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

With Modelon following their Q3 report. And we have the CEO, Jan Haglund; and the CFO, Jonas Eborn, with us to present the report before we move over to the Q&A session. But before I hand it over to the company, I would like to remind you to ask questions throughout the session, and you can do so via the chat function under the video window. So, without further ado, a warm welcome, Jan and Jonas.

To present the Q3 report for Modelon. My name is Jan Haglund. I'm the CEO of Modelon, and I will share this presentation with Jonas Eborn, our Chief Financial Officer. In today's call, we will summarize and I will highlight some of the main events in the third quarter. Jonas will go through more details about the financials. I'll wrap up with a summary and outlook, and we're looking forward to your questions at the end. So, the third quarter of 2024 then, from a financial point of view, it showed growth in net revenues. We came out at SEK 20.5 million, a growth of 7%. Annual recurring revenue came out at SEK 56.4 million, a 5% increase quarter-over-quarter and a 20% increase year-over-year. And here, I'd like to highlight that this growth was driven by our flagship product, Modelon Impact, where the growth was actually 53% year-over-year, a pretty strong number. Operating expenses, excluding NRI, came out at SEK 32.7 million, which is an increase by 7%, mainly driven by increased salary cost. Our adjusted EBIT came out at minus SEK 12 million, about flat or slightly decreased from last year. And for the period then January to September, we had some improvement in adjusted EBIT to minus SEK 37.9 million, an improvement of SEK 2.8 million. The reason we talk about adjusted EBIT and excluding NRI is that we had onetime restructuring costs in the quarter of SEK 7.1 million, which also are visible in the result. Now it's good to see the growth in annual recurring revenue, but we're not happy with the profit and the profit improvement here, which we want to be stronger. And that's the main reason why we, during the third quarter, launched an efficiency program, an efficiency program that really is the result of a strategic review where we come out with a conclusion that we have a lot of market opportunities, especially as a software company, especially as a company with a Software-as-a-Service business model generating recurring revenues. And that is what we will focus on going forward. And with this, we see also efficiency opportunities, and we are taking out costs in order to faster come to positive cash flows and positive profit. We are taking out costs on an annual basis of SEK 25 million. The full effect of this will be seen from the first quarter 2025. We will already see some effects in the fourth quarter this year. We estimated at that time that restructuring costs would be SEK 8 million when we launched this on September 25. And as I just mentioned, the number came out at SEK 7.1 million, slightly below what we had estimated. And we're doing this by taking out external costs and by simplifying our internal setup into fewer sites, fewer teams and with even more focus then on generating recurring software revenues, primarily based on our flagship product, Modelon Impact, which I just reported had a very strong growth in the quarter. So that gives me confidence that we are on the right track and the focus will be going forward now on customer relations and upselling both to existing customers and winning new customers. To do that, I've also decided to adjust the organization of the company and to create a new executive team. So, with me going forward, I will have a Chief Strategy Officer, Johan Andreasson, who's actually one of the founders of the company. Johan has a long history in system simulations and a very strong academic background. And Johan will now get a position to focus on strategy and innovation to strengthen our product innovation, both on our own merits, but also together with partners and academia. Peter Dermont, who has been with the company several years, both in engineering as well as in customer-facing roles, both in Europe and North America, is promoted to Chief Product Officer and will drive business-driven product decisions to maximize product growth. David Higbie has since several years, been Head of Sales for Modelon, will now take the role as Chief Revenue Officer with full responsibility for the entire customer interface, not only sales, but also customer delivery as well as support. David has a very long and solid background, not just from Modelon, but also from other parts of simulation industry. Jonas Eborn, who is with me on this call today, is also one of the founders of the company and will continue as Chief Financial Officer. Jessica Perdius, who has been with the company a few years, has a long and diverse background from other companies, too, is promoted to Chief Human Resources Officer and will help in the growth of the company and the securing of talent that we have in several places in the world where we are active. And then last but not least, Jonas Norberg continues in the role as Chief Technology Officer. Jonas has been in that role with Modelon since a few years, but also has a diverse background from Software-as-a-Service industries and companies in various companies since before. So, Jonas is very well acquainted to what it takes to build a development organization for software and SaaS. This is a very strong management team. I'm very pleased to work with everyone here to take the company forward. I've spent my time during the quarter a lot with customers. I count now more than 20 individual customer meetings, both in North America and in Europe. And I've done this to get a confirmation of our strategy, to get input to our strategy and obviously, to understand how we can do more for our customer base in order to grow the company. The feedback from customers has been overwhelmingly positive. I'm encouraged that we are positioned in the right way. I get positive feedback on the fact that we have built a cloud-based product offering. That's something which is not unique, but not all competitors have come as far as we have when it comes to delivering the service through a scalable cloud solution. I also get positive feedback on our product, Modelon Impact on the usability, on the feature set and the growing capabilities, not just to build simulation models, but also to analyze and experiment in order to build better products. One of the key takeaways is that we have expansion opportunities. We have, in many cases, helped customers to build simulation models and now they want to expand into using these simulation models to build, you could call it, virtual test beds where you take out physical prototyping and replace that system simulations. In those cases, very often, you want to expand into engineers that don't have a long background in system simulation, but rather are domain experts, if it's of automotive or energy systems or aerospace. And that, of course, puts requirements on us to even further build features and simplifications for ease of use. I also hear customers talking about digital twins, where they see that system simulations can be working in conjunction with physical systems as a sort of benchmark towards running systems and as a way of optimizing and making the running systems even more effective. This is a very exciting area, and I'm looking forward to working further with all these customers and many more to build our business. It was very good timing during the quarter to also run the event that we call Modelon Innovate, this happened early October in Copenhagen, and we had a great lineup of speakers, companies and experts who together were discussing the opportunities of system simulation to improve their businesses. Companies that spoke included Meta, Volvo and many more. And I have to say I was proud to see how we contribute to these companies' success, and they actually work on solving some of the sort of greatest problems of our time like sustainable energy provision, for example, like autonomous cars, like electrification, like health care and scalable health care, all of this kind of different technologies and companies were shown at Modelon Innovate. So, this obviously strengthened relations both between these companies, but also with us. And I look forward together with the entire Modelon team to work forward towards these successful cases that we saw presented at Modelon Innovate. This was the second time we did Modelon Innovate. We did the first time 2 years ago, and I think we got encouraged to continue along this path. Talking about customers and customer cases, we have 2 new customer cases that I'd like to highlight we have published during the quarter. One is with the Korean Hanon Systems, who's a leader in HVAC systems where they use our tools for system simulating, replacing, prototyping, speeding up development. Another very exciting case is with MAN Energy Solutions, a German leader in energy systems that is a good example of a company taking a step into sustainable energy provision. And this is an area where we see a lot of opportunity and also growth for system simulation. MAN is using our products, Modelon Impact in order to build virtual test beds or virtual prototypes of large industrial heat pumps that are used then to heat industries and entire cities, in fact. The benefit of using system simulation is that you can do this much faster and much quicker. MAN, they're building heat pumps, not just on traditional technology, but actually on new environment-friendly technology with new refrigerants. This is quite tricky to build physically, and they see a lot of benefit by building this first virtually in a system simulation environment. They've actually been able to prove that they have an accuracy of better than 95% between simulations and real systems. And the next step will actually be to calibrate this in kind of a digital twin setup in Denmark, where they are building a real-life plant with an industrial heat pump. So, we're very grateful for this. We're grateful for customers sharing their experiences, and we're looking forward to many more of this type. Finally, I'd just like to highlight how we develop our products. Our key product, Modelon Impact, releases all the time through the cloud service, but we also bundle them into releases. This one is called 2024.2. So, we do 2 major product feature releases per year. And this one then includes a lot of features around analysis, experimentation and calibration. The common theme in these features that we have built and invested in is really what I talked before. It's more about expanding the use of the product, not just building a simulation model, but actually being able to use it for analyzing different scenarios, not just one scenario, but maybe 10, 100 or 1,000 different parallel simulations that can be done through our cloud-based setup. This kind of experimentation then helps companies to do things that would take a very long time in a physical setup and to do it much quicker and obviously at lower risk because you don't break something. Calibration is a very exciting feature because that allows you to compare simulation results with measurement data. If you have measurement data, you obviously want to figure out if your simulation is accurate enough. So, you can do that, but you can also do the other way around. You can start with experimental data and then figure out what would it take to optimize the system towards the experimental data that you see. For example, how do you want to set parameters in your simulation model. That is now possible with our tool. We're really happy about this, and I'm looking forward to -- I get encouraging feedback already from customers, and I look forward to many more customers using these features. So that was a brief summary of some of the key events in the third quarter, and I'll hand it over to Jonas to go through more details about the financials. Jonas, please take it away.

