Zalaris ASA

OSE:ZAL

Earnings Call Transcript 2023-Q4

[Hans-Petter Mellerud, executive]

Good morning. I'm Hans-Petter Mellerud, the CEO and Founder of Zalaris. Joining me today for this webcast presentation of Zalaris Q4 '23 results is our CFO, Gunnar Manum.

We are using Teams for this purpose and hope that you will find it informative and engaging. You can use the Q&A function to ask questions that we will answer at the end of the presentation. Please note that the presentation is being recorded. You can access the recording on the Investors section on our website after the meeting.

Let's begin with the presentation. First, we'll look at some of the highlights of the quarter. In Q4 '23, we in team Zalaris delivered on our communicated targets, resulting in the eighth consecutive quarter with all-time high revenues of NOK 312.4 million, up from NOK 25.6 million in Q4 last year. This represents 24.7% year-on-year growth in actual terms and 14.1% in constant currency. We are now at NOK 1.25 billion annualized revenue company, well above our aspiration just 1 year ago. Adjusted EBIT was 10.7% at NOK 33.4 million at 118% from NOK 15.3 million in the same period last year. We continue delivering on our growth aspirations for '23, ending the full year with revenue of NOK 1.13 billion, up NOK 27 million year-on-year, with an adjusted EBITDA of NOK 96 million, an increase of 107% year-on-year.

Zalaris success in the market continued. We sold around NOK 20 million annual contract value of signings in the quarter and more than NOK 160 million for the year, thus delivering around 124% of our annual sales target needed to continue our target 10% growth rate in '24. Zalaris' all-time high EBIT, combined with increased focus on capital allocation, enabled us to deliver NOK 34 million of operating cash flow in the quarter. As already mentioned, in the quarter, Zalaris continued its strong signing streak for the year and signed several new agreements with a total annual contract value of about NOK 20 million bringing the total for the year to around NOK 160 million. In Managed Services, we continue to see good demand for our global payroll value proposition. The potential for expanding existing customer agreements to new geographies was proven by our agreement with a global retailer.

It was expanded from our initial coverage of approximately 3,000 employees in the Nordic country to also cover 10,500 employees in the U.K. and Ireland. Now in total, representing about 15% of their global workforce with a corresponding upside for the remaining 85%. Similarly, we expanded our relationship with the bank Santander in Norway to full coverage of the Nordic region during the quarter. In APAC, we sold our first multi-country payroll deal based on our PeopleHub EC payroll SaaS solution to operate our global tax-free shops, Heinemann. With this deal, we have a country versions for Australia, Singapore, Malaysia, Hong Kong, Macau and China.

Professional Services sold approximately EUR 25 million of total contract value throughout the year, which is more than 25% above our budget. Demand remained strong for application maintenance services and project implementation services related to SAP HXM. During the quarter, Zalaris was awarded 4 new years with the German State of North Rhein Westphalia in a public tender for an increased scope with improved pricing to support and managing their SAP payroll solutions serving around 700,000 employees and pensioners. The contract has an estimated annual contract value of well above EUR 2 million. After the quarter, we closed a landmark agreement as a subcontractor to one of Germany's largest system integrators.

The agreement involves implementing a new HCM solution covering employee data management and payroll for one of the most innovative and progressive German states, with our part of the contract valued at approximately EUR 15 million over the next 4 years. With these contracts on top of already existing agreements to serve other states and public entities, Zalaris is one of the leading professional services providers of SAP-based people services to the public sector in Germany, a huge and stable market. The potential for continuing our market success in 2024 appears good as we left the quarter with a solid pipeline in both managed and professional services.

So let's look at our segments. Managed Services revenue increased 23.1% as reported and 14.2% in constant currency to NOK 229 million, also a substantial increase compared to last quarter. This growth was driven by new contracts, upsell and volume increases, which accounted for 51% of the increase as well as new customers, which contributed 49%. Our net revenue retention in constant currency remained strong at 104% year-on-year as existing customers expanded their geographic footprint and functionalities. All our regions showed good growth with DACH leading the way with 23% year-on-year. Managed Services represented 73% of our total revenue, slightly higher than last year.

Then let us look at Professional Services, our consulting practices. Professional Services revenue grew 22% in reported and 7.2% in constant currency to NOK 75.3 million. Our Professional Services capability has been key to win our recent contracts and is increasingly also being used in Germany and U.K. to implement managed services contracts based on PeopleHub and our standardized template-based solutions. Most of the growth in this segment came from the U.K., which grew by a massive 93% compared to last year, a big contributor being a large agreement with a leading European airline to implement a global SAP-based payroll solution. Germany has revenue in line with last year as consulting resources were increasingly used to implement Managed Services projects.

