains intact, albeit with an extended execution phase. As discussed throughout today's presentation, there's a strong focus on strengthening our business fundamentals. Our strategy remains focused on our core markets of Collaborate and Transact and Infrastructure, acknowledging the close linkage between our Transact and Infrastructure business. The core focus of the execution phase is to enhance our ability to win new business, both new customers and new products to existing customers. Key to doing this in our Collaborate business is to focus on large, complex multi-vendor enterprises where our value proposition and price point resonate more strongly. Also, enterprises where there will be a longer tail for on-premises our traditional business. These include organizations like large critical health care providers, higher education institutions and law enforcement. To accelerate our innovation for these customers, we often work in a co-development engagement, smaller targeted pieces of work. Two significant drivers of demand for Transact are compliance and real-time payments. ISO 20022, an electronic messaging global standard for financial information, is driving compliance issues to large financial institutions and payment processes. For some years now, countries have been rolling out real-time payment streams, creating new challenges for monitoring and managing these rates. We are targeting customers and prospects with existing products and value-added services to address these challenges. Now on Slide 19. Core to our Collaborate strategy and road map is the customer journey. This is a market segment that has been going through significant disruption for a number of years, not just the structural market change of work from home, but the rapid innovation in the applications, infrastructure and devices that define the collaboration space. The major challenges we are facing, i.e., customers moving away from their on-premises infrastructure, our core strength; b, vendor tools for cloud-based deployments; and, c, data limitations from vendor APIs. To address this, we are leveraging our extensive large enterprise customer base where the average number of seats is greater than 25,000. Our GTM is focused on large multi-vendor customers and prospects where scale and complexity plays through our core strengths and price point. We can grow with customers through renewal yield, upsell of seats and new products. To deliver on this, we've refocused our product investment to differentiate from vendor tools or simply stated as value beyond the vendor tools and working with vendors on migration assurance. On Slide 20, we take a look at the Transact and Infrastructure strategy and road map. The Transact and Infrastructure segment is a curious dichotomy of systems, processes in Infrastructure that have been around for 40 years and rapid disruption with modern payment methods driven by customer experience. This is capped off with the demand in compliance standards and services level environment with serious penalties for breach or failures and a large dominant vendor landscape. The challenges for IR reflect this dichotomy, a, customers are slow to adopt new products; b, it's difficult to project how the segment evolves with cloud; c, aligning to large vendor priorities that can be difficult; and d, in a dynamic market, new competition emerges. To address these challenges, we've rebalanced our GTM to align with our customers' journey more closely. We'll benefit from the long tail of on-premises our core strength. At the same time, we are broadening our monitoring strategy to an ecosystem play to increase our value proposition and leveraging targeted co-development opportunities with key customers to better align to near-term opportunities. Moving to Slide 21, Collaborate customer wins. In June, we closed a significant new customer opportunity with Sutter Health based in California. They are large, multiple-property integrated health provider with over 53,000 employees. They have a large multi-vendor environment and have previously been using Cisco's Prime Collaboration Assurance, or PCA, which is at end of life. They licensed our complete Cisco product set as well as our MS Teams solution. In the critical world of health services delivery, they lack the end-to-end visibility across a complex environment of video, room and network endpoints, making it difficult to identify and troubleshoot issues. Sydney Healthcare has been an IR customer for more than 10 years, leveraging our full suite of Cisco products to monitor and troubleshoot their critical voice and video environment. Several years ago, they acquired a large organization and recently made a strategic decision to consolidate the 2 collaboration environments and standardize on IR. Critical to this process is migration assurance. And our new agreement gives them the tools and the capacity to do this, growing our license from 80,000 seats to 135,000 seats and extending the term for another 3 years. In our prior earnings, we disclosed a significant new customer win with LANcom, a large service provider in Taiwan for 120,000 users supporting their Cisco on-premises users. In March, we expanded this agreement to 250,000 users, adding additional vendors of Avaya, MS Teams and Cisco Webex. They now have a single enterprise-wide solution for their operations teams with monitoring tools that provide proactive alerting, troubleshooting and resolution. On Slide 22, we now look at a couple of key Transact customer wins. Earlier, I talked about countries rolling out real-time payment schemes and modernizing their payment platforms. Qatar Central Bank, or QCB, is in the process of [indiscernible] including adding new payment types and services. We signed a 5-year agreement with the bank for a holistic monitoring solution across cards real-time and nonstop. This will provide QCB with rapid notification issues so that their scheme partners are aware prior to customer escalations. A core strength by our customer base is the long-standing nature of our customer relationships. Evertec, a large payment processor in Puerto Rico, has been an IR customer since 2004. Earlier this year, we signed a new 5-year renewal for our solutions to continue to provide visibility across the full service transaction processing environment, merchant acquiring, payment processing and business solutions for over 2.5 billion transactions annually. On Slide 23, we break out the R&D spend across the key product and platform categories. In FY '23, 67% of R&D was spent on SaaS/hybrid platform. Going into FY '24, we've adopted a more balanced approach to innovation investment. We are moving to a focused customer-driven approach with smaller pieces of work to deliver on near-term opportunities. The outworking of this is that we will reduce spend by about 50% to $7.5 million. Slide 25 captures our priorities going into FY '24. There is not too much change from FY '23, a clear and consistent set of priorities as we work hard to continue the business growth trajectory. One, field leadership in all 3 regions continue their focus on improved sales discipline, renewal yields and new business pipeline. We are confident in the plans we have in place, the design of the GTF model and leadership's commitment to growth. Two, we've rolled out a commissioning plan that rewards new. There is a foundation of new pipeline, but we need more, and we are working with an external company to embed a funnel plan approach to build new customer pipeline. Three, the renewal book is stronger in FY '24 and is expected to benefit from the processes, cadence and discipline implemented in FY '23. We are very focused on some of the challenges impacting Collaborate renewals. In FY '23, we focused our approach to innovation and R&D spend. We will benefit from this approach in FY '24 with customer-driven solutions, co-development with customers and vendors and a near-term focus. Five, our cash position has strengthened. We have done some balance sheet [indiscernible] through prudent cost management and operational performance will continue the improvement of the company's working capital position to fund growth. Coming to the final slide, I would now like to remind you that IR does not provide specific guidance. However, coming into FY '24, we note the following observations to inform the market. One, customer sentiment is steady, and we are not encountering budgets being cut or withdrawn. In the same way that we are focused on cost management, many of our customers have adopted that approach as well. Two, we've entered FY '24 with a stronger renewal book over the prior period, which is weighted to the second half skewed to the Collaborate product line. We do have a number of significant renewals in June of our second half. We expect Collaborate churn to remain with customers migrating to UCaaS-based infrastructures. Three, we entered FY '24 with pipeline that is broadly flat over the same time last year. Our focus on larger enterprises is evident in the pipeline mix. Five, we expect growth in all regions with stronger growth in the Americas and Europe coming off lower basis. And six, delivering into our plan, we will see an improved cash balance at year-end based on higher sales, cost management and ongoing collections focus. Operator, that concludes the presentation. We can now open it to questions.

