SoftwareOne Holding AG (SWON) Earnings Call Transcript & Summary

Good day, and thank you for standing by, and welcome to the Q1 2023 update of SoftwareOne. [Operator Instructions] I will now hand the conference over to your speaker today, Anna Engvall, Head of IR. Please go ahead.

Good morning, and thank you to everyone for joining SoftwareOne's Q1 2023 Trading Update. My name is Anna Engvall, Head of Investor Relations at SoftwareOne. And joining me today are Brian Duffy, our CEO; and Rodolfo Savitzky, CFO. Brian will kick off by saying a few words on his first impressions and priorities after 10 days at SoftwareOne. The presentation of the results and Q&A will then be hosted by Rodolfo. Before handing over to Brian, please 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 Brian.

Good morning. I'm pleased to welcome everyone to our Q1 2023 trading update. It's a great pleasure to be here today for my first call with you as CEO of SoftwareOne, and I will use this occasion to share a few of my very first impressions and priorities. Since joining 10 days ago, I've taken the opportunity to spend time with my team and the Executive Board here in Switzerland and to meet new colleagues across the company. I'll soon be leaving for a 5-week global connect tour to meet with local teams around the world as well as clients and partners. And it's still very much early days, but I'm pleased to say my conversations so far have confirmed my initial impression of SoftwareOne. Firstly, there's an incredible team of talented men and women here at SoftwareOne and a huge amount of passion within the organization, which I could feel immediately. In prior roles, I've been part of driving large transformations, and these are rarely [ deep ], but I can see that SoftwareOne has the right people and culture to continue embracing change, and this will inevitably be a part of our future in the technology sector. The long-term opportunity in cloud is massive products at SoftwareOne. Customers deciding that approximately 30% of their workloads have moved to the cloud only so far. At SoftwareOne, we have a powerful global software and cloud solutions platform, and there's still untapped potential to fully capitalize on this opportunity. To get there, we have to put the customer at the center of everything we do to ensure their journey to the cloud is successful. Enhancing our partner relationships will also be a priority for me. Our independence, our global reach, our local presence and expertise creates a unique value proposition. We have much to offer both old and new partners as we build strong and mutually beneficial relationships. I'm also convinced that embedding operational excellence across the organization in our go-to-market, delivery and support functions will bring significant value and make us stronger and more scalable for the future. Now to conclude, I would add that I'm incredibly excited to lead SoftwareOne's next chapter together with the team. I look forward to reporting back to you soon again on our progress. And I'll now hand over to Rodolfo to take you through the business development and financial performance in Q1. Rodolfo?

