Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2019-Q1

[Hans-Petter Mellerud]

Good morning. My name is Hans-Petter Mellerud, and I am the CEO of Zalaris. And I'm here together with our CFO, Nina Stemshaug. Thank you for joining us again for this webcast presentation of Zalaris 2019 Q1 results. Please observe that the conference is being recorded. You will find a link to the recording on the Investor part of our website.Let's go straight to the presentation. Revenues in the first quarter 2019 were NOK 192.4 million. Year-on-year growth in the quarter was 3.3%. We launched several new customers with an annual contract value of approximately NOK 20 million during the quarter. As the contracts were phased in during the quarter, around 43% of the contracted potential was included in the quarter. As communicated during our Q4 webcast, we implemented a streamlined organization in Q1 with the goal of offering a coherent customer offering and driving profitability. We have initiated several actions to improve our EBIT margin to a target level of 10% by ultimo 2019. I will give you more information in our organization and our improvement activities towards the end of the presentation.Now let's take a quick look at the numbers. We achieved revenues, as I said, of NOK 192.4 million, a year-on-year increase of 3.3%, driven by growth in the Managed Services segment. Our adjusted EBIT was NOK 6.5 million, down from NOK 11.4 million in Q1 '18. The lower profitability is partly explained by shortage of consulting capacity in Professional Services, which has led to increased expenses for external services. This is to be mitigated through new hires and more resources allocated to customer-oriented tasks. We have also initiated several group-wide initiatives to reduce cost and increase utilization. The Q1 '19 EBIT margin showed a slight improvement quarter-on-quarter when adjusted for positive year-end assessments in Q4 '18. And we expect to improve our profitability further throughout 2019. Then looking at our 3 regions. Northern Europe, slight growth from NOK 107.4 million in Q1 '18 to NOK 107.8 million in Q1 '19. Price reductions within renewed contracts was compensated with an increased scope of deliveries with the launch of new customers and increased functionality and services to existing customers.Central Europe increased by NOK 4.1 million from NOK 70.8 million in Q1 '18 to NOK 74.8 million in Q1 '19. Total growth compared to Q1 '18 on 7% due to expanding services to a number of new customers.U.K. and Ireland, strong growth, up from NOK 8.1 million in Q1 '18 to NOK 9.7 million in Q1 '19. Growth due to ongoing delivery of significant projects from the U.K., accompanied by increased sales closed in Q4 '18.Now let's take a look at the key financials, and Nina, please take us through it.

[Nina Stemshaug, Chief Financial Officer]

