NNIT A/S (NNIT) Earnings Call Transcript & Summary

Hello, and welcome to the NNIT Interim Report for the First 3 Months of 2020. [Operator Instructions] I'm now pleased to present Jens Binger, Head of Investor Relations. Please go ahead.

Thank you, and good morning, and welcome to this call regarding NNIT's financial performance for the first 3 months of 2020 and outlook for 2020. Slide #2. My name is Jens Binger, and I'm Head of Investor Relations. With me today is CEO, Per Kogut; and CFO, Carsten Krogsgaard Thomsen. I will briefly walk you through today's practicalities for the meeting before handing over to Per and Carsten. Today's earnings release as well as the slides being used for the presentation will be available on our website, nnit.com. The conference call is scheduled to last approximately 1 hour. The presentation is expected to last around 30 minutes. After the presentation, we open up for questions. Today's agenda can be found on Slide #3. Note that this call is being webcasted live, and a replay will be made available on NNIT's website. Turning to Slide #4. I need to advise you that this call will contain forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause the actual results to deviate considerably from the outlook set forth. Further, some of these expectations are based on assumptions regarding future events, which may prove incorrect. With these words of introduction, I will hand over to Per Kogut and turn to Slide #5.

Thank you, Jens, and a very warm welcome from me as well. The first month of 2020 have brought extraordinary challenges to everyone. Here in NNIT, we have faced these challenges on a global scale due to our presence in Europe, U.S. and Asia. With more than 800 employees in our Chinese offices, we have been monitoring the situation around COVID-19 closely since the beginning of January. We have exchanged many learnings on how to secure employee health and safety while working remotely and continuously securing stable IT operations for our global customer base. These learnings have been utilized in our headquarter here in Soborg and in all our affiliates. We observed a reopening of the Danish society and are gradually opening up our offices in Aarhus and Copenhagen in a controlled and calm manner. Since the outbreak of the COVID-19 pandemic, NNIT has continued to secure stable IT operation for all our customers. Many of our customers handle infrastructure services which are critical to Danish society, such as food and drug production or distribution, public transportation and government IT infrastructure. At the same time, we support our customers in adapting to the new situation with many employees working from home. NNIT's financial performance was, only to a minor extent, impacted by COVID-19 in the first quarter of 2020. Specifically, the efforts of COVID-19 was seen within the project business in the local Chinese market in February and March and in the utilization of project resources in Europe and U.S. during the 2 last weeks of March. Despite the COVID-19 situation, NNIT's financial performance for the first 3 months of 2020 was in line with expectations. The significant cost restructuring initiative we announced in August '19 have also progressed according to plan. Please turn to Slide #6 for the financials for Q1 2020. I will provide you with the overall financial highlights for the first quarter of this year. And later, Carsten Krogsgaard will go more into the details. In Q2 2020 -- sorry, in Q1 2020, revenue decreased by 3.7% driven by a 29% decline from the Novo Nordisk Group. Revenue from all other customer segments increased in total with 9.4%. Revenue from life science increased -- revenue from life science in Denmark increased with 26%, and life science internationally increased with 18%. Revenue from the enterprise and public segments also had strong growth rates/operating profit before restructuring cost was DKK 47 million, equal to an operating profit of 6.5% compared to the 6.1% Q1 '19. Please turn to Slide #7. In March 2020, we announced the renewal of the maintenance agreement with Novo Nordisk. The new contract secures important business with Novo Nordisk for another 5 year. NNIT will continue to deliver full stack platform and infrastructure services to Novo Nordisk globally, and new offerings such as hybrid cloud are added to the stack of services in order to remain their strategic partner on IT services. We continue to see growth in order intake and revenue in the international life science segment, supported by our strong partnership with Veeva both in Europe, U.S. and China. Among the Q1 highlights is the implementation project of a regulatory information management system for a top 5 global pharma company. We consider a win like this a testament to our capability and continuously stronger position within the global life science industry. In Q1, we renewed and expanded the infrastructure operation with the Danish union HK and renewed the infrastructure contract with DLG. Further, we won 2 very important Microsoft D365 deals with Norlys and several other minor Microsoft-related deals. NNIT's increased focus on specific services and technologies was set forth in the revised strategy released back in January this year. And this translate into business growth as exemplified by the winning solutions, namely Microsoft solutions, hybrid cloud, data and AI and the employee experience. Please turn to Slide #8. Together with our subsidiary SCALES and our offshore capabilities and partnerships, we want to become the market leader in Denmark within Microsoft cloud solutions. NNIT covers all 3 Microsoft platforms, Azure, M365 and D365, and we do have a strong Danish market position. Combined with our capabilities and size, this unique strong position on all 3 areas within Microsoft make NNIT very attractive for midsized and larger customers. As a customer, you can choose to gather and integrate your services and harvest synergies from one vendor instead of having many Microsoft partners as part of your IT and cloud setup. Our experience is that many customers become more and more frustrated with their multi-vendor setup and the lack of link between the different Microsoft partners. As the 3 Microsoft cloud platforms are becoming more and more coherent, it becomes important to have an overall strategy for how to utilize the platforms and gain value from the vast amount of data generated. And this is exactly where we, NNIT, make a mark on our customers' digital transformation journey. So from this sales pitch, Carsten, let's go into the financial details.

