Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2021-Q3

[Hans-Petter Mellerud]

So we see that we have had some -- an issue with the sound here. So for those that have not been hearing us, we will actually then revert back to our first slide and start over again. So again, welcome to everyone. So with team Zalaris, continued our positive development in Q3 with new wins and expansion of agreements with existing customers. We see a trend shift and strong sales in Germany and the U.K. as the Zalaris brand is increasingly being recognized. Year-to-date sales resulted in contracted annual recurring revenue, increasing with another NOK 9 million to an all-time high of NOK 81 million. As we will see later, the positive development in sales is expected to continue. Even though the situation related to COVID-19 is normalizing in many countries, team Zalaris is still operating in a flexible mode of working from our offices and home. This seek to address concerns from our employees about health issues.Employee engagement is at an all-time high, significantly since last year in all markets and business units. In August, we had the pleasure of acquiring the ba.se GmbH team in Germany. And for the first time, 2 months of ba.se financials are also included in our quarterly results.Taking a closer look at the figures quarter-by-quarter. Revenue for the quarter ended at NOK 195 million, up 3% from the same period last year. EBIT continued to improve to 7.2%. This is the highest reported Q3 EBIT since 2016. As we had always got 8 new colleagues in Germany from ba.se, our full-time equivalents moved to -- correspondingly, up to 773 FTEs at the end of the quarter.So also taking a look and repeat what Zalaris is about. Our business model with long-term agreements and recurring revenue is in these times one of the favorites among investors. We have offered Software as a Service, Business Process as a Service and outsourcing delivery models since we were founded 21 years ago. 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 20 years of uninterrupted growth. Our approximately 880 employees deliver services from 13 countries, including France with a population of more than 66 million and frequently including the country deals, which we set up now in Q3. In addition, we can deliver 250 countries through partners with our key product concept.Our short-term aim is to be deliver services with own solutions and service centers for all EU and European economic area countries. 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.Triggered by COVID-19, large companies across the globe are reprioritizing their investments from 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 become the new normal, driving the need for fully digitized people processes. Even though you see many are delaying large new investments, project to support working from anywhere and secure business continuity are being prioritized.Team Zalaris is extremely well positioned to support existing and new customers navigate and position themselves in this situation. Our innovative products and services portfolio covered a whole product spectrum and value chain.Our large market unit is Germany, delivering 35% of our revenue. Germany and the U.K. are our markets with the largest potential. In addition to being a 7x size market compared to our home market in Nordics. A higher number of sweet spot customers with more than 1,000 employees are located here. As just mentioned, we established presence in France during the quarter. And as also said, France is very frequently included in multi-country deals.Poland and U.K. are our fastest-growing market units. Poland has doubled revenue since our acquisition in 2017 and is now 100-plus employees strong. Poland is particularly excelling in the professional services and application maintenance segment. U.K. is rapidly turning into a more Managed Services-oriented organization from experiencing strong interest in its cloud and outsourcing offerings. However, as you see from our figures, the Nordics is still different in delivering continued solid results and recurring revenue growth.This is the slide that reminds me of what fantastic company we have built. We have a diverse portfolio of customers in most industry segments. Some of the leading brands in the regions where we operate with a fantastic upside in supporting them in continuing digitized people processes, simplified work life and achieve more.Then let's look at our segments. We experienced a trend shift and strong sales in Germany and the U.K. as the Zalaris brand is increasingly being recognized. In the quarter, Managed Services revenue increased to NOK 132.5 million. The higher revenue is mainly due to the inclusion of ba.se, partly offset by headwinds from currency movements. Revenue is approximately in line with last year and adjusted for these countries.Our efforts in streamlining sales and cooperating across regions continue to