Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2017-Q4

[Hans-Petter Mellerud]

Good morning. My name is Hans-Petter Mellerud. I am the CEO of Zalaris, and I'm here together with our CFO, Nina Stemshaug. Thank you for joining us for this webcast presentation of Zalaris' 2017 Q4 results. We will also comment on our performance for the full year. Please observe that the conference is being recorded. You will find a link to the recording on the Investor part of our website. Let us go straight to the presentation. The fourth quarter of 2017 marks the end of an extraordinary year for Zalaris. We entered the year as a mostly Nordic player with some activity in Poland and the Baltics and an offshoring operation in India. We celebrated the new year as a European player with activities stretching across Northern and Central Europe, the U.K. and Ireland, India and Thailand. We have secured a position as leading provider of multi-process payroll and human resources outsourcing with a scalable platform in regions characterized by growth. Why have we taken these steps? We have done so in response to customers' expectations. New technologies and cloud solutions drive demand for new services and cross-country offerings. Basic outsourcing of payroll and HR services is still an important part of our business, for instance, the Santander agreement we announced in December, but our Consulting and Cloud businesses are also growing fast. I'm pleased to say that responses from our customers already have been positive. We have increased business with existing customers, as we have expanded our offering and capabilities to new geographies. We are already winning new customers with the competency and experience from our combined organizations that we expect to announce soon. We have also been challenged by other industry leaders to help them design, develop and implement sophisticated new integrated solutions that will significantly change their talent management processes. Now let's take a closer look at the numbers. First of all, please note that Q4 is the first quarter where we see the full P&L effect of our acquisitions in 2017. Sumarum was included from May 2017, ROC from October. On an annualized basis, revenues -- or the quarterly revenues have grown steadily quarter by quarter and reached NOK 193.5 million in Q4. And on an annualized basis, revenues in Q4 was NOK 774 million approximately, more than twice our revenues in 2014 when -- which was the year when we listed on the Oslo Stock Exchange. Our profit and margin in the fourth quarter and for the year are marked by the extraordinary transactions and also stated integration costs. Transaction costs are booked as other costs and amounted to NOK 9.3 million in Q4 and NOK 23.4 million for the year. In addition, we have used significant management time and external costs for the ongoing transition program expected to last until the end of Q4 this year -- excuse me, Q2 this year. The full year ordinary result before tax was negative NOK 6.5 million. This includes a NOK 12.1 million negative noncash euro-NOK currency effect in Q4 related to our euro-based debt used to finance the thoroughly euro-based sumarum and primarily euro-based ROC acquisitions. With sumarum and ROC becoming part of Zalaris, we have positioned the company as a leading provider of consulting and outsourced human capital management and payroll services with a scalable platform in regions characterized by significant growth. As shown on these charts, the Nordics are no longer the dominant market. Germany was, in fact, the largest for Zalaris in Q4 in terms of revenue. Norway's share of revenues have been reduced from 43% to 26% from Q4 '16 to Q4 '17. But these numbers conceal that Norway revenues have, in fact, increased 9%. The number of employees served by our HR consulting team was slightly up again in Q4 after having had the short dip in Q3. This is mainly due to the launch of a new large Norwegian customer on the Zalaris platform. Services provided for this new customer include payroll and SuccessFactors solutions. As ROC is mainly consulting business, the acquisition had no significant effect on this KPI. Zalaris group headcount, including ROC employees, was 829 at the end of Q4 in 2017. And with that, I hand over to Nina to cover the key financials before I return to say a few more words about the market and outlook. Nina, the floor is yours.

[Nina Stemshaug, Chief Financial Officer]

