SoftwareOne Holding AG (SWON) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the SoftwareONE Half Year Results 2022 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Anna Engvall, Head of Investor Relations. Please go ahead.

Good morning, and thank you to everyone for joining SoftwareONE's H1 2022 Results Webcast. My name is Anna Engvall, Head of Investor Relations at SoftwareONE, and joining me today are Dieter Schlosser, our CEO; and Rodolfo Savitzky, CFO. Before handing over to Dieter, let me draw your attention to the usual disclaimer regarding forward-looking statements and non-IFRS measures on Slide 2. With that, I will hand over to Dieter.

Good morning. I'm pleased to welcome everyone to our H1 2022 results. We had a strong first half of the year with our integrated model of software, cloud and services, continuing to deliver across all our markets. Gross profit for the group was up 16% year-on-year in constant currencies to CHF 470 million in H1. After a strong start to the year, Q2 was again very healthy with growth above 17%. Both business lines contributed to this growth. This performance is a clear indication that we are well positioned and are meeting the needs of our customers as they continue to prioritize cloud-first digital transformation and navigate today's challenges. Adjusted EBITDA was CHF 118 million, implying a margin above 25%. This was driven by both gross profit growth and an increased focus on operational excellence and specific cost control measures that have been put in place since early this year. Our clear focus is on profitable growth and adjusted EBITDA was up 13% in Q2, which is a very positive development. But I also believe there is scope to do even better as we implement specific initiatives to optimize our cost base while we continue to grow. Finally, with these sets of results, we are fully on track to meeting our target for the full year, which are mid-teens gross profit growth and an adjusted EBITDA margin above 25%. Before diving into the specifics by business line, I would like to put these results in the context of the overall macroeconomic environment and what we are seeing in terms of demand. As emphasized before, the market opportunity in front of us is massive, a total addressable market of over CHF 600 billion. The software and cloud market is expected to grow at 14%, and our addressable service market at over 30% per annum at least until '25. This outlook hasn't changed. And while we closely watch the environment, we continue to see demand develop in a very robust way with minimal delays in customer decision-making. As also emphasized by industry experts, during these challenging times, organizations will prioritize certain IT investments to accelerate their digital transformation and increase efficiency. And as pointed out by Satya, the cloud will be beneficiary given the flexibility that it offers. Now let's look at our results from a regional perspective. They are strong across the board. Again, solid double-digit growth in all 4 regions. And our growth markets, LatAm and APAC, are now also at scale with CHF 100 million-plus gross profit run rate. EMEA delivered a strong performance led by services. NORAM posted excellent growth with impressive results with Microsoft. APAC was strong across both business lines with several key markets posting 25%-plus growth rates. LatAm delivered strong growth in Microsoft as well as services, driven by larger markets such as Brazil and Colombia. We believe our global business model with a presence in 90 markets is a powerful competitive differentiator for us in today's environment, where customers are demanding more and more local delivery paired with global best practices. Driving into the performance of each of our 2 business lines, starting with Solutions & Services, which delivered 36.5% gross profit growth in H1 this year. Overall, the performance was broad based across service lines, customers and geographies. Our service portfolio is fully geared towards our customer needs and pain points. In particular, XSimples, our pay-as-you-go offering for our SME customer base, continued to deliver a phenomenal level of growth of over 70% year-on-year based on Office 365 and AzureSimple combined. As a result, we now support 7.7 million managed cloud users, up from 6.9 million 6 months ago and from 1.7 million at the time of our IPO. This is clear evidence of how we want to drive scalability in the business and create stickier revenue streams. I would also like to highlight our cloud services, in