Good morning, everyone, and welcome to Pexip's third quarter presentation. My name is Trond Johannessen, and I'm the CEO. Together with me today, I have Øystein Hem, our CFO, Åsmund Fodstad, our Chief Revenue Officer, and Christine Arnesen, our Head of IR. Together, we will take you through the highlights of the third quarter and what Pexip is focusing on going forward. Before going into all those details, I will do a quick recap on what Pexip is all about. Since Pexip was founded in 2011, the company has grown to become a global technology company. We are building our business on unique technology, and our mission is powering video everywhere. The Pexip platform powers video interactions within the public sector and the private sector and in a wide range of industries and application areas.
We are serving more than 4,400 customers globally, and these are mainly large organizations with complex needs and requirements for video communication. We have taken a focused and differentiated approach to the video communications market. We're not competing with the major video conferencing players like Teams, Zoom, Google Meet, and Webex. We're rather cooperating with them to make custom solutions and good interoperability between systems. We are approaching a part of the $20 billion video communications market where we can be unique and differentiated with our technology. We are cooperating with Microsoft and Google to deliver tailored solutions and the best integrations. The market niches we are approaching constitute around $5 billion annual revenue base, and we aim to take number one positions in several areas of that market. Our core solution areas are defined as Secure Spaces, Video Innovation, and Connected Spaces.
I'll give you some more detail on those three. In Connected Spaces, we help organizations that have a mixed infrastructure of video communication equipment in their meeting rooms. They need that equipment to function seamlessly together and communicate mainly into Microsoft Teams meetings. Pexip's technology makes that work in a very seamless and good way. Video Innovation is for those that require an embedded, customized video solution. We're providing our technology, for example, as a video platform, as a service solution, giving our customers the ability to use Pexip's technology to build their own customized solutions on. Our main target verticals here are within judicial, health, finance, and retail. Also within judicial, finance, and retail, we have ready-made solutions that only need certain configuration for them to be quickly ready to be put into use.
In Secure Spaces, we provide video solutions for organizations that are particularly concerned about complete privacy, control over data, and data sovereignty. We work with governments, defense organizations, and other large organizations across the globe that typically require on-premise or private cloud solutions. These three solution areas are unique. They have different ecosystems, different characteristics, different competitor landscapes, and they require a bit different strategies. Let me elaborate a little bit on this. Within Connected Spaces, we serve a mature, well-established market. Pexip has a high market share and a market-leading product that requires little investment. Sales channels are efficient, and our partnerships with Google and Microsoft put us in a position to stay ahead of competition. In total, this gives a very profitable and cash-generating business. Within both Video Innovation and Secure Spaces, we are serving large, fast-growing markets where our unique technology gives us a competitive advantage.
Within Secure Spaces, we are basically the only provider of a modern on-premise secure collaboration solution in the market today. In Video Innovation, our flexible deployment methods, interoperability knowledge, and various certifications put us ahead of many other providers in the market when it comes to building tailored, customized, communication solutions based on video. Here, we're looking at attractive investment opportunities where we will invest in both technology and market development to create growth. In summary, Connected Spaces, mature, well-established market with a high market share, very profitable and cash-generating business. Video Innovation, Secure Spaces, large, fast-growing market, attractive investment opportunities where our technology is unique and we have a unique position to create growth. We need to have slightly different strategies for these two businesses within Pexip to make sure that we get the maximum potential out of both of them.
Now, with that as background, let's move over to the third quarter highlights. In the second quarter presentation, we promised we would get back to you with updated financial targets. Happy to do that now, and to give you targets for 2023. Here we are targeting an EBITDA of NOK 100-150 million, with a 40% EBITDA to free cash flow conversion on that number. I'll come back to more on the targets in a short while. Actual performance in the third quarter, we delivered an EBITDA of NOK -56 million, and we see the effects of the cost reduction programs we have done in the P&L for the third quarter, where we have significantly lower costs than we had in the second quarter. The cash flow ended at a NOK -39 million, also a significant improvement from previous quarters.
