Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2019-Q3

[Hans-Petter Mellerud]

Good morning. Thank you for joining us for this webcast presentation of Zalaris 2019 Q3 Results. My name is Hans-Petter Mellerud, I'm the CEO of Zalaris. Please do also welcome our interim CFO Anders Sjaastad, who will support me in the Q&A session. Please observe that the presentation is being recorded and you will find a link to the recording on the Investor part of our website. Let's go straight to the presentation. Main focus for the group remains on executing the 2020 EBIT improvement program with several ongoing initiatives to consolidate functions, reduce physical locations as well as increase market-facing activities. This will throughout the year result in net downsizing of approximately 6% of our Q1 2019 employee base and reduce our personnel costs with approximately 8% when fully executed from Q1 2020 and going forward. Our market success this quarter is represented by signing several new and renegotiated contracts in Germany as well as U.K. and Ireland closing their first local Managed Services deals. In Northern Europe, Zalaris also secured agreements for expanding services with existing customers to cover mobile and new HR cloud functionality. Financially, this is not much visible in Q3 revenues, but will gradually increase revenue from Q4 as well as positive impact on the bottom line. Looking forward, we will experience effects on financials in the last quarter of 2019 from supplier consolidation and renegotiations that are now completed. Consolidation of our internal SAP hosting infrastructure that will ensure access to our scalable platform in all our geographies is also well underway and projected to be completed in the first quarter of 2020. Additionally, we are increasing implementation of robotic process automation projects. With these initiatives, we are aiming to deliver on Vision 2020, our previously communicated EBIT improvement program, targeting delivering cost reductions of NOK 4.7 million relative to first quarter in 2019 as a baseline and an EBIT of 10% by first quarter in 2020. Revenues in Q3 was NOK 190.7 million with an adjusted EBIT of NOK 5.8 million giving us an adjusted EBIT margin of 3%. Adjusted EBITdA was NOK 19.4 million. We'll come back to this metric later on and describe what it is and what relevance we believe it has as a key metric that we will be tracking on going forward. Throughout the quarter, Zalaris managed to renew some of the long-term contracts as well as onboard new customers, which results in robust and healthy pipeline going forward. Emphasis has been on expansion with increased utilization of existing capacity. We have focus shift from internal to market-facing activities. In doing so, the scale effect results in increased profitability. Now let's take a quick look at the year-over-year numbers in comparison with the same quarter last year. We can see an increase in group revenues, which in the quarter amounted to NOK 190.7 million compared with NOK 176.2 million for the last year. Relative to negative performance last year, there has been a significant improvement on the EBIT, which is a direct result from postacquisition stabilization, ongoing Vision 2020 initiatives and increased utilization. Additionally, we present several of the key metrics, such as adjusted EBIT, EBITDA and EBITdA that all shows strong positive trends this quarter. Reported net profit for the quarter has been minus NOK 6.6 million for the period, negatively impacted primarily by unrealized foreign currency loss. This is then recouped in other comprehensive income and can be seen in total comprehensive income coming in at NOK 1.1 million. Operating cash flow under IFRS shows only a marginal increase, but a large increase after adjustments for items that do not reflect core operating activities. Geographically revenue distribution remains stable with largest portion of revenues coming from Northern Europe where revenues have grown year-over-year by 7.4%. This has been primarily driven by new sales in Managed Services. Outlook for the region is positive with a healthy pipeline, including securing agreements for expanding services with existing customers. Second largest region, Central Europe, has also performed significantly better than last quarter with a revenue growth of roughly 10% attributable to renewals and new sales. Region has been additionally positively impacted by developments in Poland with growth and healthy pipeline in Professional Services. Revenues grew in U.K. and Ireland as well, where first local Managed Services deals were closed. Distribution of revenues from largest clients on a group level remains relatively stable with a small decrease due to sales to new customers. So let's take a closer look at the overall group performance. As mentioned before, the overall revenues increased by 8.2% relative to the same quarter last year. Revenues have also increased compared to the previous quarter and just a small decrease compared to Q1 this year despite usual negative seasonality effects on Q3. Year-to-date revenues amounted to NOK 571 million with NOK 551 million for the same period last year. Growth has been fueled by strong performance in Managed Services in Northern Europe, several new large clients in Central Europe within the public sector and positive trends in U.K. and Ireland. Tailwind due to foreign currency appreciation against NOK has had only a minor effect of approximately 0.7%. Profitability has improved significantly compared to loss-making third quarter last year. Group EBIT for the quarter was NOK 4.8 million and adjusted EBIT NOK 5.8 million. Improvements have been primarily driven by increased revenues and cost savings initiatives, which had about 15% of the planned effects show in Q3, with targeted full impact to show in subsequent periods. For example, the trend of lagging cost savings effects can be seen in U.K. and Ireland where costs have been reduced by 5% compared to the previous quarter and 10% compared to first quarter this year. In Northern Europe, Denmark has significantly improved its EBIT margin primarily driven by improved contribution margin from Managed Services. Rationalization of operations in the Baltics resulted in one-off redundancy costs in Q3 and Q4 and will positively impact the EBIT from Q1 '20 and onwards. Positive operating cash flow as reported under IFRS has been NOK 8.8 million for the period, contributing to increase in cash balance of roughly NOK 5 million after investing and financing activities. This however includes items such as short-term debt repayment of NOK 11.3 million related to releasing the final payment for the acquisition of ROC in September 2017. Net investment cost in customer projects of about NOK 3.3 million and net cash interest payment of NOK 6.7 million. Adjusting for these items, we get the cash flow figure for the quarter that more accurately illustrates core operating activities of NOK 30.2 million, which represent a healthy development. Let's now take a closer look at financial performance for both of the business segments. Looking at both segments separately, we can see year-over-year increase in revenues in both. The growth in Managed Services is at roughly 3% compared to the same quarter last year and slightly lower than previous quarter this year, mainly due to seasonality impacts. Several new customer contract renewals and new sales in Nordics and Germany as well as first new contracts with Barden and ABB in U.K. and Ireland are ensuring high levels of recurring revenue in this segment. Revenues in the Professional Services segment amounted to NOK 55.7 million, up from NOK 44.7 million in the same quarter last year. Higher revenue growth of almost 25% in Professional Services has brought the proportion