Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2018-Q4

[Hans-Petter Mellerud]

Good morning, everyone. My name is Hans-Petter Mellerud. I am the CEO of Zalaris, and I am here together with our CFO, Nina Stemshaug. Thank you for joining us for the webcast presentation of Zalaris 2018 Q4 results. We will also comment on our performance for the full year. Please observe that the conference is being recorded. You will find the link to the recording on the investor part of our website. Let's go straight to the presentation. 2018 has been a year of growth and extensive integration activities, and as usual, all numbers referred to are in Norwegian kroner unless otherwise has been stated. Full year revenues amounted to NOK 745 million compared to NOK 577 million in 2017. The uplift reflects our 2 acquisitions of sumaram and ROC in 2017. The last quarter of 2018 marks the end of an exciting and demanding year for Zalaris. Extensive efforts have been made to integrate our new businesses enabling our new Pan European organization to fully utilize our scalable model. The integration of our acquired companies has been more time consuming than what we anticipated. But we have finally reached a stage where our full focus can return to where it should be, on our customers. And with increased focus on customers, we see increased sales and growth in revenues.Increased sales activity and a strong pipeline have led to signings of several new contracts in the fourth quarter with go-live in 2019. One of these are the global real estate agency, KnightFrank, with 18,000 employees headquartered in the U.K. The combination of new and continuing business demonstrates our strong market position in Europe and also the long-term nature of relationships with our customer base. Now let's take a quick look at the numbers. As already mentioned, we had growth in revenues for 2018 of 29% to 2017. Q4 amounted to NOK 194 million, marginally higher than Q4 2017. For the fourth quarter of 2018, we improved our profitability and margins slightly compared to Q4 2017. For 2018, adjusted EBIT is affected by the extensive integration activities over the course of the year. Pretax profits for the quarter was strongly impacted by a noncash reevaluation of net debt to EURO. However, we see a corresponding positive effect on total comprehensive income showing NOK 12.4 million for the quarter. So all in all, we look back at the year with growth in revenues and the fourth quarter with growth in profitability and margins. Even though the end of 2018 was a step in the right direction, we still have much untapped potential. So let's take a closer look at our regions. Nordics and Baltics, the largest region in Zalaris, delivering 60% of the company's revenues. The increase is driven by higher cloud revenues and additional change to our sales to cloud customers. Central Europe was affected by temporary lower consulting capacity. We are working on getting Central Europe back on track in the following quarters of 2019 when it comes to capacity. Growth in U.K. and Ireland is achieved by improved utilization and strong pipeline built in the last quarters. So let's take a closer look at the key financials for the fourth quarter. We will start by looking at the operating revenues for the group. Revenues in the fourth quarter amounted to NOK 194 million, marginally higher than Q4 2017. We see that cross selling our products and services increased in the last quarter, even though the benefit that comes with acquisitions have not materialized fully yet. The revenue growth is below our ambitions, but we now have finally reached a stage where the majority of our focus has returned to where it should be, on the customers. Full year revenues amounted to NOK 745 million, driven by our previously mentioned acquisitions. Adjusted EBIT for the quarter, excluding other costs, was NOK 10 million compared to NOK 9.4 million in the corresponding quarter last year. Profit margins improved in Q4 versus Q4 2017. Efforts throughout 2018 proves potential for further margin improvement going forward. Net financial items for the quarter was negative NOK 19.3 million, including an unrealized noncash foreign currency loss of NOK 12.7 million related to debt denominated in EURO. Net loss for the full year 2018 was NOK 1.3 million compared to NOK 12.2 million loss in 2017. The previously mentioned currency related noncash effect had a similar positive impact on total comprehensive income for the quarter ending on NOK 12.4 million. We had an increase in total assets by NOK 31 million during Q4 2018 to NOK 726 million at the end of the year, an increase in equity from NOK 95.6 million to NOK 108.4 million. Equity ratio consequently increased slightly to 14.9%. Cash and cash equivalents at the end of the year was NOK 107 million, largely unchanged quarter on quarter. Cash balance declined due to negative operating cash flow after investments and interest payments of NOK 5.1 million. Net interest-bearing debt at the end of 2018 was NOK 271.6 million, up from NOK 253 million in Q3. Based on Zalaris' communicated dividend policy, the board of directors proposed no dividend distribution for 2018 with the goal to further strengthen the company's ability to deliver on its growth aspirations. We will then turn to the segments and add some further comments to explain details in our operations. Fourth quarter revenues in the HR Outsourcing segment amounted to NOK 106.5 million this year, up NOK 1 million from same quarter last year. The increase is partially from cloud licensed revenue recognized with effect from Q4 2018. Revenues in Consulting declined by NOK 4 million to NOK 50.1 million, a decrease mainly caused by temporary reduction in consulting capacity in Central Europe. Strength in the U.K. Consulting business partially compensated for the decline in Central Europe. The Cloud Services revenues in the fourth quarter this year amounted to NOK 37.6 million, up NOK 3.6 million from the last quarter in 2017. Higher project activity and timing of revenues were the main drivers behind this growth. EBIT for HR Outsourcing segment in the fourth quarter was NOK 7.1 million, a decline in margin mainly explained by additional customer startup