Tieto Oyj (TIETO) Earnings Call Transcript & Summary

Good morning, and welcome to TietoEVRY's Third Quarter Earnings Webcast. My name is Tommi Jarvenpaa, the Head of TietoEVRY's Investor Relations. This morning, we will go through our earnings development and outlook. With me here today are our President and CEO, Kimmo Alkio; and CFO, Tomi Hyrylainen, who will next go through the highlights and results of the quarter. Kimmo, please go ahead.

Thank you very much, Tommi. A warm welcome also mine and Tomi's behalf to our third quarter results announcement. Our third quarter performance characterized as a bit provided insight already a week ago given that we did the guidance change. Let us go through the main drivers of the current environment and third quarter performance. Our main message in that improved profitability in a weakening market environment. The weakening market environment contributing to our revenue development, revenue decline of 1%. Furthermore, a high degree of attention on the resilience of the company, resilience of all the businesses, a lot of attention on the cost base management enabling us to improve profitability to 13.5% level. Today, we are also confirming that the strategic review of TietoEVRY Tech Services is progressing, and we have advanced to an exclusive process with a nonindustrial buyer. Just to move forward, again, I want to reiterate, confirm the message from a week ago in terms of the guidance change, organic growth around minus 2% from the prior 0% to 3% level. And just to confirm, which we are elaborating on today by business as well that the softening market environment contributing to the revenue challenges when we talk about the short term. While the profitability level, the guidance at the 12.3% to 12.7% range from the prior year 12.0% to 13.0%. And the driver for the profitability guidance, narrowing and development naturally has to do with the resilience and the profitability development overall. I'd like to also confirm our perspective given the dynamics in the marketplace, this is good to spend a minute on with one of our main messages today is that during the third -- especially towards the end of the third quarter, we have seen weakening of the market environment and we anticipate this to continue into and meaning as we'll enter 2025. The market demand for IT services, likely not a surprise continues to weaken. Some of the shorter cycle consulting tend to be much faster impacted in a softer economic environment and the lower demand environment has started to impact also software businesses. And we confirm, as has been the case in prior quarters, very high degree of attention on the customer side on their own efficiency on their own resilience thus emphasis on short-term ROI versus longer-term transformation. I do believe that this is visible in the industry as a whole as well, and we confirm our attention and activity level increasing on AI and Gen AI intensity, cloud and data being the foundation, volumes are still relatively low. Thankfully, the activity levels are up. I think the confidence that this will be a future value generator continues to improve. And we confirm in the case of our company, the attention on the instability of the geopolitical environment, and we highlight this as everybody is well aware, due to the exposure of Ukraine. From a customer side, very importantly and positively, we have strong customer wins in all of our businesses. Highly modern technologies, cloudification, data centricity, AI in. So important to see a good progress in winning new footprint. We are talking more and more an increase in the level of visibility on the AI front. Just to confirm what we are sharing today, both from a customer reference standpoint, the readiness of the company overall, readiness of the company, including the responsible AI training. We are running for all employees and at the faster pace releasing really interesting customer cases to the marketplace. I'd like to also confirm that Tietoevry Create will be launching kind of next-generation AI lab during the latter part of the year, productizing innovation cycles and including design thinking and responsible AI into our value proposition. I would also like to share with everybody that nowadays, we have all of our businesses have been releasing their value propositions. Every business has the value proposition that consists of both the expected value delivered towards customers through our software and services. And the second dimension being the potential implications contribution of AI, Gen AI technologies towards operational efficiency in own operations, so these user stories are being released at an accelerated pace. All the information is available on the website naturally and being communicated actively towards current and future clients, and specific section also on responsible AI and how we link this to our overall sustainability objectives. Then to go into our more financial view and the business highlights, we already highlighted organic growth of minus 1%. Adjusted EBITDA, 13.5%, important to see a healthy cash flow of EUR 58 million, order backlog at plus 8% level. Here, I would like to highlight that the primary contributor is as we also communicated in the second quarter, the record high backlog in the banking side and that backlog to be realizable over next several years. That's a prime contributor to the strong backlog generation. Our commentary would also be that in terms of third quarter order intake quite typical as the seasonality in third quarter, slightly better than the third quarter a year ago. Then if we go into Tietoevry Create organic development on the top line, negative 4%, healthy profitability continues we'd like to be very clear that this type of a digital engineering, primarily shorter cycle consulting engagement is experienced a weakening market across geographies. This is much more profound at this point in time than in prior quarters, and we continue to highlight the challenges we have had in Sweden, a lot of attention going in. We are also sharing that the decreasing internal revenues is impacting growth as we began the specialized businesses running as independently as possible a couple of years ago, we -- it is, from our standpoint, very understandable each business decide what type of business partners one uses and this internal revenue development is with us for a couple of quarters, and then it will be normalizing, we believe, across the businesses. And to confirm in the case of Create, in light of the weaker market environment, softness in revenue development. Very importantly, we have ongoing really active capacity management actions underway and significant degree of attention, especially on the nonbillable side of the Create business. While we are highlighting quite a bit on the implication short term on the market environment, very positively, I want to add that significant contracts in the telecom side and a U.S.-based pharmaceutical clients. The team is working very actively and increase the pipeline in the U.S., and we continue to be committed and believe that once the economy bounces back, we'll be playing a much bigger role in the U.S. market. And here, as highlighted earlier, the next AI lab to really increase the speed towards client value and increased activity level on the AI side. For banking, main highlight being stable profitability, we had 4% organic growth driven by part of the portfolio, specifically the credit, the cards and financial crime prevention. And we are also highlighting openly that the Norwegian Bank merger that took place 1 year ago is impacting revenue negatively and that will be with us for a couple of quarters in light of the very high comparables from a year ago. Stable profitability, and we'd like to remind everybody increase in depreciation of capitalized R&D impacting by approximately EUR 2 million in this business, also a high degree of attention on efficiency measures, both in terms of slightly lower growth era and to ensure that we have the right cost structure post strategic review and to confirm Endre Rangnes began as the Managing Director, 3rd of September. Then to go into Tietoevry Care. Here, the highlight being solid performance, softening demand in certain markets, I would say only 3% organic growth in terms of our historical top line development, we are seeing very tangibly growth being affected by the Public sector deficits in Finland and then in Sweden, practically in the municipality sector, and we have some legacy software exposure in Norway and Sweden. Just wanted to highlight these developments and we remain very committed and positive of the strong competitiveness if we think about the first 9 months of this year in winning new footprint with the Lifecare software solution and as an example, double-digit growth in the data and analytics side of Care. And we confirm we absolutely continue to drive our investments for market expansion. I think more to come in the subsequent quarters, but this is highlighting Norway. And to confirm the healthy profitability level, supported by our long-term investment and attention on R&D, scalability and continued attention on efficiency. In the case of care, we are releasing at a very healthy pace, new use cases very specifically being strengthening actually our Lifecare solutions suite, samples included Gen AI assisting classified customer feedback data and we have Gen AI-enabled speech-to-text recognition already improving in the proof-of-concept stage, the workflows of doctors in the sample hospitals where these are running. In the case of Tietoevry Industry, we are highlighting softening demand in certain markets and very specifically in the paper, pulp and fiber industry and Public sector Finland. These are factors why we are seeing only 1% growth, while the larger part of industry, the data platforms did continue to grow profitability level of 16.3%, does deserve further efficiency measures, which are currently being worked on and will be taken forward to the latter part of the year. Then when we go into Tech Services, here, a couple of very important considerations, improved profitability from 9.5% level a year ago now to 10.5%. And very importantly, business mix is developing favorably. Cloud platforms and security, 20% growth, data and applications, 4% level. While the tradition infrastructure solidly in our expected range of minus 7% to minus 9%, was at minus 8% level. End user services tends to be, as expected, highly volatile much lower profit level declining by 7 percentage points as a cumulative sum organic growth of negative 3%. And as recognized the profitability improvement achieved through systematic attention on the cost efficiency, and that potential will naturally continue. We'd also like to highlight that the ransomware customer settlement impact on growth was approximately 1 percentage point. With this in mind, I'll hand over to Tomi.