Thank you, Brian. A warm welcome from my side as well to our Q1 trading update. We have had a solid start to the year. We continue to see healthy demand as our clients remain focused on cloud-first digital transformation. Q1 revenue for the group grew by nearly 9% year-on-year in constant currency to CHF 239 million with both business lines contributing to growth. Our core service lines, Cloud, Application and SAP Services, continued to show particularly strong momentum. In marketplace, underlying demand was strong across both our Microsoft business and ISV portfolio. Adjusted EBITDA was nearly CHF 40 million with a margin of 16.6%, down 1.8 percentage points compared to prior year, but in line with our expectations. With this solid performance, we remain confident in our full year 2023 outlook as communicated in March: to deliver double-digit revenue growth and an adjusted EBITDA margin of 24% to 25% of revenue. Before moving on, I would also like to welcome the team from Beniva Consulting, an acquisition announced today. And I will come back to the details later on. By region, EMEA delivered a solid quarter with revenue up 9%, driven primarily by strength in large enterprises in the DACH countries. APAC remained very dynamic, up 23% as a result of strong results in key markets such as China, Singapore and Malaysia. Meanwhile, NORAM saw a revenue decline of 3% on the back of more cautious customer spending and soft results in Microsoft. Finally, LATAM was up nearly 4%, driven by good momentum in services, partially offset by softer Microsoft revenue in Colombia, Brazil and Mexico. Moving on to our business lines. Software & Cloud Services delivered over 11% revenue growth. Our core service line, Cloud, Application, SAP Services, grew by over 20%, partially offsetting the expected decline in certain legacy services. xSimples grew 20% in Q1, down from over 70% last year, reflecting that we have reached the end of the shift to pay-as-you-go from existing multiyear agreements. Growth in xSimples was also impacted by changes to Microsoft's Cloud Service Provider or CSP platform. Moving on to Software & Cloud Marketplace, which grew by over 6% in the quarter. Microsoft billings grew 13%, reaching USD 4.2 billion in quarter 1, up from USD 3.7 billion last year, with solid momentum across customer segments. As flagged in our quarter 4 results call, Microsoft revenue was negatively impacted by the shift from legacy CSP to New Commerce Experience. After a transition period with lower incentives on the legacy CSP platform, the NCE model comes with higher pricing, more favorable incentives and longer-term subscriptions. Our portfolio of ISV continued to show strong growth momentum with revenue growth of approximately 30%, driven mainly by our hyperscale portfolio and strong demand for IT security and visualization solutions. As I mentioned at the beginning, we have today announced the exciting news that we will acquire Beniva Consulting, an Elite ServiceNow Partner, with around 75 experts in North America. Beniva is a provider of professional services and brings deep capabilities and know-how around ServiceNow, the preferred vendor for IT workflow management solutions in enterprises moving to the cloud. The strategic rationale for this acquisition is compelling. It expands our ITAM service line from a USD 2 billion addressable market to the over $7 billion IT Service Management market, within the broader IT Operations Management space. Complementing our existing ITAM practice, it will enhance our ability to help clients reduce costs by improving their IT operations. In terms of financial impact, Beniva has an excellent growth track record, and its attractive margins will be immediately accretive to our Services business line. Now let's move on to the detail around the numbers. As I have already shared with you the headline numbers, let me characterize the quarter further. The Q1 results are fully in line with our expectations and are consistent with our plan for an acceleration of growth through the year, particularly in the second half. As a result of the strong Swiss franc, ForEx headwinds had a significant impact of approximately 4 percentage points on revenue growth. However, given our natural hedge with similar exposure from OpEx, the ForEx impact on adjusted EBITDA was again minimal. Contribution margin increased by 2.3 percentage points, reflecting optimization of delivery costs, compensating for the continued shift in business mix towards services. And SG&A expenses grew by 19%. And the adjusted EBITDA margin was 16.6% of revenue, 1.8 percentage points below prior year. The year-on-year development of adjusted EBITDA is shown in the bridge. While revenue growth and slightly lower delivery cost had a positive impact, SG&A increased faster than revenue due to a normalization of commercial activities as well as increased headcount and wage inflation of around 5%. The normalization reflects a planned higher level of travel and sales and marketing activities compared to prior year, which was partially impacted by COVID and also included one-off co-marketing investments from strategic partners. Moving on to the business line view. Before diving into the numbers, it is important to explain certain adjustments to the allocation of sales expenses, which have been implemented in the context of our operational excellence program. Specialized sales resources are now assigned to the respective business lines, while key account managers continue to be allocated based on contribution margin. The contribution margin in Services was 36.4% of revenue in Q1, comparing favorably to peers, and up 4.1 percentage points versus prior year, driven by the operational excellence initiative. SG&A grew at a materially lower rate than top line, translating into an adjusted EBITDA of CHF 2.3 million. The margin in Q1 was 2%, partially reflecting seasonality, but this year-on-year improvement yet again confirms that we are on track to meet our 15% target. In Marketplace, the adjusted EBITDA margin was 42.5%, down compared to prior year, reflecting an improved contribution margin, offset by increased SG&A, partially driven by the allocation of solution consultants to this business line. I would also like to provide an update on our operational excellence program. As a reminder, this is an organization-wide initiative to drive effectiveness and efficiency. We are targeting savings of CHF 15 million this year and the full run rate of CHF 50 million next year, with up to 50% being reinvested in innovation and growth projects. Deployment began in January. And as of today, we are on track to deliver these savings in operational improvement. In the commercial work stream, sales roles and the organizational model has been defined, and implementation has started. We have also launched an exciting artificial intelligence-driven cross-selling pilot in NORAM. In delivery, we have made great progress completing the review of spans of control and layers. Up to 80% of personnel transitions have already been implemented. Finally, the support functions that shift from country finance teams to shared service centers have started. And in HR, we're piloting a shared service center in DACH. I will conclude our presentation with the full year outlook. We have had a solid start to the year with strong underlying demand across our Microsoft business, ISV portfolio and core service line. We remain focused on implementing operational excellence across SoftwareOne to help improve our efficiency and effectiveness and to deliver the planned savings. While we recognize the uncertain macroeconomic environment, we generally see healthy demand in our markets and are confident in meeting our guidance for the year. Thank you, and we will now go to the questions.

[Operator Instructions] And the first question is from Kathinka de Kuyper from UBS.

A couple for me. First of all, welcome from my side, Brian. I'm really looking forward to working together with you. In terms of the strategy, so we get a new perspective from a new CEO. So maybe could you comment on what parts of the business are going to be a priority for you? And have you already seen some opportunities where you can take advantage of? And then secondly, a question for Rodolfo on the margin. Especially in Marketplace, the margin was quite weak, while the top line actually improved if we compare it to Q4. Can you just comment on the moving parts? Is it just the sales roles which impacted that? And if so, where can the margin then get to longer term?

Sure. I will take it and then I'll hand it over to Rodolfo. So firstly, I would say that in terms of the organization itself, I am extremely excited by the passion that our employees have to serve our customers, firstly. Secondly, I would say that we are in a unique opportunity given the independence that SoftwareOne has within the ecosystem. Customers know that they need to transition to the cloud with but the opportunity, obviously, for us to help them in that journey. I believe the answer of why to transform has been answered by many customers around the world. And now our opportunity is to help them to move from A to Z in a constructive manner. And secondly, I would say that -- and I hope with my experience and partnerships that I have within the ecosystem, the one area we will be able to look at in time will be establishing further partnerships with new players and, in addition, deepening the partnerships that we currently have. But in addition, I am 10 days in, so over the next 100 days, we will be reviewing the overall strategy. I'm coming back to you later in the year with an update specific to that. And I'll turn it over to Rodolfo.

