Hello, everyone. Good morning, and welcome to Clavister's Q2 2022 interim report. As usual, I have John Vestberg with us and David Nordström. We will start with a presentation, moving over to a Q&A session, where hopefully you will use the Raise the Hand button and ask the question on your own, 'cause I would love to hear your voices as well. Otherwise you can type the question during the presentation, and I will ask the question. John, should we get started?
Yes. Thank you, Jenny. Again, welcome, everyone. We will start with a summary of the quarter, the key highlights, if you wish, and some of those will be further elaborated on in sections during the presentation. We had a lower order intake this quarter compared to the same quarter last year. This is mainly due to a very large single order in the comparative quarter last year coming from the defense sector. We also see, and this is something we will elaborate on a bit later, the transition to the new business model is also impacting order intake negatively. If we then look at sales grew by 21%, so that is something we are pleased to see, obviously.
Our recurring revenue element grew by 10%, which is in line with the transformation we are doing towards a more recurring business. One area which saw particularly strong development was the identity and access management business, and we'll talk more in detail about this in just a second. Similarly, within the defense sector, where we continue to see a number of very interesting activities and continued successes. Our traditional firewall business also saw a good growth. We added more than 30% of new customer contracts in the period. Another important metric is the fact that we doubled the amount of hardware devices or hardware units shipped to our customers in the quarter. Our 5G security business saw a slower development in the period. I'll get back to that as well.
Finally, as a summary point, we continue to run our cost optimization program, which is progressing according to plan. Moving on to the identity and access management solution area. As mentioned, very positive development, which includes continued strong sales and healthy profitability. I think most of you know that this solution business is managed through our fully owned subsidiary, PhenixID. In the period and in the scope of identity management solution, we have a product called Signing Service or Workflow Service. A new version of this product was released in the quarter as well, and it sets a quite good benchmark for the type of business we are running within the area. This is a product that manages digital signatures, and I'm sure you've all seen or maybe been using other types of document signature systems.
This is a product that is compliant with EU and ETSI directives and uses strong factor authentication, including BankID and so forth, to make signatures also much more compliant than what you typically find in you know other types of solutions. One of the customers who has been integrating this new product quite extensively in their business is Region Stockholm, and there's also a number of other Swedish public administration organizations who have started to use this product. We have a change in the leadership in PhenixID as well, where Peter Laurén, the previous CEO of PhenixID, left the business early in the quarter, and Johan Edlund has been appointed as new CEO.
What we've seen so far is that our identity and access management business with PhenixID has grown to become one of the leading suppliers in this area, especially in the Nordics area, Sweden, of course. What we continue to see is that the strong demand for these type of solutions continue to increase, and not only within the Nordics, which is, of course, the home base for our business so far, but also in other parts of the EU. We know that the digitalization and use of digital signatures is strongest within the Nordics, especially in Sweden, but other European countries are definitely picking up. Very interesting future for this type of solution. Moving on to defense. As mentioned quite a lot of activities and successes within defense, starting with just a market situation.
We all know the tense situation in the world continues and defense budgets are rapidly being increased as we speak, and indirectly and directly, this drives additional demand for cybersecurity related to defense. One marketing example of this is the very large trade show in Paris called Eurosatory. This is the largest defense trade show in the world. We had the opportunity to present an exhibit at this trade show in June, where the solution was demonstrated for basically most of the major players in the industry, most of them would be found on that trade show. The response was overly positive. Good, really good confirmation on the viability of this technology. Especially the artificial intelligence component is something that is appealing to many of these players.
We and the industry tend to realize that the future in cybersecurity includes the ability to be able to respond to zero-day threats and unknown threats. Here, artificial intelligence is a key mechanism. Moving on to some current defense projects. As you probably know, we signed a major deal with BAE Systems for a major Western European military organization. This is for integrating our software into the Combat Vehicle 90 infantry vehicle platform or vehicle. This project is progressing according to plan. We have been through both the R&D part of the project, we have been through the pre-series part of the project, and we are now moving into series deliveries, and those are starting around year-end. The shipments for or related to that project is done spanning over a four-year period.
