Tietoevry Oyj

OMXH:TIETO

Earnings Call Transcript 2018-Q3

[Tanja Lounevirta, Head of Investor Relations]

Good morning. We have today announced our third quarter results and are happy to introduce the highlights of the quarter. We will start with the presentation by Kimmo Alkio; and for the Q&A session, Janne Salminen, our acting CFO will join us.My name is Tanja Lounevirta. I am Head of Investor Relations, a warm welcome on my behalf, and now handing over to Kimmo. Please.

[Kimmo Alkio, CEO & President]

Thank you very much, Tanja. Also on my behalf, a very warm welcome to our third quarter review. And as usual, I'll begin with the main highlights, talk a briefly about the industry development and then overview of -- and most important messages per business area.And as you've seen from the tone of our message, we are actually pleased to be providing a very, what I would call, a straightforward good report with the 7% growth and 11%, all well in alignment with our own expectations, so overall a good quarter and a good foundation for seeking to also complete the full year 2018 successfully.Practically, in the third quarter main highlights being naturally the growth development, solid profitability, performance specifically in Technology Services and Modernization and our Product Development Services business being the strongest this quarter, PDS naturally being strong for quite some time. And furthermore, given the magnitude of currency impact, we have maintained, as reflected up on 3 months ago, quite a bit of focus on internal efficiency to seek to offset as much of the currency as possible.Few comments regarding the market. No significant changes. It is a highly dynamic, highly competitive market. The part that I would like to highlight is the ongoing -- I would say the overall market wide kind of acceleration of the data-driven businesses, data-driven services, data-driven capabilities. Whether one talks about machine learning, artificial intelligence, the overall appetite for enterprises and the public sector to be able to take advantage of the existing vast amounts of data for the benefit of their customers, for the benefit of reinventing their businesses, it is a very active market segment and that's it is -- I believe we are -- we need to be somewhat pleased that we started our investments 2.5 years ago around data-driven and AI-centric capabilities. Overall, other than that, no significant change in the market conditions per se. Very competitive market, again, as we have seen throughout the year 2018.Regarding, the key figures. Revenues EUR 367 million, reported growth of 3.4%, growth in local currencies 7%. And also we are quite pleased with the organic growth in local currency of 5%. So now we are at the closer to levels where we would like to be quarter-in, quarter-out. Overall, profitability wise, EBIT of EUR 40.4 million, 11%; adjusted EBIT, EUR 41.6 million, 11.3%, landing solidly within the spread that we had in the group management in mind and in perspective.Overall, development of the order intake, order backlog, the win rates we have all continue to support our growth ambition. It is naturally somewhat interesting in the industry as a whole, that the backlog follow-up is becoming a bit more difficult given that the -- there's a lot less of the type of large outsourcing contracts, usually more DevOps type of short duration projects where the whole sector dynamics are changing.We are comfortable with the way our order backlog is developing and we have a fairly good view how we believe it will also develop towards the year-end. So overall, development from a full company standpoint, quite nicely synergistic and in alignment with our longer-term plan of growing faster than the market and keeping the trajectory around profitability improvement as we have been able to deliver during the recent year. So Q3, in that sense a fairly good data point.Furthermore, a couple of considerations regarding the business mix. You remember we have reflected on this kind of market sentiment for actually 5 years by now on the shifts from the traditional services infrastructure and application type of services towards the highly innovative Customer Experience Management, data-centric services. So it is very important that we have been on this path, we are walking this path relatively well. The traditional services for the first 9 months, roughly flat, I'll go through in more detail the infrastructure and application services in a minute.The growth businesses. We know we have room for improvement growth businesses, in this case, being 8%, the other services and solutions, including the inorganic part up to 21%. The whole agenda an appetite for investing for future growth has been important and it is working fairly well for us at this point in time. To talk a bit more about the growth businesses, per se, so Customer Experience Management 12%, quite not as high level of growth for the first 9 months nor in the third quarter as we believe the market opportunity we have been a bit short on resources. The overall market momentum and capabilities, knowledge wise, is at the good level for Tieto, some resource shortage as reflected up on a second ago.Data-driven businesses to continue to grow roughly at the pace that we have set our own expectations, Cloud Services, good at 19%, quite consistent throughout the year, including the third quarter. Security Services, we had some disappointments in the second quarter. With that in mind, the year-to-date growth only 4%, the third quarter growth nearly 30%. So we had -- we did experience a type of bounce back on security as we had also expected.Regarding the Industry Solutions, these are the main. The Lifecare side, the Payments, Credit Solutions, Case Management