Modelon AB (publ) (MODEL) Earnings Call Transcript

Okay. I think it's getting time to get started. Magnus and Jonas, you are with me, right? And good. So a warm welcome to Modelon's investor presentation for the second quarter and first half year 2023. And without further ado, I would like to hand over to the CEO, Magnus Gafvert; and the CFO, Jonas Eborn. Please go ahead.

Thank you, Jenny, for that introduction, and welcome, everyone, again to this presentation of the interim report for the second quarter for Modelon. And my name is Magnus Gafvert, I'm the CEO and one of the co-founders of the company. And I have with me here today, sitting in the next room, my colleague, Jonas Eborn, CFO and also one of the co-founders. And...

And welcome, everyone.

After introducing the bullet highlights of the quarter, I'll do a quick overview of the company before moving into the business highlights of the second quarter. And then I'll hand over to Jonas, who will provide you with a financial update for the period. And after that, we'll head into a Q&A session. And I believe that you are all welcome to provide questions during the presentation using the Q&A chat. And bullet highlights of the quarter is that we are pleased to report a solid software revenue growth amounting to 36% in the second quarter, driven largely by significant paid-up upsell win to a customer in India in the automotive space. We're also seeing a good improvement of our EBIT with SEK 4.7 million increase compared to the second quarter 2022. And this improvement is driven by revenue growth. We're also pleased to announce that in the quarter, we released a major version of our flagship product, Modelon Impact version 2023.2, shipped to customers in June or provided to customers in June. We're also announcing, in this quarter, new reseller partners in Asia, Toyota Tsusho Systems in Japan and Tae Sung S&E in Korea, distributors for Modelon Impact. With that, a quick overview of Modelon. We are a business-to-business software company in the system simulation sector. And that means we are helping technology companies around the world and in various industries to digitize engineering workflows related to the innovation, development and operation of high-technology products and systems, which can be anything from a car to an aircraft to our power plants in parts or in whole. And in digitizing such workflows, you need to have, at hand, digital representation of your product or a digital model that can reproduce and predict the behavior and performance of this product and the engineering size in the digital world before it exists or is built in the real world. And this is precisely what we provide, software tools to create such models and to use them for these purposes. And this brings tremendous benefits to our clients. It means that they can develop their products faster, cheaper and arriving at a better performance in the end. Our flagship product, Modelon Impact, is pioneering the simulation industry, being the first cloud SaaS platform for system simulation. It is based on a proven and high-threshold technology that we have been developing and supplying to industry customers for more than 15 years. Before, Modelon Impact was released in the third quarter of 2020. And we are investing in our business, in the products to grow an annual recurring revenue business based on this platform. And we are pleased to see that since the launch of this Modelon Impact, we have had a consistent growth of our rolling 12 software revenues and also annual recurring revenues, although we have a slight deviation in this quarter, which I will explain in the next slide. We are, for our size, a highly internationalized company. We are around 100 people distributed over 10 offices in Europe, North America and Asia. And we have -- that means that we have presence in the key markets, key market regions that we're operating in and are able to support and meet our customers closely, which is very important for our success. It also means that we have almost all our business outside Sweden and where me and Jonas sit, in our headquarters in Lund. This, in combination with very strong simulation and analysis markets globally, which is also consistently growing at a good pace, means that we are setting out ambitious goals for the company to arrive at and achieve an ARR growth of 35% in the medium term; to turn cash flow positive in the short term; and to reach and exceed EBIT margins of 20% in the long term. And with that, let's move into some specifics of the second quarter. So again, pleased to report good software revenues in the second quarter amounting to SEK 14.3 million, which is a 36% increase versus the same quarter last year. And it's driven by a significant upsell, as I said in the introduction, with an automotive customer in India. And the background here is that this is a customer that has been using our multi-platform product line for many years and a customer that we are in -- we have a close relation with. They are, as many companies in the automotive industry, going through changes related to the electrification of the industry, shifting from combustion to electric vehicles. And that has opened up opportunities, creating new opportunities for us to grow our installed base with this customer, which is what's realized in the second quarter. This transaction is not a recurring license to the largest part. And the reason for that is also that the recurring business models are not as mature in that region or widely accepted in that region yet. The ARR growth in the second quarter amounted to 8% compared to same quarter last year. We are seeing a slight decrease of the ARR in the second quarter compared to the first quarter. And this is again explained by a single customer in the automotive industry, another customer that is subject to the electrification changes. They have been using also our multi-platform product line for development of air-conditioning systems, it's a Tier 1 supplier in -- for conventional cars. And now changes means that we are reducing our footprint with this customer. So