Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2022-Q1

[Hans-Petter Mellerud, executive]

Good morning. My name is Hans-Petter Mellerud, I am the CEO of Zalaris. Please do also welcome our CFO, Gunnar Manum, who is here with me today for this webcast presentation of Zalaris Q1 '22 Results.

We are using Teams for this purpose, and hope that we will deliver on your expectations. There is a Q&A function that you can use to ask questions that we will respond to 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.

So let's first look at some of the highlights of the quarter. The NOK 115 million annualized contract value that we saw last year started materializing in Q1 as planned. This resulted in our all-time high quarter to date, with a revenue of almost NOK 210 million, representing 12% growth from Q1 last year in constant currency. Add to this, almost NOK 19 million deferred revenue from implementation projects and you find that at team Zalaris, that is really humming.

Our adjusted EBIT ended at almost NOK 15 million or 7.1%. This is expected to increase throughout the year to our 10% target when our new projects go live and revenue from these start being recognized, bringing us to NOK 900 million plus with annualized revenue by Q1 '23.

Our signing streak continued in the quarter. When including the new top 10 deal, Stora Enso, which signing-wise slipped the quarter, we are on track delivering on our target of selling NOK 100 million ARR needed to maintain our growth in recognized revenue also next year. Add to this, our Professional Services units continued winning new long-term customer relationships that I will come back to later.

As mentioned as part of our Q4 presentation a couple of months ago, we are still excited of the potential from our acquisition of German SME payroll and HR SaaS provider, vyble, in February. Our cash position is healthy, and the Board has proposed a dividend of NOK 1 per share.

We are not directly impacted by the war in Ukraine as we have no operations, nor work with any suppliers located in Russia, Ukraine or Belarus. With a distributed network of service centers operating on one common IT solution, we can move work quickly between various locations, if we should need to, and still deliver on customer commitments. We are continuously monitoring the situation and are maintaining our business continuity plans. We are actively supporting where we can, promoting democratic and human values.

We left '21 with a promising pipeline capable of continuing our sales streak this year. In the Nordics, the big win that we worked on this quarter was Finland headquartered Stora Enso. Stora is a leading global provider of renewable solutions in packaging, biomaterials, wooden construction and paper. We are transforming Stora's transactional HR function through implementing Zalaris PeopleHub payroll and time, fully integrated with their global Workday-based HR solution to serve their 6,000 Finnish employees.

20 FTEs are transferring to us, and Stora moves right into our top 10 deal list and immediately strengthened our position in the global production industry vertical. Revenue effect, however, with moderate margins in the transition phase to be seen already from June this year.

Our U.K. team of big kahunas continue to impress through signing KAEFER in the U.K. and Ireland for the implementation of a SaaS solution, including SuccessFactors and PeopleHub. KAEFER's 3,000 employees serve a large and growing range of industries, with asset integrity services as access solutions, insulation, inspection and testing, protective coatings and asbestos management.

In Germany, we continued strengthening our position in retail with ba.se and Zalaris Incorporation signing iconic retailer KaDeWe. I guess that everyone that has visited Berlin has visited this fantastic powerhouse of retail. As part of the agreement, we will implement SuccessFactors for KaDeWe in combination with fully service payroll on our PeopleHub platform delivered by ba.se.

For us, a testament to our capability and ambition of serving retailers with fully digital people solutions, such that they can maximize the time management and employee spend serving customers, not performing administrative work. We also upsold our Travel expense solution as Business Process as a Service to support Yunex's 3,100 employees in 22 countries.

Our Professional Services continued delivering on expectations in the quarter. In addition to securing successful implementation of our numerous ongoing payroll & HR transformation projects, Professional Services continued its strong developments signing new agreements with leading brands, such as Hitachi, Veolia and Porsche in the U.K. In Poland, we signed new and extended agreements with companies as ABB, Lidl and Ryanair to provide Application Maintenance Services.

In Germany, we extended our long-term agreements for Application Maintenance Services with the state of Rhineland-Pfalz, extended our agreement with Bitzer AG for our global rollout and finalized a new payroll solution to serve ThyssenKrupp Elevator’s 7,000 employees.

In Australia, our fresh 5-person strong team started off with a bang and signed a good-sized agreement to implement payroll for Google. Way to go.

