NNIT A/S

CSE:NNIT

Earnings Call Transcript 2019-Q3

[Operator]

Hello, and welcome to today's NNIT interim report for the first 9 months of 2019. [Operator Instructions] I'll just remind you, this is being recorded. So today, I'm very pleased to pass you over to Klaus Skovrup, Head of Investor Relations. Please begin, sir.

[Klaus Hosbond Skovrup, Head of Investor Relations]

Thank you and good morning, and welcome to this NNIT call regarding our financial performance for the third quarter, first 9 months of 2019 and outlook for 2019. My name is Klaus Skovrup, and I'm Head of Investor Relations. And with me today is CEO, Per Kogut; and CFO, Carsten Krogsgaard Thomsen. I'll briefly walk you through the practicalities for today's meeting before handing over to Per and Carsten.Today's earnings release as well as the slides being used for the -- this presentation will be available on our website, nnit.com. And the conference call is scheduled to last approximately 1 hour, and the presentation is expected to last around 20 minutes. And after the presentation, we open up for questions.Today's agenda can be found on Slide #3. Note that this call is being webcasted live, and a replay will be made available on our website after the call.Turning to Slide #4. I need to advise you that this call will contain forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause the actual results to deviate considerably from the outlook set forth. Furthermore, some of these expectations are based on assumptions regarding future events, which may prove incorrect.And with these words of introduction, I'll hand over to Per Kogut and turn to Slide #5.

[Per Kogut, President & CEO]

Thank you very much, Klaus, and a warm welcome from me as well.In Q3, our revenue increased by 4.1% driven by double-digit growth from our international life science, Danish life science and finance segment clients as well as 6.7% growth from our enterprise clients, some of it due to one-off impact from 2 customers. Operating profit before restructuring cost was DKK 69 million, equal to an operating profit margin of 9%, in line with last year. Net profit was DKK 50 million, equal to an increase of 3.1% compared to Q3 2018.Our order backlog during Q3 for 2019 increased by DKK 195 million, which is 19% above the same period last year. And lastly, free cash flow was negative by DKK 3 million for Q3 '19 due to increased investments and a negative impact from our working capital, which Carsten Krogsgaard will elaborate about somewhat later. Please turn to Slide #6. Looking at our results for the first 9 months, revenue, as mentioned, increased by 3.3% compared to the same period last year. The growth was driven by international life science and finance customer groups. Operating profit before restructuring cost was DKK 158 million, equal to an operating profit of 7%. This is 2.2 percentage points below last year. Net profit of DKK 125 million decreased by 17% compared to last year. Our order backlog for '19 stands at DKK 2.9 billion, which equals an increase of 2.7% compared to the same period last year. Please note that the backlog from Valiance -- the Valiance acquisition was not included in the total backlog at the beginning of Q4 '18 but generated revenue in November and December last year. Therefore, the backlog growth at the beginning of Q4 '19 must be expected to overstate the revenue growth of the full year. Besides this, it should be noted that Q4 '18 is a strong comparison base, among other things, due to a high revenue from the Novo Nordisk Group in this quarter last year. Finally, free cash flow was negative by DKK 70 million for the first 9 months of '19. The cash is impacted -- or the cash flow is impacted by the acquisition of HGP, which we did earlier this year, and a negative development from working capital. Please turn to Slide #7. That being said, I'm pleased that we, in the third quarter, won an operations and development agreement with Norlys, a Danish utility company. We expanded our consultancy agreement in a new area with an existing life science client, and we won a cloud server transition project from an existing public company.Please turn to Slide #8. As mentioned a couple of times, our backlog for 2019 is DKK 2.9 billion. This is 2.7% above the backlog at the same time last year. And again, please note that the backlog from Valiance was not included in the total backlog of the beginning of Q4 '18, while the backlog growth in the beginning of Q4 '19 must be expected to overstate the revenue for the full year. The backlog from private & public increased 4.9% and life science clients increased by 36%, while the Novo Nordisk backlog continues to decline with 13% compared to the same time last year.So this was the overall financial comments from me. And now I would like you, Carsten, to walk through the details.

