Pexip Holding ASA (PEXIP) Earnings Call Transcript & Summary

Good afternoon, and welcome to Pexip's second quarter presentation. My name is Trond Johannessen, and I am the CEO. Together with me today, I have Oystein Hem, our CFO; and Åsmund Fodstad, our Chief Revenue Officer. Together we'll take you through the highlights of the second quarter and some outlook comments on the future. But before diving into that, let us do a quick recap of what Pexip is all about, what our strategy is and what makes us unique. Pexip has grown to become a global technology company. We now serve more than 4,000 clients in the private sector and public sector across the globe. These are large companies, large organizations with complex needs for video communication. We do serve them through a network of partners, which enables more efficient scaling and also better connectivity and integration with the rest of the clients' IT infrastructure. Since 2011, we have grown our ARR, annual recurring revenue, base to USD 106 million. And we have established Pexip as a leading player with an attractive parts of the video communication market. Pexip is built on unique core technology that is underpinned by approximately 50 active patents. It is the combination of transcoding, self-hosting capabilities and the fact that the technology is built as a platform that makes it unique. It's not a single feature, but this as a package that makes it unique and extremely well suited for the use cases that we work within. Pexip has taken a focused and differentiated approach to the video communication market. We are not competing with the major videoconferencing players like Teams, like Zoom, Google Meet and WebEx, we are rather cooperating with them to enable customized solutions. As an example, we worked very closely with Microsoft to enable the best integrations there is with Microsoft Teams. We are approaching a part of the $20 billion video communication conferencing market, where we can have unique and differentiated position based on our unique technology. The market niches we are approaching make up an annual revenue pool of around $5 billion and we target to take #1 position in several parts of this market. Our core solution areas are defined as Secure Spaces, Video Innovation and Connected Spaces. Secure Spaces is when complete privacy and control over data is required. Mostly here, we talk about government organizations, governments, large entities that have very specific needs and requirements for the protection of their data. It's the whole thing about where is my data, where does it go, when -- can I have complete control over it. And we work here. We are proud to see a lot of very interesting public sector logos on our customer list that trust us to take care of their most critical communication needs. Video Innovation, it's about embedding or customizing a video solution completely for the specific requirements of a niche. Here, we work within 4 verticals specifically. We work within health, judicial, finance and retail. And we will show you later a very specific custom solution we have made within the judicial sector, which is called Pexip Virtual Courts, which completely digitizes the court process with extreme savings realized for the judicial system. Finally, Connected Spaces, it's where Pexip is coming from. It's a traditional interoperability business where we make sure that organizations that have a diverse set of video conferencing equipment installed can ensure a seamless integration between them for the best user experience. And here, we work very closely with Microsoft and Google. Now with that as background, let's get to the beef of the presentation, the Q2 highlights and the areas of focus. During the quarter, we have reorganized our commercial organization completely. As a result of that, we have realized and committed approximately NOK 200 million in annual savings. In addition, we have clear plans in place for another NOK 100 million in annual savings. This puts us ahead of the plan to be EBITDA neutral in -- for fiscal year 2023 and in the position to be cash positive exiting the first quarter of 2023. Our EBITDA ended at minus NOK 99 million adjusted for restructuring costs and the cash flow ended at minus NOK 65 million. ARR was up 14% year-over-year and ended $106 million and revenues were up 10%, ending at NOK 195 million for the quarter. The quarter itself in terms of ARR development ended up pretty much flat with an increase of USD 0.5 million through the quarter, which is in line with the underlying quarter 1 performance. On the sales side, we see particularly strong underlying momentum in the Secure Spaces and Video Innovation area as well as the Public Sector in general. On the product side, we launched Pexip Virtual Courts during the quarter, and we will show you a demonstration of that later. Now a little bit more about the cost reductions that we have been going through. It is clear that Pexip has been scaled for a higher growth rate than what we had actually realized. This is not a sustainable situation. And we have, as a #1 priority to bring Pexip back to profitability to cash positive operations and to profitable growth. During the quarter, we have reduced our annual run rate salary personnel expenses with approximately NOK 130 million. We have reduced from 571 employees, which was the peak number mid-Q2 to 474 active employees today, a reduction of approximately 100 people. In addition, we have identified and committed savings on other cost items such as IT and cost of goods sold and other operating expenses of another NOK 64 million. This gives us about NOK 200 million actual realized and committed savings and should be able to give us an EBITDA positive operation in 2023. We have also clear plans in place for an additional NOK 100 million cost reduction that we will implement during the coming quarters that will put us in a place to be cash flow positive, leading the first quarter of 2023. In order to realize such significant cost reductions, we needed to change the structure of the organization and the way we work. Historically, we had very much a functional organization divided into 3 geographical areas. Now we have 7 business units with clear P&L responsibilities, which again are divided into squads, by customer type and solution area. This significantly reduces and flattens the -- reduces the number of layers and flattens the organization to get us closer to the customer. It increases the speed and agility of the whole organization and enables us to better drive growth in the target verticals. It makes it easy to prioritize resource allocation. We can put more resources where we see that we have momentum, and we can reduce where we don't have enough momentum. And it also makes it possible to adjust the cost levels on a continuous basis based on the performance on the P&L level in the different squads. Let's move to an overview of the sales performance in the second quarter. We have included so more detail than we have done historically to give you a better picture of the buildup of the aggregate ARR development. But on the aggregate level, it was pretty much a flat quarter compared to the first quarter with $0.5 million increase. Year-over-year, we had a 14% growth in annual recurring revenues. The main reasons for this relatively soft sales development are related to, of course, competitive dynamics but also supply chain issues where our customers don't get the hardware they need to be able to install our software. And in addition, a certain overcapacity being installed at the clients because of the ramp-up that was done during the pandemic. To understand this better, let's go one level below the aggregate numbers and look at our different solution areas. Secure Spaces grew -- has grown 23% its annual recurring revenue base this year. Video Innovation has grown 11%. In total, these 2 business areas have increased their ARR by $2.8 million during the second quarter alone. And if you compare that to the $0.5 million, which is the aggregate number, you will immediately see that some things has to be reducing here. And Connected Spaces is really pretty much flat and has been so for 3 quarters. And this is the main reason why we see the soft development on the total aggregate ARR figures. Legacy areas, this is virtual meeting rooms. This is partner fees, some smaller revenue sources that we have for different historical reasons. That area is continuing to reduce, and that is as expected and has also been reducing constantly for the last quarters, impacting the aggregate numbers negatively. So as you can see, it's a differentiated picture. We have areas here that develop very nicely and we have areas that impact negatively. Looking at the development across geographies and products. It's also pretty consistent across the board. We have growth in Asia Pacific. We have growth in Americas and a decline in Europe during the second quarter. Main reason for decline in Europe is that the legacy areas are largely located in Europe. On the product side, we are seeing that the service business is taking a slightly larger portion of the total compared to the self-hosted software business, but there is nothing dramatic in these figures. So a relatively consistent picture. Back to the aggregate level again. The 14% increase in ARR from second quarter last year. The main driver here is new customers coming in, that's about $18 million or 20% increase. We have a positive development on churn, which is now 8.8%. So the first time we have it below 9%. The upsell is 4%, which is a lower figure than we would like it to be, but it's likely to be impacted also by a certain overcapacity still being installed in the client base. So net retention ended at 95%. Now Åsmund will talk a bit about a few customer wins and product launch that we had during the quarter. So Åsmund?