However, with our new public services wins, we also expect significant growth with stable revenue streams over the next 4 years in our German Professional Services unit. APAC continued its positive development, closed several new agreements and took revenue to breakeven levels for the quarter. 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 58% of the total revenue. Our long-term relationships with customers continue being visualized through 83% of our Q4 revenue in this segment coming from customers that were also customers in Q4 last year.

Our right-shoring metric continued developing positively during the quarter, increasing the percentage of near and offshore as a percentage of total head count with 1% since last quarter and around 4% during the last 12 months. This lowers our resource cost and is a significant step towards our Zalaris 4.0 target of 50%. We expect this trend to continue.

And again, let me remind you what company Zalaris has become. Our business model based on long-term agreements and recurring revenue is favored by many investors. We have offered software as a service, business process as a service and outsourcing delivery models since we were founded 23 years ago. And to reiterate, more than 90% of our revenue in Managed Services and around 55% of our revenue in Professional is recurring based on long-term agreements. Our historic churn is low in the 2% to 3% range. Delivering payroll and HR services based on one common global IT platform, the Zalaris PeopleHub had supported by local competent resources, has been key to our success and 23 years of growth. Now EUR 100 million plus run rate company, we are being 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, we enable them to operate seamlessly across borders. Our approximately 1,100 employees deliver 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 our 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, digitalization 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 based 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, basing from software-as-a-Service to a comprehensive outsourcing solutions.

We can integrate to 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 SuccessFactors and the S/4HANA product portfolio. Professional Services is also responsible for implementing new Managed Services customers. Managed Services accounted for 73% of our revenue in Q4.

Professional produces a corresponding 27%. 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 in supporting them in continuing digitizing their people processes, simplify work life and achieve more.

And with this, I hand over to our CFO, Gunnar Manum, who will take you through the financial part of the presentation.

[Gunnar Manum, executive]

Thank you, Hans-Petter. The revenue for the fourth quarter was NOK 312 million. That was an increase of 25% year-on-year, an increase of 14% when measured in constant currency. In the fourth quarter, approximately 81% of total revenue was invoiced in currencies other than NOK. Revenue in Managed Services increased by 14%, while Professional Services had an increase of 7% in constant currency.

As launched in previous quarters, significant Professional Services resources, particularly in Germany, are being utilized on the implementation of new customer and change orders within Managed Services, thus reducing the external revenue capacity within that division. Approximately 51% of the reported revenue increase in Managed Services comes from customers that were customers in Q4 last year and 49% of the growth came from new names. New contracts signed in Managed Services during the quarter has annual recurring revenue of approximately NOK 8 million. If we include upsell to existing customers, the figure is approximately NOK 22 million. In addition to the revenue that will come from the new signings in the fourth quarter, we have the revenue that will come from new contracts signed in early periods, but not yet implemented as of Q4.

This slide shows the total future revenue impact of all these new contracts. The total net annual recurring revenue from these contracts is NOK 96 million, which represents a further increase in annual revenue for annual services of 15% when compared to the revenue for 2023. In the top graph, we show on the left, the current annual recurring revenue for Managed Services of NOK 785 million based on the annualized revenue figure for the fourth quarter. This figure is NOK 52 million higher than the estimate presented in Q3. About 30% of the increase is explained by positive currency movements, while the rest is due to the annualized effect of higher level of recurring revenue from existing customers in Q4.

On top of that, we have NOK 96 million in additional net annual revenue from signed contracts that will go live mostly in 2024. Thus the contracted annual recurring revenue going forward is NOK 881 million. The timing for the additional net amount of NOK 96 million in annual revenue is shown in the bottom graph. On top of the estimated recurring revenue of NOK 881 million within Managed Services, we currently have changed orders for more than 12% of the recurring revenue, that is NOK 108 million and revenue from Professional Services and APAC of NOK 312 million based on the full year figure for 2023. This gives an estimated future annual revenue for Zalaris or approximately NOK 1.3 billion based on signed long-term Managed Services contract and calculated using the average exchange rates for the fourth quarter. This is 50% higher than the total revenue for 2023.