particular, Azure, which is up 43% year-on-year due to accelerating demand from our customers as well as AWS and Google where we have made great progress in building out our capabilities, supported by acquisitions such as HeleCloud and the strategic collaboration agreement signed with AWS earlier this year. Our cross-selling statistics, a key measure of the strength of our synergistic portfolio and customer relationship, continued to improve. Gross profit from 16,400 customers purchasing both software and services increased to 73%, up from 67% a year ago. A key development for this reporting period is, of course, the disclosure of profitability by business line. Today Solutions & Services is breakeven at the adjusted EBITDA level, and we see significant upside here as the business has achieved critical mass leading to SG&A growing below gross profit in the future. Now turning to Software & Cloud. Gross profit grew nearly 5% in H1 2022 to CHF 275 million. In Q1, we reported 1% growth on the back of a high comparative quarter last year, while in Q2, the growth rate was 8%. Total Microsoft billing reached CHF 9.6 billion in H1 2022, growing in line with the overall Microsoft market. Momentum was positive across all customer segments. Also public SMEs showed lower growth in Q2. We also continued to see strong momentum in our ISV portfolio on the back of PyraCloud/Goatpath adoption and demand for the Digital Supply Chain. As for margin, you will see that Software & Cloud is currently at over 50% adjusted EBITDA margin, stable compared to prior year and at the high end for the sector. Moving on to the most critical part of our business. That is our people. Over the past 6 months, we continued to expand our talent base, hiring over 1,000 people globally, bringing our current workforce to around 9,000. This illustrates our continued ability to attract talent even in a very challenging market where qualified people are scarce. Attracting talent is not something we take for granted. To remain an employer of choice, we continuously invest in employee certification as well as specific learning and development initiatives to upskill employees and offer them more structured career path. Culture, values and purpose also play critical roles and always have at SoftwareONE. We take every opportunity to bring our people together for community services and to celebrate key moments. We also prioritize staying close to them, listening to their opinions on a daily basis as well through our annual employee service. A few key examples include our hugely successful Ukraine Collection, Pride Month, Green Month, Women's Day and our monthly cultural days. Lastly, I also want to highlight the progress that we are making on SoftwareONE Academy. The academy is an important initiative where we combine business and purpose by bringing in people from all walks of life into a career in technology. We now have more than 200 apprentices across 11 countries, and we are seeing great progress with transitioning these learners into our teams at SoftwareONE. And last but certainly not least, I would like to give an update on where we stand in terms of our ESG journey. As planned, we have now conducted an in-depth stakeholder analysis and materiality assessment to identify the priorities and pillars of our sustainability framework. These areas relate to specific sustainable development goals adopted by the United Nations, which you see on Slide 10. Firstly, we intend to take steps to further reduce our CO2 emissions as well as support our customers with their sustainability journeys. We do this by enabling their digital transformations to the cloud, which results in less energy use and emissions compared to on-premise environment, particularly when data centers are run on renewable energy. Our collaboration with RIB Software on MTWO is a great example of how we can make a difference in the construction industry, a sector which today has the highest carbon footprint. In addition, we will prioritize fostering an environment, which promotes diversity and equal opportunity and continue to work with nonprofit industry customers through ONEImpact as well as build on our already best-in-class ethics and compliance organization. As the next step, we are working with our Board and subject matter experts to develop specific ambitions and set competitive targets. And importantly, our first sustainability report will be published in 2023. With that, I would like to hand over to Rodolfo to take you through our financial performance in the first half.