Thank you, Trond. Let me start with the Collective Spaces and Capgemini. In Connected Spaces, Pexip continues to win large enterprise customers, and we today hold 15% of the Fortune 500 logos as our customers. We win a connected solution or Connected Spaces solution for Capgemini in fierce competition this time with Cisco. Pexip wins because we offer a better environmental cloud solution than their current setup, and we offer a substantial reduction in cost for them. Do more with less is important to these organizations and they have high consciousness around it. Capgemini buys the Pexip premium solution, including interop endpoint registration and our one touch join to simplify the usage for their employees. In addition, they have added through Pexip professional services to ensure that they have a solution that always works. For Capgemini, it's all about simplicity, reliability, sustainability and a future-proof solution. Therefore, they do choose Pexip. Looking at a different customer from Q2, Region Östergötland. Pexip wins another county in strong competition for this time with Sweden. In fact, we're actually replacing their entire installation with Region Östergötland. Digitalization in the public sector is very strong. It's a must for these institutions to be able to serve and meet their citizens, not to talk about the enormous savings it represents going digital. Pexip win this customer for 3 major reasons. Security is of their highest importance for a customer like this. In addition, they won one vendor for the entire video infrastructure, and they are dependent on an unique Microsoft education, which Pexip represents. In addition, they have chosen to also use the Video Innovation solution for patient-doctor consolidations to have equal health care coverage to their country citizens. Region Östergötland buys the Pexip solution to standardize on 1 vendor and for their needs in all 3 categories: Connected Spaces, Security Spaces and Video Innovation. Future opportunity for Pexip with this customer is also expanding their Video Innovation solution with an in-field ambulance technology, including variables and so forth. No other vendor than Pexip can offer such a complete solution to a demanding customer like Region Östergötland. Moving on to Public Sector. The world has changed and consciousness around cybersecurity, privacy, where does my data go, mission-critical meetings and solutions both for government and large organizations, new regulations like Schrems II and GDPR underline the strong opportunity that Pexip has in this market. For Secure Spaces and especially in Public Sector, Pexip has a strong momentum with our unique technology and solution. These organizations do not make compromises when it comes to privacy and security. As I said, we already have a strong position in this market, but we keep on winning customer by customer like Region Östergötland, that we just spoke about. But also like Ministry of Justice, U.S. Department of Veterans Affairs, Bundeswehr, FORSVARET, NAV, EU Parliament, NASA and so forth. These logos and wins validates Pexip's unique position and technology for these segments. In fact, Public Sector has, over the last year, become a significant investor and spender in digitalization. Security and forward-looking solutions to basically serve their citizens. Hence, Pexip continues to develop specialized solutions for these markets. Like in Q2, when we launched and released our new Virtual Courts, which is both a Public Sector solution and also one of the new initiatives for Video Innovation. Pexip now have a complete solution for the judicial segment available globally. We have our first 3 customers using this digital solution and have a strong pipeline here going forward. Pexip do not change the way these organizations actually work, but instead, we improve and make them more efficient. In fact, they eat out of their backlog when it comes to the trials that should have been done. There trials that are before could not do because of witnesses and others were all over the place, and they run trials faster and improve witness protection programs. Imagine the savings in pure dollars, but also for the entire society by using digital solutions from Pexip. Virtual Court is also a great example of how video has moved from just traditional video meetings to mission-critical solutions for these organizations, where the Pexip video solution is the essential part. Let me demonstrate for you how it works via a video. [Presentation]