So good morning and thank you for listening to Zalaris presentation of the financial results for the first quarter of 2019. We start by looking at the operating profit revenues for the group. And as usual, all numbers referred to are in Norwegian kroner, unless otherwise has been stated. Revenues for Q1 '19 amounted to NOK 192.4 million, an increase compared to Q1 '18. Year-on-year growth in the quarter was 3.3% driven by growth in all regions, as already elaborated by Hans-Petter on the previous slide. The decline from previous quarter is mainly driven by an extraordinary high level of change orders delivered end of the year 2018.Group EBIT for the quarter was NOK 6.5 million compared to NOK 11.4 million in Q1 2018. Q1 '19 was marked by increased personnel costs. The personnel costs as a percentage of revenues increased with 2 percentage points both compared to the first and the last quarter of 2018. The year-on-year increase is partly caused by a strengthening of our capacity in our service center in India, enabling us to transfer tasks within customer service deliveries. We also had an increase in number of employees in some of the group's support functions as accounting and controlling, IT and HR. The personnel costs and, thus, the group profits in Q4 '18 were positively affected by year-end assessments, as mentioned in our quarterly reporting for Q4 '18.When excluding these year-end adjustments for comparable reasons, the EBIT margin slightly increased quarter-on-quarter. And during fiscal year 2017 and fiscal year 2018, total costs as a percentage of revenue within finance and accounting department, also including other costs as management and legal services, increased with approximately 3 percentage points as a result of integration activities related to acquired companies.We have already initiated actions to come back to a more normal level by centralizing this function, automate processes in our new regions and utilize our accounting team in India. Also within IT, HR and other group functions, cost reductions initiatives have been identified. In addition, the quarterly EBIT was somewhat affected by increased expenses for external services compared to Q1 '18. This is a result of temporary reduction of internal consulting capacity, especially in Germany.Net financial costs for the quarter were NOK 1.1 million, including a noncash foreign currency profit of NOK 8.3 million related to debt nominated in euro. Total comprehensive income for the quarter was negative by NOK 1.1 million, including a loss of NOK 7.4 million in currency translation differences.Total assets amounted to NOK 756.4 million at the end of the first quarter of 2019, up NOK 119.4 million year-on-year and NOK 30.8 million quarter-on-quarter. Main reason for the increase from previous quarter was the adoption of IFRS 16, 1st of January 2019, which relates to right-of-use assets and lease liabilities. The adoption of the new standard increases the assets with approximately NOK 50 million end of the quarter. A more detailed description of the new standard and the effects on our accounts is to be found in Note 8 in our interim report.Equity decreased by NOK 20 million year-on-year and by NOK 3.6 million quarter-on-quarter, amounting to NOK 105.2 million end of the quarter. The decrease mainly related to a dividend distribution in Q2 '18 and the announced share buyback program initiated in the first quarter 2019. As a consequence of this and the increased amount of total assets, the equity ratio decreased from 15% to 14% during Q1 '19. Cash and cash equivalents were NOK 69.3 million at the end of the first quarter 2019, down from NOK 107.8 million at the end of last quarter previous year. We expect to see an improvement in the working capital after having implemented and improved and more efficient invoicing process in our German business unit, and we'll now after ending most of the integration activities, turn our focus back to normal business, including following up outstanding payments in our new regions on a more regular basis.Negative cash from financing activities amounting to NOK 11 million includes the decrease of lease liabilities as part of the adoption of IFRS 16. Net interest-bearing debt at the end of the quarter was NOK 299 million. So we will then turn to the segments and add some more comments to explain details in our operations. During the quarter, we have tuned our business and organization into 2 business segments by merging the previous business segment HR Outsourcing and Cloud into Managed Services. Meanwhile, Consulting has been renamed Professional Services. This change was made as a natural consequence of how our business is evolving in the markets we operate. By streamlining our organization towards coherent customer offerings, we are able to improve the utilization of capacity both within our sales and service organization and align with customer needs across our regions.Professional Services is a segment that has grown through our recent acquisitions. And going forward, we aim to provide a better understanding of the value creation of this segment, in particular, the long-term and stable nature of customer relationship with recurring revenues accounting for more than 60% of this segment's total revenues.The Managed Services segment has, since the beginning of fiscal year 2018, contributed to 7% of group revenue with long-term recurring revenues. Revenues in Q1 2019 amounted to NOK 143.7 million compared to NOK 138.9 million same quarter previous year, a year-on-year growth of 3.5%.The strongest contribution in the quarter came from Central Eastern Europe due to expanded scope of deliveries, as already explained. Northern Europe slightly increased revenues by launch of services to new customers in the quarter, as DNB and Kongsberg Group, in addition to an upsell of additional functionality within SuccessFactors to Codan. The decline in revenues caused by price reductions in renegotiated contracts, as announced in previous quarters, could thus be compensated for. Revenues in the Professional Services segment increased by NOK 1.4 million to NOK 48.7 million in the quarter compared to Q1 '18. The segment has shown strong growth within Central Eastern Europe, supporting new customers directly and through strategic partners. The main new business contributors on the revenue side are the German customers, Freie Universität Berlin, E.ON and SAP Germany. In addition, the increase for the segment as a whole reflects the continued increase in utilization, especially in the U.K., which has contributed by change orders for Veolia and Compass. The Managed Services segment had an EBIT of NOK 15.3 million in Q1 '19 compared to NOK 18.8 million in the same quarter last year. The decrease in the margin mainly reflects the price reductions effectuated in Q3 '18. Initiatives have started to reduce costs through automation and increased utilization of offshore resources in service deliveries within this segment. The segment shows a positive trend in the margin compared with the 2 previous quarter.EBIT in the Professional Services segment amounted to NOK 7 million, which is the same level as the corresponding quarter last year. The margin decreased compared with the previous quarter as a result of increased use of freelancers at a higher cost than internal capacity. In general, both segment EBITs were positively affected by the year-end assessment in Q4 '18.So with that, I hand over the microphone to Hans-Petter. Thank you.

