Itera ASA

OSE:ITERA

Earnings Call Transcript 2018-Q3

[Arne Mjøs, Chief Executive Officer]

Okay. Welcome to the interim report for the Itera, the third quarter. My name is Arne Mjøs, I'm the Chief Executive Officer. And we will have the same agendas we normally do. We start with the highlights for the third quarter and then as for -- Bent Hammer will take the financial review. I will continue with the business review and some comments about the outlook. So in the third quarter, we had delivered NOK 121 million in revenue compared to NOK 108 million last year. That represent a 12% organic growth year-over-year. The EBIT was NOK 6.4 million, same as in last year. That represent a margin of 5.3% compared to 5.9% margin last year. If I look at the core business of Itera, we also have data center, I'll come back to that. But if I look at the core on digital business, which represent about 75% of the business, we have a year-to-date revenue growth of 23% and an EBIT margin of 10.5%. And Itera's data center, we have been in the data center business for a very long time. Obviously, that the public cloud is actually accelerating. So about 50% of the data processing power in the market is already on the public cloud. So that's why we accelerate the transformation into cloud. So that is also hitting the margin and the growth. But we will look into that part more in detail later. We also have a very significant interest in our scalable hybrid model. And we are also happy to win a very prestige award they call the Experience Provider of the Year by the Global Sourcing Association, which is a very important milestone in the delivery model that we have established. And the last but not least, we also have a successful employee stock purchase program in this third quarter. Okay. So that was the summary for the third quarter. So please, Bent, go into the financial review.

[Bent Hammer, Chief Financial Officer]