On the cost side, we have completed the first phase of the cost reduction program with an annualized cost reduction effect visible in the third quarter P&L of NOK 184 million. We are in various stages of implementation and planning of the next initiatives to come. Revenue ARR year-over-year was stable in the quarter and ended at $101 million. The revenues in the third quarter were 3% up year-over-year and ended at NOK 189 million. From second quarter to third quarter, ARR was reduced by $5.4 million, mainly driven by the loss of one large contract and reduction in legacy areas.
On the sales side, we have been happy to announce that we were awarded a strategic contract with a global technology partner to embed Pexip's technology into that partner's product for better functionality. This is a clear signal that our technology is unique and relevant in today's market. A bit more on the cost reductions we are currently in the process of implementing. The program is progressing well, and the impact in the third quarter annualized is NOK 184 million. We are in the process of planning and implementing activities in the next stage of the cost program. In total, with the realized and planned reductions fully implemented, we are looking at the cost base in 2023 of NOK 940 million. This is NOK 400 million below the cost base we had in the second quarter this year.
This gives us confidence in delivering a 2023 EBITDA between NOK 100 million and NOK 150 million, with a cash conversion on that number of 40%. Financial targets for next year. On the revenue side, we are planning for a flat to positive overall ARR base. As you know, this is a mixed bag of solution areas, and we target more than 20% growth in Secure Spaces and Video Innovation, while we are more modest in our assumptions around Connected Spaces and legacy areas. The progress with the cost program so far makes us confident that we can deliver a profitability with an EBITDA of NOK 100 million-NOK 150 million next year, even with such modest revenue assumptions.
Using a 40% conversion from EBITDA to free cash flow, we end up with a solid positive cash flow for the year and out of Q1. Now, let's move over to sales development. Happy to give it over to Åsmund.
Thank you, Trond. Good morning, everyone. Let me go through the sales development of Q3. Again, we ended up Q3 on NOK 101 million and with a 1% growth in ARR. This is mainly due to the loss of one large contract and decline in legacy areas. Going one level down, looking at legacy areas, we are declining within the expectations, as well as some conversion to Connected Spaces. If you look at Connected Spaces, we have growth year-over-year with a flat development in Q3 isolated. For Secure Spaces, and without the termination of that large contract, we see growth both in Q3 and year-over-year. In Video Innovation, we had steady growth and this time 18% year-over-year.
Pexip continues to focus our efforts where we have the biggest opportunities, and that is within Secure Spaces and Video Innovation. The ARR development for Q3 is at a neutral level. Sales to new customers continues to be strong, and again, excluding the churn of one large contract, churn is slightly down compared to the previous quarter. Expected decline in legacy is of course also driving both down sell and churn for Q3. Now, let's talk about some of the customer wins that we had in Q3, and I'm happy to share some of them. Trond mentioned it already, that we secured in the Connected Spaces a significant contract with one of the world's leading global technology companies. This company or this cooperation basically enables this tech company to again embed the Pexip technology into their own product and their own technology solution.
This is very different than any strategic cooperation that we had before, or this tech company had with any other vendors. Again, embedded in their own technology offering. Why do we win this one? This company could have chosen any vendor out there, but they still choose to partner with Pexip. Number one, Pexip's unique technology, capability, and feature sets, as well to be able to productize a customizable software platform that is unique to Pexip. Of course, Pexip's long-term industry experience and our ability to be both flexible and agile working with a large tech company is a win for us. Thirdly, Pexip's excellent relationship with both their technology group and their engineering teams was a win to us. The contract is $1.4 million and is a multi-year agreement.
In addition, we are proud to announce this morning a strengthened partnership with Google, where Pexip again is providing a seamless interoperability solution with a guest join feature, making sure that any hardware device and any software solution can join a Google meeting solution besides the Google specific products. Google could also have partnered with anyone, but they have chosen Pexip to bring this solution to the market, and it will again just make video conferencing work, and Pexip is instrumental in making sure that that takes place. Moving to Secure Spaces, and especially in public sector, Pexip had a strong momentum with our unique technology and solution, and Valtori is a great example of this. We win Valtori based on the exact needs for secure collaboration, data privacy, and security.
