Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2023-Q1

[Hans-Petter Mellerud, executive]

Good morning. My name is Hans-Petter Mellerud, I am the CEO of Zalaris. Pleased to also welcome our CFO, Gunnar Manum, who is here with me today for this webcast of Zalaris Q1 '23 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.

Let's first look at some of the highlights of the quarter. In Q1 '23, Zalaris delivered the fourth consecutive quarter with all-time high revenues of NOK 261 million. This represents 25% as reported and 17% in constant currency year-on-year growth. We are very well positioned to deliver on our target of generating NOK 1 billion in revenue for '23 as a whole.

Adjusted EBIT when excluding investments in building up our Asia Pacific entity, which I will cover in more detail later, was 8.2%, amounting to NOK [ 21 million ] for Q1. This was up from 7.1% and NOK 14.8 million in the same period last year. Our EBIT program as announced in Q3 22 is on track.

We are targeting an annualized adjusted EBIT of NOK 100 million by the end of '23. Our success in the market continued with the signings of new long-term customer contracts. We are way ahead of delivering on our sales target, reporting continued 10% growth with closing 75% of the annual sales budget and on this first quarter with 3 quarters to go.

All our regions finished the quarter with a new song pipeline of projects. New and significant agreements are targeted signed during the next quarters. Our robust model was proven through securing another year of historical churn.

In the quarter, we raised a 5-year EUR 40 million bond loan at favorable terms with strong interest in the market as part of refinancing the soon to mature or already matured EUR 35 million on loan. Within Managed Services, which includes our software as a service and outsourcing division delivered as previously mentioned, considerably above operations for growth in the quarter. In the quarter, we sold another NOK 70 million of annual contract value. This amounts to approximately 75% of our sales budget for the year, securing our growth path in the quarters to come. In addition to Siemens spin-out in the [indiscernible] which I will cover in more detail on my next slide, we signed a number of new agreements with significant upside during the quarter. For [indiscernible] global battery player, we then deliver a global payroll solution supporting an estimated 100 employees covering the 5 plus countries where they will establish operations.

For Ericsson, we are expanding our Nordic relationship to also covering Hungary and the 3,000-plus employees there. Expanding existing relationships is an integrated part of our strategy, and we have significant upside estimated at approximately 5 to 6x our existing served employee base in managed services for this. Ericsson alone has more than 100,000 employees worldwide, all of which we are serving approximately 20%. And in Hungary, it's one step in the right direction.

We've worked long and hard with one of the leading global retailers, having more than 100,000 employees worldwide in securing a master services agreement that puts the framework for [indiscernible] other countries. For Denmark, where we [indiscernible] deliver people on payroll as a SaaS solution covering the approximately 3,000 employees.

At the end of Q1, yes, the back of approximately NOK 105 million in annual recurring revenue from signings yet to go live and be recognized as revenue. All our regions finished the quarter with a strong pipeline of projects that we hope will be signed in Q2 and following quarters.

For Siemens spinout in Yunex, which have implemented a complete payroll and HR infrastructure and service or [indiscernible] employees covering the 46 countries in which they operate. This includes complete people functionality for time and attendance and payroll, including our AI-powered solution for chatbot and now sharing [indiscernible] seamlessly integrated, integrating true suite of SAP SuccessFactors solution for master data maintenance and talent management. Much the same that we have delivered for Siemens spinoff Yunex that we won last year and is in production with all injury now. This is just larger.

We cover all large employee populations with our people and payroll. Small [indiscernible] and countries will be delivered partner that is fully integrated into our [indiscernible] concept, allowing the customer to see a consolidated global overview of payroll at all times. As a result of the deal, we will establish a large solutions in new countries as the U.S., China, Czech and Chile that give us substantial capability to win other large global agreements.

In the Nordics is a good example of the deals that now winning on the base good and comprehensive user-friendly solution in combination with flexibility to adapt to customer needs, add to this, local presence either with own operations or through in-country partners and [indiscernible] that we now serve.