Thank you so much, Åsmund. My name is Oystein Hem, and I will take you through the financial results. Let me start off by giving you a quick summary of the P&L before we dive into the underlying drivers. Our revenues increased 10% year-on-year to NOK 195 million. Our cost of sale is now at NOK 29 million or 15% of revenues and employee benefit expenses increased 37% to NOK 204 million which, together with other operating expenses, gives us an EBITDA, excluding restructuring costs, of minus NOK 99 million. Including restructuring costs and depreciation, our net operating loss was NOK 150 million for the quarter. In terms of recognized revenues. Our revenues increased 10% from NOK 177 million in Q2 of last year to NOK 195 million this quarter. The increase is driven by the increase in Pexip-as-a-Service, which grew 34% and is now NOK 100 million for Q2. Our self-hosted revenues declined 7%, driven by lower software deliveries this quarter compared to Q2 of last year, which you also see in the ARR development, where we have a slight decline in ARR from self-hosted software. Our cost of goods sold is overall in line with the level of Q1, which is now NOK 29 million or 15% of revenues, driven by increased service revenues as well as lower software revenues in Q2. In terms of operating expenses, the main driver for operating expenses for Pexip is salary and personnel expenses. Salary and personnel expenses, excluding share option-related costs, grew to NOK 195 million for Q2, reflecting a somewhat higher level of employees in Q2 compared to Q1. And in addition, we had an impact of increased currency rates to the U.S. dollar which increased our total cost base approximately NOK 5 million compared to Q1 of 2022. Looking at other operating expenses, they are on a fairly similar level as they were in Q1 of this year, continue to reflect a higher cost related to sales and marketing and travel compared to Q2 of last year. This quarter, we had 2 larger events for customers, one in the U.S. and one in Europe, driving both travel and sales and marketing costs. In Q2, we also had restructuring costs related to parts of the cost benefits that we have realized now going forward. We will start to see the impact of that in terms of the P&L, partly in Q3 and then in Q4 for people and salary and personnel expenses. And then for other operating expenses, we expect part of that to come in Q3, but mainly in Q4. Similarly, for the cash flow improvement. The fact that we have been able to execute this cost program on the people side from decision to full execution within Q2 also gives us confidence in both being able to deliver on our promise to be EBITDA positive in Q4 and 2023 as well as the next phase of the cost program that we have in front of us. Looking then at the cash flow for Q2, which is overall negative, minus NOK 65 million. The main driver is the negative operating result, which has helped somewhat by an improvement in net working capital. We have a normal investment level of NOK 16 million, which is mainly related to own software development. And for Q2, we also had a positive impact of the change in exchange rate, which improved our U.S. dollar-denominated currency holdings with NOK 25 million. With a healthy cash balance of NOK 525 million out of Q2 together with expected improved cash flow from the cost savings that we now have realized, we are confident that our current cash reserves are sufficient for the journey back to profitability and then cash flow positive operations from Q1 of 2023. With that, I give the word back to you, Trond.

