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

Hello, and welcome to the NNIT Inteirm Report for the first 9 months of 2022 Call. My name is Lauren, and I will be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Par Fors, CEO, to begin. Par, please go ahead.

Thank you, and thank you all for joining our Q3 earnings call today. We look forward to providing an overview of the results for the quarter before answering your questions. Please turn to Slide 2 at the agenda. Firstly, we will provide a helicopter view of the third quarter's performance and the strategic progress we are making with the divestment of our infrastructure business and the consolidation of our global delivery capabilities, among other things. Secondly, Pernille will present Q3 business unit performance and the group financials as well. Lastly, we'll take your questions after a short recap of the key takeaways for the quarter. Let's turn to Slide 3 for the highlights. We spent a lot of time and resources in the third quarter on the carve-out of our infrastructure business, which was initiated this summer and remains our key strategic priority to establish NNIT as a highly specialized IT services provider with 2 strongly positioned business units. The process is progressing based on constructive and thorough dialogue with our customers and other stakeholders. In parallel, we continue the efforts to streamlize -- streamline our outsourcing organization in the Philippines, and we expect the transformation to be completed by the end of this year, with full effect from Q1 '23. While this move entails high staff costs during the quarter, it will strengthen the global delivery capabilities and contribute to ensuring lower salary expenses and improve profitability going forward. In terms of daily operations, we are reporting moderate revenue growth and higher earnings. We certainly expect further improvement, but we are pleased with the progress that has been driven by acquisitions as well as stronger performance in the LSS and CDS business units, which constitute the NNIT of the future. During the quarter, we entered 7 new contracts, including a multiyear assignment for Lantmännen Unibake. The order backlog continued to increase with solid contribution for LSS and CDS as well. Please turn to Slide 4 for a brief strategic update. As already mentioned, the effort to transform our company into a specialized IT services provider with 2 strong business units continued in Q3. The carve-out concerns half of the group revenue and is not completed overnight. While this process is certainly progressing, it is crucial that we treat every customer with the greatest respect. And we have, therefore, entered into a lot of constructive and thorough dialogues during the quarter. We are cracking on with this work while making targeted efforts to separate the discontinued activities from the new NNIT in our financial reporting as well to provide new financial guidance for the continued activities. As always, please keep in mind that the transaction is subject to regulatory approvals as well as other customary closing conditions. The efforts made in Q3 and previous quarter had a positive impact on profitability as we were able to ensure continued progress. Cost reduction programs have been introduced across the businesses, a business unit to rightsize the organization and improve capacity utilization. As we noted, good progress in Life Science and CDS in particular, during the third quarter. We also continued to build the order backlog with new contracts and a strong order intake within Life Science in particular. After the balance sheet date, we continue this positive traction as we announced Danish Agency for Higher Education and Sciences has awarded NNIT with a contract value exceeding DKK 300 million for the future state educational grant and loan payment system in Denmark. The positive development supports our expectation of improving capacity utilization in the coming quarters and also the coming years. Before we turn to the comments on business unit and group financial performance, I would also like to highlight that we committed -- we are committed to the Science Board -- Based Targets initiatives in Q3 as an important step on the long road to becoming carbon neutral and part of the climate change solution. On the back of the commitment, we will set both short-term and long-term target for the reduction of CO2 emissions and submit those within 24 months. Finally, we also announced a change in the management as Pernille will take on a new role as Executive Vice President for Strategy, Transformation and M&A. I'm very pleased that Pernille will be 100% dedicated to spearheading the transformation work based on her deep insight into organizational change, business transformation and her profound understanding of the agreement with Agilitas. I'm also pleased that Carsten Ringius has agreed to join us as CFO no later than the first of December this year from a similar processor in K.W. Bruun, bringing extensive experience from TDC and Maersk Kline as well. I personally look forward to continue the cooperation with Pernille in her new role and, of course, also welcoming Carsten. On this backdrop, I will let Pernille provide an overview of the quarterly segment performance and group financial one last time. Please, Pernille.

