Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2020-Q1

[Hans-Petter Mellerud]

Good morning. My name is Hans-Petter Mellerud, I am the CEO of Zalaris. Please also welcome our CFO, Gunnar Manum, who is here with me today for this webcast presentation of Zalaris Q1 2020 results. Still being in the middle of the COVID-19 disruption with the majority of us still working from home, we are using Teams for this purpose for the first time. Hope that we will deliver on your expectation. There is a Q&A function that you can use to ask questions. We will, as normal, do the Q&A at the end of the presentation. Please observe that the presentation is being recorded. You will find a link to the recording on the Investor part of our website. Without further ado, let's move on to the presentation. We are celebrating Zalaris' 20th anniversary. This is a time of reflection, gratitude and appreciation of how far we've come together since the company started in 2000, with only 1 person in Norway, and we are now more than 800 in 12 countries. Whilst these are unprecedented times for all of us in the COVID-19 predicament, we also see this as an opportune time to renew our identity and strengthen our shared sense of purpose as a team to serve our customers better. We have updated our mission to resimplify HR and payroll administration and empower our customers with useful information, enabling them to invest more in their people. Our values bind us together as one company. They shape the way we behave towards each other, our customers and our partners across the markets we serve. The new logo is the culmination of this process, symbolizing our ambition on being people-focused, agile and the continued simplification of processes to improve customer experience. With Zalaris providing fully digitized solutions and outsourcing services for HR and payroll, we are well positioned to deliver on an expected increased demand from the market for solutions that support reducing operating costs and allowing flexibility to work from anywhere. We completed Q1 '20 with an increase in revenue to NOK 200.6 million, growing 4.3% year-on-year, a new high for Q1. Adjusted EBIT for the quarter increased to NOK 13.4 million, up 44% from NOK 9.3 million in the same quarter last year. In the period, we continued our success in the market, signing a new -- a number of new and extended agreements with important customers, keeping churn at a low point. Zalaris rapidly adapted to the challenges of COVID-19 and is currently delivering as normal on customer commitments with 75% of our workforce operating from home. Cash and cash equivalents showed a positive development with an increase of NOK 5.1 million in the quarter. So let's move to the next slide. So as mentioned in the introduction, we continued our success in the market, extending agreements with a number of long-term customers and winning new strategic relationships in Q1. Our agreement with Circle K, providing multi-country payroll and transactional HR services, including time and travel expenses, was extended with 5 years from next March, and thus, in reality, securing a backlog of work for 6 years from that, serving their almost 13,000 employees in Scandinavia, Baltics, Poland and Ireland. We also extended our agreement with Yara, a customer since 2003, for the provision of services to their Scandinavian employees. Having recently also signed an agreement for their employees in Lithuania, we now deliver multi-country payroll for Yara in 4 countries. Gassco is another loyal customer that extended for another 5 years. Another exciting win in Norway is our entry into the municipality vertical, winning the Country -- County Council of Trøndelag with approximately 5,500 employees as a customer. This win is in a partnership with Capgemini and Oracle and opens up a whole new market for our services. Our intent is to combine the next-generation payroll solution resulting from this project with our other municipality customer, Bø, to a leading solution for the municipality sector employing almost 0.5 million people in Norway. Extending our agreement for application maintenance services for the German state of North Rhine-Westphalia for another 4 years is another fantastic win. This allows us to continue supporting the state delivering perfect payroll for their mind-boggling 700,000 employees and pensioners. In these days of COVID-19, many are envious on our large contracts in this public sector, providing stability and interesting work for our employees. Adding MAHLE to our U.K. customer list for outsourced payroll services was another win and one step to build scale in our U.K. operations. And I should not forget our agreement with AluNorf, a German Norsk Hydro subsidiary that we communicated yesterday, implementing SuccessFactors performance management to their 2,300 employees. So the world has entered unprecedented times due to the outbreak of the COVID-19 pandemic. Home offices and updated labor compliances are the new normal, and we are in a position to support our customers in simplifying HR and payroll, facilitating reskilling giving and empowering our customers with useful and timely information. We are poised to serve as a critical backbone for our customers, ensuring the smooth running of their HR functions. Our modern and scalable IT infrastructure is anywhere in real time. As you know, governments in countries where we operate have introduced restrictions as part of the pandemic. We were able to introduce remote work for our employees within days. No additional investments were needed to secure access equal to that of sitting in our offices. Our standardized and well-documented processes, in combination with our geographically