Net sales missed our forecast of SEK23.6m by 18% and amounted to SEK19.3m (24.2), corresponding to -20% growth y/y. Solve had a rather solid quarter as sales aligned with Q3 last year. On the other hand, Serve saw its sales decline by about 50% y/y. According to management, the soft development is due to two larger customers terminating their contracts. However, the customers leave for structural reasons, taking the operations in-house or abroad. Thus, while hurting sales heavily, it should not be viewed as an indication of Serve doing a bad job.

Management sees potential for growth within Solve even in this somewhat soft market, with less customer demand and more available consultants, although profitability is the top priority. While Solve has a diversified exposure, its rather small operational units can be sensitive to rapid shifts in demand in local markets and sectors.

Regarding Serve, the situation is tougher. Losing two large customers in the current market environment, where we believe the demand for less specialized consultants like those in Serve so far has been softer than the more specialized consultants in Solve, for example, is tough. Thus, we do not expect any significant rebound in Serve short 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.

The average number of employees was 92 (98 including sub-consultants), down from 102 and 114 in Q2. While a lower number of employees typically suggests lower sales going forward in a consulting firm, considering Xavi Solutions low Sales-COGS/employees/working day (discussed below) and management’s statements of the company’s capacity to generate revenue being unaffected by the cost cuts, we believe the reduction in headcount is mainly related to overhead. Thus, we expect roughly flat sales and an improvement in Sales-COGS/employees/working day.

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.

Sales-COGS/employees/working day was SEK2 681 (2 694) and was roughly flat y/y. For comparison, most profitable IT consulting firms had around SEK4 500 in this quarter – Q3 is typically lower than average due to vacations. Thus, Xavi probably has too high overhead costs and possibly a low utilization rate. As the new management focuses on reducing overhead costs, we assume that is the major factor behind the soft number. While the Serve segment likely somewhat lowers the number, considering our discussions with management, we get the impression that high overhead costs and high general costs are the main issue – i.e., the company is staffed for substantially larger volumes. From this perspective, the cost-cutting initiatives seem necessary to take the company into healthy Sales-COGS/employee/working day numbers.

The Contribution/employee/working day was SEK-250 (329), corresponding to a decrease of about SEK 580 y/y. While the personnel costs most likely are affected by the SEK 6.1m in restructuring costs, lowering the Contribution/employee/working day, considering the low Sales-COGS/employees/working day number, getting a solid Sales-COGS/employees/working day is more or less impossible. If Xavi Solutions succeeds in improving the Sales-COGS/employees/working day with the above cost reductions, the Contribution/employee/working day will follow.

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 amounted to SEK 17.2m (adjusted for SEK 6.1m in restructuring costs), came in somewhat below our forecast of SEK 18.6m, and was roughly flat y/y. As the split of restructuring costs between Personnel costs and Other external costs is undisclosed, it is difficult to comment on the deviations relative to our forecasts. However, the cost reduction initiatives are expected to cut costs by SEK 7.7m annually, which should take Xavi Solutions to profitability, considering the quarter’s sales and adjusted OPEX.

EBITDA (adjusted for SEK 6.1m in restructuring costs) was SEK -0,7m (SEK 1.4m), corresponding to an EBITDA margin of -3.6% (4.8), compared with our expectations of SEK 0.7m and 3.2%. At the same time, EBIT (adjusted for SEK 6.1m in restructuring costs) amounted to SEK-1.5m (SEK 0.5m), which resulted in an EBIT margin of -7.8% (2.0%), compared with our forecast of SEK 0.0m and 0.1%, respectively. While the adjusted OPEX roughly matched our forecasts, sales was 18% lower than expected, resulting in a softer EBITDA and EBIT than anticipated.

We lower our sales forecast by 15% for 2024 and increase our EBITDA and EBIT forecasts by about SEK 5m for the following reasons:

We forecast an EBIT margin of 4% and flat sales growth in 2024.

We leave our Base Case at SEK 0.50 (0.50), as the positive impact from the forecast increases is offset by us raising the WACC following an increased risk-free rate.

While Xavi Solutions is valued in line with the median peer for EV/EBIT 2024 and 2025, it is trading at a ~50% discount on EV/Sales. Thus, if Xavi Solutions can improve its margins further than the 4-5% we expect in 2024-2025, in line with the peer average of 9%, for example, its EV/EBIT valuation multiple falls significantly.