this is -- this has been expected for some time. We are in close contact also with this customer. So changes in that industries are -- in that industry are sometimes to our favor and sometimes not. So we see both in this quarter. We're also seeing a bit of a slowdown. The Modelon Impact ARR amounts to 27% in the second quarter versus last year. And it's temporarily slowed down because we are currently doing a planned strategic transition from on-premise installation as the main delivery model towards a managed cloud service. And during this change, it means that the necessary customer interactions to close deals are increased, which extends the sales cycle. And as an effect, we see a slowdown of the ARR growth for Modelon Impact in the second quarter. We are doing this change, of course, to improve our growth and scalability. So we are confident that when this change is completed, we will have shorter sales cycles and a more streamlined delivery model and products giving a great experience for our customers. So it's a temporary effect. Next slide is more details on the activity in the quarter. So start by introducing again our target industries, energy and process, industrial equipment, automotive and aerospace, and also exemplifying with some of our existing customers in these sectors to show how we are working with leading and global innovation-driven technology companies, the most successful and the most demanding companies out there really. And I'm sure you recognize all the brands here as very well-renowned and great companies. And we are very, very proud to work with such fine companies that they trust us with our solutions. And in the quarter, we have won a number of new customers of this similar character. So in the energy sector, we have, in the U.S., an innovator in carbon-free energy systems for maritime transportation. And this is a very interesting and exciting customer. They are developing technology based on ammonia as an energy carrier. And that's very clever because ammonia has a high energy density. It's widely available in a sustainable, renewable form. And there is already a fair amount of infrastructure in the world related to ammonia. And it's particularly suited for maritime transportation, where also there are large needs for improvements of the carbon footprint. And as some of you may recall from school, ammonia includes a fair amount of hydrogen. So basically, what you do is you reform the ammonia, take the hydrogen and feed into a fuel cell and create electrical energy from that. It's very clever. It's extremely interesting. And we're much enjoying to contribute to such exciting developments. We also have a European provider of a sustainable waste energy solutions. That's basically incineration of waste and recovering the heat used that either to distribute to consumers directly or to create pressurized steam feed into turbo generator or to produce electrical energy. So this is a type of thermal system that we have been working with for a long time. And we are -- we have very mature solutions to support development of those. In the industrial equipment, we have a European provider of indoor climate systems. And that's -- well, simply put, it's smart ventilation and shading systems. We have a U.S. water heater manufacturer that are doing tankless water heaters for commercial use. And the benefit of that is that you eliminate -- reduce or even eliminate the heat losses from the stored heated water. We have a Japanese factory logistics and automation system provider. They're doing large-scale trains and control of such trains using Modelon Impact. We have a Japanese provider of store refrigeration products that -- that's basically the refrigerated displays or showcases that you see in supermarkets, and to improve them, optimize them for energy consumption and function. In the automotive space, we have a European automotive thermal systems consultancy. That's an expert company in the thermal comfort in electrical vehicles and optimize that with also taking into account, of course, energy consumption and range. And last listed here is the Indian automotive company with a large upsell I told about in the previous slide. Notably also, all the new Modelon Impact customers in the second quarter have onboarded with a managed service option, which also is a receipt of the progress we're doing in this ongoing transition. Overall, we see the developments in our pipelines to be healthy activity, healthy across both regions and the industry sectors. We are seeing actually an increased lead generation from our marketing activities, which is, of course, great. I understand that there are macro effects out there driven by the geopolitical situations and macroeconomic. We're seeing some of that, of course, but not at the level that raises concerns really. And I know there are many other companies actually that suffers more from this. And I think a key background here is that the solutions that we provide to our customers, they are not of a nice-to-have character. It's not a sort of convenience software. It's a need-to-have. Our customers need these solutions in order to be successful and competitive. And I can relate that a bit to these larger trends in the simulation industry that's also driving the growth of the total market. And first, it's that of digitalization of the engineering work. And for many companies and in several sectors, that journey has just started. And it's necessary to adopt these methods and harvest from the benefits of working in the digital domain to be competitive. It's a must-have. And the digital models are at the center of many of these workflows. Of course, then we provide something that's necessary. And we have the clean technology aspect. All the industries are subject to enormous pressures to improve their products and systems to become more sustainable and clean. And the innovation pace needed there is it's simply impossible to keep up with unless you work extensively with the digital methods and simulation of the type that we provide. And we are, as also exemplified, I believe, on the previous