deliver results, bringing Managed Services EBIT to NOK 16.4 million or 12.3% of revenue. The margins we achieved in the Nordics are higher than those achieved in other regions due to a more mature delivery model. And we will apply our model and experience in right shoring and automation in the Nordics to our new contracts in Germany and U.K. The positive margin development is expected to continue as the agreements go live. We estimate that our group organization and people health platform has capacity to support the business at least double our current size without incurring much additional cost. A key to positive margin development is thus to utilize this capacity by growing revenue from existing solutions and services. Approximately NOK 120 million of additional business delivered with target margin is needed to reach our goal, as expressed in our Q2 communicated road map to 10% EBIT. With the go live of our recently announced contracts, that currently are in the project implementation phase, we are well on our way to reach this target.In the previous quarters, we have continuously reported a strong pipeline. It was just with great pleasure that we can continue our signing stream from earlier in the year in Q3 for our people health platform-based solutions. In the quarter, we signed new long-term customer agreements about -- with about NOK 9 million contract value, that is annual contract value, and ARR when fully implemented. In Germany, our Managed Services team signed new outsourcing agreements with the automated supplier, HÖRMANN, and the not-for-profit organization, BLV. We are progressing well with the implementation of a highly automatic solution for Telefonica scheduled to go live in Q1.In the U.K., we signed a 5-year agreement to deliver a comprehensive SaaS payroll and workforce management solution to Sony Interactive Entertainment Europe. The people behind the Sony PlayStation that are trusted in Norway.In the Nordics, our position as a leading vendor to the finance and insurance sector was further strengthened through our expanded relationship with existing customer, Santander, to a Nordic solution. In Sweden, we completed our implementation project for the Danske Bank and had a successful go live with super customer feedback. Our agreement with Nordea to provide a new pension tailor solution is another new product addressing the needs of this sector and another example of growing our services with existing customers.Then let us take a closer look at Professional Services, our consulting practice. Adjusted for currency movements, Professional Services revenue were in line with the levels last year with revenue of NOK 62.9 million. Add to this deferred project revenue from supporting Managed Services implementation projects of approximately NOK 8 million for the quarter and a final organization that currently is running at full capacity. We have a short-term negative EBIT impact of higher than normal use of external consultants in combination with cost for trainee program building new consulting capacity in Germany. We are almost back to a normalized resource situation in Q4 with further normalization expected in Q1. Do also keep in mind that the deferred project revenue comes with no margins owned in Professional Services. That is also a contributor to the lower margin. Gunnar will talk more about this in his section.In Germany, our Professional Services unit successfully completed projects for Stadtwerke Krefeld and BITZER. We have been selected to support the Doctors Without Borders with the new SuccessFactors base HR solution, and we are very proud of supporting them. Our team continued its positive development, winning additional workplace application maintenance services and a number of new projects. The team also is increasingly supporting the Nordics with implementation and development in capacity.In Professional Services, we see the application maintenance services, AMS, helping customers maintain their payroll and HR systems, mostly on long-term or subscription basis, continuing at more than 50% of the total revenue in Q3. Developing AMS services as a group-wide offering is a key focus area for our Professional Services business unit. As mentioned previously, we are well underway to use our Polish Professional Services practice as the core of this offering. We have moved some of our Nordic customers successfully, resulting in improved access to capacity, faster turnaround of change orders and more satisfied customers. So important to acknowledge when evaluating our Professional Services business is that contrary to many consulting businesses, around 50% to 60% of revenue is recurring. And as mentioned on the previous slide, this is a key contributor to that 84% of our Q3 revenue in this segment come from customers that were also customers in Q3 last year.So with this, I hand over to our CFO, Gunnar, who will take you through the financial part of the presentation.

