Tieto Oyj (TIETO) Earnings Call Transcript & Summary

Good morning, and welcome to Tieto's Second Quarter Earnings Webcast. My name is Tommi Jarvenpaa, the Head of Investor Relations at Tieto. In the second quarter, the market we can further which impacted our growth. At the same time, we delivered a significant improvement in our profitability underlining the resilience of our business and the progress we have made over the past year. This morning, our President and CEO, Endre Rangnes; and CFO, Tomi Hyrylainen will will walk you through the highlights of the quarter and our financial performance. After the presentation, we will host a Q&A as usual. And with that, I would like to hand over to Endre. Please go ahead.

Thank you, Tommi, and good morning, and welcome to Tieto's Q2 presentation. As Tommi alluded on, the second quarter was shaped by 2 distinct developments. On one hand, market conditions became more challenging than expected, particularly in Tech Consulting. On the other hand, we delivered a significant improvement in profitability, 5.5 percentage points compared to Q2 last year, confirming that the measures implemented over the past year are developing. And this presentation, we will address both these developments. We will outline the market dynamics we experienced during the quarter, discuss the actions we are taking in response and explain why we remain confident in our long-term strategy and outlook. So with that, let me start by briefly revisiting the strategy that we presented at our Capital Markets Day last fall. As communicated back then in November of last year, 2026 will be a year of transition and execution. Our objective this year has not been to maximize short-term performance, but to build a stronger company for the years ahead. So during the past 12 months, we have fundamentally reshaped our cost base. We have simplified the organization and we have strengthened execution across the group. And these actions are now clearly visible in our profitability. While market conditions have become more challenging than anticipated, particularly in technology consulting, our strategic priorities, the 4 are the same and unchanged. We are confident that the actions we are taking today is strengthening the company's competitiveness and supporting the medium-term ambitions we presented at our Capital Markets Day. Let me now illustrate how the strategy has translated into concrete progress during second quarter as we also did for Q1 of this year. Starting then with customers first. So we continue to invest in customer-facing capabilities. AI has become an increasingly important part of customer discussions across the group. And we are seeing clearly growing customer interest in particularly in AI applications. At the same time, we have now 1,500 employees already completing Microsoft rapid AI skilling program. Then the simplification of the group has continued according to plan. So in Q2, we completed the divestment of Edlevo and HR Payroll businesses within Indtech, and we continue to accelerate the transformation of Tech Consulting through competence renewal and also organizational changes. Our expansion priorities also continue to progress well. We are seeing encouraging momentum in our target markets, particularly in DACH and Iberia with new customer wins and a healthy commercial pipeline supporting future growth. Finally, our cost optimization program continues to deliver ahead of plan. We have already achieved annual run rate savings of EUR 115 million and remain firmly on track towards our EUR 130 million target. And then more importantly, I would say that cost discipline is now embedded across the organization and has become part of how we operate on a daily basis. Then, of course, it's 1 theme that cuts across all 4 strategic priorities, and that is artificial intelligence. AI is no longer a separate initiative within Tieto, it is increasingly integrated into our products, customer solutions and the way we develop software also internally, important long-term technology shifts, shaping our industry. So during the past year, the discussions have involved rapidly from R&D and experimental projects towards practical deployment at scale. We see increasingly also competitive advantage is built in on trusted software, deep domain expertise and also business-critical customer workflows rather than access to AI models alone. And we believe that this plays directly into Tieto's strengths and our client base. While AI investments continue to increase, we are not yet seeing a broad-based recovery in technology consulting. Instead, customers are prioritizing targeted AI use cases, data foundation and productivity improvement over large-scale transformation programs. So we believe this represents a transition in how technology budgets are allocated rather than a reduction in overall technology demand. And the slide that we have ahead of us illustrates a few examples from across our businesses. AI is now embedded into our software portfolio to anti-money laundering in Banktech, clinical documentation. The common denominator across all of these examples is that AI is solving real customer problems and creating measurable business values. At the same time, we are applying AI internal across the