Well, thank you, Per. If you turn to the next slide, called financial preparedness. So just before digging into the financials, a few words on how well prepared we are if COVID-19 was to hit companies really hard. As you can see, net debt-to-EBITDA gearing is still very low at around 1.1x. And this still rings -- leaves ample room for value-creating acquisitions if such opportunities should show up. Regarding our financial facilities or bank facilities, we recently entered into a new 3 plus 1 year committed credit facility with Danske Bank and SEB, and this amounts to a committed facility of DKK 900 million. And of that, we have only used DKK 350 million at the end of Q1. So we still have a lot of financial resources left. Just a few words on the bankruptcy of Arnold Busck. This was a very small customer of ours. And in worst case, we expect to lose up to DKK 1 million, which we will provide for in Q2. Turning then to Slide 10, a brief status on the implementation of a cost restructuring plan. All in all, I think we are progressing very well, according to plan on all elements, which you can also see when we dig into our margins and the development in our COGS and admin costs and so on. One -- just a few words on our utilization. This was at the beginning of the year up at the targeted level and well above last year. The same was true in March, but we did see a modest impact in the last 2 weeks due to COVID-19. When we look at our preliminary numbers of April, we are actually up at the targeted level again on our utilization, so that is very satisfactory. I will then say a few words on how the cost restructuring plan impacts the margins of the different parts of our business. So the numbers you're seeing today for Q1, we have increased project margins due to the cost program, having higher utilizations, better project management. We also see an increase in margins on our service level agreements in both the private & public segment and in other life sciences outside Novo Nordisk. All in all, that means that both gross profit and operating profit margins in the private & public segment and in the other life sciences segment, we see a large increase in our margins here. When it comes to the Novo Nordisk, then we also have an impact -- positive impact from the cost restructuring program, but this is not fully able to mitigate the loss of the application maintenance agreement and also the large price reductions on the operations maintenance agreement. So we are seeing margins in Novo Nordisk coming down. Turning then to Slide 11. As Per mentioned, we see a decline of 3.7% in our revenue, but a decline in cost of goods sold is higher. Here, we see a decline of 4.2%, which then leads to a higher gross profit margin of 0.4 percent points. And our operating profit margin also increases by 0.5 percent points, so we are in Q1 at 6.5%, which is in line with our expectations. And you should bear in mind that our seasonality is so that the margins in Q1 and Q2 are normally substantially lower than the second half of the year. You can also look at the numbers this way that despite higher -- we have a high operating margin despite the loss of the application maintenance service level agreement and the price reductions on the operations maintenance SLA. And here, you should be aware that these price reductions had impact already from the 1st of January, so not from the date of signing, as previously communicated, but already from the day of signing that was part of the agreement that was made. Lastly, you may be surprised to see that the effective tax rate increases to 24.5%. This is very technical, but it's due to a lower tax deduction on our long-term incentive programs, and this is following the decline in our share price, which is substantially lower now or was at the end of Q1 than at the time of the beginning of these incentive programs. This evens more out for the full year, where the impact is expected to be only around 0.7 percent points. If you then turn to Slide 11 (sic) [ 12 ] on life sciences. Well, here, you see the clear picture where the decline of 29% in the Novo Nordisk revenue, tax revenue in life sciences down with 12%. But we still see very strong growth of 26% in Denmark. Our life sciences internationally grows with 18%. But here, you should be aware that we saw a very high decline in China due to the COVID-19. So if you exclude China, then the growth in the rest of the world was actually 44% and a very nice growth. Gross profit margins and operating profit margins both declined with around 4 percent points, and this is entirely due to the decline in revenue from the Novo Nordisk Group. What we actually see now is that other life sciences has a significant increase in their margins supported by the cost restructuring program and also by higher -- high-margin project revenue. This means that, for the first time in our history, Novo Nordisk and other life