[Gunnar Manum, Chief Financial Officer]

Thank you. Taking a closer look at the figures quarter-by-quarter. Consolidated revenue for the quarter increased by NOK 5.7 million compared to last year from NOK 189.7 million to NOK 195.4 million, which is an increase of 3%. As already mentioned, the increase in revenue is due to a positive revenue growth within Professional Services in Germany and Poland and the inclusion of ba.se, partly offset by negative currency movements. In local currency, the Professional Service revenue in Germany grew by 14% and the revenue in Poland grew by 8% year-on-year. Demand revenue related to ba.se for the quarter was NOK 8.9 million. Revenue in the Nordic region was approximately in line with last year when adjusted for currency movements. EBIT ended at NOK 14.1 million, up by 6% compared to last year. And I will comment on this in more detail later on. We have signed a significant number of new BPO contracts during the year, which will result in increased revenue going forward. Last quarter, we started visualizing the future revenue effect of these contracts.During the third quarter, we added another NOK 9 million in expected annual recurring revenue, an increase of 13% from the previous quarter. And demand to additional ARR year-to-date is now NOK 81 million. This amounts to 50% of the total revenue for Managed Services in 2020. This contract are generally 5 years terms, which gives a total contract value of approximately more than NOK 400 million. In addition to this comes change orders relating to new contracts, which normally represents approximately 10% of the recurring revenue.The ARR for the third quarter of NOK 510 million, as seen in the top graph, is the an annualized recurring revenue from customers at the end of the quarter. The new signings and nonrenewals are those which are still to take effect. When these are fully implemented, the ARR is expected to increase to NOK 565 million, an increase of NOK 55 million or 11%. The timing of this increase is visualized in the bottom graph on the quarter that represent expected go-live dates for the new BPO contracts.All the new contracts that's now being implemented has a negative impact on the revenue short term, a significant revenue-generating capacity, i.e. consultants of being utilized on this projects. We do generate revenue from this, but the revenue is deferred. For the last 12 months, we have deferred revenue of NOK 36 million compared to NOK 8 million last year, an increase of NOK 27 million. The increase in deferred revenue year-to-date is NOK 20 million compared to last year. This revenue will be recognized on the contract periods from the start with the regular service delivery, but distort the revenue graph in the company.Coming back to the EBIT. The EBIT of NOK 14.1 million for the quarter was NOK 0.8 million higher than last year. The EBIT margin was also marginally higher than last year. The EBIT margin within Managed Services Northern Europe increased through improved customer margin, which is generally a result of operational improvements in our service delivery. The inclusion of ba.se also contributed. This was partly offset by lower margin in Germany. The Professional Service capacity in Germany should be normalized by the end of the year. And this, combined with an increase in the Managed Services activity in Germany, as noted by Hans-Petter, should improve the EBIT margin in Germany.A key to further positive margin development is to utilize our capacity and fixed cost base for growing revenue from existing solutions and services. Approximately NOK 120 million of the additional revenue delivered with our target contribution margin it is needed to reach our EBIT target of 10% This was previously noted by Hans-Petter. We expect the annual recurring revenue from the signed contract, as shown in the previous slides, and additional contracts in the pipeline go live our way to reach this revenue target.Looking at some of the other P&L items. Personnel costs for the quarter year-on-year is approximately 7% lower when adjusted for higher cash employee options expenses and the inclusion of ba.se. The decrease is mainly due to additional [indiscernible] of being capitalized on the customer contracts. The increase in other operating expenses of NOK 10 million is mainly due to the increase use of external SAP consultants in Germany and Poland and the inclusion of ba.se. Net profit for the period was NOK 0.7 million compared to NOK 1.8 million last year.Moving on to the cash flow. During the quarter, the company had a positive cash flow from operations of NOK 13.4 million, which was in line with last year. The cash balance at the end of the quarter was NOK 169 million. After the payment of the acquisition of ba.se of NOK 42.5 million, which is the net of cash acquired and other CapEx and lease payments. The net interest-bearing debt at 30 September was NOK 191.8 million, which correspond the ratio of net interest-bearing debt over adjusted EBITDA of 1.9.And then I turn to Hans-Petter to take the markets and outlook.