distributed service centers and talented employees, allowed us to shift work between locations in real time. This makes our company resilient because even if governments and authorities impose travel or other restrictions on an employee or a group of employees, Zalaris can continue to work and deliver on customer commitments, fortifying our recurring revenue streams. To date, we see limited impact on our revenue and pipeline development from COVID-19 despite management diverting much time to secure business continuity. We see revenue drop in some areas as, for example, in processing travel expenses, while increasing other areas as handling layoffs, short-term work, et cetera. Thanks to our diverse and very solid customer base, the majority of our customers seems to tackle the situation fairly well. With this being on a positive note, we are, of course, preparing for a new normal and potentially a worsening of the situation. Some sales processes seems to take longer time. However, we expect to see increased demand for some of our services as customers are looking to reduce costs and streamline their organizations to fit the new normal. We have seen increased activity in big multi-country deals coming out of previous crisis, however, not as serious as this one. It has shown in the past to provide good opportunities for outsourcing-based value proposition as ours, delivering lower cost and process improvements. These are, to me, outsourcing times. It's really back to where our outsourcing started. So even though our almost -- we have worked almost 2 months from home, and this has been a very hectic period, we have radically improved as a team, using digital infrastructure as teams, has improved communications and the way we work. We will take all the learnings and adapt our behavior to the new normal with the goal of maintaining agility, teamwork and lower operating costs. So let's move on to review our operations. Looking at both segments separately, we can see a 4% year-on-year increase of revenues in both. For Managed Services, we see marginally higher revenue in Northern Europe and higher euro to NOK exchange rates partially offset lower revenue in Germany. Focusing during the last few quarters has been on the renewal of long-term contracts, as previously mentioned, as well as the efficiency and our cost reduction program. This has had a negative impact on our ability to take full advantage of potential growth opportunities. Increased revenue through existing and new customers is a key focus going forward. In our Professional Services segment, we had a significant revenue increase in Poland and higher euro/NOK exchange rates, partially offsetting marginally lower revenues in Germany and U.K. Revenue from Professional Services continued to be negatively impacted by the restructuring process, particularly in Germany, where offices has been merged. This trend is now stabilized, and we have initiated changes in management, eliminating one management layer. This is both reducing costs and increasing agility and opening up new career opportunities for our employees. So as you can see, our EBIT improvement program has resulted in significant personnel reductions over the last 12 months, the majority in Managed Services and group overhead. Going forward, we will continue our program with the goal of further organizational simplification and utilization of our near and offshore capabilities. Teaming experience gained through COVID-19 has strengthened our view of the potential for achieving this. Looking at Managed Services, we have spent a large part of our sales capacity over the last couple of years prolonging the majority of our large agreements, currently resulting in almost 0% churn. We can now rechannel this sales capacity to continue growing our business on this basis, knowing that we have a substantial backlog of work. As previously mentioned, our value proposition should hit perfectly to customers coming out of COVID-19, looking at reducing costs and implementing digital processing supporting working from anywhere. In Professional Services, we see that Application Maintenance Services, helping customers maintain their payroll and HR systems, mostly on long-term or subscription basis, has developed very positively amounting to approximately 67% of revenue in Q1. At the same time, we see that we have good improvement opportunities in utilizing our productive capacity, here visualized through productive hours worked on revenue-generating activities. We can conclude that the key reason for not meeting our 10% EBIT target in Q1 is us not converting free debt capacity to revenue compared to Q1 last year. Partially, as we have used more consulting resources to clear a backlog of application maintenance work for our Management Services customers with a goal to improve quality and customer satisfaction as well as to adapt to a continuous flow of digitization opportunities. We are currently addressing this through various means, including better resource sharing amongst our operating entities. Looking at the segment profitability on Managed Services. The segment EBIT is up 1.8 percentage points to 11.8% and NOK 16.7 million compared to the same quarter last year. The positive margin development can be contributed primarily to the effects of our EBIT improvement program and staff reductions. EBIT in the Professional Services segment amounted to NOK 6.3 million compared to NOK 8.7 million in the same quarter last year. The main driver of the increased profitability is, as previously mentioned, reduced conversion of available capacity to billable hours as discussed. So with that, I hand over to Gunnar for a review of our financial performance.