The adjusted EBIT for the fourth quarter was NOK 33.4 million, an increase of 118% year-on-year. The adjusted EBIT margin was 10.7%, up from 6.1% last year. Through our EBIT improvement program, we have increased earnings significantly, and we have exceeded our targets for the program with a NOK 55 million increase in EBIT for the full year 2023 compared to the baseline that we set in the third quarter 2022. The EBIT in Managed Services was NOK 29.6 million, which was NOK 7 million higher than last year, and the EBIT margin increased by 0.9 percentage points to 12.9%. This was a slight drop in margin compared to the third quarter, which is mainly explained by additional investments in business development and increased capacity in preparation for the volume growth in 2024. The EBIT for professional services was NOK 10.4 million, an increase of NOK 6 million compared to last year, mainly due to increased margins in Germany and the U.K.

Moving on to some of the other key P&L items. With the increased revenue and ongoing transformation project for new customers, the number of FTEs have increased by 43% year-on-year. This, together with the negative currency impact from having more than 80% of our personnel costs denominated in currencies other than NOK largely explains the increase in personnel expenses. The revenue per employee in constant currency increased by approximately 7% year-on-year. A majority of the new FTEs have come from nearshore and offshore locations. Other operating expenses were 2.1 percentage points lower as a percentage of revenue compared to last year, but the absolute numbers were negatively impacted by currency movements as well as an increased number of externals to handle the volume increase.

The EBIT was NOK 27.1 million for the quarter compared to NOK 9.7 million last year. Net financial expense was NOK 15.6 million compared to NOK 5.2 million last year, and the increase is mainly due to higher financing costs as well as an unrealized currency loss on our euro-denominated bond line. Net profit for the period was NOK 20.9 million for the quarter compared to a loss of NOK 12.1 million last year. We continue to have a strong cash position with a cash balance at 31 December of NOK 136 million. And this graph shows the bridge between the cash increase of NOK 15.3 million in the quarter and the EBITDA. The operating cash flow was NOK 33.7 million before a positive reclassification from customer project assets to intangible assets of NOK 10.4 million relating to prior quarters in 2023.

The net interest-bearing debt at 31 December was NOK 315 million, down from NOK 333 million at the end of the previous quarter. Our leverage measured by net interest-bearing debt divided by EBITDA, decreased to 2.1 at the end of the fourth quarter, down from 2.5 at the end of the previous quarter.

Now that concludes the financial section, and I will now leave the word to Hans-Petter to give you some perspective on our bright outlook.

[Hans-Petter Mellerud, executive]

Thank you, Gunnar. To sum up, let's look at Zalaris outlook for the next 36 months. I will use the opportunity to reiterate some of our financial targets from our Capital Markets Day in September. We believe we can maintain our target growth rate going forward. Over the last 2 years, our annual growth rate has been approximately 18%. When removing the impact of currency changes, the annual growth rate has been approximately 14%. The growth comes mainly from increased revenue from existing customers within Managed Services and from recurring revenue from long-term contracts with new customers. These contracts typically have an initial duration of 5 to 7 years.

Going forward, we have set an annual growth target of 10% with a targeted total revenue of NOK 1.5 billion by 2026. The growth target for Managed Services and Professional Services is 15% and 5%, respectively. As a result, recurring revenue from long-term contracts with customers in managed services will represent an increasing share of total revenue, moving from 68% in '21 to targeted 77% in '26. For 2023, we report, as you know, our revenue close to NOK 1.1 billion. Additionally, we have approximately NOK 100 million net of churn in annual recurring revenue already contracted for future periods as Gunnar has just gone through. Hence, we believe this revenue target to be well within reach of that time period. On a regional level, the highest growth is expected to come from the DACH region as the total addressable market in DACH is approximately 4x the Nordic market.

We're also strengthening our U.K. and Irish sales capacity and aim to repeat our success in Germany there. Add to this, our positive development in APAC, that is expected to deliver an annualized revenue of NOK 30 million by the end of this year. As communicated in September, we have increased our focus on increasing operating cash flow conversion. The target is for an operating cash flow conversion before interest payments of 65% to 70%. This will be achieved through working capital improvements, particularly in trade receivables and by ensuring that transformation projects for new customers are at least cash neutral during the implementation stage, which has not always been the case in the past. Based on the target EBIT of 12% to 15% in 2026, that should give an operating cash flow before interest of approximately NOK 190 million to NOK 250 million, a substantial improvement from the current levels.

