Tieto Oyj (TIETO) Earnings Call Transcript & Summary

Good morning, and welcome to TietoEVRY Second Quarter 2023 Earnings Webcast. My name is Tommi Jarvenpaa, the Head of TietoEVRY Investor Relations. We are living very exciting times for the company. Next, our President and CEO; Kimmo Alkio, together with our CFO; Tomi Hyrylainen will go through the highlights and results of the second quarter. Kimmo please go ahead.

Thank you very much, Tommi, and a warm welcome to everybody for the second quarter results announcement. Exciting times indeed and a lot of good momentum that we are going through as TietoEVRY. Our highlights for the second quarter, solid underlying performance, growth of 3%, profitability, 10.5%. Our growth continues to be driven by the businesses that should be driving our growth -- 2 of the software businesses, TietoEVRY Banking and TietoEVRY Care and our digital engineering business TietoEVRY Create. Fair to recognize the second quarter performance has been impacted by continued high inflation. The inflatory era remains with us, and impacted by fewer working days and fewer working days impacting both growth and profitability understandably negatively. Our ongoing efficiency measures and strong order backlog, which is up organically by 8% for the second half of '23 will support our full year performance outlook. Also, in terms of our strategic reviews, we have an update today in the case of TietoEVRY banking, conclusions updated to early '24, and we'll cover the details in a few minutes further and TietoEVRY tech services, strategic review progressing as planned. Furthermore, and very excitingly, earlier today, we have announced us acquiring a U.S.-based digital engineering company MentorMate with approximately 1,000 employees, really increasing our growth potential in North America overall. And I'll cover those -- that background also in further detail. In the current environment, good to offer a perspective on the market as well. Market, we read it as a mixed market environment. We see continued healthy opportunities, continued healthy demand worldwide in the areas which do drive our industry-wide growth opportunities, specifically in areas of cloud, cloud-native application development, data, data management, machine learning towards AI and GenAI as well as security services. And from our standpoint, very importantly, healthy continued demand for industry-specific software. So this gives a good footing for the growth opportunities moving forward. In parallel, -- it is important to highlight that we do continue to see a temporarily softer international market, especially in the second quarter and first quarter in the U.S. And we continue to see, as predicted decline in traditional infrastructure services. In the midst of a mixed market, we have been able to deliver solid financials in the first half of '23, with over 5% growth and 11.4% profitability. And as mentioned, we entered the second half with really strong order backlog for -- to be realizable end of this year. And we want to highlight naturally, given the inflatory era, very important that we continue high degree of attention on efficiency and price increases, kind of standard procedure to make sure that we continue attractive profitability improvement. Short commentary on the dynamics furthermore of the market, we have a very active agenda as TietoEVRY supporting our customers, modernizing their businesses, becoming more competitive in terms of driving a combination of efficiency, agility, competitiveness kind of this comes directly from our strategy. Our thinking remains very, very consistent. The addition we have made in the recent few months, given the developments on generative AI, the opportunities to actually be driving I'd say bit, mid- and long-term growth through new products and services with GenAI embedded and furthermore, driving for further delivery type of optimization. We are running a company-level program, bringing together the expertise, including third parties to accelerate actually the impact in the market we've been able to launch certain use cases, already very, very meaningful in full support of the larger customer base. The type of data access -- proprietary data we have access to, being able to apply GenAI as an example in the health care sector. And we have a few other interesting already live implementations in place as an example, in retail. This is an area that we expect to be very, very active moving forward as well. Couple of reflections on recent customer wins, the commonalities in the customer wins, naturally reflecting a significant degree of insight on the customers' business processes, what examples would be Offshore Norge, then public sector in Norway in the community of Oslo. Other commonality would be on our capabilities in the industry software area and health care software where the data capabilities, from a standpoint of data management, data engineering, machine learning, AI, towards GenAI. These are the factors that help us to win a good degree of share in the marketplace. I'd also like to reflect here in the beginning briefly on our development of our sustainability game plan. We have a very good foundation. We have systematic implementation recently. And I'd say, on a continuous basis, we have seen positive trend in diversity, visible in the share of females in new recruits. Furthermore, during the recent months, we have been very active in a multitude events in our main go-to-market countries contributing to the societal dialogue around the importance of diversity and our contribution to this important phenomenon and direction. Lately, we have also been recognized for the third time by EcoVadis as being globally in the top 1% in the sustainability priority, sustainability progress overall. So this will continue to be a sustainability naturally very high on the agenda. Then to one of the more exciting parts also of today, our recent acquisition of MentorMate in the U.S. company profile, headquarters in Minneapolis, strong customer base in U.S., several larger customers in Europe as well, fits actually super well our operating model with a highly dynamic and efficient go-to-market significantly expanding our delivery network. The company having nearly 900 people in Bulgaria and as mentioned, fits this whole strategy of scaling TietoEVRY Create and the capabilities fit exactly correctly in the areas of design, data, cloud and AI. MentorMate 2022 profile, $60 million (sic) [ $65 million ] in revenues, growth of approximately 40% and -- and this business shall be accretive to TietoEVRY Create objectives as soon as the integration has started. Furthermore, just to confirm why this is important for our company. This advances to Create ambition to become a leading digital engineering player globally, fully according to our strategy. This very practically expands our customer base and growth potential in the U.S. market and enables us to consolidate our operations in the U.S. to be able to play much more active market penetration for TietoEVRY Create as