Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2022-Q4

[Hans-Petter Mellerud, executive]

Good morning. My name is Hans-Petter Mellerud, I am the CEO of Zalaris. Please do also welcome our CFO, Gunnar Manum, who is here with me today for this webcast presentation of Zalaris Q4 '22 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, please let's move on to the presentation.Let's first look at some of the highlights of the quarter. In Q4 '22, Zalaris delivered the fourth consecutive quarter with all-time high revenues of NOK250 million. This represents 22% year-on-year growth in constant currency. We are well positioned to deliver on our target of generating NOK1 billion revenue by the end of '23. Adjusted EBIT, ex Asia Pacific, was NOK15.9 million for Q4. This was up from NOK10.2 million in the same period last year. Our EBIT improvement program is on track. We are targeting an annualized adjusted EBIT of NOK100 million by the end of '23.Our success in the market continued with the signings of new long-term customer contracts, delivering on our sales targets, supporting continued 10% growth and delivering recurring revenue in many years to come. Our robust model was proven through securing another year of historic low churn. All our regions finished the quarter with a strong pipeline of projects. New and significant agreements are targeted signed during the first quarter of '23.Within Managed Services, which includes our SaaS and Outsourcing division, we delivered considerably beyond our aspirations for growth last year. In the quarter, we sold another NOK12 million of annual contract value, or ACV, bringing total sold ACV for the year as a whole to more than NOK100 million. This means reaching our sales target needed to continue our target growth for '23 and beyond. In addition, we extended 18 of our 19 customer relationships up for renewal, securing another NOK180 million long-term ACV and low churn going forward. At the end of Q4, we had a backlog of approximately NOK72 million in annual recurring revenue from new signings yet to go live and be recognized as revenue.In the Professional Services, our consulting division, we sold NOK280 million of new projects. This represented more than 130% of our sales target for the year. Of this, approximately NOK160 million was with some of our existing large clients, demonstrating the long-term nature of the relationships we have with this customer group. As previously mentioned, all our regions finished the quarter with a strong pipeline of projects. New and significant agreements are targeted to be signed now in Q1 '23.Let's take a look at our segments. Managed Services revenue grew with 28.5% compared to last year when adjusted for currency movements to NOK186 million. The majority of the growth came from new contracts, up-sale and volume increases, contributing with 17.2%. More change orders contributed with 6.6% and a one-off revenue recognition relating to a customer project with 6.3%. As such, we see the faster-growing segment, Managed Services, accounting for 75% of our revenue for the quarter versus the 71% that we have seen in previous years.Then it's time for Professional Services, our Consulting practice. Adjusted for currency movements, Professional Services revenue remained relatively constant, but grew 2.2% to NOK61.9 million. Our Professional Services capability has been key to win our recent contract and is increasingly also being used in Germany and U.K. to implement managed services contracts on the basis of PeopleHub and our standardized template-based solutions. We strengthened our resource situation, adding several trainees and associate consultants contributing to healthier cost levels. In addition, we added significant resources in our Poland and Indian delivery centers. This still has some short-term impact on our margins, but increasingly allow us to increase change order revenue and contribute to reducing the use of expensive external consultants, resulting in improved margins in quarters to come.And again, let me remind you, in Professional Services, we see that Application Maintenance Services or AMS, helping customers maintain their payroll and HR systems, mostly on long-term or subscription basis, continue generating around 50% of the total revenue. We are progressing well in developing AMS services as a group-wide offering out of our Polish professional services practice, as mentioned earlier, with new significant wins with Hitachi and ABB and services sold to the likes as Ryanair last quarter. Our long-term relationships with customers continue being visualized through 75% of our Q4 revenue in this segment coming from customers that were also customers in Q4 last year.Our improvement activities are organized as a formalized EBIT improvement program, reporting to me, targeting NOK40 million to NOK50 million improvements in EBIT by the end of '23. Key elements of the program include: improved customer margins in Northern Europe through full implementation of Zalaris 4.0 operating model and near-/offshoring by the end of '23, resulting in NOK8 million to NOK10 million annualized cost savings. The Zalaris 4.0 model refers to a model where responsibility for delivery to a customer resides nearshore and using on- and offshore resources where needed instead of our traditional model with ownership of customer delivery onshore.Then secondly, implement Zalaris 4.0 operating model and near-/offshoring for our German operations by end of '23, resulting in NOK8 million to NOK10 million annualized savings. While Nordic operations are close to our target operating model of using 50% near-/offshore, Germany is currently using close to 0. Our key focus is to change this and to implement this where possible, taking account of language challenges and limitations in our customer agreements.Then secondly, we will continue utilizing existing capacities to serve new customers and additional change orders