company. AI tooling increasingly become a part of how we develop software, improving engineering productivity and enabling us to deliver solutions to customers faster and more efficient. And this is, of course, the request that we daily get from our clients as well. So I would say that this is an important capability that supports all our businesses as we speak. Turning now to Q2 itself. The quarter was characterized by 2 very different. We did see market conditions weakening further, particularly in technology consulting, resulting in revenue development below both our -- so you see that our profitability remained very strong, an improvement of 5.5 percentage points versus Q2 of last year, demonstrating that the actions we have taken over the past year are clearly delivering results. The market environment became more challenging during the quarter than we anticipated at the beginning of the year, as customers continue to postpone larger transformation programs. And we also saw some softer demand in parts of our software portfolio. And as a result of that, we have updated our full year revenue growth outlook to reflect the current weaker market environment and also a shift on customer spending. At the same time, our execution continues to be strong. The cost optimization program is delivering according to plan. Profitability improved across all 4 businesses. and we continue to accelerate the transformation of Tech Consulting. And as discussed earlier, this includes reshaping our competence base investing in AI capabilities and strengthening the business for next phase of growth. During the quarter, we also completed the divestment of Edlevo and HR Payroll businesses and follow completion of the transaction, we have decided to launch a new EUR 90 million share buyback program and the current program has been completed. This again is in line with our capital allocation principles and our commitment to return excess capital to shareholders. So overall, while the market environment has become more challenging, the quarter reinforces our confidence that the company is becoming stronger operationally and strategically. Let me then briefly summarize the quarter through the key financial metrics. Revenue for the quarter was, as you can see to the left, EUR 427 million, corresponding to an organic growth of minus 5%, again, mainly driven by the minus 6% in Tech Consulting. And as discussed, the weaker development was primarily by the deterioration of the consulting market while our software business continued to be affected by previously communicated legacy headwinds, like we have said, with Banktech and Caretech and slightly softer market conditions also in selected areas. The highlight of the quarter was clearly profitability. As you can see to the right, the upper right, adjusted for EBITDA -- adjusted EBITDA improved to EUR 63 million or 14.9% and reflecting the structural benefits of our cost optimization program together also with improved operational execution across the group. So we're now seeing the tangible financial impact of the actions that we have taken now over the past year. Then also the balance sheet seems to be -- not seems to be, but it remains to be very strong. Net debt-to-EBITDA was 1x at the end of the quarter. And even if we exclude the temporary impact from the recent divestment proceeds, leverage would remain comfortably below the target range of approximately 1.9x, providing financial flexibility. Order backlog last year, when we signed several large contracts in Banktech and then together also with a slightly softer market demand during the quarter. And finally, cash flow from operating activities remained healthy at EUR 21 million, factoring in from a comparison point of view that -- we also had divested businesses in the [ EUR 51 million ], but you can see below the 21 number. So with that overview, let me then move into each of the business areas. Starting off with Tech Consulting. As mentioned, market conditions continued to weaken during Q2. And as discussed earlier, increased geopolitical uncertainty, the technology shift driven by AI resulted in customers postponing large transformation programs leading to lower demand than we had anticipated, and this is reflected in the organic growth of minus 6%. At the same time, the quarter also demonstrates that actions we have taken are working. Despite the weaker market, profitability improved significantly to 12.7% and supported by higher utilization and continued cost optimization. We need to keep in mind that if you're excluding now the divested businesses from Tech Consulting, the head count reduction is minus 16%, revenues minus 6%, and we have improved profitability to 12.7%. So it's important market. We are also preparing the business for where the market is heading. And AI is changing the consulting market rapidly. Customers increasingly expect higher productivity, smaller delivery teams and faster execution. This is why competency renewal, AI capabilities and software engineering productivity has become a central part of the transformation of Tieto's Tech Consulting. Our competence shift is well underway. As mentioned, around 1,500 consultants have completed Microsoft rapid AI skilling program, more than 400 employees are participating