a whole. Naturally strengthens the full talent base opportunity for talent to have very exciting projects within the global network. Integration begins immediately and as mentioned earlier, that the announcement has practically been done today. So very exciting time and part of our strategic direction and M&A capability. As mentioned, as part of our strategy launch in October '21 has been built into the company and nice to see this progress as well. Let us next go into an update of a lot of interest to everybody regarding the strategic reviews. In the case of TietoEVRY banking, we continue to make good progress, standalone legal structures have been established. We want to be open that a bit of time is required for the management to finalize the strategy and to establish the operations to become fully independent and able to operate as an independent company. Furthermore, we expect the strategic review decisions to take place during the early part of '24 followed by rigid implementation. I'd like to confirm, we are fully committed to a strategic review, as announced and firmly believe we will be concluding in early 2024. We have a strong asset base within Fintech software, and we have now the right leadership in place. Once all considerations have been completed, we will announce the outcomes accordingly. Next, I'd like to provide an update on the tech services side on the right side, Tech Services Strategic Review progressing as planned. In the second quarter, naturally, the significant preparatory step was accomplished as the operations became integrated regarding the end-to-end operations go-to-market, full operating model management system reporting and everything that goes with end-to-end operation. The ongoing operational simplification will continue and will improve performance in the second half in combination with the already launched overall efficiency program. The preparations aiming at the potential sale or listing as a spinoff is fully on track as we had originally announced. Next, I'd like to go into our business highlights. Some of the main group-level figures highlighted already in the beginning. Organic growth of 3%, adjusted EBITDA 10.5% and cash flow from operations, EUR 11 million has to do with the natural seasonality in cash flow. And as mentioned, order backlog for second half, up by 8%, up by 6% in equivalent currency. So overall, important in terms that after 6 quarters of strong growth, we had only 3% growth, very important that we have a healthy backlog going into the second half. In terms of TietoEVRY Create, a solid growth in a more challenging market, this we highlighted at the end of the first quarter, growth currently driven by Austria and Norway, temporarily softer international market, specifically U.S. I'd like to here highlight that we have seen some early signals of healthier pipeline and very interesting to see on the degree of market bounce back that we predict, and we've seen many of the industry players predicting a bit similarly. Healthy demand in the areas of data and AI further fueled by the customer interest in the potential of generative AI. And this is very interesting domain specifically in the Create side, given that we have such strong data practices, data, machine learning, AI and towards generative AI. Naturally, for the second quarter, the fewer working days, tangibly impacting growth and profitability in the create side as a consulting business. We are maintaining stable capacity while temporarily lower utilization rate as we strongly believe in the growth bounce back. In the case of TietoEVRY Banking, continued strong growth. Second quarter, we had healthy growth across a vast proportion of the banking portfolio, growth in Wealth, the Financial Crime Prevention, Credit and the Banking as a Service. As what we had predicted, profitability has been impacted by the increased technology costs and increased costs resulting from legal separation thus deserving further efficiency improvement activities. The profit improvement actions contributing to second half naturally increased the much earlier initiated price increases, efficiency measures, including all aspects of efficiency naturally also the technology cost optimization, which is a significant part in the case of TietoEVRY Banking. Regarding TietoEVRY Care, second quarter continued strong performance. So, this has been flying steadily at a fine level, strong growth driven by combination of Healthcare and Welfare for your information, the other services we have in this business has to do with the laboratory services as well as the data platforms for the Care sector. This time, especially driven by Healthcare and Welfare, and very interesting additional market share gain through the strategic win within the social reform in the country of Finland, within the district of Ostrobothnia. Our continued strong profitability. And as earlier mentioned, the GenAI, new type of innovation and proof -- the type of proof-of-concept initiated second quarter through a joint effort between TietoEVRY Care and Silo AI as our partner company. TietoEVRY industry, fine performance, steady performance in the second quarter, growth of 4%, driven by growth in Pulp & Paper as well as Data Platforms. There is a multitude of portfolio in the Industry business. This time, the other parts did didn't grow faster. This is a bit of a signal that better is also possible in the areas as an example of the of the public sector document management. Growth and profitability impacted by timing of a few customer contracts shifting between the quarters. And here, we are mentioning that healthy order backlog for the second half. Then an area naturally a lot of interest in the case of TietoEVRY Tech Services, a bit challenging negative growth of 5%, naturally second quarter, a lot of effort on the integration, efficiency measures, including operational simplification will be contributing to second half performance. It's fair to highlight that the business mix is evolving towards more scalable data, application and cloud services, while volume reduction in traditional infrastructure and low-margin hardware and software resell. We'd like to also highlight that the Traditional infrastructure of minus 11%, we believe, was exceptionally low in the second quarter, and we anticipate more normalized levels for the second half of the year. Cloud Platforms and Security up by 12%. Hardware/software resell down by 13%, and that's natural area we are to optimize given the low-margin nature of the business. Profitability impacted by negative growth naturally and high salary inflation as well as the technology cost inflation. The efficiency measures, which I know I've said 3 times already are very important and are on schedule as part of our profitability improvement. Overall, with the consideration, I mentioned that we [ expect ] more normalized level in the Traditional Infrastructure, meaning lower than the minus 11%, second half growth outlook, we believe shall be more favorable. Next, I'd like to hand it over to Tomi.

