Modelon AB (publ) (MODEL) Earnings Call Transcript & Summary

Welcome everyone. Modelon just published a report for the First Quarter of 2023 here this morning. And with me today here in the Digital Studio, I have CEO, Magnus Gafvert together with CFO, Jonas Eborn. Welcome.

Thank you Mike for that introduction. And welcome everyone to this presentation of the interim report for the first quarter for Modelon. So, my name is Magnus Gafvert, I'm the CEO of the company and one of the co-founders. And with me today, I also have my colleague, Jonas Eborn, CFO, and also one of the cofounders.

Hi, and welcome, everyone.

And please, next slide. So today, after a quick introduction to the company, I will walk through the business highlights of the first quarter. And then I'll hand over to Jonas, who will share a financial update for the period. And after that, we'll go into Q&A. And I believe you're all welcome to hand in questions in the chat during the presentation. So next slide, please. And I'll start with bullet highlights of the quarter. So we are pleased to report that we continued our ARR growth in the first quarter amounting to 14% and continue also to be driven by new customer acquisitions mainly. And also, we're seeing an increasing mix of upsell business in that growth. Also, in the quarter, we had some multiyear prepaid software transactions that contributed to an improved cash flow of SEK 10 million compared to the same quarter last year. The success of our customers and the strong positioning of our flagship product Modelon Impact in the sustainable energy sectors continue also to be demonstrated by new customer testimonials that we published in the quarter. Also in the quarter, we announced a partnership with Latin American specialist, Iquant Consulting, specialist on industrial asset management systems, a partnership to deliver solutions for predictive maintenance based on digital twins. And with that, let's move to next slide and a quick introduction to the company. Modelon is a business-to-business software company in the system simulation sector. And that means that we're helping industry customers across the world and from various industries to digitize engineering workflow related to the innovation, development and operation of high-technology products and systems. And that could be anything from a power plant to an aircraft or a car or parts of those. And in digitizing such engineering workflows, you need to have at hand a digital representation of your product or system that can reproduce and predict the behavior and performance of this product in the digital domain before it is built and exist in the real world. And this is precisely what we provide software solutions to create such digital representations or simulation models to use for those purposes. And that brings tremendous benefits to our clients. It means that they can develop their products faster at a lower cost and also with a higher quality and better performance in the end. Our flagship product, Modelon Impact, is pioneering the simulation industry by being the first cloud-native SaaS platform for system simulation worldwide. It is based on proven technology that we have developed and also supplied to industry customers over more than 15 years. And it was first released in the third quarter of 2020. And we're currently investing significantly to grow and accelerate our recurring revenue business base driven by this platform. And we are pleased to see that since the launch in 2020, we have consistently grown our ARR quarter-by-quarter. We are also a very highly internationalized company for our size. We are around 100 people, and we're distributed over 10 offices in Europe, North America and Asia. And that means that we have presence in the key regions, key market regions that we are working on, which is a great benefit. We're able to meet and support our prospects and customers on site. It also means that we're having the majority -- almost all of our business outside Sweden. So even though our headquarter is located here in Lund [indiscernible]. The global simulation and analysis market is very big. It's estimated to more than $8 billion in 2020 and growing at an annual rate of close to 8% and continue -- projected to continue doing so for the foreseeable future. So based on this market opportunity, the strong positioning of our flagship product Modelon Impact and our international presence, we have set out ambitious targets, ambitious financial targets to grow or reach an ARR growth of 35% in the medium term, to turn cash flow positive after the current investment period in the short term and then to approach and exceed EBIT margins of 20% or more. And with that, we can turn into the first quarter. Again, I'm pleased to announce that -- or present that we had an ARR growth amounting to 14% in the quarter which take us to SEK 47.2 million. Modelon Impact continues to be the main driver of this growth, as per our strategy and plans, and with a growth in the same period of 41% compared to the first quarter last year. Again, new customer acquisitions is dominating the sales mix. Although we are, as I mentioned, also seeing an increased share of upsell business in this. And this is also in line with the land-and-expand strategy that we are employing for Modelon Impact. So we are typically working with large technology companies, large global technology companies, and we typically enter those accounts with small to moderately sized initial transaction, meaning that we start working with department for a certain specific workflow or application and then working with the customer to expand the usage, attracting more users and also addressing other teams, departments, business areas or programs and so on. The sales cycle in our industry is typically 6 to 12 months, at least, sometimes longer. So that speaks a little bit to the time scale of these dynamics that we see in the expand business. And if we move to the next slide, we can go a little bit into the -- drill down a bit on the activity in the first quarter. I'll start by also highlighting some existing customers that we have in our focus industries of energy, automotive, industrial equipment and aerospace that shows the type of customers that we're working with. And I'm sure you all recognize that the logos you see here are very well renowned, leading global, often technology companies, highly innovative. And of course, we are very, very proud to earn the trust from such fine companies to deliver our solutions to them. And in the first quarter, we have landed some new customers of this same character. So we have, for example, a British multinational oil and gas company in the -- who are using Modelon Impact in the context of energy systems based on hydrogen which is very interesting. So I think most of you are aware that we have what's called an emerging, what's called hydrogen economy, focusing on the carbon-free hydrogen as an energy carrier and infrastructure and technology for this. So there's a lot of activity going on here around the world, and it's very exciting to be part of this. And we have several customers already working in this space. We also have an American global power generation equipment provider, that's a long word. Basically, it's a company -- this is an upsell. So this is a company that provides equipment to large thermal power plants, combined cycle and other. So very large pieces of equipment, boilers and similar. They are using Modelon Impact to develop next generation of technologies, for example, using different working fluids such as CO2. We also have an upsell to a German fuel cell innovator, a specialist company, again, related to this hydrogen economy activities. We also in the quarter landed an American multinational beverage corporation, also very exciting. So they are using Modelon Impact in the design improvements and design of beverage coolers and also, I believe, dispensing machines. So again, driven by needs to make these devices more energy-efficient and sustainable. Also, we have upsell in the aerospace sector to a German National Aerospace Research Institute. So overall, looking at the pipeline development in the quarter, it's steady compared to the previous quarter. And we see notable activity in the U.S., continue to see that, and also in the HVAC&R, that's heating, ventilation, air conditioning and refrigeration sector and sustainable energy sectors. As demonstrated by the wins and also represented in new leads in the quarter, we have been focusing on those sectors also in our marketing activities, attending industry conferences, industry events and similar. So next slide, please. So why are these companies coming to us? So basically, again, it's the strong positioning of Modelon Impact to help these companies address the current and future challenges that they are seeing. And those