NNIT A/S

CSE:NNIT

Earnings Call Transcript 2024-Q3

[Operator]

At this time, I would like to welcome everyone to NNIT's Third Quarter Results for 2024. Today's call is being recorded.

[Operator Instructions]

I'll now turn the call over to speakers. You may now begin.

[Par Fors, executive]

Thank you, operator, and good morning, everybody, and thanks for joining this webcast. My name is Par Fors, and I'm the CEO of NNIT. With me today at our headquarter at Eastern Søborg, I have our CFO, Carsten Ringius. And together, we will present the results for the third quarter, which we released yesterday evening.

Please turn to Slide #2. I will walk through the key business highlights, including the regional performance. After that part, Carsten will go through the group results, including our adjusted financial outlook for the year. Before heading to the next slide, please pay attention to the disclaimer in the bottom of the slide.

Let's turn to Slide 3. The third quarter was a tough one. We knew the quarter was going to be soft, as also mentioned during our last webcast. However, the quarter turned out to be more challenging than we expected. The 2 key reasons for the low performance were the slow to materialize recovery in the data migration business and the market slowdown in the Life Sciences area.

Since the start of the year, the data migration business has been challenged as backlog and pipeline were weak. Even though we have built a pipeline during 2024, the nature of the data migration projects is that they typically take longer time to start than some other life sciences projects. Therefore, we have not seen the full effect of the recovery yet, even though, of course, we have reduced our capacity in this area to match the demand.

In the U.S., the data migration was around 1/3 of the total revenue in 2023. This is a region where the decline has been the largest. In Q3, the revenue declined around 60%. And for the first 9 months, it is down by around 70%. We do see that projects are won, and we are trailing better as we speak, but the pace of the recovery has been slower than we initially expected.

In Europe, the data migration business is a much smaller part of the business than it is in the U.S. We do also see that the European business has not been deteriorating as much in revenue. The revenue has declined around 30% for the first 9 months of this year in this area. As in the U.S., we are recovering slowly as the backlog and pipeline are getting stronger. With that being said, and then on an overall level, we still believe this decline is temporary, and we will start to be soon on our feet again.

During the third quarter, we have seen a moderate slowdown in the life sciences market. Firstly, we have experienced that project has been postponed and sometimes even put on hold. Customers are more hesitant to sign new agreements or expand current ones. Secondly, we have also seen that projects that we have won, either from expansion of engagement with existing customers or new customers have been with a shorter time frame and scope than earlier observed.

And thirdly, we have seen a good traction and demand within the data and digital and manufacturing areas, but less demand for larger transformation within research and development. These 3 observations have been the root cause for the challenges that we've seen in Region U.S. and in Region Europe.

Furthermore, the slowdown in the Life Sciences market has also been reflected in the market intelligence, and we are looking at where we can see that the CAGR for the -- we see that in the CAGR for the next year is lower than that what we shared at our Capital Markets Day in September last year. This is not an excuse for our soft performance in Q3 as we do see that NNIT is well positioned in the Life Sciences area, and we still expect to grow faster than the market as we also stated at the Capital Market Day. However, to ensure that we are well fitted and prepared for future profitable growth, it has been necessary to adjust our internal capacity to fit the current market demand and conditions.

These adjustments were made in Region U.S. and Region Europe and equals to around 5% to 10% of the capacity that has been taken out. Despite of the poor results, we did see a number of things that went our way. For instance, our internal software KPIs are tracking such as customer satisfaction and good level of attrition. Our customers do appreciate our services and deliverables, whilst our employees are very happy to invest their careers with NNIT.

Of other things, I would like to highlight that we won the largest contract ever in the U.S., a contract that we have started to deliver upon and that we are ramping up according to plan. Another win that we had, which we announced on the 30th of September was that we are becoming the new supplier of a critical SAP Debitor system, a contract that is strategically important for NNIT and part of our public sector business. Right now, the project is in its transition phase.

All of the good things, including the initiatives we have carried out during the first 9 months of the year will take us back to profitable growth. This will not only be an enabler for our Q4 performance, but also setting us up right for our long-term aspirations.