Thank you, Kimmo, and good morning. We delivered solid underlying performance in Q2, as mentioned. Why do I say that? -- working day adjusted growth was approximately 4%, and working day adjusted profit exceeded prior year level. The market environment, as mentioned was mixed during the quarter, with continued healthy demand in software, cloud and data services where the traditional infrastructure services declined slightly faster compared to prior quarters. Inflation remained high, both in technology cost and in salaries. As mentioned, Operational Integration of Tech Services was completed during Q2 according to plan with historical restated financials provided at the end of June. Our order backlog development was strong with overall improvement of 6% and 8% improvement for the backlog realizable in Q2. This improvement gives us confidence to deliver solid full year performance. Our onetime cost estimate for '23 remain unchanged. On operating cash flow, it was EUR 11 million, which is slightly improved from prior year. To note, Q2 cash flow is seasonally low due to working capital increase, which primarily comes from prepayment changes and changes in personnel-related liabilities. Free cash flow was also impacted by seasonality. Net debt-to-EBITDA increased slightly to 1.6x due to seasonally lower cash flow and dividend payment of EUR 86 million in April. Attrition continued to decrease with 12-month rolling attrition at 12.5% compared to 13.5% at the end of Q1. Our net head count was slightly down from Q1, reflecting slower recruitment pace due to decrease in attrition in addition to continued head count reduction in TietoEVRY Tech Services as a result of efficiency measures as mentioned. We update our salary inflation estimate for the year to 5% from earlier range of 4% to 5%. Next, I'll summarize the performance drivers for Q3. On growth drivers, we expect good momentum to continue in Banking and Industry to come back to healthy growth levels. We also expect continued healthy underlying growth in Create. However, less working days and high comparable due to Ukrainian currency devaluation prior year will have approximately 5% negative impact to organic growth for Q3. As discussed already in our Q1 report, the health care reform in Finland will impact the demand of TietoEVRY Care for H2. Also, a decline in Traditional Infrastructure, we expect to continue, driven by acceleration of cloud transformation. On the positive side, our strong order backlog will support our H2 performance. On profit drivers, inflation is expected to continue at high levels, which makes it demanding for all market participants to maintain or expand margins. High technology costs will continue to impact Banking and Tech Services and Tech Services efficiency measures will start to contribute to Q3 profits. In addition, vacation period will have positive impact to profitability for Q3 and the second half. On other drivers, we expect FX to continue at high levels, minus EUR 56 million for Q3 and less working days similarly to Q2, will have a negative impact on growth of minus 1.4% at group level. Then to our Q3 profitability outlook per businesses, 3 of the businesses, Create, Banking and Care are expected to be below prior year, Industry above and Tech Services at or above prior year profit levels. Back to you, Kimmo.