[Carsten Krogsgaard Thomsen]

Yes. Well, thank you, Per.If you turn to Slide 9. Let me start with the revenue development where you can see a growth in Q3 of 4.1%. As Per already mentioned, this was due to continued strong growth in the international life science segments and in the finance segment and also due to 2 one-offs in Q3, which I will elaborate a little on.We made a settlement with a customer in the enterprise segment of around DKK 5 million to DKK 6 million. This settlement meant that we had been recognizing too little revenue in the first 2 quarters. And therefore, we are taking this into our numbers in Q3. So that has a positive impact in Q3 but is, of course, neutral when we look at the numbers year-to-date.The other one-off is a DKK 11 million to DKK 12 million sale of hardware to PANDORA. This is hardware that we had been owning in Thailand in our service to PANDORA, and that is now being taken over and will be reused by the new vendor. Here, we have a kind of average, for NNIT, margin on this hardware sale. We will always discuss when something is one-off because in other quarters and other years, we also have hardware sales. But we just wanted to mention this to you.When you look at the cost of goods sold and the gross profit, you can see a much better balance, actually a complete balance between these. While in the first quarter our costs were growing faster than our revenue, even if you do adjust for the one-off settlement of the DKK 5 million to DKK 6 million, we still have a better balance in this quarter. And the gross profit margin is only a little lower than last year if you make that adjustment.Looking at sales and marketing costs. We see an increase of 9%. This is purely due to timing of marketing costs. And you can see that year-to-date is around 0. And for the administrative costs, you can see that they are still declining due to cost savings and layoffs in the administrative area. All this leads to an operating profit margin before special items or restructuring cost of 9%, in line with the last year and well above the 2 previous quarters. If you adjust for the one-off of DKK 5 million to DKK 6 million, you would get a margin of around 8.3%, so a little lower than last year but not the big decline that we've seen in previous years, which shows that we are getting a better balance between revenue and costs. And we see that our cost restructuring plan is progressing. This, you can also see under the special items, which is here purely the restructuring costs, where we have DKK 16 million of restructuring costs in connection with layoffs in September in Denmark. Subtracting these gives us an operating profit margin of 6.9%.On net financials, we see a gain of DKK 7 million against more or less 0 last year. For the first 3 quarters, we see a gain of DKK 12 million, and this is primarily due to hedge gains and some currency exchange gains, which I'll elaborate a little on, on the coming slides.Finally, we see an almost halving of our tax and a much lower effective tax rate. This is due to the fact that in Q3 '18, we had some negative adjustments to our tax rate regarding previous years whereas we have had some positive adjustments, i.e., giving us a lower tax rate in Q3 '19. So all in all, we end up with net profits a little above last year.Before turning to the next slide, I would just like to give you one additional information which we have not given you before. With the acquisitions we have been making with SCALES, Valiance and HGP, we also get what we call PPA or purchase price allocation-related costs and costs related to the earn-out mechanisms. So that is costs regarding depreciations of the value of customer contracts we have taken over, software depreciations and also the part of the earn-out consideration, which you cannot provide for and you have to take over a 3-year period. Now this all adds up to 0.5% points in the first 9 months of this year.The SCALES PPA is soon running out since -- as we get closer to 3 years of buying them. Valiance will be in there for another 2 years and HGP, of course, for another 3 years. But everything else being equal, you will see that this negative impact on our margin will diminish over time.If you then turn to the life science slide on Slide 10. I think we see a little on the revenue side the picture we've seen in previous quarters. We see a decline in Novo Nordisk revenue of 16%, so a larger decline than in the previous quarters. And as Per mentioned, you can also see that in the backlog. We see -- still see a very strong growth in international life sciences of 95% and an organic growth of more than 20%. And we also in Q3, see a strong growth in life sciences in Denmark where we see high project sales. So we here get a growth of 12%. All this adds up to a total growth of 2.5%, with the international life sciences part more than compensating for the decline in the Novo Nordisk.What you then see is that our cost of goods sold still increased more than our revenue by not -- by the same factor as in the first 2 quarters. This is, of course, due to the fact that the acquisition of Valiance and HGP gives us extra costs, of course, also extra revenue but also extra costs, and the large decline we see in the Novo Nordisk, especially in the project revenue. Here, it's not been possible to reduce the costs fast enough to compensate for that. But still, we see a better trend here than in the previous quarters, which you can also see that the gross profit margin is now down by only 2.5% points compared to 5.3% points year-to-date. And this also means that our operating profit margin before special items is now only down 2.8% points compared to 5.1% points in the first 3 quarters. The life science business gets its part of the restructuring cost with DKK 7.7 million. Here, you have to remember that the reductions have, until now, primarily been done in Denmark. And in the later quarters, you will see layoffs in the Czech Republic, in China and in the Philippines. If you then turn to the private & public. We see a growth of 5.7%. Here, this is, to some extent, driven by the 2 one-off settlements that I mentioned -- well, the settlement of DKK 5 million to DKK 6 million and the sale of hardware to PANDORA of DKK 12 million. Again, we see that the revenue increases more than cost of goods sold, but we do see our gross profit margin now increasing -- sorry, we see actually now revenue is increasing faster than cost of goods sold, of course, helped by the 2 one-offs. But even if you do adjust for that, we still get an improvement in our gross profit margin. And the numbers, as you see them reported, gross profit margins increases from 9.7% last year to 12.4%. Even if you adjust for the one-off settlement, then you still get a margin above 11%, so an increase compared to last year. This also gives us an operating profit margin in Q3 of 5.8% before special items. And if you adjust for the one-off settlement, it's still a margin around 4.5%, so quite a big improvement compared to last year. If you then turn to Slide 12 on the currency development. As I think I say almost every time, we are getting quite small impacts from the currencies at the moment. In Q3, we had a small headwind of only 0.1% point compared to last year. And -- yes, so all in all, not all that big an impact right now. And of course, we are hedging 14 months ahead. When you then look at Slide 13 on the net financials, you can see that our total net financials for the first 9 months give a gain of almost DKK 12 million compared to a loss of DKK 3.7 million last year. This is due to currency hedge gains. You might then ask the question, "How can we get so big gains when the currencies have not moved all that much?" Well, that is, to a large extent, due to the fact that there is, at the moment, a big interest differential between the Chinese CNY and the Danish krone, which means that we -- by hedging risk-free actually to gain on these interest differentials. At the same time, we have also had some luck/skill in the timing of hedging. The same goes for our currency gains. So this is when we exchange foreign currencies in our subsidiaries into Danish krone. Here, we have been getting a gain of DKK 5.3 million compared to DKK 1 million last year. Our interest expense on bank charges is more or less in line with the last year and is still at a very low level. You can also see when you look at the bottom part of the slide that we still have some positive impacts on our books since we have a DKK 8.7 million currency hedge gain part on equity for the future period. Okay. If we then turn to the employee development on Slide 14. You see our employees increasing with 2.1%. This is primarily driven or completely driven by the international part of our business. And this is very much due to the inclusion of Valiance and HGP but also by further off-shoring to the Philippines, where we are increasing with 61 FTEs. At the same time, we see that we are taking down the number of FTEs in Denmark with 78 -- sorry, with 0.8%. If you then turn to the balance sheet. I think we have more or less the same comments as last time. Intangible assets, and that is goodwill from our acquisitions, is increasing, and that is, of course, due to the acquisition of Valiance and HGP, which were not on our books 30th of September last year. We also see that trade receivables increased with DKK 48 million. This is due to settlements with 2 customers, where these customers have not yet paid their settlement. So when they pay these, that will improve our cash flow in the next quarter.We also see other receivables and prepayments increase with DKK 113 million due to a few large projects with the Novo Nordisk Group but also the inclusion of HGP. And then of course, our contingent considerations increased with DKK 83 million, and that is, of course, related to our earn-out on the Valiance and HGP acquisitions.If you then turn to Slide 16 on our cash flow development, which is, of course, impacted by the lower operating profits for the year and the acquisition of HGP. So we see cash flow from operating activities decreasing with DKK 66 million. A substantial part of that is due to changes in net working capital, and this is due to other receivables where transformation projects are paid over the whole SLA contract period. So we don't get the full impact of that in this year's cash flow. And of course, the lower net profits for the period also had a negative impact.We see cash flows from investing activities increasing negatively, and that is, of course, due to the acquisition of HGP and then some timing of our investments.Turning to our outlook. We maintain a low single-digit revenue growth and an operating profit margin of 8% to 9%, excluding restructuring costs of DKK 15 million to DKK 25 million. Remember, we have already booked DKK 16 million of that in Q3.As Per mentioned, you should also be aware when looking at the full year outlook that Q4 revenue and operating profit margin is expected to be lower than last year's Q4, which was particularly strong and also with a strong impact from Novo Nordisk in that quarter, and this impact is much more uncertain this year. So we expect declines in both revenue and operating profit but still to keep our guidance for the full year.So Per, over to you.