Please turn to Slide 4. As mentioned, the third quarter result was not in line with our expectations. Our revenue declined leading to a negative growth of 1.6%. It had a direct bottom line effect where the group operating profit margin, excluding special items, ended at 3.9%. As a result of this development, we adjusted the full year outlook on October 22. Carsten will go into more details with the outlook and the financial figures later in this presentation.

Please turn to Slide 5 for the regional performance update. There is no doubt that the third quarter was a challenging one in Region Europe. Despite organic growth of 0.6%, the growth was materially impacted by market slowdown in the Life Sciences space and the slow to materialize recovery in the data migration business, as we mentioned before. As mentioned earlier, we have seen a transition in customer behavior where projects are initiated with a shorter time frame and with a more narrow scope than earlier, especially in the R&D area. However, we do also see areas of business that are continuing to do well, such as the data and digital and the manufacturing area.

The profitability in Region Europe was significantly impacted by the lower revenue than planned, resulting in having too much capacity compared with the demand, which negatively impacted the gross margin. However, we do also see that the figures last year was somewhat polluted by the carve-out from Aeven, where the decline in gross margin compared with last year is indicatively correct, but the magnitude is probably a bit overstated.

To ensure an uplift in profitability in the fourth quarter, it has been necessary to adjust our capacity and continue to have tight cost control. These actions will positively implicate the fourth quarter.

Please turn to the next slide. In U.S., an organic growth was minus 8.3% and, of course, that's not satisfying. The aforementioned slow to materialize recovery in the data migration business was the primary driver for the shortfall in revenue. The business area declined with around 60% during the quarter, which, of course, had material impact on the overall revenue. The uplift from the largest contract win and the continued good performance in our group company, Excellis, was not enough to offset the decline of revenue in the data migration business of around 60%.

Furthermore, we saw that the moderate market slowdown impact in the U.S., but not to the same extent as in Europe. Despite the negative growth, Region U.S. was able to maintain its gross margin level compared with last year. This is mainly due to capacity adjustment and limiting the number of subcontractors as demand was lower.

Further capacity adjustments were made to rightsize capacity going into the first quarter, which will enhance profitability.

Please turn to the next slide around Region Asia. In Region Asia, we continued to be faced with macroeconomic challenges, especially in China. This has caused a hesitant customer behavior as the demand for external support is soft. However, we have also seen that price has become an even more important factor as there is a price pressure that is emerging. This has also caused Region Asia not to enter into some agreement as it will not have been profitable for us.

On a similar note, Region Asia has also withdrawn from projects due to low profitability. The turnaround initiatives we took in Region Asia during the first half of the year continue to unfold as planned. The gross margin is up almost 10 percentage points with last year as we have improved our utilization and optimized our staffing of projects. We're happy to see that the impact of the turnaround and expect this trend to continue into the fourth quarter.

Please turn to Slide 8 for an update of performance in Region Denmark. Looking at the reported organic growth for Region DK, it looks like the region is stagnating. However, Region DK revenue was impacted by a positive one-off in Q3 of '23 of around DKK 15 million. The one-off does not impact the reported figure for the first 9 months. In the region, we continue to see improved performance within the public and private segments with all areas growing. A testimony to our strategy and how we work with the public sector is that we were happy to be chosen as a new supplier for the critical SAP Debitor system tendered by ATP. The project has begun, and we are currently in the transition phase.

In addition, we see that our Public business has done well. And looking ahead, we do believe that we have a solid backlog and pipeline in place going into next year. The profitability improved with especially the gross margin improving by 1.5 percentage point to 24.8%. The better gross margin performance is mainly driven by more billable employees being released from internal projects and moved to external projects.

As crucial internal projects are getting completed, we do expect to reallocate more billable people to external projects, supporting the gross margin development. We also expect that the new began transition of the ATP project will improve profitability from the fourth quarter and also going into 2025.

Please turn to the next slide. This concludes my part of the presentation. I will now hand over to Carsten for the group financial performance and the financial outlook. Please, Carsten.

[Carsten Ringius, executive]

Thank you, Par. Please turn to the next slide. For the third quarter, the group revenue ended at DKK 445 million, entailing a decline in total revenue growth of 1.7% compared with the same quarter last year. The revenue declined organically by 1.6%. The variance between the total revenue growth and the organic growth is the impact from foreign exchange only.