slide, we are very happy that the majority of our customers are doing very important work in this respect using our tools. And we have the SaaS cloud aspect, the need to move the engineering work, also the simulation work to the cloud, not the least because of the need to collaborate across team, distributed something -- development accelerated by the pandemic. So of course, it's a very good position to be pioneering our industry with solution on the cloud. This is exemplified by a customer story, a great customer story that we published in the quarter. And this is again a U.S. company, an innovator, Aircela. And they have a very interesting solution. They are revolutionizing the liquid fuel production basically for combustion engines to do carbon-neutral fuel. And they are basing this on the very interesting idea that -- something called direct air capture. And that means that you're picking the carbon dioxide from the atmosphere. And you take the carbon in -- out of that and combine it with hydrogen that comes from green hydrogen, renewable green hydrogen to synthesize combustion fuel. And they are developing solutions that are small scale so that basically you can have your own production units at home and then fill up your car with this. So this is a bit of a different route compared to electrification, traditional electrification, to actually use a carbon-based fuel as energy carrier, which comes with also many benefits. And Aircela are testifying -- well, they're actually using Modelon Impact then to capture chemistry and physics of their system, which means they can test -- come up and test new concepts without building them, thereby saving a lot of time and cost. And they are testifying how the tools that we provide and the models, they unlock development paths that would otherwise be impossible to achieve. So that's again speaking to the necessity of a need-to-have of the type of solutions that we provide. So a great customer story from a very, very interesting company. And again, Modelon Impact, fundamentally high level, it's a platform where you can create digital models of different industrial systems and then use these models in workflows throughout the product lifecycle, from innovation to development, testing and operation of these systems. And we deliver this functionality then on the cloud, providing all the benefits that comes with that. And as I said, in the quarter, we released a new major version in June. And it includes substantial new features related quite much to benefit on the advantages of the cloud delivery, so meaning parallel execution of experiments, sharing of information and workspaces and connectivity with other platforms. We're also seeing significant improvements in our industry application, the built-in industry application support, including hydrogen systems, fuel cells, HVAC&R, tell some more about that, it's heating, ventilation, air-conditioning and refrigeration, microgrids, thermal power plants and carbon capture. And we're also doing quite substantial updates -- upgrades in the cloud back-end improvement to support future robust scaling of a managed service. So again, this release and developments are much related to this ongoing transition also, where we're making the managed cloud the leading and main delivery model compared to the on-premise that we have been prioritizing previously. And the new partners in Asia to distribute Modelon Impact in that region. We have Toyota Tsusho Systems, that is the main IT provider within the Toyota Group. And they will distribute Modelon Impact in Japan. And of course, with a particular network within -- with the Toyota Group companies. And we have Tae Sung S&E. It's the leading CAE firm in Korea, providing one-stop simulation solutions to virtually all industries, including software consulting and training. Both of these partnerships are nonexclusive. And we are thrilled about the broadening of our market contact surface in the region based on their networks and their recognition and brands, so very fine companies. We are currently working actively with onboarding activities such as training of their staff and also started to arrange customer-facing activities, webinars, seminars, et cetera, to start building pipelines. And it's early days. But we're still -- we're already seeing leads coming in from these new channels. And also, we have had the first customer win already. Expectations are still that it does take time to ramp up -- onboard and ramp up a new partner of these types, so expecting 6 to 12 months before we really see activity at the level we expect. And from that, I'll conclude with this slide, which is another customer testimonial. This is interesting, again HVAC&R, the heating, ventilation, air-conditioning and refrigeration. This is a sector -- this is technology that is responsible for a fairly large amount of the carbon dioxide emissions in the world and which means that it's a sector with enormous potential for improvements, improved technologies and also subject to stronger regulations and so on. All this creates big leads here. And we see good activity in this sector. And we're very well positioned to address that. And this is also what we exemplify with -- or demonstrate with this customer testimonial. So Mitsubishi Electric is a huge multinational electronics, electrical equipment manufacturing company. And they have several major product lines, ranging from nuclear power plants, I believe, to other things. In this case, it's about HVAC systems, commercial and domestic, which is where they are one of the leading provider globally. And they have been using our solutions in their product research and development work for many years and testify how satisfied they are with that and with our support. And of course, in addressing -- focusing on this sector, it's great to have the experience and majority of our solutions that comes from many years of engagement and also the name of such a strong and good brand as Mitsubishi Electric standing behind that, so very fine testimonial. And with that, I hand over to Jonas for the next part.