challenges and requirements can be categorized into these 3, let's call them, mega trends that are also driven -- driving the overall growth of the simulation and analysis market, really. So the first is that of digitalization. So it basically means that to be a competitive technology company, you need to shorten your development times, you need to get technology quicker on the market and you need to do that with a higher and higher quality and performance. And this is simply impossible to do working in traditional ways with physical prototypes and test beds and so on. So to move more and more of the engineering workflows into the digital domain is a key strategy for many of these companies. And again, we're very well positioned being offering this solution to create the models and to use them for these purposes. And then we have the next trend related to clean technology or sustainable energy. It's not only the energy industries, but all technology industries essentially are under very high pressure to deliver improved products and systems to meet the higher and higher demands of sustainability. Very high -- very rapid innovation rates and taking new solutions to the market as quickly as possible. And this is only possible by working extensively with the type of simulation technology that we are offering. And this is also why we're seeing the majority of our users using Modelon Impact for such purposes. And then we have the SaaS cloud. So of course, accelerated during the pandemic, the need to work collaboratively in distributed teams and sharing data using -- working with centralized data, that's one aspect in the simulation world. Another important aspect is the almost infinite access to computation resources on the cloud. So again, we are very well positioned here to being pioneering our industry on the cloud with Modelon Impact. I should also mention on this, the major thing out of the clean technology sustainable energy. Modelon Impact has a lot of built-in functionality model components that are very well suited for this type of applications. So again, extremely strong positioning. Next slide, please. And this is also highlighted then by some of the customer testimonials that we published in the period. Some of you may be aware that we had our first ever user conference, international user conference in Stockholm in October last year, where we attracted more than 50 leading technology companies from around the world, from 15 countries, actually. And from those attendance, we have produced some testimonials that we saw here. So 3 of those were presented in this quarter. So first one here is MAN Energy Solutions. So MAN is an energy technology provider, global, really large, more than 14,000 employees and over EUR 3 billion in turnover. They are using Modelon Impact in the context of large-scale industrial heat pumps. And those, again, we're talking really, really big equipment used in the process industry, energy industry to manage and transfer heat from one place to another, basically being able to not waste heat with flue gases and similar but to reuse it in the process or to reuse it for purposes of district heating and similar. So this equipment is extremely -- first, it needs to be adapted to the new energy technology available, meaning, for example, intermittent renewables and so on. And also, it's very, very expensive to test and validating test beds. So they're using Modelon Impact to do test and validation in the digital domain using trusted models built using the model components provided with Modelon Impact. And we have another. Next one here is Fondazione Bruno Kessler. So this is a top Italian research institute focusing on sustainable energy solutions, and they have a lot of activity in this hydrogen economy context. So they are using Modelon Impact to analyze and assess complete hydrogen energy systems, from steam generation to hydrogen generation, production with electrolysis to storage and then conversion to electricity and fuel cells, et cetera, assessing the total balance of those very complex systems. And we have Iquant Consulting using Modelon Impact for the purpose of having physics-based digital twins to combine with their asset management solutions for the purpose of predictive maintenance. The combination of physics-based digital wins with this predictive maintenance solution is innovation that results in much more accurate failure prediction. And this actually also manifests, if you go to the next slide, please, in this partnership that was announced in the period where Iquant will combine their platform with Modelon Impact for the purpose of having those physics-based digital twins and thereby offering a much more accurate and higher performing predictive maintenance total system. So this is -- it's again, it's very exciting to be part of this another emerging sector of digital twins in the industry. This partnership will focus on power plants and energy infrastructure And as a first step is intended to deliver a number of pilot projects driven by Iquant. So next slide, please. So Modelon Impact essentially is a platform to create digital models of this technical industrial systems and then use these models in workflows from early engineering workflows from the innovation and research and then into the detailed design of the parts, combining the parts into the whole again, and then verify and validate that the engineering design meets all requirements and then put this into operation. So it can be used throughout all these phases. Then we take this value proposition and package it in a cloud solution, and that's unique then for us. And in that, engineers get access through subscription services. And we can offer also computation services, exploiting the computational resources available on the cloud and also integrations and web apps based on the platform here. And we have then a business model to monetize on this value that also leverages the cloud. So currently, in our product development, we're focusing on the upper part here to strengthen the robust scalable aspects of this platform as we have also guided previously. So it's basically taking us to the next step in going towards scalable SaaS business. And we -- in the quarter, we have put down a lot of work here, and we expect to have new capabilities included in the upcoming release in the second quarter that will drive -- help us to drive growth looking forward -- going forward. We also had a release in the first quarter that was more focused on the lower part of the picture here. So that's user improvements related to the supplied model libraries used by engineers, almost like LEGO bricks, to build their digital models and notably improvements also in addressing these sectors of sustainable energy and hydrogen economy. Next picture, please. Yes. So I'll conclude my part here with another case study we presented in the quarter. This is also very, very interesting. So this is Honda Motor Company. You're all aware, it's a leading international manufacturer of cars, motorcycles and power equipment, shipping close to 30 million power units a year, which is a lot. And they have a target to transition their manufacturing plants to become carbon neutral. And this means that they need to convert those significant plants by new technologies for energy, could be on-site renewable sources, it could be connecting to grids and then storage solutions and so on. So it's a very large selection or array of different configurations you can think of. And also you will have different constraints and needs for each individual plant, so this is a complex thing. So how will they address this? So they used Modelon Impact to have a framework for managing this process. So they build essentially a digital model of a complete plant and they include all these options, more sustainable energy options, carbon-neutral. And then they used built-in sophisticated algorithms to optimize and simulate the different options to come up with the one that gives the carbon reduction while also meeting all the constraints and minimizing the operation of the total cost of ownership really while providing the desired performance. So there's -- well, they conclude basically Modelon Impact was the right choice for this job. And if you look at the picture here, you see the digital model of the U.S. plants to the left. And to the right, you see what's called a sankey diagram of the energy flows over a year for the converted plant. And this is very interesting because the need to convert existing plants to become more carbon-neutral, it's not by any means unique to Honda or the automotive industry, but really all manufacturing industries. So this case study has attended quite some attention. And we're in discussions with several prospects based on this. So it's a great story. And with that, I hand over to Jonas.