So thank you, Hans-Petter, and good morning. I will walk us through Zalaris' financial performance in the fourth quarter of 2017 and also comment briefly on numbers for the full year. We start looking at the operating revenues for the group. And as usual, all numbers referred to are in Norwegian kroner, unless otherwise has been stated. As Hans-Petter mentioned, Q4 is the first quarter where the full P&L effect of our acquisitions are shown. Q4 '17 revenue was NOK 193.5 million, which is an increase of 84% compared with Q4 '16. Revenues of the acquired businesses was NOK 81.6 million in the fourth quarter of 2017. Revenue increased NOK 42 million, 33% from Q3 to Q4, and the growth was mainly coming from ROC Group. But also Zalaris and sumarum showed an increase in revenues compared with Q3 figures. Growth in Zalaris pre-acquisition businesses, their organic growth, was 7.4% from Q4 2016 to Q4 2017. Reported revenues for the full year of 2017 were NOK 577.3 million, up from NOK 396.6 million the year before. As you will see on this chart, HR outsourcing remains our biggest single reporting segment in terms of revenue. But whereas this segment was 87% of group revenues in Q4 2016, the corresponding number for Q4 2017 was 55%. When we look beyond the relative numbers, we will see that HR Outsourcing has, in fact, grown through the year from NOK 92 million in the last quarter of 2016 in Q4 2017. Most of the change stems from the sumarum acquisition. Organic growth in the pre-acquisition businesses was around 1.5%. Consulting revenues in Q4 was NOK 54.1 million, which is a remarkable upswing of NOK 50.6 million from Q4 2016, which is mostly attributable to the acquisitions. The increase in Cloud revenues is partly driven by continuous strong demand from Zalaris' existing and new customers and also driven by our new businesses through the acquisitions. Whereas HR Outsourcing stands for about 85% of the revenues in the old Zalaris companies, the Consulting segment is the strongest segment revenues, but for both sumarum and ROC, with respectively 62% and 70% of the revenues being generated in this business area. Group operating profit for Q4 was NOK 12.4 million, excluding other costs, which amounted to NOK 9.3 million related to transaction costs, as you have heard already from Hans-Petter. HR Outsourcing showed the continuous strong margin, whereas Consulting and Cloud were negatively affected by a low utilization, caused by a low utilization of SuccessFactors capacity and post-acquisition integration activities. The integration activities relate to the alignment of the different service lines within the combined businesses as well as system integration of the new acquired companies on Zalaris ERP system to ensure efficient and fully aligned internal processes. The integration also includes a reorganization of the F&I Department. Operating profit for the full year 2017 was NOK 37 million, excluding other costs, which amounted to NOK 23.4 million. Our HR Outsourcing business performed well in the last quarter of 2017. Profit margin in our 2 other segments was marked by integration and associated activities, which will be temporary. In HR Outsourcing, Q4 '17 operating margin was 11.3%, which is 3.9 points higher than in Q4 2016. Revenues and profits in Q4 2017 were also positively impacted by a termination fee. But also when excluding this effect, the margin improved from the same quarter previous year. Fiscal year 2017 operating profit was NOK 38.8 million, corresponding to a 10.1% margin. In Consulting, the operating margin was 3.2% in Q4 2017 mainly because capacity was channeled to the integration activities, as already mentioned, and SuccessFactors training. Operating margin in the Cloud segment was 2.2% in the quarter. And for this segment, too, low utilization and integration costs in the acquired businesses had a negative impact on the margin, where pre-acquisition Zalaris business had a stable strong margin in the period. Group cash and cash equivalents was NOK 56.3 million at the beginning of Q4 2017 and NOK 37.7 million at the end of the period. The main changes are as follows. Cash flow from operations was positive NOK 20.9 million, mainly driven by changes in accounts payables and receivables due to the increased business and also other short-term debt. Cash outflow from financing activities was NOK 20.2 million, including NOK 22 million repayment of borrowings. Cash used for investments amounted to NOK 19.4 million, and the main investments were related to new portal release and CRM system, in addition to the system integration project for the acquired companies. The Campus Leipzig in Germany was finalized in October and was also partly included in the investments in Q4 2017. As one would expect, we have seen quite significant changes in our balance sheet through the year due to the acquisition of sumarum and ROC. Total asset at the end of 2017 was NOK 563 million, up from NOK 192 million one year before. And the equity ratio was reduced to 20.3% at the end of 2017, down from 52.4% the year before. Interest-bearing debt was NOK 223 million at the end of the year, up from NOK 1.4 million at the end of 2016. The increase from previous year is related to the 2 acquisitions. Going forward, the company will carefully manage its financial position with the aim of strengthening its capital structure. For your convenience, we have included this overview of the main changes in our balance sheet quarter by quarter. You will recognize the table from our Q3 presentations, and we have here only included the updated numbers for Q4. And other than that, the comments are the same. So with that, thank you very much. And Hans-Petter, the microphone is again yours.