As a reminder, we are talking about approximately 120 combat vehicles being equipped with Clavister equipment. We are also running a number of so-called proof-of-concept projects with other key players in the industry, and they follow a similar use case, similar pattern, so basically integrating software in defense platforms. Obviously, our ambition is to be able to transform those pilot or proof-of-concept projects into commercial integrations with yet additional platforms. We are basically expanding our base. We have a number of research activities as well, funded research activities, I would like to add, within the defense market or defense industry. One recent news that you might have seen is Clavister being part of a consortium which was recently granted EUR 25 million by the European Defense Fund.
This consortium includes, apart from Clavister, really impressive companies, General Dynamics, Leonardo, and 14 other companies. The goal or the scope of this project is to develop new technologies for autonomous vehicles. Our role is quite obvious, of course, I mean, we are delivering the cybersecurity components to these new vehicles. That project starts immediately after the year end. Also yesterday, we announced a proof of concept project here in Sweden. We were awarded by the Swedish Defense Materiel Administration. For those of you who do not know, FMV, they are the exclusive, state-owned purchaser of military equipment for the Swedish Defense. And they are managing as well a number of development projects to ensure that the Swedish Defense is equipped with modern and high-end technology.
This project specifically is related to their space communication or military satellite communication, and our products will be used, or our technology will be used to detect anomalies, and thereby being able to detect threats flowing through military satellites. All in all, a lot of activities happening in the defense sector. If we then look at our firewall business, and just as a reminder, our firewall business represents the majority of Clavister's business up until now. As I mentioned earlier, we saw a very high volume of deliveries of firewall products in the quarter. We doubled the amount of devices that we shipped to our customers compared to the Q2 last year. We were able to add more than 30% of new customer contracts.
These are software license contracts that are recurring. Basically this forms a new level of revenue baseline for the company for this business. We believe our assessment at least shows that the new business model that we have introduced is one of the strong contributors to why we see these growth numbers. We have essentially lowered the threshold for new customers to become a Clavister customer and we see that the entire pricing model and the OpEx model, which it entails, is really appealing to many customer segments. There is a flip side to the new business model. We've touched on this in previous reports, but we will repeat it as well.
There is a short-term negative impact from the new business model, both on order intake, as you saw in the report, and also on net sales. Reason being that we have deliberately set very low prices on the initial hardware. The hardware is a delivery mechanism for the Clavister software and should have as low threshold for the customer as possible. The price is kept very low. We have moved then the majority, or the rest of the contract value over to the recurring software element, which obviously means that we will be able to see longer contracts in the end or longer customer loyalty, I would say. We would see higher total contract value.
We've seen as well that the average initial contract lengths have been a bit shorter than what we've seen previously. Obviously, that means that the initial order value is lower. Again, the upside or the other flip side of the coin is then a higher total contract value and more stable order intake levels over time. We don't get the lumpiness as in the previous model. Moving on to 5G security. This quarter was a slower quarter in terms of 5G security business. We did not sign any new significant license deals. There are a number of those in the pipeline, obviously, but no one that we were able to catch in Q2. However, we have then used the time well.
We have our professional services consultants that have been working intimately with our mobile operator customers to make sure that the licenses they have acquired previously are now being deployed so that the software gets up and running and starts producing revenue for Clavister going forward. If you recall or have read up on the business model, the 5G security business model is very much attached to mobile data growth, which means that the more operators we deploy our software to, and as those mobile operators are experiencing data growth, we will see an impact as well on our revenue generation. We can also conclude, and I think you might have seen this from other 5G related businesses as well, that the 5G mobile technology as such is definitely the fastest-growing mobile technology. That's without doubt. The market penetration is still very early.
I mean, the dominant networks are still 4G and 3G. It's early phase, but we don't see any change in the reality of the cyber threats towards the networks. The threats are real, and this means that the demand for this type of solution is still genuine. We have good hopes for the solution, but obviously, the take-up rate has been a bit slower than expected. With that, moving over to David.
Thank you, John. I will elaborate a bit further on more financial metrics, starting with order intake. As John, mentioned, we see a quite large decline in order intake in the period that is primarily explained by the fact that we don't have a large defense order in this quarter, which we had in the comparison quarter. We will see and expect a lumpiness in order intake based on these types of deals. Another explanation is, as also mentioned, the transition to new business model. To elaborate a little bit further on that, it is of course, when the hardware component is cheaper, that has an initial impact on order intake as we basically charge less for hardware, meaning that we move more value over the course of the engagement.