for the public sector, Production Excellence, Tieto SmartUtilities, hydrocarbon management, making up the vast majority of our software business. Number of these solutions, suites continue to undergo significant architectural and technology change. Specifically in the Lifecare side and in SmartUtilities, the third one being Production Excellence and Payments, the VAM 2.0, we completed the software releases already during the summer timeframe. And naturally in the third quarter, we have seen clearly better progress, clearly better predictability as far as the R&D development in the core solution areas are concerned. And these software businesses will be opening up then in our CMD also further.Couple of other highlights regarding the main indicators of performance. I think the highlights primarily would be on the bottom left side on offshoring. Everything else is very, very consistent with expectations. I think worth noting on the offshore side, first time we have surpassed the 50% level. PDS being up to 72% and this has been a great asset for Tieto in terms of customer satisfaction, overall delivery quality and the ability to actually be very price competitive. And as commented, for 5 years now in a row, we do not set the percentage target. We simply accelerate offshoring as rapidly as our customers would like us to do. And this type of philosophy and logic has worked well and it is working well to our advantage. And the customer confidence regarding our total delivery capabilities offshoring is in a good shape.The balance sheet, no special developments. Cash flow very much according to our expectations and normal could type of a third quarter seasonality. So main indicators in that sense also look consistently fine.Next, if we go in to, as usual, first the overview of the service lines and the industry groups in terms of the aggregate picture visible on this page to businesses worth highlighting. Naturally, the Product Development Services at 18% growth. Also the second one I would like to highlight is from an industry group standpoint, Public, Healthcare and Welfare 12% growth which is really, really strong in a market which is really in a 2% to 3% growth range. So our presence profile, execution capability in these domains has been really strong.Okay. And we'll begin with the Technology Services and Modernization. We are absolutely pleased with the 4% growth in local currency. A background being that infrastructure business declining by 4%, application services business growing by 8%, this is delivering the overall fine top line for TSM, profitability level healthy at 13.8%. And naturally, number of initiatives have existed for quite some time in terms of efficiency -- continued focus, attention on efficiency.As commented briefly earlier, cloud looks good at 19% year-to-date. I commented the infrastructure and application services already. And furthermore, we have during the year launched our public cloud acceleration program, already placing additional investment led by our CTO, including reskilling of existing talent, existing employees, given the type of acceleration in interest, starting with application modernization and modernization of full infrastructures, consisting both of private and public cloud. So this is a short reflections on why -- what has happened and development fairly good in the third quarter.During the fourth quarter, we expected adjusted operating margin to be below or close to the Q4 2017 level. Naturally, a year ago, we had a number of efficiency programs, larger ones kicking in during the fourth quarter. Overall, solid development expected.Business Consulting and Implementation, I think regarding the performance of all businesses this quarter, this is the only business which deserves a bit additional explanation from a profitability standpoint, growth being healthy, over 20%, given the contribution of Avega. Organic growth in local currencies, 5%. 5% is below our own expectations. We know we have a few service practices within BCI that we believe will again perform better.Growth and more or so profitability impacted by one troubled project. We were by -- we need to take the additional hits during the third quarter. We believe furthermore that the challenges in this specific project in question should be more or less done for the year and more of a bounce back, again expected for the fourth quarter.So with that in mind, we expect the adjusted operating margin to be close to the levels of Q4 year ago. So Business Consulting Implementation, important business, healthy opportunities and it's an area where we continue to fine-tune our own gamebook within. And we believe the future in BCI will absolutely be attractive as well.Industry Solutions, 2% growth in local currencies, organically 4%, the media product divestment being visible. We are not fully happy, although it is fully predictable or was predictable, the top line development. Given the R&D challenges we have had especially in the early part of the year, naturally impacting some of the growth opportunities. We have one of the solution areas where we are currently not selling more. But given that the backlog is so big, we are focusing on more the delivery side and making sure those happen with high quality. That's one of the top 3 solution areas I refer to.Profitability wise, we bounced back according to our own expectations, roughly 14% level. Off the solution areas we are seeing healthy performance, overall, in our Lifecare business, including growth side, hydrocarbon management and credit solutions also performing fine on the top line side. Sales of Payment Solutions, specifically, a timing of the license sales and we actually had a very high comparable quarter in Payments a year ago, influencing somewhat.With