sciences have the same average margin. You can also put it this way that the Novo Nordisk margins have now been normalized to the level of life sciences in general. The decline in revenue from Novo Nordisk also means that their share of our revenue is now down to 26% compared to 35% last year. So we are rapidly becoming less dependent on Novo Nordisk but, of course, still a very significant customer to us. Turning to private & public on Slide 13. Here, we see a nice revenue growth of 5% very much driven by the public and enterprise segments. And here, again, we see a very strong growth in SCALES. We are very happy that our margins in private & public also increased by around 6 percent points due to the cost restructuring program, other efficiency measures and also due to the high growth in SCALES. So that means -- this means that we, in the first quarter, have an operating profit margin before special items of 4.3%, so well above last year full year and I think shows that we are on the right track to making private & public more profitable. You should, again, take into account that Q1 margins are normally lower than the average for the full year due to the seasonality. If you then turn to Slide 14 on the currency development. Well, as in previous quarters, we only see a rather modest development with relatively modest impact on operating profit margin with a slight headwind, only 0.2 percent points, and a slight tailwind on the currencies. But it's not having a big impact. And as you know, we are also hedging our exposure. Turning to net financials on Slide 15, not much to say. We are at the same level as last year and still having very low interest expenses. Turning to Slide 16 with the employee development. Here, you can see that the total number of employees are declining 5.5%. And if you adjust for the HGP acquisition, then the number of FTEs are declining with 7.5%. The decrease is very much driven by a decrease in Denmark through the cost-restructuring program, but also in China and the Czech Republic, again, due to the cost-restructuring program but also due to the loss of the application maintenance agreement with Novo Nordisk. Turning to the balance sheet on Page 17. I won't go into great details, but you should note that our intangible assets increased due to goodwill regarding the HGP acquisition. We see our lease assets decreasing due to no major additions and the depreciations of these contracts. Our employee benefit obligations increased and this is due to the new employee vacation at the so-called Feriefonden. And then you see that our contingent considerations are declining. And this is due to earn-out payments to SCALES and Valiance. So now all earn-out payments have been done to SCALES, we are out of this period, and we have paid the first year's earn-out to Valiance. Turning to cash flows on Slide 18. We see a small improvement compared to last year due to higher cash flows from operating activities and then partly countered by higher investments due to the payment of earn-outs in Q1. If you then turn to Slide 19, a short look at the backlog development. Here, we see the backlog declining with around 9%. You should, as I said before, be careful about interpreting this decline since a larger and larger part of our business is project business with a lower visibility than the SLA business. So this year, we are seeing a large decline in our SLA business due to the loss of the application maintenance agreement and also due to the loss of the Pandora agreement and the price reductions on the operations maintenance agreement. Then on the other hand, we see a high growth in our project business. So when you just look at the backlog numbers, they do actually exaggerate the impact on our full year revenue. And when we also look into our weighted pipeline, then the decline is smaller than the 9%. Of course, the decline is driven by Novo Nordisk, where, again, the 33% is probably overstated. And we see private & public declining a little due to the Pandora agreement, while we then see strong growth of 19% in other life sciences. Turning finally to our outlook. As Per has already alluded to, our financial performance in the first 3 months were completely in line with our expectations, actually a little above last year. We did see a minor impact of COVID-19 in the last 2 weeks of 2020. We see a normalization of utilization in April. But overall, when we look at our guidance, when we look at our backlog-weighted pipeline and when we do also look into larger uncertainty regarding COVID-19 and the impact on our customers, then we maintain our guidance of minus 4% to minus 8% on revenue growth and 6% to 8% on operating profit margin. But we do believe that there is an increased likelihood that revenue growth and operating profit margin will end in the lower end of the guidance intervals. And with these remarks, over to you, Per, for the closing remarks.

