Review of Q2 2023

Q2 2023 net sales amounted to cSEK25.1m (29.0m), corresponding to -13% y/y growth. This was 11% below our expectations of SEK28.1m, while the number of working days in the quarter amounted to 59 (60). Sales-COGS per employee and working day decreased by 2% y/y, which, combined with increased personnel expenses per employee and working day, resulted in a clearly lower contribution per employee and working day than expected in the quarter. According to management, sales were affected by the recent market slowdown with lower utilisation rates and increased competition for customer contracts. 

Given a somewhat lower share of sub-consultants in the quarter, COGS came in 7% below our forecast of negative SEK5.3m. At the same time, other external costs and personnel expenses largely aligned with our expectations and amounted to negatives of SEK2.9 (-3.4m) and SEK20.9m (-21.3m), respectively. However, EBIT was negative SEK3.9m (-1.9m) compared with our expectations of negative SEK1.6m due to employee churn and lower sales-COGS and contribution per employee and working day than expected.

According to management, the market slowdown that began in 2023 is now playing out within all business segments, with increased competition for customer contracts and lower utilisation rates as a result. As such, we note that the current market conditions continue to affect its business, as the Q2 2023 figures came in below our expectations. To meet the market situation, Xavi Solutions looks over its internal administrative resources and renegotiates contracts to manage the currently lower utilisation rates while management states that the focus ahead will be on sales, both regarding new and existing customers, to stand firmly once the market sentiment turns.

Q2 2023 net sales amounted to cSEK25.1m (29.0m), corresponding to -13% y/y growth and came in 11% below our expectations, while the number of working days in the quarter amounted to 59 (60). We believe the decreased sales y/y stems from the net loss of headcounts, one less working day than last year and lower sales per employee and working day. According to management, sales were affected by the recent market slowdown with lower utilisation rates and thus increased competition for customer contracts. As such, we believe the utilisation rates will continue to be affected ahead, while this can hold back the hourly rates in the short to medium term.

An IT consultant’s sales are a function of the number of employees and their revenues per working day. In fact, the number of revenue-generating employees, i.e., excluding administrative personnel, etc., would be a better measure. However, as those figures are not disclosed, we use the total number of employees as a reasonable proxy.

At the end of Q3 2023, the number of employees amounted to 102 (114, including sub-consultants), implying a net decrease of 5 employees q/q, while the average number of employees was 102 (111, including sub-consultants). Consequently, Xavi Solutions has continued to see employee churn, which partly explains the softer sales in Q2 2023 compared to our expectations, while it could be serving as a leading indicator for future sales.

The number of employees at the end of the quarter is a leading indicator for sales growth in the coming quarter. While sales are dependent on other parameters as well, the starting number of employees for the coming quarter is, together with the number of working days, the only relevant figures we know in advance.

Moreover, the difference between the average number of employees and the number of employees at the end of the quarter can give us a clue about the quarter’s employee churn, which is costly for any company. However, as sales generation and employees have nearly a 1:1 ratio among IT consultants, we believe employee churn is even more critical in such firms.

Q2 2023 sales-COGS per employee and working day was SEK3356 (3408) compared to our expectations of SEK3577 and thus decreased by 2% y/y. Consequently, with increased personnel expenses per employee and working day, Xavi Solutions saw a substantially decreased contribution per employee and working day, which amounted to SEK107 (466) compared with our forecast of SEK519. We believe that the outcome can be explained by several factors, such as lower utilisation rates, employee churn, and increased competition due to the current market conditions, which could have affected the hourly rates.

Sales-COGS/employees/working day is a proxy for the revenue generation of one employee during one working day, indicating how advanced services the company provides and how high its utilisation rate is. While sub-consultants and reselling software and hardware can affect the accuracy of this measure, we try to consider that by subtracting the cost of goods sold, which typically consists mainly of expenses related to sub-consultants and reselling. Also, as we use the total number of employees, the share of administrative personnel can alter the number. A high share of administrative personnel might not be unwanted. For example, when focusing on expansion, investments in administration are typically front-loaded.

Contribution/employee/working day is sales-COGS-personnel expenses and indicates the profit contribution for the average employee per working day. We believe it is a proxy of how much revenue consultants generate compared with their seniority and, thus, their salary. For example, a high sales-COGS/employees/working day might not be worth much to shareholders if most are paid as salaries to senior consultants.

Total OPEX (other external expenses and personnel expenses) in Q2 2023 amounted to SEK23.8m (27.7m) and came in largely as expected, as both other external expenses and personnel expenses aligned with our expectations. In addition, the COGS came in somewhat lower than expected at SEK4.9m (5.4m) versus the expected SEK5.3m due to lower sub-consultant usage. However, that was offset by the softer sales in the quarter, resulting in a lower EBIT than anticipated.

EBIT in Q2 2023 amounted to negative SEK3.9m (-1.9m) compared with our expectations of negative SEK1.6m. The lower-than-expected EBIT is due to the employee churn and the softer sales and contribution per employee and working day, which, as mentioned, is due to several reasons, such as lower utilisation rates and increased competition due to the current market conditions. Notably, a one-off goodwill write-off affected the Q2 2022 EBIT figure in the graph below.

Following Xavi Solutions’ Q2 2023 report, we decrease our 2023e–2024e sales forecasts by 6–8% thanks to lower utilisation rates and increased competition for customer contracts due to the current market conditions along with the employee churn seen in the quarter and thus lower net recruitment than expected. Overall, we believe this will impact the sales per employee and working day ahead, and thus the contribution per employee and working day, leading us to decrease our EBIT forecast for the same period. For further estimate changes, see the tables below.

Given the forecast changes mentioned previously, our DCF model suggests a new fair value range, with a Base Case of SEK0.50 (0.55) and Bear and Bull Cases of SEK0.13 (0.15) and SEK1.00 (1.20), respectively.

Following a share performance of -15% YTD, Xavi Solutions is currently trading at an EV/sales of 0.3x based on our 2023e, representing a clear discount to relevant peers. However, we argue this discount is justified by factors such as Xavi Solutions’ low market capitalisation and the recent strategic changes that mean it lacks a stable history of growth and profitability.