When you win Valtori, you actually win the entire public sector in Finland because they provide the ICT services for central government across the whole of Finland. Why do Pexip win? Our unique, highly secure solution based on on-premises solution, no one else can offer what we have here. Secondly, Pexip's ability to offer a complete public sector offering consisting of breakout rooms, virtual meeting rooms, core application layers, integrations with Skype for Business and chat solutions, and in several instances, replacing the Skype for Business solution. Thirdly, Pexip is second to none when it comes to our ability to scale a deployment up, or for that sake, down, and with our unique and flexible integration opportunity.
The customer is expected to grow for us in 2023, and there's several other government tenders coming out where Pexip now basically have set the standard for government in Finland. Very excited about another country standardizing on the Pexip solution. Moving to Video Innovation. Pexip keeps building momentum within healthcare, and ZuluCare is a good example of that. They are a provider of healthcare services and represents a great partnership and an opportunity for us, especially in Americas. Why do ZuluCare then actually choose Pexip? We offer a unique integration into other workflow systems, like a doctor-patient workflow or an integration with a medical system like Epic. That is, of course, important for someone like ZuluCare. Pexip technology also integrates with any other video software, any web browser, and every hardware platform out there.
That in combination with zero downloads makes Pexip the obvious choice for ZuluCare. In addition, ZuluCare has several large customers within the government sector, like military hospitals and so on. The combination of the integration capabilities, unique interoperability, as well as then being able to build secure custom cloud for each and every customer is of the highest importance for ZuluCare. We win this in competition with Twilio, Vidyo, Vonage, and Zoom, and others. Again, just a good reference for us in this space. ZuluCare was also a great example and a technology partner for the Pexip Marketplace. To further position us in the Video Innovation space, Pexip has developed and just launched the Pexip Marketplace for tech companies, basically.
It's an ecosystem driving video innovation, demonstrating use cases, and it includes both a developer portal as well as a developer community. Some of the largest customers that Pexip actually have today, and especially within health, is based on building vertical solutions with Pexip as the core media engine. With the marketplace, this will again expand our position, strengthen our competitiveness versus Twilio and others, and we have started to see a very good traction in this market space. With that, I'm gonna move it over to Øystein and the financials.
Thank you so much, Åsmund. To start off, let me give a quick highlight of the Q3 financial results before we go into some of the underlying drivers. Our revenues grew 3% year-on-year and is at NOK 189 million , mainly driven by solid growth in Pexip as a Service, with a decline on self-hosted software. Despite this, our cost of sales went down. This is mainly tied to the Pexip as a Service offering, which gave us an increase in gross profit of 5%. On salary and personnel expenses and other operating expenses, they are up from Q3 of last year, but combined substantially down from Q2 of this year, showing the early results of the cost reduction program.
Net, we had an EBITDA of NOK -56 million, which is eight percentage points lower than what it was in Q3 of 2021. In terms of recognized revenue and NOK 189 million in total, that is combined of Pexip as a Service revenues of NOK 106 million, which is 36 percentage points up from Q3 of last year. Whereas Pexip self-hosted software offering is down 21% to NOK 83 million. Obviously, the impact of a loss of our largest customer had a significant impact on this area, and they contributed NOK 31 million in Q3 of last year. Obviously, not having this revenue this year is a big driver behind that change, and other self-hosted revenues increased NOK 10 million in the same period.
Our cost of goods sold is substantially down from the previous quarters and slightly down from Q3 of last year, showing that the effect of some of the optimizations that we've done on our SaaS platform, taking advantage of some of the scaling opportunities that exist in the big compute platforms, both of Google and of Microsoft. Very satisfied to see this. Basically, having stable cost of goods sold despite a significant increase in the Pexip as-a-Service revenues, us powering more customers than we did before. In terms of other OpEx, they are overall up 14%, with salary and personnel expenses, if you exclude share option related costs, are up 3% year-on-year.