So let's take a look at our segments. Managed Services revenue grew with 17.4% compared to last year when adjusting for currency movements. The inclusion of ba.se added 10.2%, while 7.2% relates to new customers and volume increases. Net new signings with annual recurring revenue amounted to NOK 6 million during the quarter. In addition, [indiscernible] Stora Enso closed early April. Churn was immaterial, and we had positive feedback on agreements that were up for renewal.

More than 90% of revenue is recurring based on long-term agreements, while the remaining somewhat less than 10% relates to change orders. Leaving the quarter, our pipeline continued to stay strong in all markets. And let me repeat that we are well underway to secure our target of additional NOK 100 million ARR to be sold this year.

Then it is time for Professional Services, our consulting practice. Adjusted for currency movements, Professional Services revenue were in line with the leverage last year of NOK 62 million. Add to this, deferred project revenue from supporting Managed Services implementation project of approximately NOK 18 million for the quarter, and you find an organization that is currently running at full capacity.

We strengthened our resource situation, adding several trainees and associate consultants contributing to healthier cost levers. In addition, we have significant resources in our Poland and Indian delivery centers, and started exploring using robotics process automation to improve productivity in implementation projects.

In Professional Services, we see that the Application Maintenance Services, or AMS, helping customers maintain their payroll and HR systems, mostly on long-term or subscription basis, continue generating more than 55% of the total revenue. We are progressing well in developing AMS services as a group-wide offering out of our Polish Professional Services practice, and I'll cover some more of this later.

Our long-term relationships with customers is yet another time visualized through 90% of our Q1 revenue in this segment coming from customers that were also customers in Q1 last year.

We are continuously evaluating how we can scale our platform investments through gaining access to new markets, with the AMO strengthening our multi-country payroll value proposition and be seen as a player with global capability. Research from average show that in 2018, 64% of European-headquartered multi-country deals has an Asia Pacific footprint.

We have also seen these opportunities come our way, but have not been successful winning them. Many of our existing customers do have significant footprint in APAC. To date, we have mainly entered new countries in following our customer strategy. Finland, Poland and Ireland were established in this manner. The challenge with this strategy is that unless the customer has sufficient scale, margins will be diluted until we reach critical mass. This requires winning new customers in a country where you most often are relatively unknown, it can take time.

Another alternative is to establish presence through Professional Services, building on our relationship with SAP, selling and implementing cloud solutions based on SAP's success factors, making our brand known and generating customer relationships that later can be converted into Managed Services, and ba.se serving incoming multi-country deals from our existing organization.

With our new operations in Australia and Singapore, we are attempting this. With 20-plus year industry veteran, Mike Ellis in the role as Executive Vice President of APAC at the helm, we now have an experienced 5-person team that has started selling our services. This has already secured our first agreement to implement payroll for Google Australia. Others are in the pipeline, and we're working really well with SAP.

Another area that we have invested in during the quarter is to build a unit for Application Maintenance Services in Poland, as previously mentioned. Based on the strong experience we have providing services to ABB and Hitachi, we figured we should use Poland as a base to get access to good people that can serve our existing customer base in the Nordics, U.K. and Germany.

Focus on producing change orders and maintaining our customer systems, increasing customer satisfaction with timely and cost-effective services. In Q1, we had significant one-off costs setting up the unit. We expect to see positive revenue and margin effects from this investment over the next 2 quarters.

As discussed in our last quarterly presentation, we have, over the course of many years, looked for a good alternative to serve the market for small- and medium-sized businesses, with fully digital payroll and HR processes. We often get incoming calls for such services. Our PeopleHub-based solutions are super for the mid and large market and complex employee agreement needs, but requires significant upfront project investments to establish fully automated processes.

When the vyble opportunity came up in early January, offering us a way into an innovative solution designed and built for the SME market, we acted swiftly and showed interest. We were able to acquire vyble in form of an asset deal, including taking over around 20-plus employees at a price of about NOK 1.1 million or onetime sales. vyble now have approximately [ 550 ] customers and a total of around 1,200 employees served that generated around NOK 1 million of ARR, it is still cash negative.

vyble has innovative sales and marketing and sell both direct to end customers and to indirect channels as accountancies and professional services organizations. Since February, we have been working to consolidate the business and make it ready for a new growth journey. Our intent is to leave vyble as a separate entity. However, utilize our scale, competence and market presence to the max, with the goal of supporting rapid growth and bringing the company into an EBITDA positive situation as soon as possible. We are still early days and are working on focusing on the company and setting plans for the future. We intend to report on vyble separately to secure transparency with the business that we are coming from.