[indiscernible] look at the segments. Managed Services grew [ 10% ]as reported, 20% in constant currency, to NOK 186.7 million. New contracts, upsell and volume increases grew with 26.4%, while the volume of change orders was 38%. Managed Services accounted for 71% of our total revenue for the quarter [indiscernible] 5% in the same quarter.

Then it's time for Professional Services [indiscernible] professional Services revenue grew 9% and 3.7% in constant currency to NOK 70.5 million. Our Professional Services capability has been key to win our recent contracts and is increasingly also new to [indiscernible] implement managed contracts on the basis of people and our standardized template-based solutions. Most of the growth in this segment came from U.K. who grew with massive [indiscernible]. Germany had reached 2.5% as consulting resources increasingly is being used to implement Managed Services projects.

[indiscernible] I think several and as social consultants contributing to healthier levels. In addition, we had significant resources in our Indian delivery centers. This still has some short-term impact on our margins, but increasingly allowed us to increase change or the revenue and contribute to reducing the use of expensive external consultants talking [indiscernible].

And again, let me remind you, in Professional Services, we see that the application maintenance services or helping customers maintain their payroll, HR systems, mostly on long-term or subscription basis, continue generating around 54% of the total revenue. We are pressing well in developing global AMS services as a group-wide offering out of our Polish professional services[indiscernible] under the brand in Zalaris Care. Operation customers continue being [indiscernible] through 89% of our Q1 revenue in this segment coming from customers that were also customers in Q1 last year.

We are on track with our EBIT improvement program as communicated in Q3 last year. The program targets NOK 40 million to NOK 50 million improvement in EBIT by the end of '23. Key elements of the program include: improved customer margin in Northern Europe through full implementation of Zalaris 4.0 operating model and near offshoring by the end of '23, resulting in about NOK 8 million to NOK 10 million annualized cost savings. We are well on our way with this with more than 25 FTEs of work being moved offshore. We did not yet see much effect on the cost side as these are being realized over the next months.

Then [indiscernible] implement a as 4.0 operating model and near offshoring for our government operations by the end of '23, resulting in 8 to 10 additional savings. While Nordic operations are close to our target operating model of using 50% near and offshore, [indiscernible] Germany, we see close to 0. In one, we have reorganized our German operations to Zalaris 4.0. Short term, this is increasing our consent and is according to our plan. Medium term, over the next quarters, we expect to see one-off effects. Our work is moved out of revenue and the organization is rightsized.

Utilize existing capacity to serve new customers and additional change orders resulting in about NOK 5 million to NOK 10 million savings. Our capacity utilization is increasingly improving as we have been able to take on new volume without increasing head count correspondingly. Resources freed up in near off-shoring will also be utilized for this when possible. As an example, we were able to onboard insurer [indiscernible] with close to 3,000 employees in Norway in January without adding more hyper. Then add contribution margin from customers to go live net of nonroutine with an EBIT effect of NOK 20 million. Yes, we are underway with that with a number of is already in Q1. We see the effect of that and also more to come in Q2.

Then we'll reduce the use of external consultants and replace with own employees with 20% to 25% lower costs, resulting in approximately NOK 5 million annual savings. We are still using a high level of external consultants, particularly in Germany and Poland. In addition to recruiting experienced people in the market, we are focusing on building new capacity from inside through structured trainee programs and activities to retain critical talent. To date, we have let go approximately 10 external resources in Poland and replaced this with similar resources in our Indian shared services at a lower cost. In addition, we see improved resource utilization from organizing Professional Services as a global business unit, and this was also now done in Q1.

Finally, we are reviewing our overhead costs, targeting, maintaining or slightly lower our existing levels and thus maintaining the positive scaling effect of increased contribution from our operating entities to our overall EBIT margin. Even though we have grown significantly over the last year, our group costs remain relatively constant with no additional headcount added. The sum of the above initiatives amount to more than NOK 50 million. Thus, we are confident that with active management will achieve target levels. And our cost and margin focus will not stop with this program.