Thanks, Magnus. Can you flip forward to the first slide with the ARR? Yes. So as usual, I'll provide some brief financial highlights, more details in the financials. ARR, we see -- I should say that this is reported at constant currency, which is very important. So we're showing the real volume growth by adjusting the historical data for the foreign exchange effects. So all of the ARR is counted at the current period's foreign exchange rates. We see that growing to SEK 46.1 million, an annual growth of 8%, although there is a slight decrease of 2% versus the previous quarter. As Magnus already mentioned, this is a multi-platform deal, where an automotive customer in their annual renewal has reduced their number of licenses a little bit but significant so that we see it here. And this is the sort of legacy software that we're selling, libraries, so it's not on the Impact platform. On Impact, we do see an increase of 27% annually. This is a little bit lower than the previous rates that we've seen at the end of last year. And this is explained by the transition period. As Magnus explained, we're in this period now shifting to the managed cloud service as a delivery model. And during that period, we do see sort of extended sales cycles, which is the reason for the slightly lower annual growth. It's still the main driver of the total software ARR growth. That's important to focus on here. We can shift to the next slide with the revenues, where we see SEK 21.1 million in the second quarter, which is an increase by 40%, which we're very pleased with. We now see sort of the shift in the trend from the low point roughly mid-last year. So we're through this transition that we've done from the services that we had with a major collaboration, co-development customer, which is now completely in the historical numbers before this period. The increase of 40% is partly explained by the low comparison number in the second quarter of 2022 but mainly by the good growth in both software revenue and service revenue at the same time. So we have 36% growth of software revenues. This was a paid-up license win in India, as Magnus explained. In the service revenues, so engineering services, the consulting that we deliver to our customers, we're now seeing the effects of our good pipeline. We can start to deliver on those projects and get a good growth also of the service business, which is important. Most of these projects are sort of using a Modelon Impact and also promoting sales to our -- to new customers. So we have our service engineers engaging and supporting the new sales of Modelon Impact. Development cost is decreasing by 12% in the quarter. Important to recognize here that all the development costs are taken as operating expenses. So they are, of course, the main contributor to the EBIT, which was almost the same as the development cost, minus 12.8% for the quarter. And this is the reason. The decrease is, in the quarter here, due to slow recruitment for some of the open positions. We don't expect a decrease to continue. We're long term or sort of mid-term expecting our development costs to grow slowly, slower than the revenue growth and sales growth, of course. And this year, around the same or slightly above sort of with inflation taken into account as 2022. And with that, we can move to the third slide here with the expenses, a little bit more detail further. So we see the operating expenses growing by 4% compared to last year. And this is largely personnel costs. Of course, we're a very personnel-intensive company. The 7% growth there is mainly from the annual salary revision, which we see at typical market levels. We're a global company. So we have engineers in all the continents almost. But this year, we have seen inflation also in all our regions where we are active and have offices. So the cash is now at SEK 90 million at the end of the second quarter, which shows that we are still investing. So we have sort of a negative cash flow over the period. I remind everyone that we financially have a target to be cash flow positive in the short term, meaning in 1 to 3 years. So the cash flow in the second quarter is minus SEK 19.8 million, while year-to-date, it's minus SEK 21.6 million. So we see sort of timing effects here in the cash flow. We had a very good sort of historically cash flow in the first quarter. And now it's turning back. So we have in the sort of half year numbers roughly where we expected to be, minus SEK 2.6 million. Timing effects, for example, could be the -- as an example, we can take this India deal. So as an paid-up deal, this is invoiced in the second quarter when we deliver. That's taken as revenue also into the major part in the second quarter, while, of course, the payment is coming later. So payment due for that business is in the third quarter. So that's one effect. We also see a little bit of macroeconomic effects with somewhat slower customer payments. Nothing alarming, there are no indications of bad debt. We have overall very stable customers, very large customers. They always pay. But sometimes, it takes a little bit longer. And we do attribute that to sort of the general economic climate in the world. And that was all that I intended to say, Magnus, so you can continue and wrap up.