So can you move forward? So I'll give the financial update. One more slide, please. Just the highlights and a brief development of our financials. First item is the annual recurring revenue, which is growing consistently. We're at SEK 47.2 million at the end of the first quarter, which is 14% growth annual compared to last year's value of SEK 41.4 million. And this is reported at constant currency. So the historical value there is FX-adjusted, as shown at the bottom of the slide. And this is to show the real volume growth. What is the underlying volume sort of stripped of any foreign exchange effects. And within this, of course, Modelon Impact is the main growth driver, increasing by 41% annually. And we can move forward to the next slide. Thank you. So the net revenues also grew slightly compared with the last historical period. But the main thing is that also the software revenues are growing in the quarter to SEK 12 million from SEK 11.6 million in Q1 2022. There is a slight decrease from Q4 which is due to paid-up licenses. So there are -- within the software revenues, there's both recurring revenue from our sort of repeat sales and also, in some cases, paid out for onetime revenue, which is primarily in the Asian market. So there are still companies there that stick to the sort of traditional business model in software. But the recurring software revenue in Q1 was SEK 11.8 million, so that's almost the entire software revenue, and increased 20% on an annual basis. So that's solid growth for the recurring revenue. Services are relatively flat, around SEK 6 million. But we do see many new orders. So there's a good -- a healthy pipeline with a good order intake. Main point with services is that there's a lot of synergies between the service business and the software sales. So all our service engineers, subject matter experts, as we call them, are engaging and supporting new sales within the different verticals in our focus industries. Development costs in Q1 are growing at 16% compared with last year, roughly also same rate for the rolling 12-month period, arriving at SEK 59.6 million for the last 4 quarters. This is included in the EBIT -- so the primary cost that we have is, of course, for development. And the EBIT for the quarter was minus SEK 18 million, which is much lower than the Q1 but also roughly the same as in Q4. So we're sort of at the turning point for EBIT in our historical development here. Important to note is that the operating costs in the first quarter includes some onetime costs, SEK 1.9 million, which are for staff changes, for updates in our organization, primarily in the development organization that has happened in Q1, and we're taking the cost upfront here. If we adjust for those onetime costs, the corresponding EBIT in Q1 was minus SEK 16.4 million and the corresponding margin to be minus 91%. But this is in line with our expectations, and we are investing, of course, with our development in accelerating our software sales and growth. And we can move forward to the next slide, a final slide for me. Looking at the operating expenses, they increased by 19% compared with 2022. This also is partly due to the onetime costs that I reported. If we take that into account, the operating expenses increased by 13% in the quarter which is more sort of guiding for the future development here. And main part of the OpEx is, of course, the product development, as I mentioned. All of those costs are taken as operating expenses for our ongoing development. If we're looking at the cash, the current liquidity is SEK 110 million roughly at the end of the period. So we're maintaining a high investment pace with our development. But the cash flow is better in Q1 than we've seen before. This is each quarter influenced a lot by changes in working capital. In the software business, we're taking a lot of customer payments upfront. So this is reflected as a change in higher deferred revenue, which is typically at the beginning of the year at a high point. In the current quarter, there's also the effects of a multiyear OEM software deal. So these are not every quarter transactions. So typically, these are 2- to 3-year periods. The payment is made upfront when we have the transaction made and contract signed, but then the revenue, of course, is reflected over the period for 2 to 3, even longer time period sometimes. And that affected the cash flow by roughly SEK 10 million in the current quarter. And I think with that, I will stop, and we'll move on to the Q&A.