[Per Kogut, President & CEO]

Thank you, Carsten. So just to sum up that we experienced a revenue growth of 4.1% and an operating profit margin before the restructuring element Carsten commented on of 9% in Q3 '19. The revenue growth was, as mentioned, driven by international and Danish life science clients as well as finance and enterprise clients.The Novo Nordisk Group still challenged us in IT, and a decline by 17% in Q3 '19 was the case and it is still uncertain going forward. We maintain our revenue growth guidance of low single digits and our operating profit margin of 8% to 9%, excluding restructuring cost in constant currencies for '19. And as mentioned further, investments are still expected to be in the area around 5% to 7% of revenue.So with these words, we would like to open up for question. Mr. Operator?

[Operator]

[Operator Instructions] And the first question is over to the line of Poul Jessen at Danske Bank.

[Poul Ernst Jessen, Senior Analyst]

I'll start with a question for Per on the Novo Nordisk relationship. You have earlier indicated that you would like to have a better discussion with Novo Nordisk, if they could give an indication on the future relationship between you and Novo. Has there been any news on that? Or can you like give any additional information? Second question is more on the restructuring versus the margin improvements in this third quarter. You made some cost reductions already in the first half, and then you do some in the third quarter. How much of what we saw in the third quarter relates to what you did in the first half? And how much comes from what was done in the third quarter? Yes, that was 2 questions.