[Gunnar Manum, Chief Financial Officer]

This is the financial review for the first quarter 2020. All figures are in NOK. As was noted by Hans-Petter, Zalaris had revenue of NOK 200.6 million compared to NOK 192.4 million in the same quarter last year, an increase of 4.3%. Personnel expenses were NOK 111.6 million compared to NOK 107.6 million last year. The EBIT improvement program initiated in 2019 has resulted in approximately 8% lower cost base, which is equivalent to approximately NOK 11.5 million for the quarter. However, this has been offset by other items, which I will come back to shortly. EBIT, adjusted for one-off costs, amortization of excess value from acquisitions and estimated costs relating to share-based payments was NOK 13.4 million for the quarter versus EUR 9.3 million last year, an increase of 44%. The adjusted EBIT margin was 6.7% versus 4.9% last year. The net financial expense for the quarter was NOK 72 million, of which NOK 66 million relates to an unrealized currency loss on the EUR 35 million bond loan and other foreign currency denominated balance sheet items. This came as a result of the significant weakening of the NOK versus euro since year-end. The euro loan was mainly used to finance the acquisition of subsidiaries with euro as a functional currency. The higher value of relevant foreign currencies versus NOK has increased the equity value of these subsidiaries by NOK 52.4 million in the quarter, which has been included as a currency translation gain in other comprehensive income. Net loss for the period was NOK 48.6 million, while total comprehensive income was positive NOK 3.9 million versus negative NOK 1.1 million last year. Moving to the next page with some further comments relating to the company's cost base. As mentioned on the previous slide, the cost base has been reduced by approximately NOK 11.5 million compared to last year when adjusted for currency effects, a reduction of 8%. This has been achieved through initiatives earlier described in the EBIT improvement program and includes reduction of approximately 52 FTEs. This reduction in the cost base has been offset by less costs capitalized to customer projects and internal development projects during the quarter and currency effects, as shown on the slide. And improved utilization of the existing organization will be a key target going forward. Moving on to the cash flow for the quarter, Zalaris had cash of NOK 87.5 million at the end of March, an increase of NOK 4 million since end December. EBITDA was NOK 30.8 million -- EBITDA of NOK 30.8 million was largely offset by an increase in net working capital, CapEx and interest and lease payments. The operating cash flow was positive at NOK 16.9 million versus negative NOK 22 million last year. And finally, a quick look at the balance sheet. As just mentioned, we had cash of NOK 87.5 million at 31 March. Net interest-bearing debt was NOK 344.5 million. This is an increase of NOK 57.9 million from 31 December, and is the result of the high value of the euro versus NOK, as previously mentioned. And thank you, and that concludes the financial review.