That is one part. The other part is, it's also mentioned, the average contract length that is shorter in the new business model also contributing to better growth. As you know, we are reporting according to IFRS. I will not derail into our accounting manual here, but as our engagement consists of parts that we deliver at point in time directly when a customer orders a contract and parts are distributed over the contract length. If then contracts are shorter, that means that you have the corresponding impact also on net sales. Over time, this will generate bigger revenues for us and also stabilizing order intake. During the transition phase, we expect to see this type of impact. Also a slower inflow within the 5G business.
There we typically see our larger order sizes. When that has a slower progress, we will then have a corresponding impact on order intake. Looking at net sales, we see a good growth. If we adjust for FX, that growth is 16%. The main drivers here are, of course, that we have been able to ship more than 30% growth of number of software contracts, meaning that we are broadening the installed base, and we're also shipping 98% more of number of hardware appliances. To read into these figures, I would explain that, of course, the growth of contracts means that we have a growth of appliances, but we are also shifting business model with new contract types associated with new hardware platforms.
The fact that we see much more appliances sold than new, totally new contracts means that there is an ongoing migrations from old platforms, old contracts over to the new platforms, new contracts, which has a higher degree of recurring revenue. This is the delta there is primarily explaining an overflow from the old to new business model. Hence it is we can expect to see a larger appliance growth than a net growth of contracts. This is then and also we see growth in net sales that we have a support from deferred revenues from a growing install base. This also translates into you know keeping the trend with growing recurring revenues. This continues also in this quarter.
Looking at margins, we see a quite clear decline in our gross margin. We have been seeing that as we have been transferring to our new business model. This has been expected, and we have been communicating this as something to expect when moving into the new model. The main driver here are, I would say, two things. One, of course, a much larger volume of appliances means that the COGS factor increases as a shared product of the fact that we ship much larger volumes of appliances. In the new model, as said, we are removing thresholds to become a classic customer. One such large threshold that we identified historically is this historic steep price of hardware.
To build a better platform of software growth, we have reduced the price point of the hardware, transferred that to the software, meaning that the initial impact is negative on margins. I think that is the main explanation, larger volumes at a lower initial price. Looking at OpEx, we are on track from OpEx perspective, but we have in the quarter restructuring costs of SEK 2.6 million related to further redundancies in the cost optimization program. Our primary aim is to reduce staff by finding ways of. It doesn't go to layoffs, but in certain cases, we also need to use that as a tool, which comes with a associated restructuring cost.
We had a release of reserves in the corresponding period. Those of you who remember, a couple of years back, we closed our R&D site in Umeå. We had a contract for that Umeå office, which we successfully managed last year to close down early, which meant that the corresponding reserve of SEK 2.8 million was released in Q2 2021. If you adjust for these factors, OpEx is SEK 44 million in the period compared to SEK 45 million for the corresponding period. Our view is that the cost optimization program is on track. We will talk about it a bit more when it comes to the number of FTEs on the next slide. Financial items, we have a...
As you see here, the items impacting cash flows remain stable around SEK 1 million, and the remaining amounts are non-cash. The largest part here is especially related to FX effects on long-term debt. As you know, the majority of our debt is in euros, and when the SEK deteriorates, we will have then revaluation effects that can be quite large in a quarter. Again, comparing to Q2 last year, those revaluations then were positive, and in this quarter they are negative. The other big parts here are the warrants to EIB and the long-term interest to lenders who also builds up the financial items, but they are non-cash in the quarter. Some balance sheet and cash flow metrics. Looking at CapEx, that have decreased a bit in the period.
That has a couple of different drivers. One such is that we have a high ratio of maintenance and research in the period. I mean, it is related to what we see in defense, which is a bit research-heavy before we get into more of a development mode. We have been working with improving efficiencies in our software, and we have then seen a higher degree of maintenance rather than new product development. In the cost optimization program, we have a lower number of FTEs, which means that the cost for R&D is a bit lower. We have also within the program, looked at where in the company do we have resources that can be used in a different way, in a more customer-facing way, in roles which is more demand generating.
We have also moved some resources from development activities to more commercial oriented roles that is also explaining the decrease here. Looking at depreciation, amortization have increased slightly, and the reason for that is that we have historically, for a couple of periods, seen higher levels of CapEx investments and hence amortization is then slightly increasing. Cash flow and looking then at what is the primary explaining factor for the weakening cash flow before working capital changes, and that is the increased COGS. We have significantly larger volumes being shipped at a lower price point, which has an impact on cash flows. We have also then some effects from the challenges that we see on supply chain, which we are managing, but it has impact on price.