costs, price reductions and renewed contracts and higher project amortization costs. The Consulting Service segment had an EBIT of NOK 10.8 million in the fourth quarter, up from NOK 1.9 million in fourth quarter 2017. Year on year increase partially driven by higher volumes and utilization in U.K. and Polish consulting business which improved margins. The Cloud Services segment had an EBIT of NOK 7.3 million compared with NOK 1.3 million in fourth quarter of 2017. The increase is mainly driven by higher revenues. Now as usual, let's take a look at a brief market update. Working with advisors to maintain the stability amongst buyers in our target market is a priority for Zalaris. Being cited as a star performer by one of the leading industry analysts, Everest, in the multi-process outsourcing provider landscape, our core business, is therefore naturally a win for us. Everest defines Zalaris as a star performer in Q1 based on our relative year on year movement on the PEAK Matrix. Everest's growth productions for the multi-process outsourcing market is 6.6% to 7% globally and 7% to 10% in Europe. The subsegment, multi-country payroll, also historically a key market for Zalaris, where we believe we are in the lead with the best technology platform and solution concept, is growing with 20% plus. Our strategic initiatives and focus is naturally aimed at how we can take and increase our share of these markets Everest estimates Zalaris to have a 9% share of the European market. Moving forward, we see a strong demand resulting from enormous activity in the market for Cloud Based HR solutions with the main players being SAP SuccessFactors, WorkDay and Oracle. Zalaris currently has and will continue serving customers independent of their global HR solution through extensive APIs and interfaces to our core Cloud Solutions for payroll and transactional HR. It is also key for us to continue building capability around the SAP SuccessFactors suite and related solutions such that we can offer a fully integrated suite of transactional and strategic HR functionality to large customers. As for example, the leading Norwegian Bank, DMB, that just went into production with a comprehensive integrated suite of our cloud solutions replacing all of their legacy HR and payroll technology with ours now in this Q1. Just from SAP alone, there are reportedly more than 50,000 SAP HR and 10,000 SAP payroll installations worldwide that are a target for conversion to Cloud Based solutions. With our large geographical footprint and capability, we are perfectly positioned to support customers on this journey. With these opportunities in front of us and still only scratching the surface of the potential of the important German and U.K. markets, we target continuing our remarkable journey, growth journey with 18 years uninterrupted growth. Profitable growth, that is. To strengthen our customer focus and thus the ability to grow, we are tuning our organization resulting from an increasing number of customers signing agreements for multicountry solutions. As for example, a key 2018 win of Carlsberg in Denmark where we from 2019 will be delivering services in all Scandinavian countries. Or the expansion of Circle K into Ireland in 2018 resulting in delivering services in Scandinavia, Baltics, Poland and Ireland. Or StarKraft with go-lives in 2018 including service delivery in Norway, Sweden, Germany and U.K., in addition to global solution for master data and travel expenses covering 12 additional countries. Or a large maritime services provider with travel expenses in 13 countries to go live in Q2 2018. We are organizing ourselves correspondingly with the goal to secure a consistent service at the right cost across all our covered geographies. At the same time, we see the differentiation between cloud and HR BPO becomes increasingly complex to describe for customers and our investors, as customers tend to demand service from both of these segments. Thus, we will, from Q1 2019, organize and report our Cloud and HR BPO segments together with all our outsourcing activities as part of a new segment called Managed Services. Managed Services will be organized and managed as a groupwide business unit with a goal to speed growth and adoptions in our new markets. In parallel, we will operate our consulting business in the new segment Professional Services. That is where we are in the process of defining the most effective operating model for the consulting business with a goal to secure local presence and entrepreneurship combining our group capability and scale. Our aim is also to improved reporting and visibility to investors in this segment which has grown larger through our acquisitions. With the goal to better visualize the significant aspect of recurring and long-term customer relationships, also found in this segment, and that we partially struggle to communicate today. Our business units will be supported by strong entrepreneurial country market organizations securing close contact with customers and the market. So to sum up, Zalaris achieved strong growth in 2018 due to full year effect of businesses acquired in 2017. The fourth quarter of 2018 marks the end of an exciting and demanding year for Zalaris. Much time and effort has been spent on the process of integrating our new businesses in Germany and the U.K., enabling the new Pan European organization to fully utilize Zalaris' scalable model. The integration process has been more time consuming than anticipated, but we have shifted most of our focus back to where it should be, on the customers. Management sees a notable shift in that tension on customer relations, business development and pipeline in our new markets, especially in U.K. and Germany. This has already materialized in new contracts and renewals in Q4 2018 and the company expects more contracts and renewals in the coming next quarter. Zalaris is determined to demonstrate that Q4 2018 was the first step in the right direction after a challenging period. Our key objectives in the next quarter and through 2019 is getting back on to our historic growth track and improving margins back to pre-acquisition ambition levels. Thank you for listening. We will now open up for questions.