Let me remind you again over what company Zalaris has become. A business model with long-term agreements and recurring revenue is favored among many investors. We have offered Software as a Service, Business Process as a Service and outsourcing delivery models since we were founded 21 years ago. And to reiterate, more than 90% of our revenue in Managed Services and around 55% of our revenue in Professional is recurring.

Delivering payroll and HR services based on one common IT platform the Zalaris PeopleHub, supported by local competent resources, has been key to our success and 21 years' of uninterrupted growth. From the outset, our goal was to help customers reduce their direct process costs by 20% to 30% by outsourcing their payroll and HR processes to us. At the same time, enabling them to operate seamlessly across borders.

Our approximately 880 employees deliver services from 14 countries, now also including Australia. In addition, we can deliver to 150 countries through partners with our PeopleHub concept. Our short-term aim is to deliver services with own solutions and service centers for all European economic area and G20 countries.

We see large companies across the globe prioritize investments toward solutions that enable unified access to payroll and HR data for analytical purposes, digitization of workflows, reduction of cost and securing business continuity of business-critical payroll. Working from anywhere has to continue normal, driving the need also for fully digitized people processes. Team Zalaris is extremely well positioned with our innovative product and services portfolio that cover the whole payroll and HR value chain.

Our services are built around our PeopleHub concept, enabling customers to manage their human capital across borders in one common cloud-based system solution, with functionality covering the whole employee life cycle. The solution is offered as Software as a Service with various additional layers of Business Process as a Service and outsourcing.

Our organization is structured in 2 business units. Managed Services deliver solutions and services based on PeopleHub. Professional Services is an SAP partner focused on advisory and implementation services of the SAP Human Capital Management and S4 HANA product portfolio. Professional Services is also responsible for implementing new Managed Services customers. Managed Services currently accounts for about 2/3 of our revenue and is growing more than 15% per annum. Professional Services produces the remaining 1/3 of revenue and is growing single digits.

Our largest market unit is Germany, delivering 35% of revenue. Germany and the U.K. are our markets with the largest potential. In addition to being 7x the size market to our Nordic home market, a higher number of sweet spot customers with more than 1,000 employees are located here. Poland and U.K. are our fastest-growing market units. Poland has doubled revenue since our acquisition in 2017 and is now more than 100 employees strong. Poland is particularly excelling in the Professional Services and Application Maintenance segment, as previously mentioned.

U.K. is rapidly turning into a more Managed Services-oriented organization from experienced strong interest in its cloud and outsourcing offerings. The Nordics is still generating more than 50% of our revenue, delivering continued solid results and recurring revenue growth.

And this is a slide that reminds me of what fantastic customer base we have. We have a diverse portfolio of customers in most industry segments, some of the leading brands in the region where we operate. Many of these with a significant upside in supporting them in continuing digitizing their people processes, simplify work life and achieve more.

With this, I hand over to our CFO, Gunnar Manum, who will take you through the financial part of the presentation.

[Gunnar Manum, executive]

Thank you, Hans-Petter. Revenue for the first quarter was an all-time high quarterly revenue and increased by 4% year-on-year in constant currency and 8.8% as reported. The increase is an effect of the inclusion of ba.se and from new contracts that have gone live and other volume changes. Managed Service revenue increased by 14.5%, while Professional Services had revenue approximately in line with last year when adjusted for the currency effects.

In the last few quarters, we have tried to visualize how the significant new signings in Managed Services last year will impact the revenue going forward. In the first quarter this year, a further NOK 6 million in annual revenue was contracted. That does not include the revenue from Stora Enso, which was signed in April.

In the top graph, we show on the left, the current annual recurring revenue for Managed Services of NOK 531 million based on the revenue figures for the first quarter. On top of that, we had NOK 71 million in annual revenue from contracts that have not yet gone live. After deducting non-churn of NOK 5 million, the contracted annual recurring revenue going forward is NOK 597 million.