Thank you, Kimmo, and good morning, everyone. So the main highlight of the quarter was our improved profitability compared to prior year. In addition to improving adjusted profit we did improve reported EBIT, both in nominal terms and in margin terms. Due to the slow market, we have proactively managed the cost base in all of our businesses to protect the margins and ensuring competitiveness. We will continue to reduce capacity in Q4, which is why we increased our OTI estimate for the year from previous 1.5% to closer to 2% of revenues. Other highlights of the quarter, as mentioned, healthy operative cash flow, and then closing of the bypass divestment, which we thought we would close already in Q3, it was closed 16th of October. So we will be recognizing a gain on sale of EUR 4 million in the Q4, which will be treated as onetime item. So we delivered healthy cash flow, operating cash flow being EUR 58 million. Net working capital, seasonal increase of EUR 20 million, driven by vacation accrual releases and AP. Accounts receivable decreased EUR 45 million, where we recovered the prior quarter weakened impact. Free cash flow was EUR 26 million, which for a seasonally weak Q3 is at very healthy levels. Interest-bearing net debt landed on EUR 900 million, which contributed to net debt to EBITDA being slightly lower at 2.1. Then to personnel topics. LTM attrition was stable from Q2 at 8.8%, which is at very low levels and reflects the current slow market environment. Our cost management measures drove capacity reductions of approximately 500 FTEs, out of which 300 in Create, 100 in Tech Services and 100 FTEs in aggregate in the software businesses. We will be continuing managing our capacity into Q4 as commented. Our new hires reflect the seasonally high graduate intake which is how we manage our competence pyramids. So our new hires were 600 in Q3. We keep our group level salary inflation expectation unchanged around 4.5%. Then I'll summarize the performance drivers for Q4. Our growth drivers on a business level, the drivers remain very consistent with Q3, however, in a slightly weaker market setting. On profit drivers, the weakening market conditions placed pressure on margins, while Q4 is typically supported by seasonal volume increases and end-of-year license sales. Now here's where the softening of the market will not place likely a bit of uncertainty how this driver plays out. Our efficiency measures are expected to support Q4 profits. We expect that we will book majority of the ransomware event-related customer settlements in the fourth quarter. We expect only a minor impact from FX and working days being positive 0.1% impact on growth. Then to Q4 profitability outlook per business. We expect Create to be below the 15% prior year level. Tietoevry Banking and Tech Services, we expect to be at or below prior year level. We expect the Industry to be at prior year level and Care to be above prior year level of 30.1%. Back to you, Kimmo.