Thank you, Tomi. So in conclusion and our typical way summarizing the way forward. The foundation for our full year execution, we believe is good based on our overall solid H1, the already activated efficiency measures, our strong backlog and seasonally over the years, clearly stronger second half. We continue to advance on Banking and Tech Services Strategic Reviews to drive and accelerate shareholder value. We continue to operate in a healthy and high engagement level amongst employees, and we see continued good ability to attract talent for the professionals in the industry. And I'd like to confirm that the generative AI does provide attractive business opportunities, and we aim to be one of the leading players in the market, as we have advised over the years, our customers enterprise and public sector across a multitude of tech cycles and we believe GenAI will again be a very interesting one. So with this in mind, indeed to confirm that the full year outlook remains intact, and these are the main drivers, specifically for now in the overall second quarter report. So time for Q&A.

Thank you, Kim. Thank you Tomi. We are now ready for the questions.

[Operator Instructions] Next question comes from Mark Hyatt from Morgan Stanley.

I've just got 2, please. Firstly, on Create, given the slowdown in that division, could you talk a little bit about what you're seeing in that business in terms of the underlying demand environment? Which markets are you seeing the most weakness? And are there any particular verticals that you'd call out there? And then secondly, just on salary inflation. Clearly, you booked your expectations for the full year to 5%, but the overall margin guidance has remained the same. So could you just talk a little bit about what gives you confidence in the second half margin outlook? And how would you offset that slightly -- expectation -- oh sorry inflation.

Yes, thank you for 2 points. So, on the Create side, so underlying -- so the mixed environment has been driven in our case. And I think we've heard it industry-wide quite a bit has been a lot to do with the U.S. market. And this business more than any other business we have is dependent on the macro cycle. And to be fair in our case, it is visible in the competitor landscape. So that would be our perspective. I did mention briefly in my earlier kind of commentary already that we've actually seen initial signs of pipeline improvement. And this will be dependent on the macro bounce back investment appetite for especially the type or new type of innovations, new projects. So that shall be the dependency -- and we are also seeing, to be fair, quite good demand in many of the markets. We've seen positive progress across the Nordic countries. We were maybe a bit behind in some of the quarters in the Nordic countries. So that's why we call it the mixed environment and part -- to be very straight, that's also why we don't talk about it. It's a negative environment. It's a mixed one.

On the salary inflation, yes, we did now update our estimate to 5%, I mean how do we mitigate against that? There's no other silver bullets to do it than the means that we do it anyway. So it's through the price increases, normal efficiency measures whether it has to do with automation or other cost optimization measures.

And specifically, for second half, it is very important that we have those programs initiated several months ago. And the most critical ones are on schedule, this gives us comfort for second half.

The next question comes from Sami Sarkamies from Danske Bank. Please go ahead.