We are seeing what our best competitors can generate margins almost twice those of us and are naturally challenged to match these through additional focus on productivity improvements, automation, offshoring and exploring scale effects for our organization, which we previously have communicated is capable of handling at least twice our current revenue level stable situation.

So then let me remind you again over what company Zalaris has become. Our 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 delivery models since we were under 23 years ago. And to reiterate, more than 90% of revenue in Managed Services and around 50% of our revenue in Professional Services is recurring based on long-term agreements.

Our historic churn is low in the 2% to 3% range. Delivering payroll and HR services based on one common [indiscernible] reported by opened resources has been key to our success and 23 years of growth. We are being seen as one of the leading class -- for the -- 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 to operate seamlessly across borders.

Our approximately now 1,100 employees deliver services from 17 countries. In addition, we convert 250 companies who partners with our people and concept. Our short-term aim is to deliver services with our solutions in the economic area and G20 countries. We see large companies across the globe prioritize investments toward solutions for [indiscernible] purposes, digitalization of workflows, reduction of costs and securing business. Working from anywhere has been the new normal, driving the need 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 people of concept, enabling customers to manage their human capital across borders in one common cloud-based system solution with functionality covering the full employee life cycle. The solutions offered as Software as a Service with various additional layers of business process as a service and outsourcing and can be integrated to all major global HR solutions.

Our organization is structured in 2 business units: Managed Services deliver solutions and services based on people, ranging from Software as a Service to a comprehensive outsourcing solutions. We can integrate to whatever global HR solution a customer has, including SAP SuccessFactors Workday, Oracle, Cornerstone, Catalyst One and others.

Professional Services is an SAP partner, focused advisory and implementation of services of the SAP human management solutions, SAP SuccessFactors and S/4HANA product portfolio. Professional Services is also responsible for implementing new managed services customers.

Managed Services accounted for 71% of our revenue in Q1. Professional Services produces the corresponding 29%. And again, this is a slide that reminds me of what fantastic customer base we have. Typically, midsized and larger companies with more than 1,000 employees and operating in 2 or more countries. We have a diverse portfolio of customers in most industry segments, some of the leading brands in the regions 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.

So 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. The first quarter, it was the fiscal second quarter with all-time high revenue. The revenue for the quarter of NOK 261 million was an increase of 25% year-on-year and an increase of 17% when measured in constant currency. In the first quarter, 78% of the total revenue was invoiced in currencies other than NOK. And the share of non-NOK-denominated revenue is gradually increasing. .

Approximately 70% of the reported increase come from new customers and upsell and volume increases from existing customers relating to monthly recurring services in Managed Services. The remaining increase comes from an additional change orders from customers in Managed Services and additional consulting revenue in Professional Services.

Revenue in Managed Services increased by 20% while Professional Services had an increase of 4% in constant currency. Professional Services resources, particularly in Germany, are still being utilized on the implementation of new customers and change orders within Managed Services, which reduces external revenue-generating capacity within that division.

New contracts signed in Managed Services during the quarter was an all-time high with an annual revenue of approximately NOK 72 million and manage those contracts signed, but that are yet to go live by total annual revenue of around NOK 105 million.

This slide shows how these new contracts in Managed Services that are yet to be implemented and totaling NOK 105 million with impact on revenue going forward. In the top graph, we show on the left the current recurring revenue from Managed Services of NOK 664 million based on the annualized revenue figures for the first quarter. On top of that, we have NOK 105 million in additional annual revenue for contracts that will be implemented. Thus, the contracted annual recurring revenue going forward is NOK 769 million. There is no material churn at the end of the first quarter.

The timing for this additional net amount of NOK 105 million in annual revenue is shown in the bottom graph, with the new EUR 5 million contract with [ Innovatix ] planned to be fully implemented by the end of next year.