Yes. So with that, I hand the word back to Jenny for the Q&A.

[Operator Instructions] We are going to start with our both analysts. And we are going to start with Stefan Wård from Pareto. And while we are getting you unmuted and online, I'm actually going to throw a question to you, Magnus. Yes, so it's our activity in the APAC region in Asia. We have the big win. And we also have two new business partners. Maybe just for you to elaborate a little bit on business model, how will it affect, what can they expect from that region going forward? And Stefan, you're going to be unmuted now. So please go ahead, Magnus.

Yes, thank you, Jenny. So good question. So yes, there are, in the quarter, several news related to the Asia region. I would say that the partners and the win in India, they are unrelated. So the win in India with that customer, it's most -- it's an effect really about a long-term relation that we have had with an enterprise customer. This one is in India. It could just as well have been in Europe or in North America, these kind of opportunities that we can identify and exploit because of our long-term relations. The new partners are important in that, particularly for the Asia region, we rely more on resellers and indirect sales channel. We believe that's an important part of our go-to-market strategy for that region. And of course, then it's also important to invest and build up the channel for -- to support and drive the future growth of our business in that region. And with Modelon Impact, we have -- the first couple of years after the release, we focused more on the regions where we have direct relations with our customers, that is Europe and North America. We're now in a position where we feel that we're ready to start to, say, unleash the indirect channels, then it's important to find then these kind of good partners to work with. I could mention that these two new partners also, the Toyota partner has also -- is also a company that we've had a long relation with. So they have also been distributing our multi-platform product line. So the news here is that they are adopting Modelon Impact. And they're very enthusiastic about the cloud and the possibilities there. So they are thrilled and very active in their engagement.

Thank you, Magnus. And Stefan Wård, you are now unmuted. So if you unmute, please go ahead with your questions.

And thank you for interesting presentation. I have a couple of questions. The first one relates to when we can see an acceleration in the ARR growth back to the trend that you have as a target. The second is relating to cash flow generation and the seasonality in cash flow generation. If you look on what you have generated during the first half, what to expect for the second half. And if Jonas perhaps could be a little bit more specific in when we can see a cash flow breakeven within this 1-, 2-, 3-year time frame. And then I have sort of a business case-related question that I can take after these two if you can.

Yes. So what order? So I think the first part is probably for me. Please very quickly refresh the question for me.

The way I read it, you're not really on your target growth in ARR. When we can expect that to materialize?

Yes. So we believe that the transition we're currently doing is a very important step to arrive at the target levels of the ARR growth. So this is a transition that we started to guide for, I think, in the third quarter last year. We were preparing for that. We saw the timing is right now to take this step. And it's a step that -- it takes a bit of time. And we're probably sort of peaking that transition around the second quarter. So we expect that it's not a sort of on/off thing. It's a gradual change that we expect will go on also throughout the second half of this year and possibly into next year, although with the effects being sort of less and less, so -- and this is -- this transition again, as we explained here, we do see that this is slowing down because of the increased lead times and the increased customer engagement, the high-touch leads to close during the transition. We're getting out of that within this time frame. And that takes us back to, I would say, the previous growth trend towards the target levels.