Thank you, Dieter. A warm welcome from my side as well. As Dieter already mentioned, our results are strong with gross profit growth of 16% on a constant-currency basis and an adjusted EBITDA margin above 25%. The margin reflects both the growth momentum and cost control measures in place since early this year. While our operating expenses increased by 18% versus prior year, the sequential growth has been limited for 2 quarters in a row now. Our revenue and gross profit were impacted by ForEx headwinds of approximately 2.5 percentage points, mainly reflecting the strengthening of the Swiss franc against the euro. Nonetheless, our operating model provides a natural hedge with similar exposures at the revenue and OpEx levels, so the ForEx impact on adjusted EBITDA was minimal. Slide 13 provides the promised transparency by business line for you to better understand the dynamics of our business. As the table highlights, we have split our business into 2 business lines and corporate with corporate, including all central functions such as CEO, CFO and Treasurer. With this new reporting, we have also introduced a new alternative performance called contribution margin, which equals revenue less external and internal delivery costs. Our current gross profit measure captures the difference between the revenue and the external delivery costs, mainly the cost of software and cloud licenses and outsourced costs for service delivery. While gross profit was well suited for a classical reseller business model, the new contribution margin measure is more appropriate now that Solutions & Services has reached scale. Moving down the P&L. Certain SG&A, such as dedicated marketing or commercial teams are fully reflected in the respective business lines while some shared resources are allocated based on percentage of contribution margin. In terms of margin, Solutions & Services moved from being loss-making in 2021 to breakeven in the first half of 2022 and was already at 7% in quarter 2. Its profitability will continue to increase over the coming quarters, although seasonality needs to be taken into account. As already mentioned by Dieter, our Software & Cloud margin is at the high end of the sector, which we see as being both healthy and sustainable. Moving on to the next slide. While our priority remains investing in growth and increasing our share of wallet with customers, we fully recognize the need to focus on operational excellence. The timing is right. Over the past few years, the focus was on rapid growth. Now that our business has reached a meaningful scale, we need to make sure it operates efficiently. As already mentioned, in quarter 1, we have launched a wide-ranging efficiency program to ensure a best-in-class cost structure. This program aims to improve our commercial model as well as optimize our operational delivery and rightsize key support functions such as finance and HR. To provide a few examples, on the commercial side, we will take a more systematic approach to value-based customer segmentation and targeting, supported by key account management to maximize cross-selling of services to our Software & Cloud customers. By benchmarking our sales forces across countries, we will ensure optimal sizing according to business opportunity. In terms of delivery, our priority is to better leverage our network of global, regional and local delivery centers. We're also standardizing our service solutions to scale them out profitably. As for the support functions, we are accelerating the transition of transactional activities to shared service centers to leverage process standardization and automation as well as lower cost of offshore locations. Some of the initiatives are already underway while other elements of the program are still being finalized. We expect to have the full project blueprint, including productivity targets, by the end of this year with benefits materially accruing from 2023. Now let me take a minute to explain the dynamics around working capital for this period and how it is likely to play out until year-end. Working capital has a disproportionately large effect on our results as our Software & Cloud receivables and payables reflect gross billings to our customers and the corresponding license costs paid to our vendor. Looking at the average days outstanding over the last 18 months, DSOs have been relatively stable while DPOs have come down compared to H1 and H2 last year. This was related to timing of specific vendor payments in the period. It is very important to emphasize that we do not see any macro trends or changes in collection dynamics impacting our receivables, neither customer nor vendor payment terms have changed. As such, we expect the level of net working capital to reverse over the course of the second half of this year, in line with typical seasonality. We still ended the first half with a net cash position and we expect it will be significantly higher again by year-end. I would like to remind you of our capital allocation strategy. Our first priority is to support our operations and to drive organic growth. Regarding M&A, we have been executing a string-of-pearls strategy to enhance capabilities across our service lines, particularly SAP services and cloud services. We expect to continue to do so. Our dividend is very important. We will continue to pay out between 30% and 50% of adjusted net profit each year. Overall, we use our balanced capital allocation strategy to optimize returns. As such, we will also look at using excess cash for share buybacks to make sure we remain capital efficient and maximize returns to shareholders. Moving on, I want to strongly reiterate our guidance for the year and for the midterm. We will deliver mid-teens growth in 2022, and our adjusted EBITDA margin for the year will be above 25%. As already mentioned, we are targeting to pay a dividend 30% to 50% of our adjusted profit for the year. The 2022 guidance is fully consistent with the mid-term guidance. Let me now move to my final slide regarding changes to our report. As promised, we have already implemented the business line P&L and have introduced a new adjusted performance measure, contribution margin, to better capture the profit contribution after deducting from revenue both the internal and external delivery costs. With the introduction of this metric, gross profit becomes a less relevant measure for our business. Therefore, as of 2023, we will start guiding for growth based on revenue, and EBITDA margin will be calculated as a percentage of revenue and not gross profit. These KPIs are more in line with market practice. We will, of course, continue to provide visibility between all and new metrics to ensure full apples-to-apples comparison. Let me now hand over to Dieter for his closing remarks.