resulting in NOK5 million to NOK10 million of annualized savings. We have, as previously mentioned, built up significant capacity to cater for moving Application Maintenance Services from the Nordics and Germany to Poland. This work is progressing and is increasingly bearing fruit. Freed-up capacity from this and other nearshore activities will be used to serve new customers that are currently in the project implementation phase. Similarly, is the case with freed-up resources in our German [ Liepzig ] and [ Hagen ] service centers. As a result, we can deliver significantly more revenue from new customers without adding headcount to our German operations.Add contribution margin from customers to go live, net of nonrenewals, with an EBIT effect of about NOK20 million. As Gunnar will cover next, we have close to NOK [ 70 ] million of sold contract value yet not recognized as revenue. When this goes live throughout '23, we have estimated a positive margin impact to be NOK20 million; then reduce the use of external consultants and replace with own employees with 20% to 25% lower cost, resulting in approximately NOK5 million annual savings. We are using an extreme level of external consultants at the moment, particularly in Germany. This [ activity ] is led by our group HR in cooperation with our professional services organizations, supported by active strategic workforce planning, focused on building new capacity from inside through structured trainee programs and activities to retain critical talent.Last but not least, we are reviewing our overhead cost, targeting maintaining or slightly lower our existing levels and thus maintain the positive scaling effect of increased contribution from our operating entities to our overall EBIT margin.You will see that some of the above initiatives amount to more than NOK50 million. Thus, we are confident that we, with active management, will achieve the targets. And needless to say, our cost and margin focus will not stop with this program. We are seeing what our best competitors are able to generate and are naturally challenged to match these through additional focus on productivity improvements, automation, offshoring and exploring scale effects from our organization, which we previously have communicated, is capable of handling twice our current revenue level in a stable situation.Almost every day, when I wake up, I think of the fantastic opportunity that we have of improving Germany, a market 4x that of the Nordic, profitability-wise, to the levels of that we have in the Nordic. Likewise, growing U.K., which is at 3x the Nordic market size to a market penetration that of the Nordic. For the year, our target is to bring Germany into a position of not diluting our EBIT target of 10%. That means delivering an EBIT on a country level of 10% to 11%. This will generate an additional EBIT north of NOK20 million, bringing Germany to an EBIT of 15% to 20%, which is the level of the Nordic, will generate an additional NOK27 million of EBIT at the current revenue level. That will be our next step and require first that we succeed with our current plan of implementing Zalaris 4.0 and harmonize all supporting IT solutions, as previously described under our EBIT improvement program.With German pricing being similar to that of the Nordic, we see our new deals sold on our scalable PeopleHub platform and delivered on the basis of our Zalaris 4.0 operations model with a potential of delivering Nordic level margins from day one.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 outsourcing delivery models since we were founded 22 years ago. And to reiterate, more than 90% of our revenue in Managed Services and around 50% of our revenue in Professional is recurring. Delivering payroll and HR services based on one common IT platform, Zalaris PeopleHub, supported by local competent resources, has been the key to our success. We have been seen as one of the leading global players in our industry.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. Our approximately now 1,100 employees delivers services from 17 countries. In addition, we can deliver to 150-plus countries through partners with our PeopleHub concept. Our short-term aim is to deliver services with own solutions and service centers for all European economic area and G20 countries.We see large companies across the globe prioritize investments toward solutions that enable unified access to payroll and HR data for analytical purposes, digitization of workflows, reduction of costs and securing business continuity of business-critical payroll. Working from anywhere has become 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 PeopleHub 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 solution is 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 HR solutions.Our organization is structured in 2 business units, Managed Services delivery solutions and services based on PeopleHub rising from Software-as-a-Service to comprehensive outsourcing solutions. We can integrate whatever global HR solution a customer has, including SAP SuccessFactors, Workday, Oracle, Cornerstone, CatalystOne and others. Professional Services is an SAP partner focused on advisory and implementation services of the SAP Human Capital Management solutions as SAP Success Factors and S/4HANA product portfolio. Professional Services is also responsible for implementing new managed services customers. Managed Services has, over the last months, accounted for 71% of our revenue, now in Q4, as previously mentioned, 75% of our revenue and is the fastest growing one. Professional Services produces the corresponding 29% for the year and 25% for the quarter.And 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 and supporting them in continuing digitizing their people processes, simplify work life and achieve more.So with this, I hand over to our CFO, Gunnar, who will take you through the financial part of the presentation.