We believe that we can offset that price to a quite large degree by increasing our prices to customer, which has taken effect from July 1st. Looking at the cash flows when we look at the balance sheet impact, we have a somewhat improvement of our cash flows, but negatively impacted by a strategic buildup of inventories. We made a strategic decision to even though it's negative from a cash flow perspective, to build larger inventories, because we have seen challenges with the supply chain issues that affects many businesses and also the firewall business. We wanna avoid a situation where we are unable to uphold deliveries because of a shortage of inventory. Now we have no such shortages.
We have been building inventory in all our appliances to make sure that we can deliver and to have a stability to deliver. We are pleased that that has been a successful endeavor, but with an impact on cash flows. That is roughly SEK 2.5 million in the quarter. Looking at FTEs, we're seeing a large decrease of the number of FTEs in the quarter, down from 133 to 119. The reason for that is, of course, the cost optimization program. In Q1, we saw some impact, but the majority of the levers identified during the beginning of the year happened in Q2.
This is partially offset with a short-term increase of external consultants, because in certain areas, to uphold deliveries, we need to have a short time increased reliance on external consultants. That is, on the other hand, easier to reduce when we have the ability to do so, and with more precision than looking at our own staff. That's a short financial summary. Over to you again, John Vestberg.
Thank you, David. We round off with the outlook, looking forward, and we maintain our outlook, compared to the previous quarters. Just to repeat and to remind again, the transition to the subscription-based business model has an initial impact on net sales. We keep our outlook for the net sales growth to moderate for this year. Looking forward after this year, we will obviously arrive to a point where the effects start to normalize, and then our ambition is to grow net sales with an average of 20% over three years. Following the effects of the cost optimization program, that has an impact on cash OpEx, and of course, then on cash flow and EBITDA, and we see those effects already in 2022.
Yes. Thank you, John. Thank you, David. Should we move over to the Q&A then? I will remind you, try to raise your hand and I will let you in, and you will get to ask John and David your question, or you can type it. I will give it a minute. Actually, we have Vidar. See if I can let Vidar in here. Vidar, can you hear me? Vidar, it's not you have to approve the request. So we will move forward until we have Vidar back again. John and David, you talked a bit about the BAE Systems contracts. Could you actually elaborate a bit, what is the outlook for Clavister in regard of the new contracts and opportunities for BAE Systems?
How will Clavister be a part of that?
Mm. So I-
How does it work?
Absolutely. Yeah. As a reminder, BAE is one of our partners in the defense industry, and last year we signed a framework contract that integrates our software into the defense platforms or the vehicle platforms they are building. They have a number of their products or their devices or their vehicles operating in several European countries, of course, including Sweden and Holland, Norway, and so forth. What we've seen in the past six months is a very strong inflow of new businesses for BAE Systems for various types of vehicles. Some of those new businesses are in shortlisting process, which means that, you know, BAE are working with end customers to finalize and formalize contracts.
Obviously, in this type of industry, it's many months of contract negotiations due to the sheer size of the contract and the complexity. What we have stated in the report as well is that we of course have a lot of expectations to be part of more business coming from BAE. Until those type of contracts have been formalized between BAE and their end customers, we are not in a position to explore more or to tell more. As soon as they have been concluded, we can come back with more information.
Perfect. Thank you. We seem to have Vidar with us right now, right? Do we? Vidar.
Do you hear me now?
Yes. Perfect.
Very good. Very good.
Welcome.
Very nice to hear about PhenixID's development, Q2. Question: how much of the Clavister sales represents or comes from PhenixID? You have close to SEK 35 million but how much comes from PhenixID?
Yeah, that's a good question. In the report, we don't disclose individual parts of the business. But still to talk about PhenixID, I would say that the identity and access management part is roughly 1/3 of the group's total sales. Order intake might fluctuate, so I think let's talk about net sales because that's more normalized. Roughly 1/3. I would say, I would add, with good margins and a good profitability. That's a very important part of our business, which we are very proud of.
Mm-hmm. Very good. Impressive.
There are more questions, Vidar. No. Okay. With almost the entire PhenixID team leaving by the end of 2022, could you give some information on how this may affect the ability to keep providing software support innovation within the EIM domain?