of revenues coming from this segment to 31%, effectively diversifying the revenue sources. Looking at the segment profitability of Managed Services. The segment EBIT is up by NOK 4.8 million to NOK 14.2 million in the quarter, which translates into an EBIT margin of 10.5%. An increased share of new customers within HR cloud as well as more efficient delivery on large well-established customers contribute positively to margin development within Northern Europe. EBIT in the Professional Services segment amounted to NOK 8.1 million compared to NOK 0.3 million in the same quarter last year. The main driver of increased profitability is improved utilization and focus shift from internal to market-facing activities within this segment. To sum up, we look at the latest updates on EBIT improvement program and add some concluding remarks. As communicated, we have launched an EBIT improvement program, Vision 2020, with the goal of returning to preacquisition EBIT margin run rate of approximately 10% from Q1 2020 and reduce monthly costs by NOK 4.7 million compared to the Q1 baseline. On the back of this program, we are continuing our work in order to streamline, harmonize and simplify the organization in order to improve synergies across countries with the aim of ensuring economies of scale, profitability and driving growth. Key elements that we executed on during the third quarter included: Consolidating our Lithuanian IT and technology operations to our Riga Service Center; consolidating our Managed Services operations in Lithuania and Estonia to our Riga Service Center in combination with using a local partner in Lithuania and Estonia; closing 3 small office locations in Germany; consolidated our Dresden SAP Application Maintenance Services team into our Leipzig Payroll & HR Innovation Center where we have capacity and free space in our own building; commenced process of organizational simplification targeting one legal entity per country with corresponding reduction of 6 legal entities, with 3 having an effect in 2019 and another 3 in 2020; continued reduction of overhead costs with focus on finance function, reduction of recurring costs expected to take gradual effects during Q4 and full P&L effect during Q1 2020; renegotiated and/or eliminated external supplier costs with effects showing from Q4 '19; increased utilization of our near and offshore capabilities in market-facing operations; ongoing work focusing on reducing group overheads as percent of revenue through focusing local capacity on market-facing activities instead of supporting group functions. In summary, the rightsizing of support functions and shift to market-facing activities impacts, as previously mentioned, approximately 100 employees with a net downsizing of approximately 50 employees or 6% of our employee base. The corresponding cost savings, when fully implemented, equals slightly more than 8% of our personnel costs. Approximately 15% of the improvements show in our Q3 results, with the rest to come in Q4, with close to full effect from Q1 2020 and some also further in 2020. Consolidation of our SAP hosting infrastructure is scheduled to be in place by Q1. In addition to drive down total hosting costs and increase service levels, we see this move to be the spearhead of delivering scalable cloud payroll services in Germany and U.K. Renegotiations with third-party suppliers was mostly completed and will gradually yield effect from Q4 '19 and onwards. In parallel, our investment in robotic process automation projects start to show and will have an increasingly effect in medium term. So let's -- the EBIT program has led to some improved ways of visualizing the underlying performance of the business and how to better exhibit the cash generation properties of the business. And thus, we have launched an EBITdA as an internal financial metric that provides us with better visibility of cash generation. It is derived by adjusting for net investments in customer projects. Net investments are movements in the balance sheet items pertaining to customer projects, excluding noncash items, such as amortization and recognized revenue. Cash flow from operations under IFRS can then be derived from EBITdA by adjusting for movements in other net working capital items, which are not related to customer projects. We believe the metric more accurately represents profitability properties of the underlying Zalaris business and we'll start reporting on this trend as a key metric going forward. With many of our EBIT improvement initiatives executed open, the focus is increasingly turning to our growth agenda. Key to delivering on our double-digit growth aspirations and continuing our 18 years of uninterrupted growth is that we focus our 2 business segments on execution of our strategy. In our Managed Services segment, we are increasing our focus on supporting existing customers with new value-adding functionality. To grow these customer relationships, we must ensure that they fully utilize the value of the solutions that they already have from us. For new customers, we are sharpening our focus around our key financial HR-based software-as-a-service and BPO offerings as multicountry payroll, time and attendance, travel expense marketed as Zalaris Payroll, Zalaris Time, Zalaris Travel, et cetera. We are proving seamless integration capability to all current HR solutions, SAP SuccessFactors, Workday and Oracle that are in the market and in use by our customers. Supported by the previously mentioned consolidation of system offering, this will serve as the basis for industry-specific offerings in our new markets. Clear segmentation and disciplined sales to target customers actively supporting the Zalaris management team is key to reach our ambitious targets. In our Professional Services segment, our focus is currently on establishing this as a global business unit closely integrated into our country organizations. Our goal is to ensure that we have the right capacity and competence levels to support our customers with advisory, adoption, change management, process and relevant configuration support. Our value proposition in this area will continue to focus around the SAP product portfolio. With our existing capability and SAP's recent commitment to their partners as an important part of the ecosystem, we believe that we have an excellent opportunity continuing our growth in Professional Services through helping our share of SAP's more than 400,000 strong global customer base taking advantage of cloud computing and ERP solutions. We experienced HR tech and solution market more buoyant than ever and are confident that we will be able to use our position as one of the market leaders to continue our growth journey. So to sum up, we are preparing to enter 2020 on a strengthened trajectory with renewed capacity and more optimized cost structure and sharper overall focus on customer value, service and business growth. We are on track with Vision 2020, including an approximately 6% reduction in FTEs and 8% reduction in personnel costs with full impact from Q1 '20 and onwards, with about 15% visible in Q3 results. Our focus is turning back to growth with the goal of delivering on our expectations of continuing our 18 years of uninterrupted growth. Key to growth in Managed Services is scaling own Zalaris software-as-a-service and BPO model successfully into Central Europe as well as U.K. and Ireland. Growth in Professional Services will focus around developing Professional Services as a global business unit and to explore further the potential of our solid partnership with SAP. The market for HR solutions and technology is more buoyant than ever, and Zalaris is perfectly positioned to capitalize on our position as a leader in this space. So with this, we are open for questions.