The timing of this additional NOK 66 million in annual revenue is shown in the bottom graph, with many of the new large new signings expected to go live in the first quarter of 2023. On top of the recurring revenue of NOK 597 million, we have normalized change orders of approximately 10% of the recurring revenue, that is NOK 60 million; and revenue from Professional Services on NOK 246 million based on the annual figure for 2021. This gives an estimated future annual revenue for Zalaris of just above NOK 900 million based on signed long-term managed service contracts. This is 60% higher than the total revenue for 2021.

As we have shown in previous quarters, we are spending considerable resources on implementing new customer contracts won in 2021 and activity level remains high, as can be seen from the graph on the slide, which was the amount of revenue and cost deferred during the last 12 months. This shows that the volume of new customers being implemented has increased quarter-by-quarter since early 2021.

Implementation projects are invoiced to our customers and generate cash through milestone payments, but the revenue and the costs are deferred and recognized in the P&L from the go live date and of the contract period. For the first quarter, demand to revenue deferred was NOK 18.5 million compared to NOK 8.6 million last year, an increase of 115%. This also has a negative impact on EBIT and EBIT margin short term as the resources spent on these projects do not generate an immediate margin.

The adjusted EBIT for the first quarter was NOK 14.9 million, an increase of 8% year-on-year. I'll come back to the bridge between EBIT and adjusted EBIT on the next slide. The EBIT margin was 7.1%, which is approximately in line with last year. The new contracts that go live in 2022 and 2023, exemplified by the NOK 71 million in additional annual revenue shown earlier, will support an increase in EBIT margins to reach our 10% target.

The EBIT for Managed Services was NOK 15.1 million, only marginally lower than last year and impacted by the NOK 1 million in additional costs for establishing the Application Maintenance Service center in Poland that Hans-Petter mentioned. The EBIT for Professional Services was NOK 6.8 million, an increase of NOK 1.2 million year-on-year and was positively impacted by increased revenue and customer margin in Poland.

Moving on to some of the other key P&L items. With the increased revenue and ongoing transformation projects for new customers, the number of FTEs have increased by around 120 year-on-year, including ba.se. A large share of new FTEs have come from nearshore and offshore locations. However, personnel costs were only marginally higher due to additional NOK 13 million in personnel costs being deferred compared to last year and a favorable currency effect of approximately NOK 3 million.

Other operating expenses increased by NOK 15 million year-on-year. Of this amount, NOK 10.5 million relates to external SAP consultants invoiced -- involved in the revenue-generating work. Particularly in Poland, many of our resources are self-employed, and the increase is partly as a result of the increased customer demand in that region. Inclusion of ba.se also added NOK 2 million in other operating expenses.

As reported on the previous slide, the adjusted EBIT was NOK 14.9 million for the quarter. The bridge between the adjusted EBIT and EBIT -- and the EBIT of NOK 4.7 million is the negative EBIT from vyble of NOK 3.8 million, the investments in the buildup of the Application Maintenance Service center in Poland and operations in Australia of NOK 1.5 million. We have made these adjustments to better visualize the performance of the underlying business compared to prior quarters. In addition comes the employee options costs and amortization of excess values on acquisitions also adjusted for in prior quarters.

In the financial report, vyble has been included as a new segment named HR & Payroll Tech investments. Net profit for the period was NOK 9.5 million compared to NOK 17.5 million last year, after unrealized currency gains from the bond loan of NOK 11.8 million compared to NOK 17.5 million last year.

We continue to have a strong cash position. During the quarter, the company acquired own shares through the share buyback program for NOK 17.7 million and acquired the assets of vyble AG for NOK 10.1 million. This, together with a negative operating cash flow of NOK 4.4 million and normal CapEx and lease payment, resulted in a cash balance of NOK 134.7 million at the end of the quarter.

The net interest-bearing debt at 31 March was NOK 213 million, which corresponds to a ratio of net interest-bearing debt or adjusted EBITDA of approximately NOK 2 million. The Board has proposed a dividend for 2021 of up to NOK 1 per share in total, with NOK 0.35 to be paid immediately following with the shareholder approval and up to NOK 0.65 are planned to be paid before the end of the year pursuant to a proposed Board authorization.

Now that concludes the financial section, and I'll transfer over time Hans-Petter to give you some perspective on our markets and outlook.