Thank you, Arne, and good morning to all. As Arne mentioned, we had a 12% growth in the quarter of NOK 121.3 million of revenues and an EBITDA of NOK 11.8 million and an EBIT of NOK 6.4 million, which was on par with last year's performance though the margin is slightly less as the top line is higher. And I will come back to more details about that later. Cash flow from operations was NOK 1.5 million, which was approximately NOK 10 million lower than last year, and that's due to the fact that most of the receivables from the August invoicing fell due over the last weekend of September. So the inflow came on Monday, October 1, instead. We had a cash balance of approximately NOK 20 million at end of quarter, and that's a full NOK 40 million below last year. And that can be attributed to the fact that we've paid out 2 rounds of dividends and also repurchased own shares all in all to a value of more than NOK 50 million. And that's the -- also puts it all on the equity ratio, so that was down to 18.1% from 30% last year. We grew the number of employees at the end of quarter by 4% to 493 employees and had, on average, 485 employees in the quarter. Looking a bit more into the details of the cost side, we had a substantial growth in the cost of sales, which is attributable to the use of more subcontractors. Personnel expenses grew by 8%, which is pretty much in line with the headcount growth. Depreciation, lower growth and then the top line suggests of only 5%, and that reflects a bit less investments that we do in the data centers these days. Other operating expenses were up by 31%. And now there are 3 main components of that. One is that we have moved into a new and expanded facility in Kiev that will accommodate all of the growth we had towards the end of 2017 as well as possibilities to grow further in a good market. Moreover, we spent more money on competence developments in the period as well as on professional services. Referring back to Arne's opening statements about the data centers and the other core digital business. If we break down the financial performance year-to-date, we can see that this core digital business had a substantial growth rate of 23% and an EBIT margin of 10.5%. This goes to show that our scalable hybrid delivery model is producing both excess growth as well as very good levels of profitability. On the other hand, we've seen for a period of time that the margins in the data center operations have been declining and we have not been able to attract a lot of new business on them. Arne will come back to a bit more about the industry trends in that respect as well. But the fact of the matter is that this business as Arne [ slated ] -- had a negative growth of 2% and also produced a negative EBIT margin of 1.1%. So this part of the business currently constitutes about 25% of the business volume as measured in gross profit terms. So we will do an investment into the -- into new cloud offerings and lift-and-shift customers one by one and some certainly residual business as contracts are expiring. Just to show even more detail about the impact these data center operations have on our total profitability, we have a fairly flat development in the total EBIT for the 9 months to date. Starting off with NOK 25.5 million last year, this data center operations had a negative impact of NOK 9.6 million in change of profitability in that period, whereas the digital business had a positive change of NOK 10.1 million. Also, it was a positive margin development of 2 points for the core digital business, whereas the data center operations had reduction in their margins of 9.1 percentage points. The 3 year -- sorry, the third quarter revenues are as usual, they had the lowest in the year because of the vacation period in July in our Nordic business. Still, we see that there's a substantial growth from the same quarter of last year. Number of employees have been rather flat during the year. We had a tremendous growth in 2017, which has now paused so far this year. And that's at least in part attributed -- attributable to 1 large national account that we are currently in the process of scaling down due to the fact that this customer has been acquired by another player that already had a full national setup and wants to continue using this. So that's kind of eliminated the other underlying growth that we had on the national operations in 2018. As mentioned, this data center puts its toll on our margins, just partially compensated by improved margins in the core digital business. Breaking down the revenue into service offerings. We see that our own service deliveries have increased by 11% to NOK 75 million, whereas the subscription revenue has increased by 5% to NOK 34 million. The third-party services including subcontractors have almost doubled to NOK 8 million. That's a -- not a large volume in total but nevertheless, a high growth in percentage terms. Other revenue like hardware-software sale has been rather flat at NOK 4 million. Referring back to the statement of cash flow. As mentioned, NOK 1.5 million generated from operating activities. We invested NOK 2.3 million in the quarter, which is down NOK 1.7 million from the corresponding quarter last year. And that's a reflection on the less investments that we are taking in data center operations. We had a positive inflow from financing activities as we had this employee share purchase program for our key employees. I will come back to that in a minute. So all in all, a net positive change of NOK 4.2 million on cash in the quarter and an ending balance of NOK 19.6 million in cash. On top of that, we have currently just over NOK 1.2 million treasury shares that at quarter end were valued at NOK 14.2 million. We're holding those for future incentive programs that are already in place like the option programs from 2015, '16 and '17 as well as planned share purchase programs for employees next year and thereafter. Our shareholders have had a tremendous journey in the last 12 months. Share price ended at NOK 11.4 million -- no, sorry, NOK 11.4 per share end of quarter, which was up from NOK 6.421 per share at the same time last year. And in this period, we also paid out a NOK 0.5 in dividend payments. So all in all, a 92% payback or -- yes. What's it called? 92 -- Yes, 92% on these investments. We have, over the past 3 years, had a very aggressive dividend policy where we have distributed more than 100% of earnings on average over these 3 years. And then on top of that, we also repurchased some own shares. So currently, we have 1.2 million shares in our holdings. And that's down almost 1 million from the end of last quarter as we had this employee share purchase program that consisted of 22 people that bought these 172,000 shares. And we had at the very end of Q2, also 98 employees in a general program who bought close to 200,000 shares. So there are a lot of people and a lot of our employees now that are holding Itera shares. And I should mention for these key employees, their shareholding is with a 3-year lockup period and also dependent on their retaining their employee status. Otherwise, we have an option to repurchase the shares if they leave within these 3 years. The balance sheet is slimmer than the same period of last year despite impacts of the new income recognition standard, IFRS 15, which inflated the balance sheets on both sides. We see that the main reduction in the balance sheet is, of course, on cash on one hand and equity on the other side, reflecting again the aforementioned dividend payments and purchase of own shares. We had NOK 14 million more customer receivables outstanding at the end of the quarter, again due to the last couple of days falling on a -- over a weekend. The mentioned IFRS 15 implementation has not had any great impacts on our results and probably will have less such in the future as well, other than what's already been recognized as balances but will be amortized over the contract periods. But these are very much linked to the data center operations so there are probably coming in new -- fewer new projects that will be impacted by this new standard. That was it for me. So I will hand back to Arne who will give you more update of the business and the industry trends that we are operating under. Thanks a lot.