all of this in mind, as commented both at the end of Q1 and at the end of Q2, we are undergoing significant technology renewal in our main software suites. We believe -- I believe these investments are extremely important. The market opportunity is clearly there. Our offering development -- overall developing fully at the planned levels. Furthermore, given that in one solution area, our hospital information systems, we have entered the stage of platform development with that in mind EUR 1.7 million being capitalized. Without the capitalization, the profitability level, nevertheless, actually very healthy. Furthermore, we expect for the fourth quarter, the adjusted operating margin to improve from the comparable quarter a year ago. So Industry Solutions has been good business, good bounce back in third quarter, market opportunity clearly attractive.Product Development Services, so indeed this business looks very, very different than 2 years ago. Even though third quarter in this business is often one of the more challenging quarters of the year, we ended up delivering absolutely stellar 18% growth in local currency as a result of the customer base expansion and expanding relationships with existing customers, so overall just really, really strong execution, including healthy profitability level at 9.9%.And furthermore, I think a bit of, kind of, a new reflection, we are identifying more and more of expansion opportunities also in adjacent sector. Up to now we really talked naturally around the telecom side, the network equipment manufacturer side, somewhat on the automotive side, a bit on consumer electronics, we are furthermore seeing good opportunities outside of -- both within and outside of these domains. And it will be interesting then to open up the thinking on PDS also in our Capital Markets Day. Furthermore, regarding fourth quarter, we expect adjusted operating margin to be close to the level of Q4 '17, which also happen to include quite a bit of nonrecurring license sales.If next, I will, as usual, go into an overview. And usually I see it is somewhat shorter regarding the industry group development, Financial Services not great development in the third quarter, minus 1% in local currencies, impacted by some of the software businesses. And the type of a facing of these businesses very important that on the payment side, as commented earlier, the renewed Virtual Account Management 2.0 was launched during the summer timeframe. Pipeline is healthy and naturally working with number of the larger global banks. The timelines for closing the agreements varies quite a bit.Also, overall, some good agreements in the third quarter in the sector and naturally our presence in Financial Services, including banking, insurance, pension insurance all across the Nordics is very strong, covering the services all the way from the infrastructure applications services, more and more on the consulting side as well and naturally strong presence with the software itself. And it was not naturally good to see the nomination into the top global, Top 25 in Enterprise FinTech in the rankings by IDC. So market good and I'm sure we'll see improving performance on Financial Services.Public Healthcare and Welfare, as commented briefly earlier, absolutely stellar performance third quarter and healthy development, actually, especially in Finland, we see solid opportunities in all of the businesses we are in. Regarding the full stack of services and capabilities we have, in the past year we have made a special leeway in new areas around Business Consulting and Implementation within this specific industry -- industry group.Industrial and Consumer Services as 7% growth in local currencies, organic 2%, fair development, not great development. And naturally the -- this sector includes customers in the retail side, utility side, basic manufacturing. Activity level is high. And in number of our markets within ICS we have actually been able to grow, but not in all the markets that we operate in. And within this business the cross advertising divestment took place.Few comments regarding the way forward. We continue to maintain our very usual type of performance drivers. The ambition on growth has clearly accelerated, as fully discussed over the last few year time frame and that continues to be important on our agenda and related investments. And naturally, we maintain high degree of attention on operational execution, including productivity programs to overall ensure we continue the good momentum we have been able to demonstrate in the third quarter and expecting to close successfully the full year. So really no special performance drivers, more of holistic, very high attention on operational execution regarding all of our businesses and all of our functions.With all that in mind, we naturally keep our guidance for the year unchanged. And as commented to begin with, it is -- it's been good and nice to be able to provide a straightforward good or strong report based on the 7% local currency growth and 11% profitability for the third quarter and bouncing back regarding some of the challenge in the areas where we had some challenges, as an example, in the second quarter.Furthermore, just in closing before we go to Q&A, interestingly, this year we have had some very positive recognition. We are talking about the Global Tech Top 100, 14 Europeans, 3 Nordic companies, Tieto being one of them. IDC FinTech Top 25 and furthermore the latest, very interesting -- actually Top 25 on gender equality whereby we were actually ranked #1 in the world regarding the technology company category. So some good recognition and naturally important to our employees and to our customers.With that in mind, why don't we go into the Q&A. Thank you.