Thank you, Oystein. Now let me give you just a quick summary and a few words about the outlook in the quarter that we're already in. Pexip's #1 priority has been through this quarter and will be through the following quarters until we are where we need to be to get back to profitability, cash positive operations and profitable growth. That's what everybody is focusing on. This is what is the prerequisite for a sound, solid, healthy company going forward and we will get there within the time frame that we have described. We're doing it by adjusting the cost base to the revenue base, and we will continue to adjust the cost base if the revenue base does not develop according to expectations. We have good underlying momentum within Secure Spaces and Video Innovation. You saw the growth during the second quarter. There is lots of things happening in this area, and we are pretty confident about the development here going forward. Our pipeline in the Public Sector, Åsmund talked about the Public Sector initiatives and the logos we have here. Our dedicated solutions within the target verticals of judicial health, finance and retail, we have traction. We have attention of the customers. We get the meetings we ask for. We are in a good place and on the path to something very good here, I believe. Within Connected Spaces, we have strategic partnerships with some of the technology giants out there. Microsoft being most notably, I mean, our prime partner within Connected Spaces. And this partnership -- these partnerships develop positively and will give increased momentum to the Connected Spaces business over the coming quarters. But in the very short term, supply chain issues and overcapacity installed in the customer base will impact our sales performance in Connected Spaces. So on the aggregate level, the ARR development that we expect in the third quarter of this year is flat to negative. And let me comment on the 2 negative. It's basically one single customer in the Public Sector that has lost budget or funding for the program where Pexip is utilized. This happens in the Public Sector. It happens in many countries, more in some countries than others. It's difficult to impact. And this time, Pexip has been negatively affected by this to a value of up to $4.4 million in reduced ARR in the third quarter. It's difficult for us to compensate fully for this by growth in the other areas. So that's why we say that it's possible that we will have a negative ARR development during the third quarter. Finally, we are ahead of plan to be EBITDA neutral from Q4 and for the full year of 2023. And we are in a position or have clear plans and will be cash positive on a run rate basis, leaving the first quarter of 2023. Last point before we go to Q&A, we will present our Q3 report on November 10 and the Q4 report in February. And now Oystein, you will handle the Q&A part.