in advanced AI training for rapid certification and we continue targeted recruitment in areas where we see future customer demand developing. We also continue to strengthen our position within strategic customers. So during the quarter, we expanded engagement with customers such as Gjensidige, as you can see on the bottom and PV Austrian pension company, supporting their business transformation and technology modernization initiatives. So these engagements reinforce our strong customer relationship and demonstrate that customers continues its critical capabilities despite the weaker market environment. Turning then into Banktech, organic growth remained affected then again by the previously communicated legacy contract runoff, which reduced the growth by approximately 6 percentage points in Q2. Excluding this impact, growth was around 0, which is clearly below our ambitions. Some market conditions were also a bit more challenging during the quarter, customer decision-making took a bit longer time than normal and delaying then partly the timing of environment profitability improved significantly from 10.5% last year to 15.6% this year, supported by continued cost optimization. So then looking ahead, we remain encouraged about the strength of our order backlog, which provides good visibility into second half or strategic software offerings, although project timing partly remains affected by the current environment. So despite the softer market environment, we continue to strengthen our customer base through several strategic wins. So during the quarter, we were selected our cloud native payment as a service platform. Noba adopted our verification of Payee solution, helping them strengthening fraud prevention and NorgesGruppen extended its partnership with Tieto Banktech for another 5 years with modernized card services and FCP solutions. We also signed a new agreement with a leading Australian bank to modernize its cash management plat position as a trusted provider of a business critical banking software and support also our long-term growth ambition. Turning then to CareTech. Underlying business continued to perform well during Q2. Growth of minus 2%, affected then by the legacy business decline. It reduced growth by approximately 5% percentage points. In addition, we have 2 customer contracts currently waiting for regulatory approval that had a modest also impact on the growth during the quarter. So excluding these temporary factors, the mobile software portfolio continued to develop well. We saw particularly strong performance in our Social Care business in Sweden, reflecting continued customer demand for the modern software solutions. CareTech continues to deliver excellent profitability, 25.3% margin, as you can see and that is demonstrating the strength of our Lifecare product portfolio and operational discipline that we have built into this specific business. We also have a good second half order backlog in CareTech and our European expansion also continues to progress according to plan. So during the quarter, we signed 2 new customers in the DACH region and continue to build a healthy commercial pipeline that supports the long-term international growth ambitions. Finally, the quarter also demonstrated continued customer confidence in our software portfolio. We expanded our customer base across both health care and social care, including new wins such as of Sophies Minde and additional deployment of Life Care platform in Finland. So these examples supports our ambition to expand our software business beyond the Nordic core markets as well. Then finally, turning to Indtech. Organic growth was flat during the quarter, which was below our own expectations. And then the weaker development was primarily driven by 2 factors: First of all, our pulp paper fiber business continued to be affected by challenging market conditions; and secondly, softer demand impacted our volume-based business impacting our volumes. Then it's also quite important that these challenges were isolated to specific parts of the portfolio. At the same time, several of the software businesses within Indtech continued to perform well. We saw continued solid growth in both Eye-Share and Public360, demonstrating the resilience of the modern software portfolio that we have built. And then we also saw that we have now we're going into Second half, we have a solid backlog in Intech, providing good visibility for second half and beyond. Profitability was another clear highlight. From 10.2% last year to 16.2% this year supported primarily by the continued cost optimization program and also disciplined execution across the business. So the quarter also marked an important strategic milestone with the successful completion of the divestment of Edlevo and HR, Payroll businesses, so further simplifying the portfolio in line with the strategy that we outlined at our Capital Markets Day. In Q2, we also continued to strengthen customer relationships across our software portfolio. So during that quarter, we signed new agreements with customers, reinforcing our position in energy, financial services and then document distribution while continuing to expand on our mobile software offerings. Then we are moving to the CFO report. So Tomi, please?