Thank you, Par. I look forward to taking on the new role and continue our cooperation also after the split of the organization, divesting IO. Let's now proceed with a brief overview over the Q3 performance in the Life Sciences business unit. Revenue of Life Sciences grew 20% and driven by the acquisition of prime4services in Q1 this year and good growth in the international part of our business, ensuring a moderate 2% organic growth as well. We improved capacity utilization in the quarter after making capacity adjustments in late Q2. Following the growth in revenue and the adjustment of capacity we lifted the gross profit to DKK 49 million and reported a continuation of the positive trend in profitability from Q2. We expect to continue this path in the coming quarters based on the positive impact of capacity adjustments and increasing activity. The strong order intake continued in the quarter as we grew the backlog by 10% and following accelerated sales within production for Life Sciences and strong performance in regulatory affairs as well as next-generation testing and validation for current customers. Let us now turn our attention to Slide 6 and the CDS business. We were pleased to see our CDS business unit returning to growth in Q3, as we lifted revenue moderately by 4% to DKK 207 million in the quarter. This is mainly driven by higher sales to Life Sciences customers, and we expect growth to pick up going forward. We adjusted our capacity back in Q2 to reduce production costs, and we have improved the utilization rate this quarter and realized a significant improvement of the gross profit to DKK 42 million. On this background, we were able to boost the gross margin to 20.3% after the sluggish performance seen in the recent quarters. We will maintain our focus on cost while ensuring that CDS is able to accommodate demand and drive growth in the coming period. CDS delivered strong order intake within custom application development in China and Denmark, in particular, combined with good traction within Microsoft Solutions as well. The order backlog for this year continued to grow at a steady pace. Please turn to the Hybrid Cloud Solutions on Slide 7. The HCS business unit saw a slight decline in revenue in the third quarter to DKK 302 million, mainly due to the expiration of an SLA contract back in Q1. We maintained our focus on cost savings in the quarter to counter the impact of slightly lower revenue and significant higher electricity prices as well as higher staff costs during the ongoing transformation of our outsourcing organization. These effects did, however, drive up production costs slightly entailing a decline in the gross profit margin to 3% in the quarter. Efforts to improve the utilization rate continue, and we look forward to completing the consolidation of our global delivery capacity in the Philippines in Q4 to reap the benefits of the move. The order intake in HCS ensured a backlog of DKK 1.2 billion. Now let's move on to Slide 8 and an overview of the group financials. Group revenue grew by 5.7% to DKK 738 million in the third quarter on the back of acquisitions and moderate growth in Life Sciences and CDS. This translated into a negative organic growth of 1.3% and due to the development in HCS. Despite an increase in production costs following acquisitions, we lifted gross profit for the quarter by 11% to DKK 100 million, entailing a slightly higher gross margin of 13.6%. The positive traction in revenue and gross profit drove an improvement in group operating profit to DKK 30 million with a margin of 4.1% in the quarter. Special items around -- amounted to DKK 50 million, comprised of restructuring costs related to redundancies and the transformation of our outsourcing organization as well as the divestment of our infrastructure operations. All in all, we reported a net loss of DKK 22 million for the quarter. Please turn to Slide 9. We maintain the suspension of the '22 outlook today in the wake of the announcement of the divestment of our infrastructure operations. While we are making progress in the carve-out process, it simply takes time to enter constructive and thorough dialogue with customers. We still need a more complete overview of the outcome of the process before we are able to split our financial reporting into discontinued and continuing activities. When we have the necessary overview, we will provide new guidance. We look forward to being able to leverage the sharpened focus on the 2 core business units after closing of the transaction with the ambition to significantly strengthen revenue and profitability of the continuing activities from '23. Now turn to Slide 10 for a few closing remarks from Par followed by the Q&A session.

Thank you, Pernille. Firstly, I'm glad to say that we continue the strategic efforts to carve-out the infrastructure business and complete the relocation of our outsourcing organization. Secondly, we would like to highlight that we saw a pickup in revenue in earnings as well as backlog growth in the discontinued business unit, Life Sciences Solutions and CDS. And finally, we are starting -- we are stating today that there is still some work to be done before we have the complete overview of the split between the continuing and the discontinuing business. We are making progress, and we are looking forward to providing you with an update as soon as possible. Thank you for listening. We now look forward to take your questions. Next slide, please.

[Operator Instructions] Our first question comes from Yiwei Zhou from SEB.

I have 2 and do 1 at a time. Firstly, a question regarding your capacity utilization. It's good to see the improvement in Q3. But could you maybe comment on the current level if you compare to what will be the normal level? That will be my first question.