Thank you, Jan. You can move to the ARR slide. So, in the quarter, we are showing an ARR of SEK 56.4 million at the end of the quarter, which is a growth of 20% annually over last year. This growth is shown at constant currency. So, we're adjusting the currency to the current period end of quarter currency rates, which is the true volume growth then for the recurring revenue. Over the second quarter, this is a 5% quarter-over-quarter growth. So, we see good, continued trend over the past 4 quarters here. Contributing factor, as Jan was saying, is the Modelon Impact new sales, which contributed with a growth of 53% annually. And this is on top of the multi-platform products, which are performing at a stable pace, more or less staying roughly the same. We can move to the next slide, Jan. We see the revenues. In the quarter, we had SEK 20.5 million revenues, a growth of 7%. And on a rolling 12-month basis, we are at SEK 81.5 million, a growth of 6% over the previous period. Main part is, of course, the software revenues. That's where we focus our efforts. In the quarter, SEK 14.4 million, a growth of 16%. And that's mainly recurring software revenue. So that came in just below SEK 14.1 million, which is also increasing by 17%, roughly the same. The service part decreased slightly by 9%. This is due to quarterly variations in the project deliveries. We often see a dip in the summer period, although the '23 number was actually stronger than usual. And if we look at the development costs, they are also increasing by 21% in the quarter to SEK 13.8 million. This is like we talked about before, driven by higher salary costs and investments in the latest release, 2024.2 million. On a rolling 12-month basis, the development costs are about the same as the previous period. We do expect these to decrease now after the restructuring. Some decrease will be seen already in Q4, but the full effect from the restructuring, we expect from first quarter of 2025. And I should say also that all the development costs are taken as operating expenses. So, they are included in the reported EBIT. We don't do any capitalization of development costs. We can move to the next slide. If we look at the expense side and the resulting operating profit and cash, the operating expenses in the third quarter increased by 7% when we take out the nonrecurring items due to the restructuring. Mainly, this is an increase in personnel costs as they are driven by the higher salaries that we talked about earlier. The nonrecurring part is SEK 7.1 million. This is all personnel costs taken in advance for the sort of coming cost of personnel that were affected by the restructuring. The adjusted EBIT resulting from this is minus SEK 12 million, so a slight decrease compared to the previous period. Cash flow, we see at minus SEK 17.6 million. This is roughly in line with the operating result. We do see some variations normally in the working capital, but this is both positive and negative and not sort of a big factor in the cash flow from operations here. The cash liquidity at the end of September was at SEK 73.8 million. This is a slight decrease from the previous year. The main factor here is that we had the rights issue that was closed in July, which resulted in net SEK 51.6 million new capital after the transaction costs. And we expect that this cash that we have now will carry us into the period of positive results and positive cash flows in the short term. And those are the main factors or the main points that I wanted to make, Jan, so we can move forward.