[Hans-Petter Mellerud]

Thank you, Nina. So now to round off and as part of my concluding remarks, I would like to share with you some insights into the market trends and the organizational changes that we have been making.As communicated and also then covered partially by Nina, in our -- we started implementing the revised organization in Q1 with the goal to improve customer experience and profitability. A key aspect in this new organization is organizing our business processes and service, that is our HR and payroll outsourcing organization, and Software as a Service, that is our cloud offering organization, into a new organization called Managed Services spanning the countries and regions that we operate. This is essentially our customer-facing service organization or our service centers.Through this change, we can ensure that all our customers experience the same service wherever they are located and still maintaining our local presence, competence and touch. At the same time, we can better standardize processes, back-office systems and IT infrastructure with the goal to realize synergies, cost savings and operational efficiency. Managed Services has been organized and managed as a group-wide business unit that operate our network of service centers with the goal to standardize operations and, as I mentioned, reduce costs. Managed Services is also responsible for all day-to-day service management of customer relationships. And Managed Services is run by our Executive Vice President, Richard Schiørn, who is reporting to me. To strengthen the sales of Managed Services across our regions, we have established a group-wide sales function supporting and enabling our country by sales organizations, prioritizing, shaping and selling deals. This effort is already showing results, visualized with a strengthened pipeline and an increased number of responses to RFIs and RFPs for Managed Services. Our global sales of Managed Services is run by our previous head of Nordic region, Executive Vice President, Øyvind Reiten, who's also reporting to me. In parallel, we will operate our consulting business in a new business unit, Professional Services. Harald Goetsch, our Executive VP and Head of Central Europe, is in the process of defining the most effective operating model with the goal to secure local presence and entrepreneurship combining our group capability and scale. Our aim is to also to improve reporting and visibility investments of this segment. And as Nina mentioned, as more than 60% of the revenue in this segment actually is recurring revenue. And we expect to conclude this work and report back to you in the next report. And since we are being questioned about the role of Professional Services unit, we will again take the opportunity to reiterate our strategic reasoning for being in advisory services, such as Zalaris, which has grown 20% in 5 years. Everest Group's research has found that 26% to 28% of multi-process HR outsourcing we've signed in 2018 have some advisory services component, which reemphasizes the importance of developing consulting capabilities for the HR service providers.Advisory services can be applied across HR in various ways and play a significant role in solving challenges, HR functions and leader's experience. This is the sort of services that Zalaris provide. And when we do it, our main goal is to address and implement tailored solution for each business needs. Services like SAP SuccessFactors and SAP Human Capital Management are examples of exactly that, services that makes the follow-up to all kind of employees in all kind of ages more relevant and efficient. Within consulting, there are 2 areas: digital transformation consulting and traditional HR consulting. Digital transformation consulting consist of pre-implementation services, implementation services and post-implementation services. On the traditional HR consulting, we define an improved performance in employee engagement and retention. As an example, root cause analysis of attrition, attrition prediction and prevention as another example, and employee value propositions, creation, content creation and communication. And you can also find more information on these topics in our recently published annual report.Then moving back to our organization. Our business units, Managed Services and Professional Services, will be supported by strong entrepreneurial country market organizations, securing close contact with customers and the market. To manage our Northern European region, we have appointed Sami Seikkula who joined us last year. He has taken over from Øyvind who I just mentioned as having taken over responsibility for strengthening our global sales. Sami has lived the main part of his career in market-oriented business process outsourcing organizations and will be focusing on strengthening customer relationships and driving growth in the region. In U.K. and Ireland, Will Jackson is continuing leading the exciting development. Harald Goetsch is, as previously mentioned, the Head of our Central European region, including DACH, the German-speaking countries and Poland. Bala Narayanan is holding the fort in APAC and is responsible for operating our fast-growing global delivery organization, including our Chennai and Hyderabad delivery centers. With the goal of accelerating synergy realization and cost reductions in our support functions, we have, as previously communicated, organized our functions for finance and accounting, HR and IT as group functions. Our CFO, Nina Stemshaug, who you have met today, is responsible for our F&A function. Chief HR Officer, Hilde Karlsmyr, has group-wide responsibility for improving efficiency of HR.Our CTO, Halvor Leirvåg, is responsible for driving our synergies and cost reductions in our local IT and customer-facing IT infrastructure, with a mandate to consolidate to one common IT infrastructure that can support both our European and local ambitions and needs, bringing the best out of the original Zalaris group infrastructure and the infrastructure that was acquired as part of sumarum in 2019. Needless to say, the whole management team is measured and incentivized on meeting our targets. And then let's start talking about targets. Zalaris remains a growth company, but our key priority for 2019 is to return to margin levels from before the 2017 acquisition. Our target is to produce a consistent 10% EBIT at ultimo 2019. To reach this target, we are carrying out the following initiatives with the goal to realize a recurring monthly positive effect of approximately NOK 4.7 million, with improvements coming from around 75% from the operating organization and 25% from reducing group overhead costs. Our initiatives are grouped in a number of categories with corresponding target contribution as percent of the total target. And the key initiatives are: one, centralizing support functions, as I previously mentioned, finance, HR and IT, to accelerate process improvements, synergy realization and cost reductions resulting in reduced personnel cost of 50% and reduced IT cost of 60% of the total, we are talking about the total NOK 4.7 million that is; then 6% of the NOK 4.7 million will come from reducing costs for external advisers; 12% coming from converting internal resource usage to market-facing capacity; 12% from increasing offshore capability utilization; and another 4% from reducing noncustomer-facing travel costs.In addition, we target higher incremental margin and lower sales costs through focusing sales efforts to improve scale utilization. We expect positive medium-term benefits from improved productivity resulting from intelligent automation and initiated digitization initiatives.So to sum up. The key priority for Zalaris in 2019 is to return to margin levels from before the 2017 acquisitions. Our target is to produce a consistent 10% adjusted EBIT ultimo 2019. We have several ongoing initiatives to increase efficiency and reduce costs, including then the centralizing of support functions and increased offshore capability utilization that I just mentioned. And we will keep you updated on our progress in future presentations.Looking ahead, we are committed to ensure that 2019 becomes the 19th year of uninterrupted revenue growth for Zalaris and that we deliver on our profitability ambitions.Thank you for listening. We will now open for questions.