Thank you, Tomi. In parallel to, of course, company continuing to build resilience in terms of the short-term weakening market environment, I would like to confirm that we are absolutely also looking into the future, remain fully committed for driving our strategic transformation of becoming a really strong software and digital engineering-centric company. This will open up new growth, scale and value opportunities over the next years, especially once we'll see the economic environment also improve. Yes, currently, we focus on resilience. And to be fair, in parallel, our businesses are working on longer-term strategies, potential market expansion choices to be prepared for future growth opportunities. And as shared during this session as well, we continue to be very active, more and more capabilities, trainings, customer engagements, value propositions, repeatable components for technology components for clients to be very strong in the AI and Gen AI domain, and we look forward to concluding the TietoEVRY Tech Services strategic review. So this would summarize the main messages. Glad to be going into Q&A.

Thank you, Kimmo and Tomi, we are now ready for the questions.

[Operator Instructions] The next question comes from Felix from Henriksson.

Felix Henriksson from Nordea. I have 3 questions, I can take them one by one. If we look at your updated full year guidance, it sort of implies a pretty weak fourth quarter of the year with roughly minus 5% negative sales growth. Can you sort of elaborate a bit more on the Q4 growth drivers? And how large of an extent the ransomware headwinds play into this growth?

Yes. So thank you for your question, Felix. So ransomware is impacting, as we commented. So in this quarter impacting Tech Services growth of 1%, so that you can count being approximately EUR 2 million impact. Then into Q4, as we commented, we are staying within our original estimate of the full impact of the ransomware customer settlements, which we have said are below EUR 10 million. So this is the delta that we have put into the revenue growth number for Q4. Then in the specific growth drivers for businesses. Naturally, as I mentioned, there is a weakening of the market impacting all businesses, Create we're commenting that the weakening of the market, now our market weakening is visible in all markets. We rather commented in Q3 that it was in specific markets. Now it's visible in all of the markets and then the internal revenue driver which remains. On Banking, we're specifically highlighting the impact of the merger impacting comparable number and 4 percentage point headwind for Q4, which is relatively significant. On Care, the budget deficits, this is, of course, where we have typically in the Q4 experienced higher licenses towards the end of the year. The budget deficits will likely impact this quite a lot. In Industry, there's a bit of a same phenomenon on the Public sector when we're not getting as much as we used to at the end of year license sales, that is the expectation pulp, paper, fiber continues as Q3. On Tech Services, specific driver likely compared to Q3 being the hardware software resell, which we comment there's negative 4 percentage point headwind into Q4. Those would be in summary, just going through all the businesses as well.

That's very helpful. Then on the demand outlook, you're talking about the market having weakened towards the latter part of the Q3 and the weakness also continuing into next year. What do you think will eventually change the demand for the better? A lot of companies are talking about lower interest rates and so on. But what's the key delta? What needs to happen sort of the market recovers in next year?

So Felix, thank you for that point as well. So as we have commented purposefully today that this type of weakening, we believe, is an indicator as we are into 2025. So naturally, in addition to the macro drivers, we read the very typical ones on the interest side, interest level and all the same ones. In addition, of course, we listen a great deal to the business drivers that we hear from our customers. I think in our case, we'll see a lot of tangible input from both the customer side on how they see the demand for their products and services picking up. We see -- and then we tend to see potential early signals from the pipeline as well. So these are something we -- as everyone would be expecting, we are looking into continuously very thoroughly. Currently, our thinking is, naturally, we are working through the business plans for next year. We can here mentioned on this call as well that as we have already commented, yes, we will begin in a weaker market. We are hopeful that second half of the year, there will be better signals and opportunities to be actually turning the corner.