[Anders Sjaastad, Interim Chief Financial Officer]

So should I read up the question?

[Hans-Petter Mellerud]

Yes, please

[Anders Sjaastad, Interim Chief Financial Officer]

So there is a question here from [ Doug Marius Narang ]. He says, I write to you that -- you're right that the cost program is on track. And if I heard you correctly that the effect in the quarter was 15%. Last quarter, you stated that you should reach 40% into Q3. It seems that the program is somewhat delayed. How much do you expect to be taken out into Q4?

[Hans-Petter Mellerud]

Yes, I think what we referred to in terms of 40% was that we had executed 40% of the initiatives in the Q2, but that we did not see the 40% of the results from the cost reduction program in Q2. So I think this is in general, I'd say, a challenge with this type of programs, particularly when it relates to both supplier agreements and also employees that we are departing with is that there is a lagging effect between action and the initiatives have been executed like terminating an agreement or renegotiating an agreement or departing with an employee before you actually see the effect. So as we have communicated, we expect to see the majority of the effects in place such that we'll have the full -- with a goal of having the full communicated effect in place by Q1 2020. We also see that there will be some also lagging effects also into 2020. But as we currently speak, we still are of the opinion that we will meet our cost reduction targets by Q1 2020. Okay. So with that, I thank you very much. If you have any questions, further questions, please do not hesitate to contact us via [e-mail]. Thanks a lot for listening.