Thank you, Endre, and good morning, everyone. So from a CFO point of view, Q2 highlights were improved profitability in all businesses and launch of our new EUR 90 million share buyback program. As discussed, our growth of negative 5% in Q2 was not at the level we expected. This was primarily due to weaker market demand. However, we were able to significantly increase our profitability by over 5%, as mentioned. This confirms the success of our cost-based reset program and the company's resilience even in weaker market conditions. In addition to adjusted EBITDA improvement, we also improved reported EBIT by EUR 35 million over 170% after adjusting for M&A gains and noncash impairments. . One-time items for Q2 were positive by EUR 50 million, which was impacted by gain on sale from Indtech divestments of EUR 57 million. Full year onetime items expectation is unchanged at 1.5 percentage point of revenues, excluding capital gains. Other Q2 events include issuance of a new 5-year EUR 300 million bond, which secures our long-term financing needs and updating our full year growth outlook, as Henri mentioned, reflecting the softer market conditions. Then to our new EUR 90 million share buyback program. So the program is connected to the sales proceeds from the divestment of Edlevo and HR, Payroll software businesses, which were closed first of 1st of June. The share purchase after completion of the current EUR 150 million share buyback program, which is expected to be completed early September. In accordance with our capital allocation policy, we aim to keep our leverage level close to 2x and distribute excess capital to shareholders. This EUR 90 million share buyback program will ensure continued effective capital structure and deliver solid shareholder returns in a tax-efficient way. The shares will be bought in public trading in Nasdaq Helsinki and canceled on a monthly basis. The execution of the program will take approximately 5 months depending on the trading volumes of our shares. So in Q2, we delivered healthy operating cash flow of EUR 21 million, which was supported by improved profitability. Our net working capital increased by EUR 29 million due to normal seasonal decrease in liabilities. Note that Q2 '25 cash flows include contribution from the divested businesses as cash flows are not restated for prior periods. On a variable basis, as mentioned, Q2 operative cash flow improved approximately 16%. On reported net debt-to-EBITDA it improved further from Q1 being 1x at the end of Q2. Main reason for the sharp decline in leverage are the divestments with divestment proceeds, decreasing the net debt and the gain on sale increasing the EBITDA. During the year, when we execute the share buyback programs, our leverage will gradually increase. On a fully adjusted basis, our leverage at the end of Q2 is at target levels, so slightly below 2x. Then to our cost optimization program, where we have reached EUR 115 million run rate savings at the end of Q2, EUR 30 million by the end of '26. As communicated earlier, this program aims for a permanent cost base reset of approximately EUR 50 million while mitigating the cost burden from tech services divestment and reducing overcapacity primarily in consulting business. Our estimate of the onetime cost from the program is unchanged at EUR 55 million to EUR 60 million, of which we have incurred EUR 49 million at the end of Q2. On employee matters, LTM attrition was at very low level being 7.3% at the end of Q2. These low levels are market-driven, we consider normal healthy attrition to be around 10%. During the quarter, we have continued with planned personnel reductions impacting primarily Tech Consulting, Group personnel reduction year-on-year has been significant with 15% reduction, of which approximately 4% relates to acquisition and divestments. We expect group salary inflation for the year to be lower than last year with 3% to 3.5%. Next outlook remarks for on growth remarks, Tech Consulting will continue to be impacted by weak market demand, and we expect Q3 growth to be slightly below Q2 level. Banktech growth is impacted by the known events in 2025, namely the legacy contract runoff with negative 4 percentage points and SP1 onetime income with negative 14 percentage points. However, Q3 revenues are supported by strong order backlog. CareTech continues to be impacted by legacy contract runoff with negative 5 percentage points, which is at the same level as in Q2. Revenues continue to be supported by growth in the modern software portfolio and the strong order backlog. Inter growth momentum is expected to improve from Q2, which is supported by strong order backlog. On profit remarks, the cost optimization program continues to contribute to profitability in all businesses and to notice that comparison period Q3 '25 included SP1 onetime income, which had positive impact on banktech level at 11.9 percentage points and at group level, 4.1 percentage points. On other remarks, there is only a minor impact from working days. Then as usual, Q3 profitability outlook per business, we expect Tech Consulting and Banktech to be below Including the onetime income, we expect Banktech to improve profitability from prior year. We expect Caretech to be at Indtech to be at or above prior year profitability level. Overall, we start to reach higher comparables as the cost optimization program benefits become visible in prior year numbers. Then a few words on our updated guidance. So last Friday, we updated our full year growth outlook due to weaker-than-expected market demand especially impacting Tech Consulting. The geopolitical uncertainty has further softened the market, which we expect to continue for the rest of 2026. Accordingly, we lowered our growth to negative 5% to negative 3% from previous negative to 0%. On the other hand, we maintained our profitability outlook of 14.8% to 15.8% EBITDA adjusted and as discussed earlier, we have been successful in executing our cost optimization program and have delivered consistent profitability improvement. Our H1 profitability was at 14.8% with seasonally strongest quarters still ahead of us. As the year 2026 includes some specific headwinds, we created this growth dynamic slide to help everyone to navigate the growth expectations on a quarterly basis. We have updated the information to reflect weaker outlook for Tech Consulting for the remaining of the year. And in addition, we have adjusted the Q2 that reflect the actual growth outcome, which included some softness, as discussed earlier.