I think we have actually a short wrap-up slide here also. So just repeating the bullet highlights, we're having a ARR growth continuing at 14%, new customer acquisitions mainly, and then this -- what Jonas mentioned, the multiyear prepaid software transactions that contributes to improved cash flow in Q1. Also highlighting the confirmation of the strong positioning of Modelon Impact from these new testimonials published and use case published in the period and also this partnership with -- in digital twins, predictive maintenance with Iquant. So -- and then highlight here also, of course, the next Q2 report is coming up on August 23. So yes, that concludes our presentation, and we could move into the Q&A.

Thank you very much, Magnus and Jonas. I'm curious rather, the Honda motors, the testimonial that followed -- that concluded that Modelon was the right choice for their project, I'm curious what you had to compete with there. What does your competition look like?

So I will have to respond to that question on a more general sense because I really don't recall exactly in that case which the competitors were. But overall, generally, there are, let's call them, for traditional system simulation tools out there, many of them are developed in the 1990s time frame. So meaning that they are adapted, you can say, not really for the current needs and the type of applications that industry work with now in terms of renewable technologies and so on. So often, those established tools are on the radar. These are tool -- softwares that our customers or prospects may be aware of, so they're often coming up in the purchasing processes. But the sector -- again, speaking a bit to the positioning of Modelon Impact, the combination of the simulation technologies that we employ, which are state-of-the-art and novel, the focus on sustainable clean technology and clean energy functionality and also being on the cloud is pretty strong to meet this competition. It doesn't mean we always win, of course. But it's -- we're very confident with the positioning and direction we have.

The development costs are trending upwards as we saw in the presentation. Could you please guide on what we can expect from the -- from Modelon in the coming years and in the second quarter when you release the new version?

So as a general guidance, the development cost will increase -- or the operating expenses will increase less than our revenue growth in sort of the short to midterm. For the near term, we are looking to reduce costs. So we're sort of flattening out the growth curve of development costs. And one reflection of that is the onetime costs that were taken. This is from updates of the organization, aiming at, at least trimming a little bit our organization so that we can meet the expectations also going forward.