Thank you very much, Jonas. So, I'll just wrap up by saying that we have just closed the third quarter, and I want to thank all customers for your confidence. I want to thank all employees in Modelon for all your contributions and effort. And I want to thank our investors and owners for your confidence and support. Based on my first quarter as CEO, I am optimistic and confident. With all the customer meetings I've been out there, I feel that we have a unique position to take us forward, to take them forward and to help our customers solve really, really important questions, not just for their industries, not just for their business, but actually for the planet. And we do that based on a unique knowledge in physics-based system simulation. We really have a strong position in that niche. And we're well positioned, I would judge to win market share and to grow revenues. We have selected a business model that I want to hold on to, which is based on cloud, Software-as-a-Service because there are many benefits of that. And I, as I mentioned, get very good feedback on that from customers, in particular, then the accessibility and scalability of cloud services across different industries and across different geographies. We are, of course, in a high-tech industry where we have competition and a fast-moving set of customers also, where we expect to get and we get new requirements, in particular, on scalability and ease of use. That means that we are in an investment phase, we have just released an important 2024.2 release, and we will continue to release new technology and new feature into next year. That means that product development costs as well as customer acquisition costs in the short term will be higher than revenue. But in the long term or even midterm, we see opportunities for significant operating profit and cash flow. And we see that the restructuring program and the new strategy that we laid out now during the third quarter will accelerate the path to positive operating profit and positive cash flow. So, with that, I'd like to thank you for listening, and we are ready, Jonas and I to take questions.

So, let's move on to the Q&A session. My first question is, can you elaborate on why software revenues were flat quarter-on-quarter, but the ARR were up 5% quarter-on-quarter.

Jonas, do you want to detail that?

Yes. So, there is always partly the paid-up licenses. So not all is recurring revenue. And we typically see those from different terms, different periods. And in the third quarter, these were relatively small. I don't think I have the exact number for Q2, but we do see a growth on recurring revenue, and that's the main part to drive the ARR, of course.

I can just add that we, in some geographies and some customers look for sort of paid-up licenses. Our preference is to build recurring revenue. So that's always what we try to drive, and that is the vast majority of our revenues. But if you look historically at our numbers, we have some variations between quarters because in some cases, in particular, in Asia, we take paid-up license deals.

Okay. So, you mentioned that Modelon Impact has expansion potential within current customer organizations. I'm curious to know what strategies are in place to make the software more accessible to the domain expert who may not be so used to simulations.