[Arne Mjøs, Chief Executive Officer]

Thank you, Bent. Okay. Then we continue with the business review section. I guess you have heard me talking about the platform economy -- yes, that's for sure. Everything is going in that direction. So this -- the platform economy, which is also a new kind of business model that also [ take ] technology challenges all business logic in all the industry. That is what's actually really happening. And if you look at the data, the amount of data that will be consumed, this is a very nice picture by 2020 showing that every person will have produced about 1.5 gigabyte per day in data. As in the home, there will be 50 gigabyte per day produced. And they're talking about it only 2 years ahead. And in a car, there will be 5 terabytes of data produced per day, et cetera, et cetera. And also, if you look at the number of IoT devices, there are coming 1 million new devices online every hour by 2020. And as we have talked about later -- earlier, it's actually, that we -- our position is to be the 1 -- #1 in creating digital business. So we have 4 pillars in our strategy we should focus on because of our customer. We work in the multidisciplinary teams. We take the full life cycle responsibility and we have a very value-added hybrid scalable model where we have more or less unlimited access to the sources. So the business model we have is actually to be both fast and agile but also have the scalability in terms of what we call the hybrid. And if you break down to typical services or features that we put into the project, we can do for the customer everything from customer journey, design. We are making a proof of concept using new technology like artificial intelligence, whatever, based on a very customer-centric approach and in a Nordic culture environment. And then we have high mobility of the [ desis ] across the Nordic but also to near shore, so the scalability in Itera is very high. So when we're delivering these kind of solutions, we are using platforms, cloud, all kind of new stuff that is coming into the market to enable new digital businesses. Our scalability has gained a lot of traction in the market. We had a visit by the Norwegian Minister of Trade and Industry, Torbjørn Røe Isaksen, at our office in Kiev. And I think he was very happy to see how this model really empower the players or the businesses both on the private side and the public side in Norway but also in the Nordics to -- with capacity, so it's a -- they can continue with all kind of digitalization projects that they have because their access to digital talents is really a bottleneck in order to continue this development. And he also said that this is no kind of brain drain from the country and that we don't have any kind of social dumping locally either, so it's to have this kind of criteria, which is very important also from a political point of view. And we are very happy that with this quarter also won the -- they award us by the Global Sourcing Association as the Customer Experience Provider of the Year 2018. That's a very prestige for -- of award that we managed to win. And the summit was actually in Cape Town in South Africa. So the whole role all players are representing and we really won their category, which is the most important for us, really to have the best customer experience built in global sourcing model. And the model that we have established -- and somebody believes it's just to have some serious is totally different. You need to have -- to become a mature player, it takes 5 to 6 years. We are more or less used to that. We had our 10 years anniversary. But as you see, the progress after the journey we have been through, we start with the first office in Kiev in 2018. And we would like to make -- innovate a Nordic setup, so that always started from a Nordic perspective. And then we had another office in Ukraine, in Lviv in 2010. And in 2014, we established the first office within EU in Bratislava. And now we have -- based on this, when we established the first office in Kiev, that was the main office. We established all kind of structure capital, et cetera. So now we are in a position to establish a new office by 9 to 12 months. And it could be everywhere in the Eastern Europe. So we have the methodology, we have the people and we have the knowledge how do we do this in a very scalable way. In terms of GDPR digital security, we have the highest standard in place. We have -- were certified as the binding corporate rule processor in 2017, 2016. We started the project in 2016. Managed to have the signed agreement with the National Data Authorities within a year, but also have the bridge to Ukraine. So with Itera, it's very easy to consider all kind of data processing of data, personal sensitive data across the border in terms of -- because we have this certification or this compliance on the binding corporate rules. And the last but not least, in 2018, we won the -- a very -- yes, the Global Award as the Customer Experience Provider of the Year. And going forward, we really believe we have the scalability. We had a visit by the board for the first time, for 3 days in Kiev in September, and they really believe that the scalability what we have established during these 3 years can actually bring Itera 2,000, 3,000 employees because we have everything in place to scale with new offices, et cetera. Okay. We have also -- to look at what I mentioned about the data, the number. There will be a substantial growth of data, of 35x more data in 5 years than we have in a day today. This is really actually a -- really, a rapid growth. And if we look at the processing power we see today, that's about 50% today. It was 41% in 2018 but yes, estimated today to about 50% of all data center processing power is in the hybrid scale data centers, this public cloud data center typical by Microsoft, Amazon and Google. And it will increase to 69% in 2021. So in order to digitize -- continue the digitalization of the world in every sector in all industries, you don't -- you can't do it on the traditional data center capability. So everyone need to move into the cloud. And that is also what we have seen in the transformation of Itera, as Bent told