[Operator Instructions] Your first question comes from the line of Chris Savage of Bell Potter Securities.

Just want to ask firstly on the R&D going forward and perhaps alluding to that slide, where you called out $7.5 million R&D spend in '23. So what is likely to be the capitalized R&D in '24 and going forward? Is that $7.5 million a good guide?

I wouldn't think so, Chris. So I think one of the points we made is we've reset some of our operating structures, and that $7.5 million is probably down 25% or thereabouts from prior years, and that represents the [indiscernible] spend on our development team. The blue bubble that talks about the innovation budget reduced by 50%, that's what we've got as a placeholder for what would be product development, capitalizable product development. Now that said, having just taken a fairly strong impairment, we're going to be very, very, very cautious about capitalizing on the balance sheet. So any capitalization is going to have to show very strong future economic benefits in the near term.

So are you suggesting that you're not going to be capitalizing any or much going forward?

I'm suggesting any capitalization will be supported by strong future economic benefits in the near term.

All right. I'll ask it another way. So that $7.5 million in '23, that's not going to be repeated in '24?

That's probably there.

All right. I'll move on. John, we've seen some management changes by region over the last 12 months, particularly in the U.S. Can you give a bit of an update on that and particularly in the U.S.?

Yes. So at a headline level, we were pleased -- that we, although lower than expected or [indiscernible], that we did return to growth in that market. We did make a management change during the year, and we were pleased to be able to bring on board the new leader for that business at the beginning of August, a very strongly experienced executive, particularly in the collaborate space coming out of that space. So what we've seen to date and what we see from the design of our go-to-market and the pipeline and the way that his leadership is starting to take hold, we're confident that we have a good opportunity to deliver on the growth objectives for the Americas. On the other side of it, the international region where we -- as we referred to, where we combine APAC and Europe, our longest-standing and experienced senior sales leader continues to do well and as we've seen from the results, he was able to -- he and his team were able to achieve good growth -- or continued growth in APAC and returned Europe to double-digit CTV growth.

So that new manager in the U.S., he or she was only appointed at the start of this month. Is that right?

Correct.

Okay. And last question -- go on.

I was going to tell you in the interim during that change, I think you're aware that I spent a little bit of time in the U.S. covering that business.

Yes. And last question on the cash becoming a problem in a good way. So given you've flagged that it's going to increase year-on-year, not so much at the half, but by year-end, are we starting to think dividends again? Or is it more going to be used for investment and/or M&A?