[Unknown Executive]

Remember that you can also forward your questions to [e-mail]. One question, Hans-Petter. Can you specify the time line on the effects of these cost initiatives? Can we, for example, expect to see results already in the second quarter?

[Hans-Petter Mellerud]

I think we -- of course, as I mentioned, a number of these initiatives have already been underway for some time and they have been initiated. Some are in the process, others are in the process of being initiated. So we will gradually see the effects of these initiatives as we move along until towards the end of 2019.

[Unknown Executive]

You talked about the need for making new hires, especially in Professional Services. Can you specify a number of new people necessary here?

[Hans-Petter Mellerud]

We haven't prepared an actual number on it. But what we see, particularly in our German organization, that we have a very high demand for our services, particularly in the cloud consulting and Professional Services part of it, and that we are basically recruiting as much as we can to support the market demand. But it is a challenge. It's a challenging market where a lot of other players are looking to do the same. So it's going to be a combinational of also building, rescaling existing consultants, utilizing offshore and the usual capacity as well as also building new resources from scratch.

[Unknown Executive]

There was a follow-up to that question, and that is in such a hot recruiting market, which mechanisms are you using to ensure that salary inflation is not a big factor for you?

[Hans-Petter Mellerud]

I think -- I mean obviously, it's a competitive market. We offer traditionally, let's say, competitive or market-just salaries. I think our -- the key focus for us is to seek employees and colleagues that have other values than just looking for the highest, say, bidder. So we like good resources that see the potential of working with Zalaris and career development in Zalaris as one of the leading HR organizations in Europe. And so a key to this is to then recruit the right people. But then in addition, in terms of, say, margin creep, what we see is also that hourly rates and daily rates are on their way up for some of these services. So what we have seen for quite a time is over the -- basically the 19 years that we have been operating is that the personnel cost has, in general, increased quite a bit more than the salary increases for comparable resources. But if I think since about the year, we have seen changes on this that is -- where also customers are apparently more willing to also pay higher rates for resources that are also -- or qualified resources that are delivering services locally in local language. And this is also something that we'll be using to at least protect our margin.

[Unknown Executive]

Final question here is you announced a renewal of the contract with Nordea yesterday. Can you indicate anything about the pricing on this contract compared to previous?

[Hans-Petter Mellerud]

Yes. Like I think we have been into that in our Q3 report last year or Q2, Q3. And initially we have offered Nordea competitive pricing. Nordea is also a business that is actively seeking how can they create value for their shareholders and employees. But we -- it's -- for us, it's a really good agreement. We can continue our journey with the leading bank in the Nordic. We can increase and support Nordea in a number of new areas. So for us, it's a fantastic opportunity to protect our business for another 5 years and support a stellar company in being the best -- having the best possible HR and people solutions supporting their business.

[Unknown Executive]

And that concludes the presentation. Thank you for joining, and see you next time.

[Hans-Petter Mellerud]

Thank you.