[Hans-Petter Mellerud]

Thank you, Gunnar. So then let's just spend some time towards then at looking at the market. So as also discussed last time, we are part of a very exciting market with healthy growth in the segments that we operate. Growth is driven by a number of factors, of which the most important is organization's realization that if their employees are their key asset, then they should have efficient systems supporting the recruiting, development and management of this key asset. Technological advances with cloud computing is also a key driver, with customers looking for simpler and more agile approaches to implement new solutions using cloud-based HR solutions. This, in turn, drive the market for multi-country payroll solutions as it simplifies rollouts, ensures compliance, improves quality and eases the standardization of processes. As a result, we see the market of multi-process HR outsourcing grow with 7% to 8% annually. The market for multi-country payroll outsourcing grow with around 20% and the market for providing services on the basis of global HR solutions, such as the one offered by us, SAP SuccessFactors, grow with more than 70% annually. And as also previously mentioned, we expect coming out of the COVID-19 crisis that particularly big customers will look for ways to save costs and outsourcing is, we believe, will be a solution that an increasing aspect will go to. So then we continue to -- or looking then forward, we seek to maintain our track record of uninterrupted growth, building on the advantages of our sustainable business model. We continue seeking a diversified customer base with a focus on medium and large customers with complex needs. Customers looking for multi-country solutions are a key focus group. We will continue exploring the potential of the attractive market for multi-country payroll growing at, as I mentioned, 20%-plus a year and services delivered on the basis of global HR solutions. Vertical solutions addressing particularly industries as municipalities and market niches are being developed. We will seek to build on our position as a North European leader and grow to cover more geography and targeting European leadership. Our platform supports the requirements of more than 50 countries, including all countries in Europe. We love working with customers in long-term and enduring relationships. This is where we excel. We will focus on increasing net promoters with the goal of growing faster with the help of our existing customers. And this is a project that is also particularly dear to me and that I follow that personally. Thus supporting existing customers with new services and geographical coverage is a natural step to drive customer value and growth. We have previously identified up to 50% upsell potential through providing such additional services. And we will just love finalizing our 20th year in business with another year of uninterrupted growth. So in summary, we are still aiming high despite disruptions introduced through COVID-19. Our focus is on growth through expanding existing customer relationships, explore new verticals and selling our core HR and payroll outsourcing services, helping customers reduce costs and variabilize costs. We will continue chasing our communicated margin targets through ongoing projects for improved operational efficiency, including maximizing the use of our near and offshore capabilities. Key to growth in the Managed Services is scaling our payroll software as a service and business process outsourcing models successfully into Central Europe as well as U.K. and Ireland. Growth in Professional Services will focus on developing Professional Services as a global business unit and to explore further the potential of our very solid partnership with SAP. We are positioned to deliver on an expected increased demand as a result of COVID-19 for solutions that support reducing operating costs and allowing flexibility to work from anywhere. This is back to the outsourcing basic value proposition on which we have built the majority of our Managed Services business in the past. And last but not least, build on our experience of handling COVID-19, being a more agile, team-oriented and demanding organization, setting clear targets and following up on the results. So thank you. With this, we open up for questions. So you can -- you have a Q&A function on, as previously mentioned, on -- in your solution. So you are free to ask questions.

[Gunnar Manum, Chief Financial Officer]

We have a question here from the web. Please tell us how business has been influenced by COVID-19 over the last 8 weeks, besides [indiscernible] working from home.

[Hans-Petter Mellerud]

Yes. As I previously mentioned, I think the 2 key impacts that we have seen with [indiscernible] a negative margin or revenue impact is we have seen somewhat reduced load of travel expenses, and we expect that to also continue being on the low end as then our customers and employees are traveling less. However, we have also seen an increased amount of work in handling additional work for customers related to tackling the COVID-19 situation, including implementing new systems, functionalities, supporting short-term work. We have customers still organizing layoffs, et cetera. On the same side, we do not see that big of a difference. However, there is a tendency that with customers focused on handling the COVID-19 situation, their minds are on that rather than looking to acquire new system solutions. So -- but at the moment, we have a comfortable pipeline of work and do not see any major disruptions also on the cost.

[Gunnar Manum, Chief Financial Officer]

Another question. Looking at Zalaris revenue growth after the acquisitions you made a few years ago, it seems like the company is now growing organic -- not growing organically as strong as the market. What is your explanation?