On a stable level, especially taking into consideration the development in currency, where our cost in U.S. dollars in particular have increased. Share option related costs are now at a more stable level than it was in 2021. Other operating expenses are on a fairly similar level to what they were in Q1 and Q2, and we see that the cost reductions in this area do take some longer to come into place as a lot of the spend is tied into existing commitments, both on events, but also on fixed contracts. Expect to see more of this in the quarters to come.
We've also highlighted the restructuring costs in this quarter to be comparable with the previous quarters, despite being at a substantially lower level now in Q3 than it was in Q2 when we did the bulk of the phase one. Lastly on cash flow, we had a net change in cash of NOK -39 million in the quarter, which is driven mainly by having a negative operating result. We had positive impact both from net working capital and the exchange rate impact of the stronger U.S. dollar. On net working capital, that improved despite them having a lot of the cash impact of the restructuring costs in Q2 now in Q3.
Overall, we are on the right track here with reducing our reduction in cash on a quarter-over-quarter level. If you compare to Q2 with 41%, and if you look to Q3 of last year, we're basically reducing our cash loss with 64% compared to the comparable quarter last year. We are on the right track, and then close now to 2023, where we expect to again have a positive cash flow and a profitable operation. Looking forward to that. With that, I give the word back to Trond.
Thank you, Øystein. Happy to do a quick summary of what we told you today and how we look at the future. Profitability, return to growth, that's basically our two main priorities these days, and profitability combined with positive cash flow. We target an EBITDA of NOK 100 million-NOK 150 million next year, with solid positive cash flow coming out of that. We see continued positive momentum in Secure Spaces and Video Innovation, driven by the world's increased focus on data security and data privacy. We're clearly seeing the results of that focus in the number of customer dialogues and the close deals we have these days. For Q4, we are looking at a relatively flat ARR development, and we estimate an ARR out of the quarter in the range of $99 million-$102 million.
Partnerships with both the tech giants like Microsoft and Google, but also with smaller partners that are building solutions on the Pexip technology, are really key to our success going forward, and we're focusing a lot and spending a lot of time on ensuring joint successes with all these partners. Last point before we go to Q&A. On February 14th, Valentine's Day, we will present our Q4 results, and we'll have the annual report at the end of March. Now, Christine, hand it to you for the Q&A.
Thank you, Trond, and thank you all for the presentation. My name is Christine Arnesen, and I am the Director of Investor Relations at Pexip. We will now go into the Q&A session of this presentation. To start off, we are joined by Kristoffer Haugland from Arctic Securities. Kristoffer, any questions from you?
Yes. Thank you. I have a question about the collaboration with the global technology company. How much did they contributed in delta ARR in Q3? And how much could we expect in Q4?
In terms of the delta ARR, they contributed by $1.4 million, which we also then put into that release. We don't expect to increase that contract in terms of the run rate revenues of that now in Q4. When they start using it and over time, I think there is significant potential for uplift, but I don't think that will be as soon as Q4 or in Q1.
Okay. Thank you. That's helpful.
Mm-hmm.
When looking at your cost base guidance, I think it seems a bit high, because when I assume 420 FTEs and the salary per FTE, including capitalized R&D of NOK 1.5 million, I get to NOK 630 million in personnel cash cost. Adding other OpEx and lease, you get to a cost base of around NOK 809 million. Could you provide some color on this?
I think the main delta there is. Obviously, the average currency that you put into effect. We're basically 5% off from your summary there. I do think that what we will see over time is that we'll continue to work on the cost base, but that will be roughly around NOK 400 million lower than what we were in Q2. I think what we then include is everything on salary and personnel expenses, everything on other OpEx, as well as the costs that go onto the balance sheet.
As you point out, our CapEx, which is roughly 60 million NOK per year, our assumptions around leases, which we expect to have slightly lower than the current base, but not substantially, as well as the impact of costs that are put on contract costs. Basically, earned commissions, but they're then accrued over the contract period.
Thank you.
Thank you, Kristoffer. We also have the following questions that have come in on email. First, Cisco and Microsoft recently announced a partnership that Cisco will become a certified Microsoft Teams Rooms devices partner. How will this affect Pexip, and especially the offering within Connected Spaces?