I would say that. No, it's a good question, and let's answer that. I think John Vestberg and I could try to answer that collectively. Our view is not that a majority of the team is leaving by end of 2022. We have a change of leadership, as we say in the report. Peter Laurén, who was the Former CEO of PhenixID, who has done a very good job in building up that business, has left us, and we have a new CEO running the business.
There are some changes in the team, but looking at PhenixID, we have a, you know, a strong performance so far this year, and we are very confident of the team and the team's ability to keep producing high-quality products and services and also supporting our customers and driving good sales. I would not agree with the statement that a majority of the team is leaving. There are changes in the team, and my belief is that those changes are fully manageable. John, do you wanna add something to that?
No, I agree. You know, for the entire business, for Clavister and PhenixID and all the various solutions, we keep on adding competence. Even though we are in a cost optimization program, that also entails that we are increasing our competence density as well. We are recruiting, and we see levers happening throughout the organization at all times. PhenixID is not an exception to that. We have good talent across the board. If there are levers, we replace them with as good talents.
Thank you. I would like to move into the 5G security business. You state that there's a slow development of the 5G security business in the period in the report. Should we be worried regarding the 5G business and the relation with Nokia?
No, you should not. The relationship with Nokia as being one of our 5G partners, of course, the most important one, to be honest and transparent, that relationship is very good. We are expanding our activities with Nokia. We are deploying more software. We have a larger install base and so forth. As David mentioned as well, the larger orders coming from 5G are typically, you know, fluctuating and one quarter without large license deals is one quarter. We've built a strong base, but we will of course expect more. We are expecting more. I think the entire industry has been somewhat disappointed about the slow take-up of 5G in general. Of course, security is then also affected by slow take-up rates.
That being said, and as I mentioned, the 5G technology as such is the most fast-growing, but from low numbers initially. Yeah, we have all the reasons to be, you know, still to be looking forward to good business with 5G. We maintain absolutely a good relationship with Nokia.
Thank you.
Yeah. Adding to that, our control over when order happens is to a quite low degree controlled by Clavister. They are controlled primarily, of course, by the end customer who runs the process, and then of course, Nokia as the dominant partner, and then by us. Which means that there will be fluctuations where certain quarters are slower and others have, you know, happens more in other quarters. I think that is to be expected. Of course, then the aim from our side is to lift the total volume and of number of deals and the size of the deals, but we will always have fluctuations between quarters.
Yeah. Question coming in. Irdeto, what kind of business is it?
Yes.
Can you elaborate?
Yeah. Irdeto is a niche system integrator. They have activities in different kinds of end user segments, but their focus is to a great extent on what we would refer to as critical infrastructure customers. That would include telecommunications, it would include transportation and similar businesses. So they are our latest larger partner signed, and we are actively working with them on a number of potential projects, which we hope to be able to get back to you within short.
Thank you. What are you most proud about, John Vestberg, in this report?
I think I'm most proud of the fact that, I would say with the exception of 5G, where we had higher hopes for the quarter, but with the exception of that, we see all the other solution areas moving forward. Some of them very strong and some of them strong. They are doing so in a period where we at the same time are managing our cost base quite aggressively, and we are running tough cost optimization program. That is a balance act that is not always easy. I'm happy to see that the business is evolving despite cost optimizations.
Thank you. I have one last question, and that's for David.
Mm-hmm.
What would you highlight in this report if you would highlight something?
I think I start where John Vestberg left off, and I think we are reducing our number of FTEs, and that is challenging for any organization. We see good momentum in the organization despite that. I'm very glad and also very grateful to our staff that that is the case. I see we set out with an ambition when launching our new business model. We did that as we saw challenges in growing our business in the way that we wanted. I see then that we keep growing recurring revenues, which are very good for us in the long run. I see that we ship much more appliances.
I see that we have, in a challenging supply chain market, been able to secure our delivery capacity. I think anyone who's in the industry or similar industries where you rely on semiconductors can acknowledge that is quite an achievement to secure that at good price point as well. The fact that we are shipping much more new contracts and building a bigger and broader contract base based on predominantly recurring revenues. I think we are setting the foundation that we aim to do. I think I'm very pleased with that. Sorry for the quite lengthy answer. Yeah.
It's good. I think, actually, with this, I would like to conclude this Q&A session. Thank you, David, and thank you, John.
Thank you.
Thank you.
Thank you for the audience.
Yeah. Thank you, everyone.
Thank you.