That's helpful. Last question for me regarding this exclusive process with the nonindustrial buyer for Tech Services. I understand it's a sensitive topic, but can you provide any more color on when did these exclusive negotiations start and how they have been developing on a time line?

Thank you, Felix, for that as well. And like you commented, this is a sensitive topic. So there's not much more to comment at this point in time. We believe, for today's purposes that we have shared that we have advanced to this exclusive process with the nonindustrial. That's more or less what we can say. And when one refers to exclusivity, I think everybody has we have all our own sample sets that how the M&A and the processes work. So that's why we talk about we've advanced this level. That's what we can say today.

The next question comes from Sami Sarkamies from Danske Bank.

I have 3 questions. We'll also be taking this one by one. Firstly, starting from the cash flow. If we look at the year-to-date operating cash flow, it's EUR 85 million above last year. Can you elaborate on the main differences and which year is more appropriate estimate of a sustainable level going forward?

Yes. Thank you, Sami, for the question. So LTM free cash flow, EUR 215 million, LTM operative cash flow, EUR 350-ish million. So this is naturally the levels that we feel comfortable with what we experienced last year was a bit more abnormal. We were losing on the net working capital elements. Now, of course, good to note that we did experience EUR 40-ish million recovery from the AR, which has last year impacted negatively the cash flows. So at these levels, we feel comfortable with.

Okay. And then moving on to Banking. You highlighted ongoing efficiency improvement program. Can you talk about the magnitude? And for example, what is the current offshoring ratio? Where are you going to take it going forward? And then maybe finally putting things into perspective, you have 17% margin target for next year. You remain below 13%. So what are you thinking on the upside potential from these levels?

Maybe this banking and the plans, we don't want to share now any concrete euros of the plan. So what we're now doing is that we are taking out all of the strategic review related excess cost that was built in. And then we're sort of further building competitiveness into these businesses. This includes SG&A and normal capacity as well. Then in terms of the -- you referred to our CMD targets from 2.5 years ago, these we have already earlier concluded, as you all likely remember that we would need market recovery to reach these levels. We will naturally guide '25 then in February once we come out with Q4.

Okay. And then finally, maybe a question regarding your forecasting ability. If we look at the segment level performance in the third quarter, there were actually a number of deviations relative to your own expectations that were given a quarter earlier. So what were some of the biggest surprises for you during the quarter?

I think there wasn't sort of, let's say, bigger surprises. So we hit our forecasted numbers June -- July and August. September, we saw this decline. And then our business is clearly indicated the softening of the market. We will not get to our forecast as they were at that point in time. And this is also the result of the guidance change that we did I wouldn't highlight any specific other driver.

The next question comes from Daniel Djurberg from Handelsbanken. The next question comes from Mark Hyatt from Morgan Stanley.

I've got a couple of questions, please. Firstly, could you just talk a little bit more about the weakness that you've seen in industry. It was kind of one of the more market slowdowns that we saw this quarter? I know Kimmo, you've talked about some of the specific end market weaknesses, pulp, paper, fiber industry and Finnish Public sector. But can you talk a little bit around where you're seeing the weakness from a kind of license or SaaS side? Or was it more on the services side? That's the first one. And then secondly, Kimmo, you mentioned in the presentation a bit about what you're seeing in the U.S. market. You called out a key win there. Looking at your peers across the industry with exposure to U.S., it seems like the demand picture in that market, in particular, is a little bit better than what we're seeing here in Europe. So how are you thinking about the U.S. market going forward and your exposure there?

Okay. Thank you for those. So on the industry side, as reflected upon, we wanted to be clear that it's very specific in the paper, pulp and fiber and then in the Public sector Finland. So let me open that a bit further. Public sector Finland is the Public 360° portfolio which is a well-SaaS-ified software that we have within that business, the budgetary cuts has very tangibly impacted any new projects very specifically in the Finnish market. And to be fair, in this Public 360° business, there is also a shift of reducing the magnitude of professional services moving into a fully SaaS-ified model. So we are a little bit in between that transition that is also impacting. But that's smaller component. But the SaaS-ification with this in mind that the good kind of readiness from a technology standpoint, what releases we have out there second quarter also AI-enabled Public 360° SaaS release but the budgetary cuts impacting really tangibly. Second factor would be in the paper, pulp and fiber cost level optimizations for customers and this would be impacting the -- given the type of a longer-term transition towards a SaaS-ified business model that would be impacting the combination of licenses and professional services. We follow your consideration on the U.S. market. We follow that naturally separately as well. I wouldn't yet go into -- we have some signals potentially in that direction that you are reflecting upon, we need a lot more proof points before we would be ready to say that there is a tangible uptick in that market.

The next question comes from Aditya Buddhavarapu from BofA.

Can you hear me?