So Chris, I'll take that question. I would say that will be a bridge we'll cross as we get to it. So you'd be probably aware of the cyclical nature of our cash given the cyclical nature of our TCV sales and hence, our cash generation from those sales. Broadly 30% comes from upfront from a sale and 70% over the life of the contract. Given that we tend to run quarter-to-quarter with the last month of the quarter being the peak and the first 2 months of the quarter being reasonably flat in comparison, and therein half-to-half, so December and June tend to be our peak period, we need a significant amount of cash set aside as "working capital" to take us through the quieter periods. So that's why we would say $18.6 million in June, and we would see that running down several million dollars perhaps to December give or take a bit. And then as the sales come through at the end of December and then sales come through at the end of June, we would see cash rising on the back of that. So there is some contingency base that's continued upon the sales being delivered. I think at this stage, I don't see the business talking about dividend, but I do see the business looking at growth and opportunities for growth. So that's probably my guidance if there's a direction.

Your next question comes from the line of Peter Cooper of Teaminvest.

Just a couple of questions, if I may. My first question relates to Slide 15, which is the EBITDA cash flow bridge. Matthew, I'm just wondering if you could just, in terms of the historical data factoring, it looks like there is a cash outflow of $2.7 million. Is that where that has been put back to the copy that could be collected by the factoring companies?

No, it's where we've actually, we've got the receivable included in the pro forma EBITDA because it's still revenue to us, but we don't collect that receivable. So what we're doing is adjusting the pro forma EBITDA to get to the net cash position.

So there's no negative cash impact on the business in the year?

No. Correct, but there is a favorable cash. I mean another way to look at it is there's a favorable cash impact to the business when that factoring runs off in December.

And in terms of being favorable, [indiscernible] the cash to remain back to the business?

Correct. So if we were to roll forward 12 months, so to this time in 2024, we would expect to have $2.7 million more in the business in cash because we would have the receivable, but we wouldn't have the factoring, so the cash would be collected by us.

Okay. Okay. Terrific. And my second question is in terms of the impairment that's been through the P&L, the noncash impairment, what are the factors that have caused that to occur in this particular financial year versus, say, last financial year?

So we have to do -- as part of our annual audit and review of the accounts, we have to do an impairment assessment across our goodwill and intangible assets. To do that, we have a fairly evolved model that looks at the products. While we have 1 CGU, we dive into product-specific drivers, and those drivers are focused on new business and retention, so renewals, retention and forecast expense growth. That goes out about 5 years. And while we're very strong in the on-premise space, we're probably finding the evolving SaaS market has significantly curtailed our future use cases in that area. And as such, we've taken the future models. We've done the NPV analysis on that. And based on historic -- recent historical trends for new business renewals and expense growth, we've been forced to take an impairment.

And you say is that across all of the 3 main product categories? Or was it in one particular product category. For example, Collaborate?

Look, I think if -- in the appendix, there is a slide that goes to a value of ARR, and that shows very clearly that the Collaborate product has significant downsell experience through the year of 26%, when you combine license, software support and maintenance. So that's been a particularly big headwind for us.

Your next question comes from the line of Stephen Fay of IR.

I was just wondering, my understanding was the renewal rate for Collaborate in 2022 was 86%. Can I just check what it was for 2023?

Sorry, Stephen, I'm not sure I'm following the question. Can you just please repeat that?

Are the renewal rates for Collaborate in full year '22, I understand last year according talking to Investor Relations was 86%. What was that for full year '23?

So I'm almost stuttering here because there's a range of different ways of looking at renewal rate, whether it's client renewal, whether it's the TCV. The best way we measure renewals for the economic impact, the financial impact, is the annual recurring revenue. And if we look at that slide of annual recurring revenue analysis in the appendix, that's got a churn rate and downsell rate of 26%, but upsell of 5% as price expansion occurred and new logos of 8%. So while the ARR was down 8% for Collaborate, that's across those range of drivers.

Okay. I'm just trying to compare '22 to '23. Is there a comparable number you can provide like if you net that out or...

There probably is. I'll take your question on those because I actually don't understand the -- what we're comparing, whether it's clients or whether it's CTV or whether it's recurring revenue. So bear with me, we'll come back to you.

There are no further questions at this time. I will now turn the conference back to John Ruthven for closing remarks.

Thank you, operator. Thank you all for joining us for our earnings release and announcement today. The better performance through the year. And as we've provided our observations coming into FY '24, we're confident in the plans that we have in place. And we're confident on the back of a better renewals book, but we're also cautious on some of the headwinds that we face. So we hope that today's conversation and presentation has given you a balanced view of the opportunity for IR, and we thank you for attending today.

This concludes today's conference call. You may now disconnect.