I have 3 questions. We'll take these one by one. Firstly, starting from Q2 surprises, it seems that growth probably cooled down a bit more than you had anticipated. And then also, you did miss your own margin guidance for Create, Banking and tech services. Can you please provide some comments regarding this negative surprise in Q2.

So, Sami, absolutely. So -- the second quarter, so I think is visible to everybody that Tech Services minus 5% to be fair, that is the predominant and very clear driver. And we did see a bit exceptionally which, to be fair, I hope I commented clearly early on as well that traditional infrastructure was temporarily higher. There were a couple of factors in the comparables a year ago, but we -- so that's a real -- that is a real factor behind. And then your second point that our softer guidance regarding the businesses, so the inflatory impact of course, it's a different story per business, inflatory impact is recognized businesses, which have third-party technology costs. Third parties are increasing prices as much as they can. In in the case of Create, as we've been very open, utilization rates periodically a bit lower. In our case, it's a factor. And to be fair, it's quite a consistent factor in that business industry-wide.

Okay. And then moving on to the full year outlook. Can you please explain what gives you the confidence regarding second half? I mean you're obviously talking about strong order backlog. But just thinking if there is a risk for any sort of order cancellations or push-outs and then we already talked about salary inflation, but I'm wondering that you're currently having lower utilization rates at Create. So if there is no pickup in sort of customer activity that might also be the situation in the second half of the year. So just would like to hear your assessment regarding the risk factors going in the second half of the year.

Thank you for that point as well. So the foundation as to play that full thing back. So naturally, we have ample proof of our predictability on the top line side. If we think about over the last few years, so the opportunity to maintain a growth trajectory, understandably one factor. Second, very important earlier mentioned efficiency programs, especially Tech Services, fully on schedule. So these are the fundamental factors. And to be fair, in the inflatory era we have had for around 1.5 years systemic even higher attention for efficiency improvement across operations, including the aforementioned price increases and everything. So those kind of continuously improving efficiency is a must do. These are the factors. And to be fair, then the macro economy, you're as good as a forecaster or better than we are -- we are reading the same signals. And as everybody else, so subject to the dynamism of macro, that is naturally one element. We tend to be one of the more resilient businesses in the industry, given the proportion we have of long-term contracts and relatively quite a small proportion based on short-cycle projects.

Okay. And then finally, just wondering regarding separation of banking that -- why was that sort of decided to postpone into next year? And is it so that we will not hear of the business plan for banking before early next year.

So thank you for that point as well. So we believe it is actually -- and hopefully, everybody sees it's really natural. Management needs a bit more time to finalize a really Fintech software-centric strategy establishing the fully independent operations. It just takes a bit of time. And to be fair, as we had mentioned one year ago, it is also a holistic consideration regarding the total readiness when is the optimal -- the best time to go out, but that this is the main consideration, a bit more time needed. And then we will be naturally sharing the outcomes as we -- as rapidly as we are in the finish line.

The next question comes from Matti Riikonen from Carnegie Investment Bank.

It's Matt Riikonen, Carnegie. I have a couple of questions. I'll take them one by one. First of all, could you describe your demand trend for new business during Q2? Was it the same throughout the quarter? Or did demand weaken towards the end of the quarter?

Thank you, Matti. So overall, we saw the performance being -- I shall address your point specifically in a second here. But overall, we saw clearly weaker performance in the beginning of the quarter, clearly healthier towards the end, I would say, including the demand side.

Okay. Good. Then next, have you seen more project cancellations or postponements in Q2 versus Q1? And do you think that there is an increased risk that they could accelerate in the second half? I think you already commented a little bit towards this direction in the previous answers, but just what is the kind of gut feeling that you have?

So the answer is no, and it's not only a gut feeling.

All right. And then regarding order backlog, you have a good order backlog now for delivery in the second half this year. But how does your order backlog look like for 2024 deliveries?