Jessica, that's a key question and a key part of our strategy to be able to help customers scale the usage of system simulation obviously, we prefer with our tool. But system simulation in general then from not only experts who have the skills and background to build system simulations to translate, for example, a heat pump or a car or an HVAC system into a physics-based model, but to actually use it to generate data. And in those cases, we address, in many cases, nonexperts. They can have some experience from using system simulation. But in many cases, they are experts of their particular domains. What we can do are several things, and we are doing many things right now. One thing is to use our service capability because Modelon has a very strong set of services expertise that we use to help customers get going. And that can mean training. It can mean onboarding. It can also mean adjusting their needs and helping them to, quite frankly, get going on building simulation models or adapting their processes to more of a virtual experimentation setup. That's one thing, so services. The other thing has to do with ease of use of our product. We are constantly working on simplifying and adding simple features, for example, for experimentation and analysis to our product so that nonexperts can, for example, run many simulations with different sets of parameters without having to rebuild the model. And you saw examples of that now in the latest release at 2024.2, where we're adding those features. And the third and last is about scalability. With cloud as a platform, we have a great opportunity then to get a broader reach of the usage and a broader scaling and usage. And that's also something where we get a lot of requirements from customers who want to run more simulations, heavier simulations and more in parallel. So that's also something we are enhancing in our product offering.

All right. And regarding the efficiency program, how do you balance between the cost cuts and the continued investments into R&D?

So, this is, of course, a balance, and we have done this program now based on a new strategy, based on a strategy where focus is very much on recurring software revenue based on sales of Modelon Impact, our key simulation tool. That means that we will continue to invest heavily into that program, into that product to make sure that we capture expansion opportunities. We will use services as an enabler. We will use services to, as I said, get customers going to teach them, to onboard them, but we will not run services primarily as a stand-alone business. So that's a strategic shift that we are doing. That also gave us the opportunity to take out some, let's call it, overhead or sort of management functions, which I'm convinced will clarify the strategy and simplify the way that we work going forward. And so that's one of the changes. And then on top of that, we have taken out external costs, which we believe will also help us because we will work on fewer sites and in fewer organizations and fewer teams. So, it's essentially an efficiency program, and I'm convinced that we will come out stronger and simple out of this.

And let's move on to the questions from the audience. Nonrecurring software sales has been strongly declining in the first 9 months. Are they going to disappear totally at some point? Or will that stay a lumpy source of revenue?

I think it's a fair guess that it will continue to be lumpy as we have seen in the past. As I mentioned, our preference is to take recurring software revenues. That's our basic business model to build a SaaS-based both business as well as delivery. But then there are customers that for various reasons, often financial reasons, in particular, in Asia that want to have more of a perpetual license setup or a paid up, as Jonas mentioned. And in those cases, we will, in some cases, show flexibility and take those.

And could you give some color on the development costs reductions that we can anticipate at full pace, get below 50% of group sales?

As we scale the company, we will grow revenues faster than we grow costs. That's the whole idea. And then we will pass them so that the development costs will go lower and lower and pass the 50% line. Exactly when, I cannot say right now. But the full effect of the efficiency program will be seen from first quarter 2025, but there will be some effects already in the fourth quarter. And we will see those effects, I think, on all lines, but it will primarily be on personnel costs and external costs.

And another question from the audience. Can you give us a rough idea of the split between new sales and uplift in Modelon Impact ARR growth?

So, we don't give the details of those numbers, but we're happy to see that the growth of 53% year-over-year is both from upselling with installed base and new accounts. So, I think it's a mix. I cannot really say if it's the percentage. But it's a mix, and there are contributions from both. And going forward, we have a very good and long list of important and large customers. And as I mentioned, I've had the opportunity to visit many of them, and I see expansion opportunities with those customers. But I also know that there are new opportunities coming in. I've met some of those also, in particular, in the energy and thermal fluid space, we see a lot of customers that are perhaps less mature in system simulations than what we see in automotive or aerospace industry. And less mature means that there are more inflection points and more opportunities to come in and win new business. So, we're working on that also in parallel. So, I expect growth will come from both.

And what has been the evolution of the average price per seat your customers are paying?

We have a competitive offer, and I feel that having talked to customers out there, I feel that we are well positioned from a price point of view. We don't get much pushback. In fact, I think we are well positioned towards competition to win new business and to take market share. So, we have had a good and steady development of price. We have not had to yield on price in order to win new deals and new market share.

And do you see room for price increases going forward?

We will continuously monitor the price development, obviously, based on how inflation effects and others take part, but even more importantly, the competitive situation. As I feel it right now, we are well positioned towards competition.

And last question. Over the next 6 months, what should we expect from Modelon?

You should expect to see more development and more investments in our key product. We will stay focused on software. We will stay focused on building a great world-leading and market-leading system simulation product. You should expect that we work with current customers and that we continue to seek more. And you should expect us to innovate also to take steps into territories that no one has been yet when it comes to system simulations. But what those areas are, I will reveal that once we are there. But I see a lot of opportunities going forward also in the near term.

All right. Thank you so much, Jan and Jonas.