[Hans-Petter Mellerud]

Thank you, Gunnar. So let's take a look at markets and outlook. So the market for both Managed Services and Professional Services are growing at healthy rates. As we have based our growth ambitions mainly on growing our Managed Services recurring revenue, I will focus on the development of the 2 of the key addressable markets for this business unit today, the market for multi-country payroll and the multi-process HR outsourcing market.With multi-country payroll, we're referring to customers that outsource the responsibility for 2 or more countries. And with multi-process, customers that outsource 2 or more HR processes. Payroll and one of the process, as for example travel expense or time and attendance, being 2 of the most common ones. Zalaris is a key player in both markets. Many of our large customers are a combination of multi-process and multi-country as our goal from inception has been to deliver a complete solution for transactional HR services, including payroll, time and attendance and travel expense processing in one common solution for our customers.Our PeopleHub solution is the core of our offerings addressing these markets. We offer multi-process, primarily in the countries where we have own coverage and where all services will be delivered in PeopleHub. Multi-country payroll is frequently also associated with global payroll covering all countries where a customer has an employee footprint.In the Metsä case that we saw in the beginning of the year, we've been delivering payroll in 28 countries. The large countries we handle in our PeopleHub, the small employee member footprint countries, typically with less than 100 employees are handled in country partners. We have system solution integrated to our PeopleHub for a seamless user experience. With partners, we can currently cover more than 150 countries. With our own solutions, we can deliver to all Western European countries that are currently focusing on countries where we have our own service center capacity as the Nordics, Baltics, Poland, Germany, U.K., Ireland, France and India. As the Asia Pacific market, or APAC, is quite bouyant, we are also currently in a number of request for tender processes with APAC footprint.Through 2021, we have seen a dramatic shift in demand. In the Nordics, we attribute this to a more structured and focused sales center as we are fairly well known in our home market, particularly among the large potential customers. It is rare that we are not invited to tender if that customer has decided to outsource or procure a new SaaS-based solution for payroll and HR. However, this has not been the case in the U.K. and Germany. This market combined is about, as I mentioned before, 7x larger than the Nordic market and with a much higher density of customers hitting our segmentation criteria. As an example, there are more than 3,200 SAP payroll installations in Germany alone, more than 10x that of the Nordic in total. This size is easily EUR 1 million SME. It has taken time after our acquisition of sumarum [ Mandra ] with rebranding to Zalaris been known as a player in the market and to train our business developers in selling the Zalaris core people core offering. We now experienced a significant spike in incoming requests resulting in side deals and projects in contracting phase, where the customer is continuing the process with Zalaris as exclusive partner. Of course, we do not win everything we bid for. But at the moment, we feel, as we are growing from moderately size basis in these regions, that we almost see an exponential growth potential. Winning key deals with branded customers as Telefonica and Sony, acting as Net Promoter has been key. However, we also hear from prospective customers that our digital marketing presence and inclusion in industry adviser market guys are helping us getting on to the playing field. And of course, it helps with a separate user-friendly user interface and a robust solution enabling one common system across all locations where our customers operate. The IT guys know that for all the benefits related to integration and security.So if you look to the performance year-to-date, we see that our budget for the year, which was the same EUR 8.5 million of recurring revenue or annualized contract revenue -- value revenue, where it has been almost net by Q4, with 94% of this already being reached. And if we see that how this ACV is comparing to the ba.se in the relevant countries, we see that we have a significant growth rates just by Q3 in countries like Germany and in U.K., Ireland while we are still in the Nordics growing at 15% of our Managed Services by the end of Q3. So knowing that we still have a number of deals in our pipeline in exclusive negotiations, we are confident that we will weigh over deliver on our ambitions for sales in 2021 and expect this to continue into 2022.So with this, let's just sum up with our road map to margins on track. We turn our attention to realizing the full growth potential of our organization. We continue our daily work on being a better version of ourselves compared to what we were yesterday, represented by our #bestingourselves. We will continue our focus on creating satisfied customers at every customer touch point and journey. We also believe that the happy employees is key to having happy customers, maintaining long term. We will continue realizing our road map to 10% EBIT, adding more revenue with higher incremental margin, utilizing our fixed cost base and execute on further operative improvements. We will maintain growth momentum of selling new Managed Services solution into Q4 and 2022 with goal of realizing 10% overall organic growth from 2022 through growing Managed Services with 15% and Professional Services with 5%.We are exploring a number of acquisition opportunities. This is key to meet expected demand of our customers for multi-country solutions and will enable us to fully utilize our capital structure and organizational potential.So with that, thank you, and we open up for questions.