Could you say something about where you -- what your goals are currently on the long term and your financial strategy there?

Yes. It's -- basically, that's what we're communicating with the financial targets that we have published. So the goal is mainly to drive and accelerate the growth on the ARR. And this is also what all the organization, from development to the commercial activities and marketing and sales, is aiming at. So really identifying what are the key investment areas, capabilities we need to focus on building up and strengthening to accelerate the growth rate. And that's really the key to also meeting those financial goals that we have set out. So we have been -- for those who are -- who knows us since before, we have been growing this company with profit for around about 15 years. And then to jump at this fantastic market opportunity cloud-based simulation platform, we chose to go into this investment period to bring in the capital needed to build this platform quite rapidly and bring it to the market and use what we perceive as a time window available right now that we are very well positioned to exploit. So, yes.

We'll move over to the analysts then, and we'll begin with RedEye, Alexander Flening. What is your question for Modelon?

Thank you for the informative presentation. You already addressed many of my questions, but I still have a few areas where I need more clarification. So firstly, you mentioned that the growth was mainly attributed to new customers and that upselling is increasing. Could you provide some more insight into how much of the quarter's ARR growth was driven by upselling as part of your land-and-expand strategy?

Yes. So I understand that there is a lot of interest since we have the land-and-expand strategy. And for -- we have really, in the sales mix, been dominated by new sales. So it's very interesting to see when the upsell start to really build up. And I would say -- we're not in a position now where we're ready to sort of share the split quantitatively. But in describing the activity in the quarter, we're reporting that we see an increase of activity on the upsell. It's too early to say if this is a more significant trend change, but it's something we're very closely -- I mean it's in line with our ambitions and what we're focusing on and, of course, how we're engaging with our existing customers. And again, it's also fairly well matched in a way with the typical sales cycle. So basically -- 6 to 12 or sometimes longer. So basically, when we win a new customer, they will use the tool throughout the duration of some project or initiative or engagement. Then they will evaluate how did this work out, should we use this tool more. And then they engage with another department, and they start evaluating as well. So it's not -- it is a process that typically does take time. If we look at the customer where we see upsell, they typically started using Modelon Impact, say, 1 to 2 years ago. So within that, that's the timeframe, quite well aligned with the typical sales cycle where we start to see the shift. So we're monitoring this closely, and we will, of course, continue to report how this evolves in the following quarters.

Okay. Continuing on that subject, I observed that Impact ARR growth decreased in comparison to the previous quarter. Could you speak -- could you provide some explanation of the possible reasons for this?

But can you please rephrase?

Yes. Impact ARR, the Impact ARR growth decreased in comparison to the previous quarter, in the contribution to total ARR. I think it's about 20 percentage points.

You mean the growth of Modelon Impact is 41% compared with, I believe it was 63% in Q4. And this is, of course, reflecting also that it's a growing share of the total ARR. So the absolute growth is roughly the same, although the percentage points decreased slightly. And this will vary. There is also the OEM deal that was mentioned, which is a recurring revenue is included in ARR, but it's not counted as Modelon Impact ARR because this is sort of a platform deal with OEM partners.

Right. Thank you for that clarification. Do you have time for more questions for me? Thank you. So yes, you also mentioned that the development of the Modelon Impact update is on track for its [ timed ] release in the second quarter. Could you speak to this update and provide any details on the development process and if any challenges have arisen along the way.

Details on the development process. So not exactly sure what you're asking for there.

So has there been any delays, has been challenges that has arisen?

This is -- I mean we're developing software of a fairly new type. So we meet challenges all the time and that we have fantastic teams to be able to cope with those challenges. So I'd say that's one of our maybe strong points to be able to take. The software technology that we develop is, I think, you probably categorize it as deep tech. It's really sophisticated software. And to put that on the cloud, it's a combination that's new, so it's also -- we see some new -- some challenges that are different from doing, for example, the CRM system or similar. So absolutely, we're breaking new ground every day and we cope with the challenges and we make progress. So as I say, we're on track to release functionality as found in the upcoming release. If we're talking about challenges, we are -- as you know, also we are -- we have been working with software development for, well, close to 20 years now, and only a few years ago we adopted the cloud and we started to transform our business into SaaS. So of course, there are -- we are evolving. If we talk about development processes and so on, we are continuously evolving, improving to work in cloud, SaaS-ier fashion, and this is evolving and ongoing all the time. And we also have, related to the development, like everyone in our industry, you need to fight for the top talent all the time. So that's also something we're focusing on continuously to attract top talent for our development teams.