Thank you, Rodolfo. As we reach the end of our presentation, there are 3 messages that we would like you to take away today. Firstly, our H1 results confirm that we are fully on track to meet our 2022 guidance of mid-teens growth and an EBITDA margin of above 25%. Secondly, we remain fully committed to our growth strategy and investing in our people, supported by operational efficiencies to deliver profitable growth. And thirdly, we are improving the level of transparency in our financial disclosure to provide an optimal understanding of our business model. This includes setting ESG targets and publishing our first sustainability report next year. Thank you, and now we will take your questions.

[Operator Instructions] And your first question today comes from the line of Kathinka de Kuyper from JPMorgan.

A couple for me, please. Just firstly, on the macro environment, given the uncertainty that we're seeing in the market, can you comment on the visibility you have into the remainder of the year? And then just to confirm, you were saying that you have not started to see any signs of sales cycles getting longer and decisions being postponed? Secondly, on the margin. Obviously, finally, we have the divisional margins and the growth is really being driven by Solutions & Services. What is your expectation for the second half for that division? And longer term, where do you expect that the margins could go? And then similarly, for Software & Cloud, is that expectation there that the margin would stay broadly stable? And then, finally, on the additional cost savings you've identified, can you just comment on the magnitude that you're expecting there?

Thanks, Kathinka, and let me answer the first 2 ones and then I will hand over to Rodolfo. You're right, on the macro environment, we have seen robust demand continuing. Our pipe reflects that. Our pipeline, our book of orders reflects this as well. We don't see currently any headwinds and the reason is, as I initiated also in my -- alluded to in my presentation, our portfolio, which we are offering is well suited now to the needs of the customers, particularly in the environment with uncertainty and where they need flexibility. So cloud is really the answer. Digital transformation is really the answer, and we are able to give this. I think you also mentioned sales cycle. Do we see a change over there? We don't, but of course, we have all these different sales cycles depending on the portfolio, which varies, but we don't see an overall trend which would go in a different direction. On the second point, which is the margin, thanks for acknowledging that. Yes, we believe that the Software & Cloud margins are healthy and stable. They are at the top end of the industry and they are stable. We will not see a deterioration on Software & Cloud margins. But on Solutions & Services, as you have seen, we are now profitable. And in Q2, we also had 7% adjusted EBITDA. There's a certain seasonality which was also -- as I also mentioned, but overall, we see the trend absolutely going in the right direction. The reason for that is very simple, right? When you incubate services and you have to make a reputation and name in the market, you have -- in the first years, you always have higher overheads. You have higher SG&A. Now since we have reached scale and since we have reached a critical mass, we can actually grow this limited growth on the OpEx side. In terms of targets, we would say our ambition would be to have an EBITDA margin of mid-teens by 2025. And that's how we see it currently. In terms of the cost savings, let me hand over to Rodolfo.

Thanks, Dieter. So on the magnitude of the cost, let me, before I get there, just remind ourselves a little bit of the context. The company, SoftwareONE, has invested behind scaling up over the past few years, which has been, in my view, absolutely the right strategy. And we have reached, as you have seen with the Solutions & Services, a point where, in general, the company has reached the right critical mass. And so it's the time now to step back and not only continue to invest behind growth, which is the biggest value driver, but to also think about what is the most efficient operating model. So as I've mentioned during my presentation, we'll tackle areas like commercial excellence, the optimization of delivery of services, and also to an extent, Software & Cloud and benchmarking of our support functions to again ensure we have best-in-class in terms of delivery but also efficiency. The advantage for a company like SoftwareONE with the guidance of growth rate in the mid-teens is that to rightsize the company we would need to go into big restructuring programs. It's simply about making sure costs significantly grow below the GP or sales growth. And so you can rightsize by maintaining something a bit lag or a large lag between cost increases and sales growth. The KPIs, the magnitude we will communicate, as I said, with the year-end results. We will finalize the blueprint in the second half of this year. Look, in terms of order of magnitude, what we can say is when a company approaches this new phase of really looking at efficiency across all the engines, it would be unlikely to -- it would be disappointing not to achieve at least, call it, mid-single-digit level of savings of the cost.