So thank you for the comments. So let me just add a bit of clarification. And of course, Matti shall remember our prior dialogues on the topic. With our business mix, we need to look at -- to make -- be very conclusive. We naturally look at the volume development per business type a lot. It's very different in an outsourcing type of business environment, Tech Services, when we look at the software businesses, depending on how much you have [ SaaSified ], how much license space, [ SKU of licensees ] and how much you have on maintenance and professional service. So the definition and significance of backlog is very different. And then again, it's very different in the case of the Create side. So my open commentary here is not to try to oversimplify our group level view from -- we can always talk about per business type, and we are not publishing the backlog per business. Most important part that we have good outlook for second half, like also thank you. You also said we are growth driven, we have been able to get into the growth bandwagon. Second quarter naturally was very modest. Q1 was continued strong. So we absolutely believe in the strategy of the specialized businesses and opportunity to be driving the growth agenda. I would probably need to leave it at that for the time being.

Okay. The point for my question was that you are strongly highlighting that you have a good order backlog for the second half. But of course, the world doesn't end there and of course it would be nice to know that what kind of pipeline do you have for '24 based on the current order backlog that you have. So, that's the reason for the question. I understand that drivers are very different in all your businesses, but it all reverts to the kind of total backlog that you have.

Matti, I can verbally confirm that our backlog for '24 is stronger now than it was at the same time of prior year for the following year.

All right. And then finally, this is my last question. In your Consulting and Software businesses, are you still hiring? And does your hiring activity prepare for top line growth also for '24.

The agenda is absolutely also top line driven. And like we mentioned in the case of Create, that we have maintained the capacity even when temporarily utilizations have been a bit lower, and that is indeed for the reason we absolutely see the growth opportunity. And we are mindful how fast we grow -- how fast we recruit, given that attrition levels are down overall. So it's a fine balance. It's a good balance. And the answer is, yes, it is growth oriented.

The next question comes from Aditya Buddhavarapu from Bank of America.

I have a couple. So in Tech Services, you mentioned that you expect the decline in Traditional Infra to normalize for the rest of the year. Can you talk about what gives you the confidence and that recovery and also what drove the acceleration in decline in Q2. Second, in Care, you mentioned the impact from the Healthcare reform in Finland, slowing down decision-making. Again, can you give us a sense of when that should start to improve as well and when you expect to see more momentum on that side of things.

Okay. So thank you. So the Tech Services, so, indeed there were a few exceptionals that existed in the second quarter. And to be fair, we have kind of quite a lot of proof points that the more typical levels have been historically in the 6% to 8% roughly range, and we have reported those very transparently. So that's the visibility that we have. And to be fair, there were exceptionals also in the comparables Q2 of last year with certain large customers. So those are just the factors why we commented it was exceptional. On the Care side, so just to confirm our game plan, our role in the -- both Healthcare, Welfare sectors in the Nordics, it's very important. We are very active. I know your point is about the social reform in the country of Finland. And the consideration is two folded, a lot of the Lifecare upgrades that were implemented -- second -- end of last year, early this year, there's a very likely time out that the politicians do take place as they formulate their decisions. and investment levels to be healthy again during '24, I would not yet predict exactly at which point in '24.

All right. And maybe just as a follow-up. In Create, I think you're still talking about some impact from working days and stronger comps in 3Q, but could you also point to where you're seeing weakness in terms of end markets? Is there any particular industry which is weaker at this point of time? And if there's been anything in particular which changes the growth outlook for that business for the second half or into 2024, given the more volatile macro.

Thank you. So maybe a couple of factors I talked on the negative side of volatility, which was your prime point. So as commented earlier, the U.S. market, so the type of work, how the U.S. has been behaving. And to be fair, I know I said it a couple of times, we hear it from more or less any industry participant that, that has been the case. Now I did comment earlier, we have seen early signals of actually healthier pipeline also in the U.S. To be fair, one other element that has to do with our Create business is the utilization rates with our Ukrainian colleagues, which we continue to support at maximum level. So there has been some utilization, kind of temporary -- of temporary nature partially in Western Europe, then I talk a bit on the more -- the areas that are uplifting the perspectives also, I commented the Nordic countries where we have known. We have room to improve. So that's why we -- these are the factors why we talk about the mixed environment. We don't think we have any need to talk about a negative environment.