[Tanja Lounevirta, Head of Investor Relations]

Thank you, Kimmo, and welcome, Janne, to join for the Q&A session. So I think we are ready for questions. And proceed to the teleconference. Moderator, please go ahead.

[Operator]

[Operator Instructions]. We will take our first question from the line of Sami from Nordea.

[Sami Sarkamies, Senior Analyst of TMT]

I have a couple of questions. First one, I'm a bit surprised you are not talking more about the new products you are in the process of launching at Industry Solutions. Could you give us some flavor on how the sales pipeline looks? And to what extent your sales in Q3 benefited from the new products or will benefit in Q4? That's the first question.

[Kimmo Alkio, CEO & President]

So as usual, so first of all, I would like to highlight 3 specific areas. So number 1, our Lifecare and many of you very well remember, it's one of our stronger software businesses and a very strong presence in all across the Nordics. So Lifecare, we have seen very clearly quite significant improvement in the third quarter and we expect that the customer deployments will now begin according to previously set timelines. With that in mind, the comfort level that, let's say, the mid- and long-term growth pattern will return naturally the probability is clearly higher. So that's one factor that it clearly seems that in the Lifecare side the challenges on R&D are quite well behind us and now we get to move on. Second factor being around Tieto SmartUtility, that's an area where the rearchitecting of the full suite, we as commented earlier, it will take longer. This is not the 1-quarter thing. So -- and within the Tieto SmartUtility, as we had reported during 2017, we won so many contracts that the backlog is so full, so there we really concentrate on getting the R&D releases out and getting the customer deployment done. And with that in mind, in the mid-term, we will then see that business kind of returning to the full kind of performance levels we expect. Third one regarding payments, so as commented there, the VAM 2.0 was released already during the summer. So there the variability for the fourth quarter is really around the sale success, closing the contract pipeline very healthy. So the dynamics that I have now reflected upon are clearly more positive than 3 months ago.

[Sami Sarkamies, Senior Analyst of TMT]

And then the second question is also on Industry Solutions. I think you said that you have decided to capitalize about EUR 2 million of R&D. Is it so that you haven't been capitalizing R&D in the past, so could you provide some reasoning for this decision?

[Kimmo Alkio, CEO & President]

Well, first of all, we haven't changed any accounting practice we have. But we have actually moved more towards platform-based development in our offering development. And thus because of our accounting principles, we needed to capitalize part of our development cost. And related to your question, whether we have earlier capitalized anything. It has been quite some time ago, but this isn't the first time.

[Sami Sarkamies, Senior Analyst of TMT]

Okay. And then 2 more questions, if I may. On BCI you are guiding for, let's say, somewhat soft margins still in Q4 because I think comparable is quite easy. You didn't yet benefit from Avega acquisition last year. So what is the reason for this margin weakness also in Q4?

[Kimmo Alkio, CEO & President]

Sure. So first of all, in this business, overall, the -- in the market, the attrition level specifically in BCI is a bit higher. So I think it's also quite a bit to do with our own capacity and being able to continuously hire more people. So that is one factor that it is not at the level that longer term we expect this business to be.

[Sami Sarkamies, Senior Analyst of TMT]

Okay. And then, finally on PDS, you had very healthy growth in Q3. Do you think you can keep this sort of growth rate in the coming quarters as well?

[Kimmo Alkio, CEO & President]

So I think that the growth rate regarding PDS -- I think that's a -- I think, we -- the guidance, I think we are already getting quite close to giving quarterly guidance per business. I think we leave it at the profitability level commentary for the time being. But the total opportunities I referred to regarding expansion potential is, if I may, much more related to mid- and long term.

[Operator]

[Operator Instructions]. We will take our next question from the line from Michael from UBS.

[Michael Briest]

A couple from me. Just following up on the R&D capitalization question. Will there be any effect in Q4? And in terms of the P&L charge for R&D this year, are you sticking with the guidance from -- I think which I think was around EUR 40 million, correct me if I'm wrong. And then a couple more after that?