And your next question comes from the line of Ross Jobber from Citi.

Two questions, if I may. The first one is more a clarification. You talked about your Microsoft business growing in line with the overall Microsoft market. Is that not a bit disappointing? Because my understanding was that you were more exposed to the higher growth parts of the Microsoft offering or maybe that's just the language used in the release, maybe you're talking about the relevant Microsoft market? And then my second question is, obviously, we've talked about macro uncertainty. You still hired at quite a healthy clip in terms of new people in H1. What are you thinking about in terms of H2? And where do you expect -- where would you like head count to be at the end of the year?

Yes. On the second question on the macroeconomic side, so from the hiring, you have seen that we hired around 1,000 people in H1. You also remember we had that initiative, which we shared with you, which we completed a couple of months ago, which was Transformance. So there was, of course, also a replacement in terms of the wrong capabilities, which we had in certain areas. For the second half of the year, we see a slower growth of hiring. It also depends on how the current environment relates to. We have seen in the first half year wage inflation, as you all know as well. But recently, in the last couple of weeks, that dynamic has changed a bit and big technology companies have started not only to go on head count freezes, but also on restructuring and cutting of head count. So that dynamic might give us a different opportunity to get the right skill set available in the market, but we are carefully watching that space. On the first one, on the Microsoft dynamics, Rodolfo, you want to jump in?

Yes. So look, a couple of comments on the Microsoft. We look at several metrics, of course. And here, in many cases, it's directional, right, because we don't have access to the last granular data either from the Microsoft books. Let's say, when we see overall Microsoft growth, our gross billings are pretty much in line. And then within the portfolio, I think we, as Dieter mentioned in his presentation, we see a slight slowdown in the public SME compensated by accelerated growth in other areas. So look, this is -- when we look at, of course, also the forecast, what we see across the region, we continue to see very positive momentum in the second half. This has been confirmed by our operations around the world. We -- I mean, the first week of the second half, we continued to see the same momentum. So overall, I would say there's always a bit of a rebalance in the portfolio, but growth in line with the Microsoft market.

And your next question comes from the line of Alastair Nolan from Morgan Stanley.

Maybe just again on the macro. I think the release did call out some weakness on the SME side. I wasn't exactly sure what that was referring to if it's in public SMEs. So maybe you could just clarify what you're seeing on that side? And then, secondly, you flagged share buybacks as a possible capital allocation policy. Just wondering if there's more detail you can provide on how you're thinking about that and the framework there? And then just finally, on the working capital outflow, I'm just trying to understand why it was so much larger in the first half. Maybe some more detail around that, and in particular, what sort of improvement you're expecting in the second half, that would be great.

Yes. I take the SME question. Yes, sorry, if that didn't come clear across. So that's the public sector of SME. As you know, we are -- the public sector ratio in SoftwareONE overall is around 15%. And in the public sector, you also do have a split between enterprise segments, large segments and the SME segment. And where we have seen a slower growth was exactly in the SME segment. For the cash allocation and the working capital, Rodolfo, you want to jump in?