[Hans-Petter Mellerud, executive]

Thank you, Gunnar. Let's round off, as I said, looking at the market. So as also talked about in my previous presentation, we see a strong interest in our payroll and HR business process outsourcing services. This has resulted in significantly strengthened pipeline and record-high signed agreements over the last 12 months. This segment is also confirmed by industry analyst, Everest Group, who in their 2020 Key Issue Survey reported that 57% of senior European stakeholders and key buyers in large European companies expected the use of HR business process outsourcing to increase in the time to come.

Triangulating this with the results of our recent Nelson-Hall industry analyst report, expecting the market for multi-country payroll to grow with 10.7% in 2023 to a market size of around $6 billion. Nelson-Hall states that the growth is driven by international expansion requiring a global footprint for payroll, which will reduce the number of payroll suppliers, need of increased visibility of the global workforce supported by advanced analytics and ability to seamlessly integrate payroll with new global HR solutions.

Zalaris has operated with the vision supporting international businesses delivering multi-country payroll since our inception 21 years ago. This is bread and butter for us, and we are well positioned in this market.

So again, arriving at my last slide, let us sum up. The Zalaris brand is increasingly well known in our markets. We see a particular change in U.K. and Germany, where our pipeline show the potential of exponential growth. We are well on our way to implement our NOK 115 million annual contract value sold in '21, making 11.5% growth for this year squarely in sight, and targeting an annualized revenue of more than NOK 900 million when entering '23. Margin improvements are on track and will materialize when new projects start generating revenue. Additional improvements are underway through new initiatives as increased automation and smart shoring.

Zalaris is well capitalized to continue growing via M&A, increased geographic coverage to fit needs of our customers and add new IP to cover white space in our own solution footprint. Our long-term agreements with recurring revenue streams from a diversified, rock-solid customer base and positive cash flow is good as gold in a market with increased uncertainty.

History shows that outsourcing-based business model, as ours, thrive particularly well if times are tough. We and team Zalaris are proud of our achievements and optimistic about our future.

So thank you. And with this, we are open for questions.

[Gunnar Manum, executive]

Yes. And we do have a few questions. The first one, can you give a comment about the short-term market trends? Are we likely to see further reduction in employee basis going forward? And how should we look at this effect compared to the structural trend of increasing outsourcing and more digitization of people processes?

[Hans-Petter Mellerud, executive]

I think at least from our own customer base, we see no material change in the number of employees with those customers now. We see them more or less having stabilized that over the last couple of years. In terms of digitizing, we see that -- yes. Maybe you should repeat that last part of the question, Gunnar.

[Gunnar Manum, executive]

How should we look at this effect compared to the structural trend of increasing outsourcing and more digitization of people processes?

[Hans-Petter Mellerud, executive]

Yes, I think that is -- I'm not exactly sure if I understand the question fully. But in terms of -- as I have reiterated or stated also in my presentation, we see a strong interest for outsourcing-based solutions aiming at digitizing people workflows fully.

[Gunnar Manum, executive]

A new question. Noted that churn was immaterial, but can you give a comment on what kind of customers that churn and why?

[Hans-Petter Mellerud, executive]

Yes. The type of customers that churn are mainly customers that are part of some, say, new structure being sold to others or also being part of -- being consolidated into one common solution by other vendors. But for us, smaller, it's -- we talk about smaller customers.

[Gunnar Manum, executive]

Yes. And a final question. Margins appear somewhat lower than last year. Any particular reason for that? And what can we expect going forward?

[Hans-Petter Mellerud, executive]

I think if you look at the actual customer margins of our long-term customers, customers that we have had for some time, they are very healthy and are also developing well. However, we see that the margins of new customers that we take on typically will be low for the first 3 to 6, 9 months. As we invest quite a lot in making customers happy in this period, we need some type of burn in to make processes work really well. So as our relationships with those new customers mature, you typically also see margins trending towards our target and such that we are on our -- through the deal period, will reach the target margin for the deal.

[Gunnar Manum, executive]

And I think that concludes the Q&A session.

[Hans-Petter Mellerud, executive]

Okay. Thank you. Again, let's remind you if you have any questions, further questions, please do not hesitate to contact us via [e-mail].

And thanks a lot for watching. Have a great day.