Well, if you take the capacity utilization, we have seen an improvement during this quarter, both in Life Science and in CDS. But I would say that there is still potential to improve it further.

Yes. So that's absolutely correct. So we are working on this in -- that's in both the business units way. And as you can remember, what happened in the beginning of the year was that we entered the year with full force expecting higher growth in Life Sciences. And then we have adjusted it throughout the year to sort of rightsize that level, but there is a lot of opportunities still within that segment to utilize -- within Life Sciences to utilize the capacity better and, therefore, improve the margins.

Great. Just one follow-up here. Is it possible to comment or provide us an index level if you compare to the normal utilization rate? For example, for the Q3.

So what you are asking is that what would be -- if it was full utilization, what would the margin be?

Exactly. Yes, yes. Maybe just utilization.

Maybe just utilization. We are not giving utilization as a number. So we don't do that here either. So -- but I can say to you that the way it has been tackled, the manning within Life Sciences has been to still maintain quite a gap to be able to grow because the people that have been brought on board in Life Sciences. They're not easily brought on board, so to speak. So there's still a lot of margin improvement on that capacity to be had.

Okay. Very helpful. And my second question here is on the wage inflation. We have heard some other IT companies talking about a wage increase in 2023. So what is your expectation?

So that's a very good question. I will say that wage inflation has different impacts to different IT companies here. It's a company with quite mature staff that has been with the company for a long period of time and salaries have basically grown with the seniority of the people. So what we have seen here has not been a very significant salary increase and wage inflation request compared to maybe competitors who have a very young staff base. So we are quite holding that here and also expect to continue to do that in next year. But of course, everything is sort of in what the development in the market is going to be. And another important element to that is also that prices to the customers are also going to reflect the -- and the new consultancy business are also going to reflect the wage inflation scene. So hopefully, there won't be a lot of margin impact as a consequence.

And the caveat to that, I also say that, I mean, given in this time, usually, our clients are more open to exploit our global delivery capabilities because we are blessed with having highly competent people, both nearshore and Prague and also offshore with our kind of reestablished operation in Manila. And that will actually give the benefit of both providing better prices to our clients and actually higher margins to NNIT. So I foresee that in '23, more clients will be wanting to go down that avenue. While, as Pernille said also, the -- usually, when you had these processes where the salaries go up and inflation goes up, there's actually some latencies to get the clients to approve higher prices. So we expect that to be able to happen in a more general extent in '23, actually.

[Operator Instructions] Our next question comes from Poul Jessen from Danske Bank.

I have a few questions. First on the CDS gross profit, which is more adopting sequentially. Are there any special items in that? Or is the level where we should see you performing going forward by increasing it further?

So thank you for that question. I'll take that. And what has happened in CDS is, as we also have alluded to previously, is that they've actually adjusted the capacity quite significantly earlier in the year as a consequence of the revenue that they were lacking. So that's, that. The -- that's kind of the initiative there. There will be also there possible further margin improvement opportunities, but they are not as near term as the Life Sciences that I just commented on. They have taken quite a hit.

But I think also, Poul, one comment is also, I mean, we're also now seeing -- see the effect of the establishment of the new organization in January. As you know -- recall, we then established 3 full P&L units. And I would say that has especially helped our consulting unit to operate the way a consulting unit should operate where you really connect the cost and revenue in the same unit and not having the split in 2 different universe as we had before. And I think you start seeing the benefit of that of both having a more focus on your bottom line and thereby also be able to deliver a better growth in business as well.

Okay. And if we look at the growth in the CDS, you have announced several contracts this year, both at ATP and in Central Bank and now the education. Shouldn't we see that your growth then should also pick up? Or are you terminating a lot of agreements at the same time?

Well, no, I would say there is no -- we see at least a continued modest growth going forward. And I think -- but I think it's really good to see. If you look on Q3 for CDS, you see 4% revenue growth and 5% cost reduction. So that's a beautiful picture, right? But I mean, the wins that you mentioned both ATP, Nationalbank, which contained a significant CDS piece. And then also, of course, [ SU ], when it comes in, it's going to be contributing a lot.

So I think the conclusion is you can expect judging from this that the growth is going quite higher.

Okay. And then more structural question on your setup. When the acquisitions made within Life Science in the past was announced and part of that was that you would keep them at as independent units not to integrate them into NNIT and thereby destroy the culture and entrepreneurship of those organizations. And recently, you've been announcing that you are now integrating these. Do you see a fear that you are more or less killing entrepreneurship of these? Or should we just see those picking out more costs?