Thanks, Dieter. Sure. So Alastair, on the -- let me start with the share buyback. I mean I already outlined it in the presentation. We have a clear prioritization, but obviously, share buyback is part of the options we are considering and we have communicated that before, but we wanted to formalize it in this particular presentation. Then in terms of the way the cycle works here internally within SoftwareONE, we do our internal strategy update. This is a regular event every year, right, looking in all regions. The strategy, we simply look at our strategy, validate the key metrics, right, growth, how much we expect to invest organically, what is -- what are some of the inorganic opportunities that we foresee. And I think a good timing for providing a more concrete update would be after we do an update on an internal strategic plan and that happens typically in the quarter, so this will be towards year-end. Now let me go to your third question, the working capital. Again, let me step back here. When I look at the fundamentals of net working capital, which are first, the terms, customer payment terms, vendor payment terms, collection dynamics, nothing has changed fundamentally when you look at the monthly metrics. And the averages are also quite stable. So for example, when you look at DSOs, we have been hovering around 60. It was more or less the position we had at the end of the first half, a little bit over that 3 days. And then when it comes to the payables, which is what created the deviation here, in general, I would say when you look at monthly averages, the payables are around 70 days, but typically at, call it, half year end there's an optimization of payables. What we do is we really try to make sure that the bigger payments, also the size of our different contracts has increased over time. So that the bigger contract, we really optimize the timing. Of course, we see the terms that we have been granted, but that we optimize in such a way to maximize the payable position. This didn't happen in June, but we will -- we are already seeing a reversal of that, and we expect that we will end the year with a working capital position in terms of DSOs, DPOs very similar to the one we had at the end of last year. And therefore, the impact from net working capital for the year we see as minimal. So the cash flow -- with the usual seasonality, the cash flow effect will reverse in the second half.

And your next question comes from the line of Knut Woller from Baader Bank.

Two questions actually. First one on the SME segment. You just cited slower spending in the public sector. So you don't see any signs of SME spending slowdown outside of the public sector? And secondly, just trying to get together around your comments regarding the margins and your midterm targets. So you expect a stable margin in Software & Cloud and you expect mid-teens margins in Solutions & Service. So looking at your above 25% confirmed adjusted EBITDA margin target, should we rather think about that to move somewhere in the range to 25% to 30%? Or will there be any further invest in potentially limiting the upside you expect in the Solutions & Services margin.

Thanks for the questions. Yes, you're absolutely right. We don't see any customer segment at the moment slowing down in the second half of the year, actually, we are cautiously positive on Software & Cloud. As you know, from a business model on Solutions & Services, the majority of what will be booked now is basically already sold. So there is, of course, a very good visibility on this. In terms of margin, give us a breather, Knut. We said that we have a target of Solutions & Services by 2025 to reach the 15%. As of now, we stick with our guidance, 25% -- above 25% for the margin. You remember our discussion, which we had in the beginning of the year, also after the Q1 presentation. That gives us the flexibility to react to market opportunities and capture opportunities in the right way and invest where the company needs to be successful in the future. So for the current environment, we wouldn't change our guidance on this.

Your next question comes from the line of Andreas Muller, ZKB.

I ask one on the Solutions & Services market, that growth certainly this year above the 30%. But how do you see the momentum going into 2023, given that you have a good visibility already? Maybe you see there you have also visibility into 2023. And how dependent is this growth also from acquisition? That's the first question.

Yes. Thanks, Andreas. Yes, let me elaborate on this from two angles. The first would be on acquisitions. You know that we -- our strategy at the moment is to really do bolt-on acquisitions. That means we add capabilities, which you can also classify as talent acquisition in other words. 20 people to 150 people in that range, right? So it's not something, which has a huge impact in terms of our cost structure. In terms of the long term, the growth, you remember, we always said we are growing either aligned or above the market when it comes to Solutions & Services. I alluded to that the market is growing above 30%, 30%, actually 30%. We want to grow above 30%. You're absolutely right, right? The baseline has come now quite big. We are talking about a run rate business, which is going towards CHF 0.5 billion next year. And that's, of course, when you continue with high growth like 36% to 40% that's a different challenge than doing this on a lower baseline. But for the time being, we are positive for 2023 as well. I think we will have this high growth in this and maybe there's a kind of a big acceleration in the 30s, around. But at the moment, we haven't really cleared it up.