As mentioned earlier, the revenue in Q3 last year in Region DK was impacted by a positive one-off. If we adjust for that, the underlying organic growth would have been 1.7%. However, it does not change the fact that the results for this quarter was not where we wanted it to be. The decline in revenue was due to region Asia and due to the moderate market slowdown and the slow to materialize recovery in the data migration business in U.S.

Despite we continue to reduce costs across the business and streamlining our ways of working, the group operating profit, excluding special items, decreased from DKK 26.5 million to DKK 17.5 million in Q3. This was partly driven by the decrease in sales, partly due to having too much capacity compared with current demand. The group operating profit margin, excluding special items, decreased from 5.8% to 3.9% during the quarter. Based on the capacity adjustments made, including the key 5 levers mentioned during the Q2 webcast, we do see a way forward to return to profitable growth in the fourth quarter.

I'll go more in details with this on the next slide. Please turn to the next slide. On October 22, we announced an adjustment to the full year outlook based on preliminary and unaudited financial figures for the third quarter. The organic growth outlook was taken down to around 6% to 7% from previously around 10%. Group operating profit margin, excluding special items, were also adjusted from 8% to 9% to 6% to 7%.

With us reporting the Q3 results and also the first 9 months, the updated full year outlook also implies expectations to the fourth quarter. During the fourth quarter, we have implicitly guided an organic growth between around 7% to 11% and the group operating profit margin, excluding special items, between 8% to 12%. The key levers for Q4 are the same as presented during the Q2 results with the addition of the capacity adjustments we have made in Region U.S. and Europe. And just to give you a brief update on where we are in the different levers, I'll start with the first one, important strategic wins in U.S. and Denmark.

We have started to deliver on the contract in the U.S., where we have people on site with the customer. We have also started the project in Denmark. But as Par mentioned, we are in a transition phase where we do not recognize any revenue, but related costs are classified as work in progress and lifted off the P&L to the balance sheet. Both projects are progressing according to plan.

Our second lever, full effect from the turnaround in Asia is also progressing as planned as both showcased in Q3 and in Q2, where we improved profitability.

The third lever, completion of crucial internal projects are going according to plan. For the past month, we have been relocating billable employees from internal projects to external projects. We expect to continue this into Q4, and we do already now see the number of internal resources supporting internal projects have been significantly lowered.

Moving on to the fourth lever, we have relocated our offices across the board, and we do see the benefits positively impacting our cost base. Restructuring of the data migration business has not been going according to plan as described on the previous slides. However, we do believe the worst is behind us and the recovery is better in Q4 than the first 9 months. And we do expect to see the positive effects of the actions we have taken in the past quarters.

Lastly, the new lever capacity adjustments in Region U.S. and Region Europe has been carried out and will have effect in the fourth quarter. We believe that some of these levers, including a strong backlog for Q4 will make us deliver on the updated full year outlook.

Please turn to the next slide. Before we head into the Q&A, we will conclude the presentation with some closing remarks.

Please turn to Slide 13. The third quarter turned out to be more challenging than we initially expected. We were especially challenged in Region U.S. and Region Europe. And as a result, we adjusted our full year outlook on October 22. However, we still believe we will return to profitable growth in the fourth quarter, driven by a number of levers mentioned on the call today. This concludes the presentation for today. Thank you for joining the call. Now we will open the line and take your questions. Operator, please turn on then to the next slide and open for questions.

[Operator]

[Operator Instructions]

Our first question comes from the line of Yiwei Zhou from SEB.

[Yiwei Zhou, analyst]

I have a couple of questions here. I'll do one at a time.

Firstly, on the -- your Q4 guidance, I can see the EBIT margin 8% to 12% is still sort of wide range. You mentioned those levers, and I understand the main uncertainty is the data migration business recovery, which I guess, at the moment, you should have a pretty good visibility for Q4. But I'm trying to understand what can take you to the higher end of the 12% EBIT margin for Q4? If you can elaborate a bit.

[Carsten Ringius, executive]

Well, I can comment on that. If we look at the backlog, we believe we have a strong backlog. So it is really about optimizing our capacity sufficient to deliver on this backlog that can make a difference as to what the absolute profitability will be in Q4 and also that we actually managed to deliver on all projects in Q4, and we do not see some final minor postponements into next year. These are sort of the most important swing factors for the profitability in Q4.