It's a very good question. And M&A is probably the most challenging art you can devote your time to. And I mean, I think that the strategy for M&A in this company is actually brilliant because the strategy is clear when we meet this new company that the end state is actually integration within NNIT. We have communicated that clearly to the company, but we are taking this in a very, very cautious process where we at the start, do not do anything. We keep the company, keep the names and that we start to collaborate in delivery, start to collaborate in sales. So when the maturity reaches a certain level, then it's actually a push from the company that has been required to actually join NNIT, not the other way around. And I think it's also important to what does kind of full integration means, and it is no drama. I mean take, for instance, Valiance, they are keeping their offices. They are keeping the premises. They're operating with as much freedom as they had before. So we are not killing the entrepreneurship in the company. We are just reaping some synergies, especially on the revenue side. So I would not say that we are fearing any killing of any entrepreneurship. And it's just the kind of cautious process we have in NNIT in order to drive growth, profitability and also benefits all other stakeholders of the business.

Okay. And if you look at the number of employees in the international offices, it's up by about 30 people in the third quarter versus Q2, but then it was down in Q2. So are these companies then very aggressive on hiring right now? Or have you transferred people from other units into the international offices? Or [indiscernible] was wrong.

I do -- honestly, there hasn't been any strategic changes apart from, of course, I don't know how have we been demonstrating. But Life Science is now part of NNIT brand. So maybe that's one change.

Yes. I think this has something to do with certain integrations and people who've been moved around as a consequence of that -- those numbers. That's definitely not been added this amount of people to the offices. So if you allow me, Poul, then I'll come back to you on that specific question to just take that offline.

Okay. Then about the final one for now is about HCS. And when you were announcing the sale, you were mentioning that some of the cost would stay at you when you carve out HCS. And if we look at their production costs and they have a gross margin of 3%, part of the production cost of HCS. Should we see it being moved to the 2 continuing business so that we cannot just build on the existing gross margins of these at the closing? Or how should we look at that?

So it's difficult at this point to give you a proxy of how continuing and discontinuing business look on the cost base just because it's -- it has an element of what you are saying there, Poul. So the divestment is, as we've said previously, a divestment with a lean cost base. So the remaining company is going to basically, as a start, carry that cost base, but then there will be a plan to take that out. So to answer your question, the gross profit margin in both of those units will be kept intact. But as a start, there will be sort of a plan to take costs out as a consequence of this. To give you an example, it could be building cost where the division between those business units is going to be different as a start. And then there's going to be action on that, and then it's going to normalize.

But that means when we see the separation of the financials then we should see hit to the gross margins of LSS and CDS?

Yes, it's a start, you will, yes.

Yes. And then being taken off throughout the next year?

Yes.

Okay. Last question here. On the HCS sale and carve-out, the electricity prices who moves up right now. Can you give a little color on how that's going to impact this adjustment of the sale price?

Yes. Luckily, they're moving down now, Poul. So that's actually quite helpful to the -- but -- so it's -- I think they're moving up and down all the time at the moment. But the way the mechanism works, I can tell you is that we basically have to give the buyer a company where we sort of adjust the price for price levels as they sit the last 2 months of the trading before they take over. So depending on where the prices sit, there's going to be an adjustment as a consequence. That's quite how this works. But again, they're moving down. And maybe just as an add-on to that, there are also other adjustments in this that are moving the other way. So you can't just take this as a one-line adjustment.

So you have an interest in pushing the closing as late as possible in this year to get out of the September October prices.

Again, if the world was just so simple Poul, but it really is. So I think we have -- and Par is also looking at me here, I think we have a joint interest, both the buyer and the seller to close this deal as fast as possible, so that everyone can start managing the 2 separate businesses. And this won't be guided by the by the electricity prices.

It was more when I said funny common, okay.

I know. But I had to answer it, Poul. So that's good.

[Operator Instructions] We currently have no further questions. I will now hand you back over to a for closing remarks.

Yes. And thank you for all your great questions. And also that was all from us today. So thank you for your participation and look forward to being you next quarter again. Thank you very much. Have a great day, a great afternoon.

This concludes today's call. Thank you for joining. You may now disconnect your lines.