Great, Carsten. Thank you. And I would like to conclude on our presentation by summing up that we experienced a revenue decline of 3.7% and an operating profit margin before special items of 6.5%. The result was as expected. Operating profit margin was slightly better than the same quarter last year. We continue to see a decline in our business with Novo Nordisk, while revenue outside Novo Nordisk have increased by 9.4%. The guidance for 2020 is maintained, but due to the uncertainty regarding the COVID situation, there is an increased likelihood, as Carsten just mentioned, that revenue and operating profit margin will be in the lower end of the guidance interval. With these words, I conclude our presentation, and we are now ready for questions. And operator, we are ready to take the first question, please.

[Operator Instructions] Our first question comes from the line of André Thormann from PBG (sic) [ ABG ].

So just starting with Novo Nordisk, maybe the decline on 29%, just trying to understand, was this below your expectations in Q4? Or was it in line?

The decline of the 29% is actually more or less in line with our expectations. Yes.

Okay. And that is -- as I understand, that is due to the OM SLA that also comes out of the number as already in Q1, right?

Yes. Yes, and also the lost contract, yes. So you can say we are taking the full hit from Novo Nordisk already in Q1. And the project business from Novo Nordisk is often in the low end in the first quarter until they get going with their budgets.

Okay. And in terms of the project business, are you seeing anything for Novo Nordisk currently? Does it look better?

No, it is actually more or less at the same level as we saw last year.

Okay. And then in terms of these agreements that you say has come down to the same margin level as other life science, just to understand here, has all agreements come down to that level? Or is it some agreements that has come below and then dragging the average down? Or how should we view this?

So what I said was that the average margin -- overall average margin of Novo Nordisk compared to the overall average margin of all other life sciences, they are now at the same level. Then you have areas where it's higher, other areas where it's lower. But on average, it's at the same level.

But the areas that is higher, I mean, of course, it's hard to say, right? But do you expect these to come down to the level as we saw for the OM SLA as well? Or what are you seeing here?

André, it's very difficult to predict. We have one large contract left, which was renegotiated a couple of years ago, and that runs for another 2 years. I believe that our project business, the margins we're having there is at a level we can expect for the future since Novo Nordisk has implemented the kind of new policies, procurement policies. They did that already last year. I think that's as much as I can say.

Okay. Okay. In terms of the utilization, just to be sure on this, I think you said that for April 2020, it is in line with your 2020 target, right? So does this mean that you have improved utilization by 4 percentage points compared to April last year?

Yes, it does.

Okay. And what is going right then? What have you done that have improved this?