[Par Fors, executive]

And maybe added to that, I would say that the capacity reduction that we see in Q3 has not had a full effect yet. We will see also that we have a much better matching of our capacity and the demand [indiscernible] with a much higher efficiency level.

[Yiwei Zhou, analyst]

Okay. Great. Very clear. And just also trying to understand here, you mentioned the capacity adjustments. I mean, I guess this is mainly referring to the [indiscernible]. And I mean, I understand the -- I think I [indiscernible] with a life science background and capabilities, normally in a good market, it's very difficult to find and hire. I mean now you're doing those sort of rightsizing initiatives. Are you confident to hire those people or find enough people again when the market to rebound?

[Par Fors, executive]

Yes. I mean I think we are -- the areas where the demand, it's also a market phenomenon that also other companies see a softer demand. So when we see demand picking up in those areas, later down the road, then we don't see any problems to recruit in those areas. But we are not making reduction across the board. It's actually in very selected areas and also a little bit in also more selected geographies because there is no secret to anyone that the demand has been softened primarily in Central and Southern Europe, while the demand in the pharma cluster up here in the Copenhagen area remains at a very high level. So it's very selective and...

[Yiwei Zhou, analyst]

Okay. Great. And last question on the project delays, which you mentioned in Europe. A bit related to the projects on your backlog or is sort of a potential new engagements with the customer.

[Carsten Ringius, executive]

It is -- some of it related to backlog projects. Remember, in the Life Science business, we operate with smaller-sized projects. And for some of these projects, you don't see a normal RFP process like you, for example, do on larger public tenders. So it is a more agile process where we see not working with specific deadlines, et cetera, but more an agile approach. And we just see some of these projects that we have been discussing are being moved. So some of it has been part of our backlog with a certain probability then being still within our backlog, but simply just postponed because of decisions pending.

[Operator]

The next question will be from the line of Poul Jessen from Danske Bank.

[Poul Jessen, analyst]

First question is regarding your comment on market expectations being taken down by the industry when you look at the longer-term guidance. I was just wondering, does that have any impact on the medium long-term guidance, which you gave at the CMD last year? And are you revising your own internal performance as well?

[Par Fors, executive]

No, that's correct that there has been a slight reduction in the market growth, and that's a kind of global life sciences market. So it's not really precise. But our ambition has been to outgrow the market, and we have been able to do that historically. And we think we have the right services and the right competence to continue to do that. Our goal has been to kind of outgrow the market with like 2x at least. That's been our goal. So we see good potential for growth even though there is a slight adjustment in the market growth.

[Poul Jessen, analyst]

So you stick to your longer-term growth that you can do 10% a year?

[Carsten Ringius, executive]

Yes, we have not changed our long-term financial aspiration. So we still think that is realistic.

[Poul Jessen, analyst]

Okay. Capacity you take now where you said 5% to 10%, when will you have the full impact of that already in the first quarter? Or is that from first quarter?

[Par Fors, executive]

I think it's going to be -- the big part will actually be impacted already in the fourth quarter. There is some people that we have taken out that are done now in October. So the 100% impact will be in Q1, but there will be a material more impact in Q4 than it was in Q3.

[Poul Jessen, analyst]

And what level of one-off should we expect there in the fourth quarter? And I assume those reported in Q3 were restructuring all of it?

[Carsten Ringius, executive]

Yes, correct. It will be a lower impact in Q4 than what you have seen now released in the Q3 numbers, so at a lower level in Q4.

[Poul Jessen, analyst]

Okay. Then a question about the regional and corporate costs that you have. How should we look at those for the remainder of the year? Last year, you had a very low regional cost in the fourth quarter. Was that a coincidence? So we should look at a more stable level this year -- throughout the year and also on the corporate cost?

[Carsten Ringius, executive]

I think a realistic expectation for Q4 is a slightly lower level than what we see in Q3.

[Poul Jessen, analyst]

For both of them?

[Carsten Ringius, executive]

Yes.

[Operator]

[Operator Instructions]

As no one else has lined up for questions in this call, I'll now hand it back to the speakers for any closing remarks.

[Par Fors, executive]

Okay. Thank you, everybody, for joining this call today. If any further questions, please contact Carsten. And otherwise, we hear from you at our next quarter results and wish you all a great day.