[Gunnar Manum, executive]

Thank you, Hans-Petter. The fourth quarter was the fourth consecutive quarter with all-time high revenue. The revenue for the quarter of NOK251 million was an increase of 22% year-on-year in constant currency and 24% as reported. Approximately 15% of the increase come from new customers and up-sale and volume increases from existing customers relating to monthly recurring services. The remaining increase come from additional change orders and one-off revenue recognition relating to a customer project in Managed Services of NOK9 million. The adjustment had a similar cost impact and thus no EBIT impact.Managed Services revenue increased by 29%, while Professional Services had an increase of 2%, both measured in constant currency. Professional Services resources, particularly in Germany and the U.K., are still being utilized on the implementation of new customers and change orders within Managed Services, which reduces external revenue-generating capacity. New contract signings for Managed Services during the quarter had annual revenue of approximately NOK12 million and Managed Services contracts signed, but that are yet to go live, a total annual revenue of NOK72 million.This slide shows how these new customers contract in Managed Services that are yet to go live and totaling NOK72 million will impact the revenue going forward. In the top graph, we show on the left, the current annual recurring revenue for Managed Services of NOK619 million based on the revenue figures for the fourth quarter. On top of that, we have NOK72 million in annual revenue from contracts that have not yet gone live. After [ taking on] churn of NOK3 million, the contracted annual recurring revenue going forward is NOK688 million. The timing for this additional net amount of NOK69 million in annual revenue is shown in the bottom graph with some of the large new signing expected to go live in the first quarter of 2023. On top of the estimated recurring revenue of NOK688 million within Managed Services, we normally have change orders of approximately 10%, that is NOK69 million and revenue from Professional Services and APAC of NOK248 million based on the figure for the full year 2022. This gives an estimated future annual revenue for Zalaris of approximately NOK1 billion based on signed long-term Managed Services contract. This is 13% higher than the total revenue for 2022.The adjusted EBIT for the fourth quarter was NOK15.9 million, an increase of 56% year-on-year. This is before the EBIT from the APAC region of negative NOK0.6 million. The adjusted EBIT margin, ex APAC, was 6.4% compared to 5.1% last year. The EBIT for Managed Services was NOK22.3 million, which was NOK8.2 million higher than last year, while the EBIT for Professional Services was NOK4.4 million, marginally lower than last year's figure of NOK4.8 million. Adjusted EBIT has improved both compared to last year and the 2 previous quarters, but are still negatively impacted by the buildup of delivery capacity for new contracts. And the positive EBIT impact of this revenue growth will gradually materialize through 2023, together with other EBIT improvement initiatives.As presented in the third quarter and addressed by Hans-Petter earlier, our EBIT improvement program should increase the annual EBIT by NOK40 million to NOK50 million by end 2023. The key contributors, as shown on this slide, will be a reduction in personnel cost per FTE by moving more work to nearshore and offshore locations, improving customer margins in Germany by bringing the German operations up to the same level of Zalaris standardization as in the Nordic region, producing the use of external consultants and contribution from signed customer contracts to go live during the next 6 to 12 months.Moving on to some of the other key P&L items. With increased revenue and ongoing transformation projects for new customers, the number of FTEs have increased by 168 year-on-year. This explains the increase in personnel expenses. A majority of the new FTEs has come from nearshore and offshore locations. Also included in the personnel expenses is a one-off recognition of approximately NOK9 million relating to the revenue recognition of a customer project mentioned earlier. Adjusted for this item, personnel expenses per FTE increased by approximately 3.7% year-on-year, of which approximately 3% is due to currency movements. There are only minor changes on the other expenses year-on-year.The adjusted EBIT was NOK15.3 million for the quarter. The bridge between the adjusted EBIT and the reported EBIT of NOK9.6 million are share-based payments of NOK2.5 million and the amortization of excess value on acquisitions of NOK3.1 million. The net loss for vyble included in discontinued operations was NOK3.9 million for the quarter. Irrespective of the current sales prices, the negative results in vyble will reduce by approximately 7% in the second quarter this year through our cost-cutting program that is well underway. Profit before tax was NOK4.4 million for the period compared to NOK1.5 million last year. The net loss for the period was NOK8.2 million after income tax expense of NOK12.7 million, mainly as a result of tax losses in Zalaris ASA for the year not being recognized on the balance sheet.We continue to have a strong cash position with a cash balance on 31 December of NOK100 million. The operating cash flow was positive NOK19.8 million from positive working capital changes. We made investments mainly in system development of NOK9.8 million. The net interest-bearing debt at 31 December was NOK281 million.And that concludes the financial section. I will now leave the word to Hans-Petter to give you some perspective on our markets and outlook. Thank you.