Well, all the initiatives that we have been talking about have been implemented. One of the initiatives was a time registration app where our employees now register their time daily. And there's a very close follow-up from the team leaders up to the managers, to the directors and all the way up to our executive management and to the Board. So this continuous focus on getting time registrations done correctly, continuous focus on looking at areas where the billable utilization might be too low and then adapting the capacity, that is really starting to work now.

And the most effective -- just to understand because we have been talking about this registration before, is that the most effective for you currently to improve utilization?

It's an important part, but it all works together. The constant management focus, employee focus, the change of culture, it all works together. So I think right now, we are at a level where we have a high billable utilization while still having, you could say, the flexibility to pick up extra revenue when that occurs. You can also take your utilization up too high and then you're not able to get new revenue opportunities when they come up.

Okay. And just one last for me. In terms of demand effects, I mean, are you seeing any negative indications on demand currently? And which, if so?

Yes. Like other companies, in some areas within consulting and kind of short-term project business, we are seeing some impact. But until now, it's not a major impact. But it is also the reason for -- that we are saying that there is an increased likelihood that we may end in the low end of our intervals guidance range.

And what is the impact, just to be sure?

That I can't tell you. It's very uncertain. We follow that closely all the time.

Okay. But it's not like specific areas or anything like that?

As I said, within some consulting and within some project business. And of course, China has been impacted heavily due to the COVID-19.

[Operator Instructions] Our next question comes from the line of [ Ole Jenset ] (sic) [ Poul Jessen ] from Danske Bank.

I assume it's me. It's Poul from Danske. A question about the international life science, you say that this excluding China, it's up 44%. Can you give indication on when you believe China will be back? That's one. Second, on the other operations, say a little about how it's performing on Valiance and HPG (sic) [ HGP ], which are the ones who are driving international growth?

Yes. Regarding China, China was really down in the first quarter. Right now, we have half of our employees back, and they are beginning to be able to have sales visits to customers. So right now, it looks like a kind of normalization from Q3 and maybe some catch-up in Q4. But all in all, of course, the China part will be lower than our original expectations. Regarding Valiance, Valiance has been performing extremely well in the first quarter, and it still looks good. They have not yet been impacted by COVID-19. HGP is now completely integrated into our European business. And our European business is performing strongly at the moment, very much driven by Veeva implementations, where both Valiance go in and do the data migrations, and we work as a partner to Veeva on change management, integration of systems and all kind of things we do there. So they're all working very well as international life sciences is in general, except for China.

So a follow-up on the Valiance and Veeva in Europe. So the ambition to do a leverage or cross-selling from not having by Valiance any activity in Europe, you're succeeding there now?

Very much. We will report to our Board on how we realize our synergies because, of course, in a business case, we expected some synergies and we are in -- higher on synergies than we originally anticipated.

Okay. Then on the private & public, where you now deliver a 4.3% margin, can you say something about what's driving the market increase, is that the cost cutting? Is it repricing of existing contracts? Better prices on new contracts? Or is it SCALES performing exceptionally?

I would say it is primarily our cost restructuring program, which is having a very positive impact especially on our big SLAs on existing customers. So we have not been repricing these contracts, but we do see margins going significantly up on several of our, you could say, legacy contracts in especially the enterprise segment due to the cost restructuring program and the normal delivery management on these contracts. SCALES is also contributing. We continue to see growth above 20%, and we see margins exceeding the margins of last year. So they're all contributing.

Okay. And then a final one, just on factoring. I can't see factoring in this report. Has there been any changes on the factoring side?

No. No. So last year, in Q4, we did 2 factorings, one with the Novo Nordisk and another, a large enterprise customer. We haven't done any more yet. If we do more factoring, we will be very transparent about it, but we have not done yet.

[Operator Instructions] There appear to be no further questions registered, so I hand back to the speakers for any closing remarks.

Okay. Thank you. This concludes our conference call. So thank you for participating in today's webcast, and feel free to reach out to us if you have further questions. Thank you.