Thank you, everyone. We are joined by Kristian Spetalen, who will ask his questions first as well as Oliver Pisani from Carnegie. Kristian, any questions for us?

Yes. Can you hear me?

Yes, we can.

Good, good. So I'll just start with a question on the customer here that you see we'll lose in the third quarter. Is this something -- is this in a Secure Spaces segment? Can you elaborate on anything there? And I mean, how do you see the risk of further customers losing funding? And why do you think they are losing funding?

So yes, this customer is within the Secure Spaces. So the sort of the ARR is counted there. In terms of the risk of this program, I think it's less likely that, that will happen to other customers also within the same geography. And the reasons are both in management change and then a fairly large restructuring on their side, which is more of a one-off event rather than something I see happening at multiple customers.

But as said that they're not switching vendor or anything, right?

No, they are then discontinuing that modernization program and going in a different path.

And can I also ask how long this customer has been with you?

So this customer we signed in September of last year, and then they changed their strategies on the early side of 2022. Also was part of the circumstances for why we were vulnerable for that type of change.

Yes. So is the deal that you announced last year?

It could be a large customer that we announced last year. That's obviously clear.

And just to build a little bit on that because you expect some flat-to-negative AR development in the third quarter. So you will have some -- I mean, the new sales are going to come up going forward. Could you elaborate on which areas we will see that growth coming in, in the third quarter and perhaps also the forth?

I think we are seeing that it's -- we have positive developments, and we are winning new customers every day. I mean, every week, we are signing up new accounts and new customers and there is upsell also in the current customer base. At the same time, there is obviously an element of churn and to have complete foresight into exactly how that's going to play out, it's a bit difficult at this stage. We don't have that type of visibility on the detail level. So obviously, as I said earlier, we have momentum. There is positive momentum in the Public Sector. There is positive momentum within Secure Spaces, in general within Video Innovation. But we, I think, to guide beyond saying that we will be flat to possibly negative is difficult at this stage.

And then with regards to Connected Spaces. Last quarter, you referred to an agreement with a strategic partner that you expect to give $4 million of AR growth this year. Have you seen any effect of this? And should we expect in the third or fourth quarter? Or what's the latest there?

I think we're seeing strong partnership there on the sell side. We have seen the first 5 customers come through already. So it has contributed to the ARR development in Q2 with significantly more potential in Q3 and Q4. So seeing early growth successes and early proof points, but there's still significant opportunity there going forward.

And do you have any other opportunities like this in the pipeline as well?

We are working very closely with our strategic partners. And I think both on working coordinated on end customer accounts as well as providing technology is something that we are working with them on.

And then just a bit over on the macro impact there. So do you see any impact from -- or how do you consider the recession impacting revenues and new sales?

I think it can be -- it's a couple of different effects. On the one hand, Pexip contributes to cost reductions in a lot of different places. We did through digitalization. I mean we looked at -- looked at the Court Systems. We're working in the health sector. What we deliver reduces costs in general increases efficiency. So it should be something that it will be prioritized to invest in during a recession. And the Public Sector is a bigger and bigger part of our business. It's, of course, less exposed to recession effects than the private sector companies. But naturally, in the private sector, in the recession, companies have a tendency to delay investments and reduce spending and that is an effect that will naturally hit us as well. So the exact of balancing of these 2 effects, it's difficult to predict.

And then moving on to the cost cuts. So you say that you have an additional NOK 100 million of cost savings targets. Could you please elaborate on this with regards to maybe the distribution within the cost line items?

I think it's going to be -- just to -- we have the plans in place. It's approximately half of it coming from personnel reductions and approximately half of it coming from other reductions in other OpEx. IT systems, operating expenses, general prudency and so on.