On top of the estimated recurring revenue of NOK 769 million build in Managed Services, we normally have change orders of approximately 10%, that is NOK 77 million and revenue from Professional Services and APAC of NOK 248 million based on the figure for the full year at 2022. This gives an estimated future annual revenue for Zalaris of approximately NOK 1.1 billion based on signed long-term Managed Services contract and calculated using the average exchange rate for the first quarter. This is 3% higher than the total revenue for 2022.

The adjusted EBIT, excluding APAC, for the first quarter was $21 million, an increase of 42% year-on-year. The APAC region had a negative EBIT of NOK 2.5 million. The adjusted EBIT margin, excluding APAC was 8.2% compared to 7.1% last year. The EBIT for Managed Services was NOK 23.5 million, which was NOK 8.4 million higher than last year, while the EBIT from professional services was NOK 10.3 million, an increase of NOK 3.5 million. Adjusted EBIT has improved both compared to last year and the 3 previous quarters, but margins are still negatively impacted by the rapid actual and expected growth in revenue. The positive EBIT impact for this revenue growth will gradually materialize through '23, together with our other EBIT improvement initiative as covered by Hans-Petter earlier.

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 145 year-on-year. This together with a negative currency impact from having more than 80% of our personnel costs denominated in currencies other than NOK, [indiscernible] of the new FTEs has come from the air business actually approximately [ ]% year-on-year when adjusted for the sale. Expenses were also negatively impacted by the current movements as well as an increased number of externals, the use of payroll partners, such as BDO on the global payroll contracts and increased travel.

Adjusted EBIT was NOK 18.5 million for the quarter. Adjusted [indiscernible] for a share-based payment cost of NOK 2.4 million and the amortization of excess value on acquisitions of NOK [ 3.2 ] million. The net loss of [indiscernible] included in discontinued operations of NOK 3.5 million for the quarter. Costs for [indiscernible] will be significantly reduced in the second quarter to a cost-cutting product that has been implemented.

Net financial expenses was [ 11.9 ] million in a currency loss of NOK 26 million, mainly related to the euro denom. Profit for the period was the NOK negative [ 22.5 ] million for the quarter compared to NOK 32 million.

We continue to [indiscernible] amount of NOK 124 million. Operating cash flows were NOK 84 million from working capital changes with investments mainly in system development of NOK 0.8 million. The net effect of the refinancing of the bond loan during the quarter was an increasing cash of NOK 40 million. The new EUR 40 million bond on expired in March 2028.

Net interest-bearing debt at stable mark was NOK 333 million. Now that concludes the financial section, and I leave the word to Hans-Petter to give you some of our markets and outlook.

[Hans-Petter Mellerud, executive]

So again, thank you, Gunnar. At this time, I will use the opportunity to talk about our investments in building our presence and what we are doing in the area of sustainability before I start. As part of our geographic expansion strategy, we decided to start APAC operations headquartered in Australia in Q1 last year. We [indiscernible] going into Ukraine right afterwards and focus rapidly moving from growth to profitability. This was probably knocked up in a moment.

However, we have access to a super experienced team that could jump out our operations and decided to go. Over the last months, this has developed into a good [indiscernible] with 18 colleagues covering 4 countries that we have one fantastic new customers to date. We have made significant advances in revenue development quarter-by-quarter and [indiscernible] to make breakeven in Q2 reaching more than NOK 6 million into revenue and targeting a [ 0 ] EBIT for the year. Our total investments since inception to date is around NOK 8.4 million. But subject to us reaching our target revenue for the year, we have developed that business having been on delivering on our EBIT target for around 3x EBIT or [indiscernible].

In addition, we have established presence in a substantial market that is of strong interest to our European headquartered buyers and a team that also is contributing positively to the development of our global business. We are excited to follow the development of this investment over the next months. So go, go, go team Zalaris.