about, that we have existing data center. We have customer data, which is very customized. And these customers -- several of these customers have in the agreement that they will move into the cloud. And the speed to move into the cloud is faster than we thought in the beginning. So now we are building what we call a managed cloud services unit, which is everything based on a cloud approach. So we put the best practice cloud foundation, and then we bridge or lift and shift the customer from the data centers to the cloud through some kind of methodology that we have in place. And that is also a great opportunity because we can look at our own customers so we have making some kind of road map planning for each customer on the data center and do this sequentially. But we can also use the same methodology when we look at other clients because they also need to go into the cloud. I will say that if you don't go into cloud within 2 years in some way or others, you won't be able to be a part of the new digital railway. We have all these kind of IoT services coming in as part of the business model. To show you one example, we have a project, we can't mention the customer because it's very strategic for the customer. But we are working for a very large Nordic company that would like to build their future e-health hub for Nordic citizens. So what they're planning is actually to look more on the data you have on your wearables. And by having a lot of data, you have about your body. For example, the Apple Watch, the new watch also have these capabilities in order to look at your heart, et cetera. So that is just one example. But a lot of new technology will be placed inside or outside your body. So you have this information daily about your body. And then use different kind of tools but not at least (sic) [ not least ] artificial intelligence to be more proactive about your health care situation but it also make some kind of new services that are more -- for -- within proactive care. So this is a trend that we see, that instead of going to the hospital with your pain, you actually are proactive in order to solve your problems or avoid problems before you, at the end, would like -- need to go to the hospital. So it's actually really reduce or disrupt the health care process that we are seeing. So of course, this is important for everyone. This is important for -- according to the United Nations goals in terms of good health and wellbeing for everyone in the world. We also have a project that we -- that also support the same or different United Nations goals, but it's actually in terms of the energy where we are teaming up with Microsoft in Redmond to use their digital twin. So the new technology, that really are building functionality that is -- make it easy to connect to city, connect to buildings, connect to vehicle, et cetera. So they make a very horizontal platform that others can play or plug into or deliver service on top in order to digital different sector and also across sector. And these are also service -- are supplying or supporting all the goals by the United Nations, for example, 7, 9 and 11. Of course, so these are just some example. If I look at the order intake, we have both existing customers but also some new ones. So the book-to-bill ratio in the third quarter was 0.9 and we have 1.1 book-to-bill ratio year-to-date. And also, the customer development as we are reporting for many quarters, so we had a -- yes, 95% of the existing customer accounted for 95% of revenue in the third quarter. And we also look at the -- if you look at the top 30 customer, it's up by 3% -- 3 points. So now it's representing 30 -- 82%. So that means that we have long visibility in our portfolio of project, our customers and delivering more and more full range of services since we are growing each year. If we look at the national ratio, it's representing 43% in this quarter. It's up by 1% the last 12 months. I believe it will increase further going. The target is 50% but I think we will pass that quite soon because that's a part of this [ schedule ] on the scalability of the group. And also in the third quarter, we have a lot of social activity. We have students project during the summertime, et cetera. So we're also used in spending a lot of time as a part of the culture -- to build the culture within and contribute also across countries. To summarize the third quarter, what we will do is to continue the solid profitable growth part in our core digital business, representing 75% today. So that is -- that will -- is continue to grow. We show very strong growth there, year-to-date, 23% and 10.5%. So that's a very solid foundation of Itera. Then we will continue our investment in the new managed cloud services unit and also lift and shift Itera data center customer into this new unit and also reduce some assets that we have in the existing data center. So we are moving a lot of people competence-wise from the data center to the new managed cloud services but also investing a lot of time in order to build a new competence for all of the people in Itera. And the last but not least, since we are integrating the company, we also manage Itera into one Itera management team. So that's also across business units so there will be some other businesses. We don't need to have separate business unit. We merge this together and then it also will have some effects on the overhead of the group. So that was what we had in the business review and to finalize the outlook, the market of course is very attractive with high demand for digitalization. All Nordics markets will focus on the profitable growth and cash flow here. And we will -- as I told you about, we will have some investments in the new managed cloud services unit and also transfer our own data center into the cloud. And the last but not least, we have continued -- we will continue the journey by larger project and customer that will increase again the revenue visibility, efficiency and the scalability of Itera. So that was what we had in this presentation. So we're looking forward to see you again in February when we are presenting the fourth quarter and the full year report for Itera. Thank you for attending today.