[Hans-Petter Mellerud]

So Gunnar, do we have any questions?

[Gunnar Manum, Chief Financial Officer]

Yes. First one, what is the reason for the headcount churn in Germany? And how expensive is it on a relative basis to replace those consultants with new hires?

[Hans-Petter Mellerud]

The main reason is Germany as well as many of the other countries where we operate is very competitive at the moment for the resources that we have. There is a strong demand, which, of course, also benefits us. And I think one of the effects that we have seen also through COVID and working from home is that we have lost some of the, say, cultural connections with employees, and this has resulted in some churn. However, we are -- we have built -- as we have mentioned, we have been both recruited and built new resources that aren't going to exactly the cost of that. But it is a significant cost to build and recruit new resources. So at the moment, the situation has stabilized. We are coming out of Q4 with more resources than what we have lost and are really back on track. And add to this, we have an extremely good development in employee satisfaction and engagement in Germany as well as in other countries. And we see that as very promising also for the future.

[Gunnar Manum, Chief Financial Officer]

Could you please provide us with the definition of the word significant with regards to your pipeline, several potential significant new contracts? So what is a typical deal size of the contracts in the pipeline?

[Hans-Petter Mellerud]

Yes, of course, significant is a subjective word, meaning different things to different people. But for us, significant, if you look at the typical deal sizes that we have, a typical, I would say, Zalaris deal will be on the low end, about NOK 3 million deal annual contract value. And a large deal would -- can typically be up to NOK 20 million to NOK 30 million annual contract value. When we passed NOK 10 million annualized contract value, that is when we would consider that a significant deal that would really contribute to our revenue growth.

[Gunnar Manum, Chief Financial Officer]

Another question. Referring to the trend shift in Germany and U.K., when do you think we can see a concrete results on that?

[Hans-Petter Mellerud]

As mentioned in our presentation, we experienced this strong trend shift, where that also is represented by the very strong growth in Managed Services in these countries. And also as mentioned, we have a very strong pipeline. We are selected as the preferred negotiation partner in a number of deals and hope to close those now in Q4.

[Gunnar Manum, Chief Financial Officer]

New question. How has your M&A work developed since the Q2 report?

[Hans-Petter Mellerud]

The M&A work is developing well. We are constantly on the outlook and in dialogue with acquisition candidates. We are working with advisers in various, say, countries as well as on a global level and expect to continue on our M&A growth journeys.

[Gunnar Manum, Chief Financial Officer]

And really sort of following on that, we -- another question, given your strong cash position and positive outlook, do you have any plans of calling the bond or changing the capital structure mix? And I can maybe answer that.

[Hans-Petter Mellerud]

Yes.

[Gunnar Manum, Chief Financial Officer]

And given the M&A activities, so it is difficult to exactly be precise on the timing of prices as like that. We do not intend to reduce the current level of debt as those funds would then be needed. But still, it could be that we would want to refinance the bond loan to get a better structure and basically better conditions. But for the time being, there are no concrete plans as of today.

[Hans-Petter Mellerud]

Okay. Thank you.

[Gunnar Manum, Chief Financial Officer]

I think that concludes the Q&A session.

[Hans-Petter Mellerud]

Okay. Thank you, everyone, for turning up. Please do not hesitate to contact us on [e-mail]. If you have any questions, then we will do the utmost to support you. Thanks again. Bye-bye.