[Hans-Petter Mellerud]

Thank you, Nina. Before I conclude with some reflections about outlook for the company and open for questions, let me share with you some pictures that illustrate current trends in the multi-process HR services. And as all good business, it starts with the customer. We have seen that talent management is becoming increasingly important. And we see that customers are favoring strategic partners with capabilities and expertise required to build the next-generation multi-process HR model on a digital platform. This, of course, is also driven by advances in technology. Whereas outsourcing of basic HR services used to be a key driver for growth, new technology and cloud solutions that could be offered across country borders emerge as a great opportunity. Tomorrow's HR services are highly automated. They offer seamless and integrated employee experience. They are delivered through the cloud and give deep strategic insight through high -- higher-end analytics. This also reflects on how our customers source services in our industry. As this chart indicates, the core Zalaris services and transaction-intensive processes, such as the provision of the cloud-based IT solution with processes for employee data maintenance, payroll and contact center, continue to be included in multi-process deal, while other interesting and potential growth areas, such as learning and recruiting process outsourcing, are typically sourced on a standalone basis. These trends are also reflected in market research that we have seen presented by industry analysts. The multi-process HR outsourcing market growth is estimated to be between 6% and 7%. Zalaris, with a strong footprint in North and Central Europe, has a reported approximately 9% share of the European market, and this is calculated prior to the effect of ROC and sumarum. We see a strong market demand for products and services within SuccessFactors, this varying somewhat with country. There are reportedly more than 50,000 SAP HR installations worldwide that are target for conversion to cloud-based solutions. The future of HR outsourcing models have digital pillars, such as cloud- and mobile-based solutions. I mentioned on the previous slide that the market for multi-process HR outsourcing has been and is growing by around 6% to 7% each year, but some markets are growing even more. According to Everest, an industry analyst, the market for multi-country payroll is continuing to grow. And this has been a key focus area for us and the source of many of our wins over the years. Our goal is to take our share of the deals in this attractive market that is growing at more than 20% per year. We will continue to deliver our services with the goal of covering more geographies. Our goal is to have global reach through our own or partner-based operations founded around our SAP SuccessFactors global HR core solution. Our new family members gives us access to Northern and Central European market that is approximately 7x larger than the old market addressed by Zalaris on a standalone basis. In addition, our methodology and capacity has been strengthened to serve our existing customer base and take our share of the high-growth market for consulting and outsourced human capital management and payroll services covering regions of multiple countries. Now let me round off with some thoughts about where we're heading. First of all, through our recent acquisitions, we have built a significantly stronger platform for continued organic growth. While transactions have been formally concluded and the company is already offering its broader range of services in new geographies, full effect of the integration is expected from mid-2018. Margin improvement will continue to be a priority going forward. A structured program is being implemented, and we have a clear ambition. We seek to maintain our -- or increase our historic organic growth rates and target industry-leader profit margins. We believe the underlying market trends are supporting our ambition. Driven by advances in digital technology, the European market for multi-country payroll and HR outsourcing is strong. Cloud solutions and mobile innovations are some of the key areas that will pave the way for growth. For Zalaris, this is reflected in a pipeline of business opportunities that remains solid. And we are optimistic about growth opportunities, both in the form of contracts with new customers and increased scope with existing ones. Thank you for listening. We will now open for questions.

[Unknown Executive]

Thank you, Hans-Petter. [Operator Instructions] The first question, what are the key priorities in the new markets?

[Hans-Petter Mellerud]

Thank you. The key priorities for the new markets is, first of all, to secure utilization of all our consulting resources through also effective staffing across borders and regions. And secondly, and in parallel, we are actively working to -- with a go-to-market strategy to secure a sell -- sales and new customers based on the Zalaris cloud-based platform.

[Unknown Executive]

And where do you see the strongest growth potential in terms of market segments going forward?

[Hans-Petter Mellerud]

We see the strongest growth potential in the cloud market segment. And as Nina has shown you, we have quite a strong growth in that market. And we see the cloud and also HR outsourcing, that will be the, say, the key foundations for growth. And in the cloud segment, we see we have significantly invested the business development capability that is currently dragging our margins down. But we expect also then, as a result of those increased growth, to see the margins increase significantly in that segment over time.

[Unknown Executive]

That was all questions for today. We will revert with our first quarter '18 results in May 3. Thank you very much for listening.

[Hans-Petter Mellerud]

Thank you.