[Janne Salminen, Acting CFO & Group Treasurer]

Well, first of all regarding Q4, we expect that the capitalization impact to be roughly at the same level as on Q3.

[Michael Briest]

And for the P&L expense for the year, is that going to be reduced by the capitalization amount?

[Janne Salminen, Acting CFO & Group Treasurer]

Well, all-in-all, we keep our guidance regarding the overall offering development amount to be as around 5% of the revenue.

[Michael Briest]

Okay. And then just on PDS, we've now sort of lapped then quite tough comparative there and the performance remains strong. Thinking back to its history in telecom. In particular, that was a more challenging phase. Can you maybe just talk a bit at the high level about the client profile now, how that's evolving and the confidence you have on continuing growth there?

[Janne Salminen, Acting CFO & Group Treasurer]

Sure. Absolutely. So I think, first of all, we are -- we have been working for quite some time on getting into a, kind of, quite different business logic than what we had, let's say, 2 or 3 years ago. Point being that we are -- we have been aiming and now becoming more and more successful in taking more end-to-end responsibility for certain R&D programs not just task-based 3-month small project delivery. So more of an end-to-end responsibility, point being that the customers are trusting us to look into certain technology innovations and delivering actually greater and greater value. And we'll try to open this up in the CMD then as much as we kind of externally -- as much as it makes sense externally. But that's one factor. That moreover the breadth of responsibility we take given the very high quality we have been delivering and as we take more of the end-to-end responsibility, we have actually delivered very efficiently on the end-to-end and with very high quality. With that in mind, and given the proliferation and the need for software engineers in all businesses, we have been able to then adjacently start to grow into other industries using more and more of a similar logic. So these are, I think, the early foundations to be fair of expansion, very early foundations. But the more we look at it, the market opportunity is pretty, pretty interesting. And as commented, I'm sure we'll have great discussion around this in CMD.

[Michael Briest]

And just finally, on the salary environment or cost environment, there's a lot of comments that a widest -- sort of macro level about cost pressures increasing. You talk about 4% salary pressure. Do you sense that given the tight labor market in countries like Sweden, in particular, the pressure on cost and salaries going into 2019 is only going to increase? And do you have enough pricing power to offset it?

[Kimmo Alkio, CEO & President]

Yes. So I think regarding the salary inflation, I fully agree that the market dynamics are an inch more challenging and you would probably agree with me that this challenge in our industry has existed for many, many years. So we continue to see this in a way that every year, and we have the mechanisms in place. We believe that every year we find the productivity improvements to offset or productivity improvements changes in the business mix, driving -- and driving the whole efficiency of the company to be able to offset the type of salary inflation. But it needs to be -- when the market is an inch more dynamic, the way we expect to do these fixes -- naturally we won't necessarily follow exactly the same menu as in previous years. But I feel pretty comfortable that we will have a view on how to continue to manage this as an equation.

[Michael Briest]

Is pricing getting any better?

[Kimmo Alkio, CEO & President]

Sorry?

[Michael Briest]

Is pricing getting any better?

[Kimmo Alkio, CEO & President]

Pricing -- there's quite a bit of variability in the different businesses. So the price competitiveness around the traditional services, it's been fierce and it is very fierce. Then we go into the kind of a unique domains or knowledge around data science, data engineering, AI, very specific industry consulting, Customer Experience Management. We go into our software domains where the unique capabilities truly are more unique. So the pricing power naturally is better in those domains. But it's kind of a polarized, some parts of it is very competitive.

[Janne Salminen, Acting CFO & Group Treasurer]

And maybe to add to that, we expect that half of the salary inflation will be offset through offshoring and also managing through the age pyramid.

[Operator]

[Operator Instructions] It appears there are no further questions at this time. I would like to turn the conference back to our speaker for any additional closing remarks.

[Tanja Lounevirta, Head of Investor Relations]

Thank you. Thank you for your questions and joining the teleconference. Before closing, I still wanted to take the opportunity to remind of our Capital Markets Day to be held 29th of November. Invitations will be sent during this week, so follow your e-mails. And then I think it's time to end the call, and thank you for participating.

[Kimmo Alkio, CEO & President]

Thank you very much and see you hopefully in a month's time. Thank you.

[Janne Salminen, Acting CFO & Group Treasurer]

Thank you.