[Per Kogut, President & CEO]

Good. Great, Poul. Let me answer the first one about the Novo Nordisk. Of course, we are in dialogue with Novo Nordisk almost every day. But I can still not give you a full insight into the overall picture, which is both the big service agreements we have with them, and of course, also all the underlying project work we have day-to-day. So to sum that up, there are no news around that. But from different angles, we are working to get that insight because as mentioned in the last quarter, this is needed for us and I know highly appreciated by you. So no news on that, but you have my promise that I'm working on that quite intensely.And Carsten, about the restructuring?

[Carsten Krogsgaard Thomsen]

Yes. So Poul, of course, it's difficult to give you exact numbers on what comes from which quarter. But in broad terms, the major part is starting Q3 where we have made around 50 layoffs in Denmark. At the same time, we have been keeping a lot of positions vacant and canceling these. Of course, we also did this, to some extent, in the previous quarters, but that has been accelerating in Q3.At the same time, Q3 is better than the previous quarters because these were impacted by some of these project overruns on the Novo Nordisk projects. So as these start to kind of run out, we will -- we are updating that negative impact as we did in the first 2 quarters. And then of course, in the first 2 quarters, we had this dispute with a customer where we had to be a little conservative on how we recognize revenue. And we managed to make a settlement which was better. And so we took in -- the DKK 5 million to DKK 6 million I told you about there, which, of course, also helps.But this also means that the first quarters were, you could say, impacted by quite a lot of you could call them one-off negatives, which are now beginning to dry out and have been replaced with a couple of positive ones.

[Poul Ernst Jessen, Senior Analyst]

Okay. If we then look at the margin improvement year-over-year in the private & public where you go from 2.9% to underlying 4.5% and now also up sequentially, is it possible to give some insight into -- is this driven by better utilization of -- or higher billing per employee? Or is it cost-cutting? Or is it a mix, for instance, driven by SCALES doing very well?

[Carsten Krogsgaard Thomsen]

It's exactly as you say, Poul, a mix of a lot of things. It's due to not having as many of these projects where we have cost overruns in the first 2 quarters. It's due to SCALES performing extremely well with high growth and very high margins. There's this one-off settlement, as I think I mentioned. If you adjust for that, then you still have a margin of around 4.5%. And then it's -- we are working very much on our utilization, I would say. We are not seeing -- we're only seeing a little on that until now. That is an area we expect to see further improvement, especially as we go into the new year.

[Poul Ernst Jessen, Senior Analyst]

Does that mean that the majority come from SCALES?

[Carsten Krogsgaard Thomsen]

No. It doesn't. It's -- plus we also had strong performance by SCALES in the first 2 quarters, so it is a mix of all this.

[Operator]

Before going on to the next question, which is André Thormann at ABG Sundal Collier, [Operator Instructions]. So André, over to you.

[André Thormann, Analyst]

Just one clarification in terms of the one-off with PANDORA on the hardware sales. What was the EBIT effect on this one?

[Carsten Krogsgaard Thomsen]

Yes. I said the EBIT impact of that is it's sold at a margin, which is close to our average NNIT operating profit margin.

[André Thormann, Analyst]

Come again, close to what margin?

[Carsten Krogsgaard Thomsen]

Close to the average NNIT margin, not net private & public but the average NNIT margin.

[André Thormann, Analyst]

Okay. And then just another one. In terms of restructuring cost that we will see next year in 2020, I mean I understand the guidance you have given on DKK 15 million to DKK 25 million for the current year is not related to PANDORA and X Cluster. So how much extra restructuring cost can we really expect next year?

[Carsten Krogsgaard Thomsen]

We cannot guide you on that yet. It depends on our order entry revenue development next year, in which areas we get our new business, our natural attrition and so on. We will guide you on this together with the Q4 annual report and guidance for that year. But you should still expect some restructuring costs next year.

[Per Kogut, President & CEO]

Okay. But it's just -- because I understand that this is -- these are major contracts, and the position lay-downs on the 250 is excluding these ones. So should we expect these restructurings to be higher than the other? Or...

[Carsten Krogsgaard Thomsen]

So André, I think it's too early to say anything about that yet.

[Operator]

Okay. As there are no further questions on today's call, can I please pass it back to you for any closing comments?

[Klaus Hosbond Skovrup, Head of Investor Relations]

Yes. Thank you very much for participating in this webcast and feel free to reach out if you have any further questions to me, Klaus Skovrup, Head of Investor Relations. Thank you. Goodbye.

[Operator]

This now concludes the call. Thank you very much for attending. You can now disconnect.