[Hans-Petter Mellerud, executive]

Thank you, Gunnar. Let's round out looking at the market and sum up. As mentioned earlier, also in my previous presentations, we see a strong interest in our payroll and HR business process outsourcing services. This has resulted in significantly strengthened pipeline and record high signed agreements over the last 12 months. The sentiment is also confirmed by industry analyst Everest Group who, in their 2020 Key Issues Survey, reported that 57% of senior European stakeholders and key buyers in large European companies expected the use of HR business process outsourcing to increase in the time to come. The current recession tendencies and inflationary pressures have, in our opinion, strengthened this sentiment further.So triangulating this with the results of our recent NelsonHall industry analyst report, expecting the market for multi-country payroll to grow with 10.7% [ in '23 ] and a market size of around $6 billion, NelsonHall states that growth is driven by international expansion requiring a global footprint for payroll, wish to reduce the number of payroll suppliers, need of increased visibility of the global workforce supported by advanced analytics and ability to seamlessly integrate payroll with new global HR solutions.Our experience operating in the market align with NelsonHall. In addition, we experienced good interest from large industrial players with global shared services that are looking to be more flexible in terms of spinning out parts of their business, like Siemens with Yunex. These carved-out businesses need a complete human capital management infrastructure that we can deliver plug-and-play.Zalaris has operated with a vision supporting international businesses delivering multi-country payroll and HR solutions since our inception almost 23 years ago. With our PeopleHub concept, we can deliver a comprehensive global solution and support customer transform their people processes. As such, we are well positioned to continue our success in the current market. And I think also our -- the previously mentioned Yunex project that we signed about 12 months ago, we went into production supporting payroll in 22 countries in now almost just 12 months, which is a really short implementation time for such a large project, fantastic work by the project team.With inflation increasing and stories about a great resignation and inflated salary expectations, I would like again to comment on how this is impacting us. We see some cost inflation and wage pressure but are well protected through contract price indexation clauses in the majority of our agreements. In addition, we still have sufficient room for margin improvements through increased automation and use of lower cost, near and offshore. This will help us maintain margins in the event salary increases surpasses indexation of prices. In macro environments, with recession and crisis-like tendencies in the past, we have seen increased demand for outsourcing solutions as customers are focusing on their core business, looking to reduce and variabilize costs. And the fact is that we are providing a service that all customers in business need payroll. There is no business without it. Paying your employees is a license to play.We have a diversified customer base of very solid companies, representing various geographies and a broad spectrum of industries, including some large public organizations in markets as Germany. We are continuously monitoring the position with the aim of maintaining and further improve our competitive cost position.So again, arriving at my last slide, let's sum up. With all-time high revenue reported, we are well on our way to become a NOK1 billion company in '23. New contract wins in '22 supports our aim of continuing our growth journey and becoming this NOK1 billion company. 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 22% in Q4. With our EBIT improvement program to deliver NOK40 million to NOK50 million of annual improvements by end of '23, we maintain our target of delivering 10% EBIT and becoming a NOK100 million EBIT company.Despite the mixed macro picture, it is key to remember that we are operating in a resilient business. In macro environments, with recession and crisis-like tendencies, we have seen in the past that demand for outsourcing-like solutions has increased as customers are focusing on their core business, looking to reduce and variabilize costs. We in team Zalaris are very proud of our achievements and optimistic about the future.Thank you. And with this, we open up for questions.