The question was to what extent the Cisco MTR partnership will impact Connected Spaces. We've seen quite a bit of confusion of that, both for customers and for investors. I think the main difference here is that it doesn't impact the installed base of the existing systems, as the existing systems in general are not able to be converted to an MTR, except the most recent and most expensive systems that Cisco has. What this does is that it introduces a new vendor into the MTR ecosystem, which I think is good for choice of MTRs. We will have to see to what extent that impacts the sale of MTRs.
Having one more vendor of that could help drive sales for MTRs, but it could also mean that customers that otherwise would have chosen Logitech or Poly or other vendors of MTRs are now choosing Cisco as they have very solid hardware. It's unclear to us to what extent this will impact Connected Spaces, certainly in the short to midterm.
Thank you. Next question is, can you please provide detail on the churn percentage in each focus area?
Our focus areas are then Connected Spaces, which is the bulk of the revenue, Secure Spaces and Video Innovation. Starting with Connected Spaces, the churn rate on that area is roughly the same as sort of the underlying churn of Pexip, around 8%. Secure Spaces is to some extent the tail of one large customer. We had a base last year of NOK 10 million, which one large customer was NOK 4.4 million. With that having now departed, obviously the churn rate is very high. Churn except that customer is minimal. To some extent it's difficult to give an answer. Overall, it's -40%. If you adjust for one single customer, it's in the low single digits.
Same with Video Innovation. It's also the low single-digit churn.
Thank you. Can you please provide more detail regarding your view on Connected Spaces? Your overall growth guidance indicates that you expect this segment will gradually reduce in absolute terms. With what speed would we expect this to occur?
I think what we are seeing is what we are planning for is a relatively flat development in Connected Spaces, flat to positive development in Connected Spaces. You know, there are four million meeting rooms out there that are video-enabled. There are 270 million Microsoft Teams users. Somehow these need to be connected, now and in the future and over the next, you know, five, 10, whatever years. The market is there. We have a very competitive solution. We are partnering with the major players. I think it's not. We're not planning for a significant reduction or anything like that in this area.
We are investing in it, focusing on it, but making sure that we also capitalize on it so that we can get the profitability out of this solution area that it deserves.
Do you expect further cost reductions from the base of NOK 940 million operational cost base for 2023?
I think what we are committing to is a profitability target, and the cost base needs to be adjusted to make sure that we deliver on that profitability target. We're not taking a revenue assumption. We're taking a very modest revenue assumption in the way we are approaching this.
Next question is, why do sales trail so far behind ARR considering the flat to negative development last three quarters?
I'm not sure if I completely agree with the premise of the question. If you look at our revenues on Pexip as a Service, it's at NOK 106 million for the quarter. If you sort of take the annualized value of that, you would get the NOK to USD ratio to our ARR of roughly 9.2, which isn't far off from the last 12 months average. In general, currency will obviously sort of delay the impact on recognized revenue, both good and bad. Now with the strengthened dollar, that means that revenues are lagging somewhat. On self-hosted software, revenues are very tied to when we actually deliver our software.
Q3 is typically then a lower revenue quarter because we have fewer deliveries in Q3, while Q4 is typically a very solid revenue quarter because we have a lot of deliveries in Q4.
The final question for today, how much of legacy ARR has been reclassified to other areas?
None of the legacy ARR has been reclassified. The legacy ARR and the products that go into that are cloud VMRs, and then self-hosted software customers that use our product mainly for VMRs in a non-secure base setting, so as their sort of collaboration tool. That's been stable all along. We have worked with our customers that have used our video meeting room solutions to transition those to our Connected Spaces offering. Because those customers typically have a lot of video endpoints and are adopting Teams. As such, we remain relevant with that customer, even though we transition them from our legacy areas over to Connected Spaces.
If you look at our churn rate on sort of customers that are leaving us within our legacy areas, it's around 20%, which means that the remaining 20% of that reduction are customers that are either then transitioned to Connected Spaces or that have reduced their deployment with us slightly.
Thank you. That concludes the Q&A session for today.
Thank you very much. Thank you, everyone.