Yes. Thanks, Kathinka, for the question. Look, a couple of observations here. As you know, quarter 1 tends to be smaller in terms of revenue across the company, but particularly Marketplace Q2 and Q4 are the bigger quarters. And here, we clearly see a significant rebound on the margin. Also, with this transition in Microsoft program for CSP, we expect a particularly strong quarter in quarter 2. We see the opportunities of, as I mentioned before, of higher pricing, higher margins for us, both translating to improved revenue and, to an extent, a little bit contribution margin. And yes, the reallocation of sales resources, it has an impact, right, on the -- particularly on the SG&A evolution. But we -- this business line, once we look at the full year numbers, will go back into the 50% -- around 50% adjusted EBITDA margin that we saw in 2022.

And the next question is Knut Woller from Baader Bank.

Regarding the one-off marketing invest you cited, too, it has been basically a tailwind in Q1 '22, and hence, missing in Q1 '23, Rodolfo. Are there any further incremental marketing invest that have to be digested that we'll be missing in 2023 versus the last year? And then looking at the cost run rate, if we strip out the acquisition of Beniva, is it fair to assume that we should have now a pretty fair cost run rate on the back of the Q1 results? And lastly, on the Microsoft price increase, you already touched a bit about it in the previous answer on the question. But the full run rate of this price increase, is it fair to assume that we should see that in the third quarter or from the third quarter onwards?

Yes, I will take the questions in reverse order. So we have seen or we're seeing a very good transition to the New Commerce Experience, the new platform, already in April, and we expect further acceleration in the coming months. So I would say we will start seeing the pricing impact already as of Q2, but definitely, I would say, pretty much the full impact in quarter 3. Now a clarification on Beniva, we announced today the acquisition, meaning the signing. Closing will still take a few weeks. And we will see the impact in our P&L most likely in the second half. So this, you do not see in the current P&L. Now when it comes to the cost run rate, we do expect the marketing and travel partially to remain in the coming quarters, I would venture to say roughly half of that. But the other half is related to the internal sale events that we normally have posted in the past, but which we didn't have in 2022 as we were under partial COVID restrictions or with COVID restrictions. In the one-off co-marketing investments, they were particularly significant in Q1. They probably represent half of the effect for the full year. And we will see a reduced effect in Q2 and a very limited effect in the second half. So they were front-loaded, right? So I would say out of this normalization activities, less than -- way less than half we will see in the balance of the year.

And the next question is from Joe George from JPMorgan.

And welcome, Brian, as well. And I just have 2, please. Firstly, on the services line, you said that growth was impacted by the legacy services. Could you just give us a little bit more detail here? What specific services were the weakest? And what are you expecting through the remainder of the year here? And then secondly, just on Beniva, could you talk around the absolute uplift that we should see to the adjusted EBITDA through the financial year? And any sort of other financial color that you can give on that?

So on the first, what we call legacy, these are services associated still to on-premise, to companies which have on-premise activities. And there are some specifically on-campus trainings that we do for companies. And again, these are clearly not priority. I would almost define legacy as something that is not part of the core lines that we have flagged. And here, almost by definition, we expect a decline over the coming quarters. Now having said that, we do expect -- and this is also helped by the commercial operation [ letting ] program. We do expect to continue the acceleration or to ramp up the acceleration of our core services as mentioned, as an example, Application Services, SAP, Cloud Services. Even though the growth was quite healthy at 20%, we expect to take this level of growth even higher in the balance of the year. Then as it relates to Beniva, we do mention that the growth is healthy, I would say, roughly in line with our portfolio. And when it comes to the margins, they're close to what we see as the target margin for our services line, right? So around 50% of investment, they are immediately accretive. And again, we do not disclose specific numbers when it comes to bolt-ons. So we will not disclose this one either. We'll start seeing the effect in H2. I mean the order of magnitude is also the typical bolt-on in the sense that it is -- of course, it has a super big effect in terms of bringing capabilities in order to address the IT service market and IT operations market. But from a size point of view, it's a relatively small [ thing ].

And the next question is from Ben Castillo-Bernaus from BNP Paribas.

Welcome, Brian, as well. Two for me. Firstly, could you just give us a sense of the impact from the reallocation of the sales headcount from Services to Marketplace? It looks to me like a kind of mid-single-digit million amount. Is that broadly what you saw? And then second question, on the services growth slowdown, just around the -- coming back on the legacy services, what was the sort of quantum of the decline that you saw, if you can add some color there? And how big are legacy services in the mix of your total Services business?

I'm sorry, I'm not trying [ of the full ] -- so if you could repeat the first part of your second question.

It was more -- you said -- I think you called out the decline in legacy services. I just wondered like how -- what sort of growth rate was that? Was that down 5? Double-digit? That was the first part of that question.