[Gunnar Manum, executive]

Yes. And we will start with some questions immediately. One relating to the buildup of the annual recurring revenue. You say that you added NOK [ 4 ] million in ARR backlog during the quarter, which is below your targeted run rate of NOK24 million in order to reach NOK100 million on an annual basis. Could you please elaborate on the signing pipeline activity?

[Hans-Petter Mellerud, executive]

Well, for the year, our target for the year was to sign NOK100 million of annual contract value. And with the signings that we have in Q4, we met that target and actually surpassed it with quite some margin. Our pipeline is very strong. Some of the deals that we had hoped that we should close in Q4 slipped into Q1, and we hope that we will be signing them in this quarter but are very optimistic in terms of pipeline development and new signings and have, in general, never had the type of deals on our table, both size-wise and number-wise, in geos also outside the Nordic and particularly in the geos outside the Nordic.

[Gunnar Manum, executive]

Could you elaborate on the NOK9 million one-off revenue recognition? What was the EBIT contribution from this project? Would be interesting to see the underlying operational margin excluding this project.So I'll answer that. And we have -- we had capitalized during the year, we had capitalized too much cost and revenue for a customer project. And this relates to how revenue are classified under IFRS 15 and the revenue should be part of the transformation project, meaning that it's capitalized or as a stand-alone project and hence, recognized as the project is delivered. The project, like many of our more sort of transformation-related project, has a sort of -- more sort of a breakeven structure, which means that it does not have an EBIT -- material EBIT impact. There is -- there are costs of approximately the same amount.

[Hans-Petter Mellerud, executive]

Okay. So to just sum up the cost -- the revenue and the costs are more or less alike, so it does not have an EBIT impact, other than it reduced the percentage EBIT.

[Gunnar Manum, executive]

Germany -- next question, Germany had an EBIT margin of 2% in 2022. Do you believe Germany will achieve the targeted margin of 15% to 20% during 2023?

[Hans-Petter Mellerud, executive]

The target margin for Germany in '23 is not 15% to 20%, it is 10% to 11%. And yes, we believe Germany will achieve that target. And upon reaching that target, we have laid the foundation to continue driving margins towards the Nordic level, which is 15% to 20%.

[Gunnar Manum, executive]

Next question. Vyble had a negative cash effect of approximately NOK30 million in 2022. Could you please comment on this and give us a time line for sale? And what will Zalaris do if it cannot sell vyble?

[Hans-Petter Mellerud, executive]

Yes. So we are working on the sale still. We have had some interest, but we have not concluded a deal. We have initiated also a cost reduction program at vyble that will take down the current burn significantly to about 1/3 of the current level, which will amount to about NOK250,000 to NOK300,000 a month at the current revenue level, that is.

[Gunnar Manum, executive]

Thank you, Hans-Petter. And I think that concludes the Q&A session.

[Hans-Petter Mellerud, executive]

Okay. Thank you all for joining. Wish you all welcome to follow us on LinkedIn and in the other social medias where we are present and to come back to our Q1 presentation in later this year. Just -- and if you have questions, feel free to contact us at [e-mail]. Thank you a lot. Have a great day.