And then I can continue with the question around cash and cash flow. Of course, these are related. So the ARR growth, that contributes to the cash flow. When we see higher growth, we will also see more cash coming in. Relating it to our financial target, the short-term cash flow positive, that's defined as a 1- to 3-year period. I would say it's more in the nearer half of that period. So sort of 1 to 2 years' perspective, we see cash flow positive in our sort of plans and what we're executing on. Of course, it's also important that we're continuously analyzing our different perspectives and sort of making plans for what if so that we have a good financing going forward. But right now, the plan we're executing on is to become cash flow positive in this short-term perspective. Was there anything -- you asked about seasonality in the cash flow, yes. And of course, we do see that. I would say that typically, we have a better cash flow in the beginning of the year. That was what we saw in the first quarter. In the second quarter, it's more back to normal in a way. There are some -- a little bit more variation than we've seen before. So we have individual deals affecting like this large India deal. So it's hard to tell. But I would say it's -- we're on that sort of normal path in cash flow. We're always, of course, being cost-conscious, that's very important, to improve our result. And of course, services is important. We have reported on the good pipeline. And we now see a result of that with a good service delivery. And that's sort of a more immediate term positive for cash flow. Typically, we get shorter delivery times and well -- sort of well-paid projects with our customers and also contributing to the sales growth with licenses. There's always a relation between the consulting engagement, we have service projects that we do and Modelon Impact for our customers.

Perfect. Jonas, that was helpful, and Magnus as well. Then my third question is a little bit more business case-like. I mean, if we -- if I look at the customer slide, you have about 38 different customers, I think. And I followed you for quite some time now. And I know that your clients are very happy with the offering. And you have a long track record with many of these. But it comes down to, I think, from my perspective, I mean, looking at the total annual turnover, each of these accounts is fairly small and has been small for a long time while these corporations are quite big. So if you could help explain, I mean, how can you scale your engagement with this client? And what are the -- your opportunity within like -- take Mitsubishi Electric, for instance. If you've been a supplier to them for many, many years, they still don't look to be that big if you follow what I mean. It's not a criticism about your offering. It's just a question on how scalable is the solution and how can we think about that in a more sort of longer term. It's not a near-term issue, it's more how big can Modelon become for Mitsubishi, for instance, in terms of user or total revenues and engagement. Are there other areas that you can expand into a little bit relating to that, please?

Yes, I'm happy -- it's a very good question. I'm happy to elaborate a bit on that. So it's true. We have, in our portfolio, a good amount of really large technology companies, where you have typically thousands of engineers working. And absolutely, these companies, they do represent a very strong opportunity for upsell and growth. And we are -- we didn't really talk about it today in this presentation. But we usually refer to our strategy, this land-and-expand strategy. And that stands, we believe -- strongly believe it's the right one. If we look at these customers, many of them are also on a journey. And the journey that they are on is to adopt simulation tools, digital methods, more broadly in their organizations. So the teams that we are working with -- and in particular, that's true for the longer-term customers we have, they are typically specialists. And the growth opportunity in the specialist community with this company, it is there, but it's not as substantial as when you move into the more sort of mainstream engineering community. So this is the step that we're seeing that we can take with Modelon Impact. And so that is then related to the companies also maturing and doing this transformation, which does take time. It looks different in different industries. It looks different in different companies. So that also means -- very important there is also that we are designing our products to support that kind of -- there is a buzzword in our industry, democratization of simulation, but basically means to take these methods and make them available for the broader engineering communities. That's one of the strong goals that we have with our product, to design it in a way that can drive and support that transition. I should say that we are -- that is on our side, a journey. So looking at our road map ahead, we see things coming up that is addressing this. We saw functionality in -- well, we see functionality in every release that actually takes steps in this direction. There is also another aspect, which is also something that we're working actively with is that you typically see also different -- let's say, different activities in these companies. You have one activity that is related to the research and innovation, come up with new technology and so on. It's typically -- well, it's sizable teams and departments. But then the good ideas are then taking from these groups and into the production teams, design and production teams, which is at a different scale. So it's also important for us, as an entry point, we are often starting off in the R&D departments. And then from that, we also need to work actively with the customers to bring our solutions also into the production use. And again, the methods, the type of simulation methods that we work with are currently in the maturity state of the industry, more present in the R&D phases than in development phases. So this is the strategy for our customers to bring these two sourcing to these. And we're working. So we're absolutely seeing that this journey is ongoing. We're looking at our growth journey with a long-term perspective. You see on the financial goals, we're looking at 20% EBIT margins long term. And these developments are -- and the dynamics of how we understand the industry here is one of the sort of fundamental aspect that makes us strongly believe in this goal. We see a very large opportunity. And we see that we're working with the right customers to enjoy that. Is that helpful?

That's very helpful.

Okay, thank you, Stefan. And we should also have Alexander Flening from Redeye with us. So Alexander, are you here?

Yes, I'm here.