In '21, [indiscernible] accept in establishing sustainability as a key element of the Zalaris strategy, targeting building sustainability thinking into all our products and services. In fact, we also realized that some investors who looked at us as an attractive investment that would fit the sustainability category, as our environmental footprint was low, our recurring revenue capability is strong, combined with our focus on maintaining good employee work conditions through exporting our Nordic venues to near and offshore locations.

And -- but as a key stakeholder, [indiscernible] customers, people processes, we could be an active player in supporting people-related initiatives. Over the last 12 months, we have launched our first direct ESG and sustainability-focused solutions as part of our product portfolio, including automated business travels CO2 calculation as part of our people and travel expense solution. [indiscernible] carbon footprint maps functionality tracking employee computing and dashboards for easy reporting and monitoring of aspects related to diversity, inclusion and equality to support our customers staying in compliance to the Norwegian activity and Statement Act and EU reporting regulations in the coming. To us, this is just a start, also making sustainability and good business for Zalaris. You can find more information on our work in the area in our recently published sustainability report.

So again, running at the last slide, let us sum up. We have had a super start of the year. With all-time high revenue reported, we are well on our way to become a NOK 1 billion company in '23. New contract wins in Q1 and our reported growth was across our communicated 10% growth target. And remember, growth is coming mainly from Managed Services. Our long-term recurring revenue machine, providing payroll services that everyone needs to stay in business, targeted at 15% annual growth but currently growing at more than 20% year-on-year.

As you have seen previously, we see almost exponential growth coming from outside the Nordic home market as we are increasingly betting on and our global solutions to the [indiscernible]. with the EBIT improvements that we are seeing the effect of in Q1, and we expect a result of our EBIT improvement program to deliver NOK 46 million of annual[indiscernible]. We maintain our target of delivering 10% EBIT and becoming NOK 100 million EBIT company.

As you can see, we are maintaining groups our open center provided IT and infrastructure, operating the [indiscernible] platform relatively same. So subject to [indiscernible] growth, we believe we can scale our margins further. Despite the mixed macro picture, it is key to remember that we are operating a resilient business. In macro environments with the recession and crisis like tendencies, we have seen in the past that the months for outsourcing solutions has increased as customers are focusing on their core business, looking to reduce and variabilize costs. We see some cost inflation and wage pressure but are well protected through contracted price indexation process in the majority of our agreements.

In addition, we still have sufficient room for margin improvements in our customer agreements through increased automation and use of lost near and offshore reasons. This will help us maintain margins in the event salary increases to pass indexation of prices. [indiscernible] team Zalaris are very proud of and really optimistic about the future. So thank you, [indiscernible] questions.

[Gunnar Manum, executive]

So we take a question. In the last quarter, you showed that the EBIT in Germany was significantly lower than the rest of the countries. Could you tell us a little bit more about how the -- they are performing in Germany?

[Hans-Petter Mellerud, executive]

Yes. So from, say, competitive reasons, we will not be sharing all the details from our countries on an ongoing basis. But as we also showed you last time, [indiscernible] and the rest of the group actions taken. We are on our way, but we are still far away from reaching our target, but we see the improvements that we have both targeted unplanned.

[Gunnar Manum, executive]

[indiscernible] Now the pipeline in devices.

[Hans-Petter Mellerud, executive]

Yes. So without going into very much detail, we have an all-time opportunities, both in our Nordic home market with some really interesting deals but still continue to see the strong also inflow in the regions outside the Nordic. Both in Germany, we see some very, very substantial opportunities size-wise with those that we have closed in this quarter and the same in the U.K.

[Gunnar Manum, executive]

Will you pay a dividend for 2022? And I think I can answer that.

The Board has decided not to pay a dividend for 2022 to ensure that we are well within the incurrence test of online and which is partly driven by the currency movements since the end of the year and today.

Thank you. And that concludes the [indiscernible] questions. That concludes the Q&A session.

[Hans-Petter Mellerud, executive]

If you have questions or you would like to set a second separate meeting with us, do not hesitate to contact us on [e-mail].. Again, thank you for watching, and have a great day. Thank you.