To sum up in this quarter, we are pleased to see that our focus on EBIT improvements and long-term value creation has materialized in us delivering on our communicated targets. Delivering Q4 with 24.7% growth and an annualized revenue of NOK 1.25 billion is a solid baseline for further growth and delivering on our communicated 3-year targets. Growth will continue with more than NOK 100 million worth of annual contract value under implementation that will show us recognized revenue over the next 12 months. Add to this, the effect of our large public sector in Germany that will gradually take effect, in combination with a positive pipeline already resulting in wins being reported now in 2024.

We continue our focus on implementing the Zalaris 4.0 operating model with the aim of bringing our DACH business towards the levels that we enjoy in the more mature Nordic people who are part of our organization. Combined this with scale effects coming from our centralized cloud solution infrastructure and organizational capabilities, continued focus on automation and improved productivity from AI functionality gradually being implemented.

Thank you for joining us. It's now time for questions.

[Gunnar Manum, executive]

Yes, Hans-Petter, we have a few questions. Starting off, given the rapid growth in APAC, when do you think margins could get to the group levels?

[Hans-Petter Mellerud, executive]

I think, we have a fair hope of seeing that for this year. But towards the end of this year, we'll be there.

[Gunnar Manum, executive]

Next question, what was the level of EBIT margin improvement for Germany? I think maybe I could...

[Hans-Petter Mellerud, executive]

Yes, I think, you should -- you have the numbers in the front of you...

[Gunnar Manum, executive]

Yes, so I can say something about that. We definitely have seen a slight improvement in Germany. But as we have communicated earlier, we are still at the sort of a single-digit level. So -- and as we also have covered, there is definitely still some work to be done. So the EBIT improvement program that we have had and is still ongoing, certainly have had a huge effect in Northern Europe, but it's taking a little bit longer to see the same effect in Germany.

[Hans-Petter Mellerud, executive]

Yes. And I think we should also differentiate somewhat because it is differentiated between our Professional Services and Managed Services. Professional Services, we've seen very good developments over the last quarters with increased focus on the utilization of resources, pricing, et cetera.

And within Managed Services, we still have quite a way to go, some to do with commercial agreements with some customers, but mainly, we see still quite a few double costs resulting from the huge transformation efforts that we are still in the process of being in turning around or restructuring our German operations into the Zalaris 4.0 operating model. And that is a process which shall be -- it takes time. And it's about a lot of people, mindsets that have to be changed, work that has to be moved, systems that partially have to be somewhat reconfigured. But we are doing very well in the process and see that as an upside to where we are today.

[Gunnar Manum, executive]

Next question. What is the current mix of nearshore and offshore versus onshore? Now I think you did cover some of this, but maybe you could expand a little bit on that.

[Hans-Petter Mellerud, executive]

Yes, so I think if we go -- you will see that on one of my earlier slides, that we have over the last 12 months, we have increased the near-offshore ratio with the 4 percentage points over the year, 1% over the last quarter, now being at about a near-offshore rate of 41%, targeting then 50% in the -- saying if that being the current target, and we are increasingly moving there.

[Gunnar Manum, executive]

Next question. Is it plan to expand list of Zalaris' nearshore countries?

[Hans-Petter Mellerud, executive]

Yes. I think we are constantly evaluating, say, nearshore alternatives, particularly also in terms of finding good countries within the EU that has a good mix of access to resources as well as, say, resource cost. But on that, we have established actually a group quite a bit in, for example, Spain over in '23 and have quite a good workforce there and see that also as a very interesting country in terms of sourcing resources at decent or so cost levels.

[Gunnar Manum, executive]

And another question, which I think I should answer, is it a potential for dividend?

Now the reason we do not pay a dividend this year, it's not because we don't have the cash to do so, but it's because that in terms of the bond agreement, we cannot pay a dividend if we have a net loss before tax, which we have. We see no reason why we should be in that same position next year, depending, of course, a little bit on the development in the NOK Euro and the potential unrealized gain or loss on the bond loan. But if everything goes according to plan, there will be a dividend then for 2024.

[Hans-Petter Mellerud, executive]

Yes, and I can confirm that.

[Gunnar Manum, executive]

And I think I'll just check. And I think that concludes the Q&A session.

[Hans-Petter Mellerud, executive]

Okay. Thank you all for listening. It was a pleasure being here announcing that we have delivered on the results and our targets for 2023. If you have any further questions, please do not hesitate to contact us on [e-mail], and we will do our utmost to respond to you as quick as possible. Thank you for listening.