[Hans-Petter Mellerud]

Yes. So are we not growing as much organic as the market? And what is the explanation? Yes, I think we can -- to a certain extent and beyond that. And I think the key reason, we have spent very much of our sales and management capacity on also prolonging agreements with existing customers. And we expect to -- and that has taken some focus away from chasing new name customers providing additional growth. So with that, the majority of this behind us and also the integration activities from our acquisitions behind us, we are now all set to -- and have been working on this for some time to continue the journey also of organic. So we have another also question here. Could you please comment on the growth trajectory of Zalaris as shown [indiscernible] purported to grow with high-single or double-digit rates. Managed Services has only grown by low single-digit rates over the past quarters. Thus, that implies us risking market share. And if so what is the reason? We do not see that we are losing market share, I think we still see that we are one of the winners when there are deals. But I think also, with that growth in the past -- and this is also a general reflection. We have been growing. In the past, the main steps in our growth has been securing large deals. And these large deals, they are not coming in -- it's not like we have a large population of large deals at the time. These tend to cluster. They tend to -- they have quite long time lines set. But when you win them, they see a big impact. So I -- as you will have seen through the announcements that we have made, we have won a number also of small- and medium-sized deals. We have also expanded services with existing customers in different territories and new services. But I think we must conclude we haven't won a really big, say, elephant-type deal over the last couple of years, and that also puts a mark on our revenue. However, we are back in the game. We have a good pipeline also now of big deals and are optimistic in our ability to win some of them. And we definitely do not feel that we are losing market share. So then I have another question here. How has the utilization of our -- of your consultants been during COVID-19? And how's the outlook for consultancy work in general, especially considering your comment of not being able to convert freed-up resource to chargeable work? Should we expect a larger hit in Q2? What is your main concern currently besides COVID-19? Are there any large renewals coming up? What is the right thing to do over lower contract margins on successful renewals? Well, [ Andreas ], that's quite a number of questions, but I'll do my best to respond to some of them. So I think the utilization for our consultants has been fairly good now during COVID-19. We have, as I said, had quite a bit of extra work. We -- immediately after on this COVID-19 being declared a pandemic and the government introducing restrictions. We launched also what we call our BCP, or business continuity planning, offering where we offered existing and new customers to support implementing system changes to handle this especially in their own systems as well as being a backup for their in-house payroll and HR departments if needed. And we have had a fairly good traction on this work. And that has been one part of also supporting the utilization for our services consultants. In addition, as I also mentioned in some of my slides, also in Professional Services, we have a -- the composition of the work that we do are -- have -- is basically to -- one is Application Maintenance Services that you'll see as of -- 66% of our revenue in Q1. These are long-term agreements that don't change our numbers. So that also secures the business for us in times like this. And then on the other project side, the most of these are also long-term projects. And also, on the sales side, we have a number of very interesting utilization on the project side. So we've been actually quite -- well, quite positive in terms of utilizing our consultants. Subject to that is have the skills that the market demands. So -- but clearly, being in this situation, we will -- we are not -- we are monitoring the situation closely and will do adjustments if we see that. So we don't see -- you asked if we expected a larger hit in Q2. I think we do not have a history of making predictions or guiding, so we do not comment on that for now other than, at the moment, we see that our pipeline of work is satisfactory. So our main concern besides COVID-19. Are there any large renewals coming up? I think our main concern is, as we have mentioned also in our slides here, is to continue our growth journey and use the opportunities that we have and we also deliver on the expectations that we have set for margin improvements, which we will continue forward. And actually, the lower contract margins for successful renewals, I think history also shows that the renewals that we have done has been done on similar margins as previously. So no, we don't expect that. So then we have a question. When will Zalaris have closed the margin gap compared with peers? Well, that's a difficult question to really respond to other than we have communicated previously our target budget of reaching 10% EBIT. And we are -- that is in our target. And I think -- well, I think that's it. So with that, thank you a lot for -- in sending questions and for watching this webcast, and we look forward to meet you again for our Q2 events. And if you should know any customers, any players in the market that are looking for ways to reduce and variablize their costs, this is the place to go.So thank you.