[Operator]

Thank you, Hans-Petter. We will now open up for questions from the audience and please also note that you might submit questions through [e-mail]. So let's jump to the first one. There are some financial items for Q4 driving the results. How do you expect this to develop going forward?

[Hans-Petter Mellerud]

I think if you look at our financial items, we -- of course, we see the large NOK 12.7 million unrealized foreign currency loss on our bond issue that we did in September that's also secured financing and growth aspirations for a long time going forward. And this unrealized currency loss, because the bond is in EURO and we are still reporting in Norwegian kroner, is say by design so to speak. Our intent was of course not to incur currency losses, but our intent was to taking up debt in EURO for assets that are in EURO to actually hedge then the bond issue. And then in addition to this, our finance costs you will also see a one-off effect in also refinancing our previous debt amounting to about NOK 2.3 million, NOK 2.5 million such that a normalized finance cost will be NOK 2 million to NOK 2.5 million lower for the quarter than what is shown in Q4.

[Operator]

Thank you. Another one. Can you please elaborate on the market potential in continental Europe and your experience so far?

[Hans-Petter Mellerud]

Yes, I think we are amazed by the potential and number of sweet spot sized customers located in this market, both the customers operating, or potential customers operating in each of these countries themselves, but also customers with multicountry potential. We see a huge potential. I think we must just realize that our brand is not still yet well-known in none of these markets and we are taking steps to improve brand recognition. That's -- day to day, it's hard work. But our prime focus for the moment is to focus on becoming known by industry advisors as well as selling to our existing historic customer base which also encompasses a long list of very well-known companies in this region. So all in all, I think we've just seen the start of activities in both Germany and the U.K. and we see some real, real interest now.

[Operator]

Thank you. Another question. Should we expect lower structural profit margins in the HR Outsourcing in 2019 and going forward as a result of lower rates in contract renewals?

[Hans-Petter Mellerud]

No. I think we will see some temporary effects based on the price reductions that we have given, but I think in general, with the digitization efforts going on, continuing digitization in Zalaris as well as with the public entities that we interact with and so on, it is to be expected that the per unit cost of transactions will go down as we digitize more. But we are in the lead I would say in the digitization efforts. I believe that we will be rather able to, through scale and then automation over time, to see higher margins than what we have been delivering to date. But for a period where we actually invest, and in some cases also have to give price concessions to customers prior to us being able to realize the benefits as a way to win new long-term agreements and relationships with the customers, we might see for a limited period of time on a contract by contract basis somewhat of a lower margin. But from a structural point of view, we do not believe that we will have a lower margin and I think this view is also supported if you look at some of our global competitors that are still doing very well.

[Operator]

Thank you. We will revert in May with our Q1 2019 results. Thank you very much.

[Hans-Petter Mellerud]

Thank you all for listening, and we look forward to welcoming you back in May. Thank you.