Tomi, and I would like to summarize now as we are 22 days into Q3 already, I would like to summarize a bit of where we stand with the company. As we have discussed today, market conditions have become more challenging than we anticipated, particularly then in Tech Consulting. And this has affected our short-term growth. And we have updated our revenue outlook accordingly. However, our strategic direction has not changed. As we have outlined at our Capital Markets Day, 2026 remains a year of transition and execution for Tieto. So given the pace of the technology change and also what's happening with AI, I believe that 2026 has actually become a transformation. We are reshaping the company, strengthening our competitiveness and preparing the business for the next phase of growth. Across the group, we have continued to execute against our strategic priorities. We are simplifying our portfolio, strengthening customer relationships, expanding into selected growth areas and building a more competitive cost base. And at the same time, we continue to invest heavily in future capabilities through large-scale AI upskilling targeted recruitment and continuous competence renewal, ensuring that our people have the skills needed for a next generation of software and consulting. Everything starts in the market, and that's a driving factor for everything we do. Then we are only halfway through the year. There is still a great deal of work ahead of us. and the coming quarters will continue to require discipline, focus and execution. Having said that, I'm really proud of the progress that we have made over the past year. The actions we have taken are strengthening the company and they give me confidence that we are building a stronger Tieto going forward. So with that, we are opening up for Q&A.

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

And Firstly, just on the growth guidance revision. Obviously, H1 organic growth is about minus 4%. And so the new 5% to 3% range -- negative 5% to negative 3% range, still implies quite a wide range of outcomes into the second half. So could you just explain what the main swing factors between the top and the bottom end of that range, in particular, what you're assuming for the sequential growth trajectory in Tech Consulting and the software businesses through Q3 and Q4. Secondly, on Tech Consulting specifically, you said that the market demand has deteriorated further and customers postponing investment decisions and delay in transformation programs. Could you give us a bit more color on specifically what types of projects are being postponed? And what reasons are you hearing from clients, customers prioritizing spend elsewhere in the short term, for example, on AI projects or hardware procurement? Just a bit more color on that would be really helpful. And then finally, on the cost savings plan, clearly, having a big impact, the margin result very solid. How much of that EUR 115 million that you've already achieved was already reflected in the second quarter P&L? And how much have you still got left to flow through? And once the current program is finished, what are the remaining levers to help protect margins, particularly if revenue performance in Tech Consulting remains challenged.

Yes. So let's take the first one first related to the full year outlook, minus 3% to minus 5%. As already mentioned by Tomi when you look at now the Q3 number and the guidance related to the top line for Tech Consulting, we are saying that, that's going to be weaker than we had in Q3, indicating that this has an impact on the overall picture for the total group. I mean, Tech Consulting is approximately 40% of the revenue of the group. And that, of course, has a huge impact on the totality, as you understand. When you look -- we put this into perspective, I think that is quite important, like they say in Spain, [indiscernible]. And I think it's quite important that, I mean, there are some millions taken out now of the outlook. But from a EUR 1.7 billion company, this is not a big amount. So we need to keep that in mind all the time. From the software businesses point of view, we have a very strong visibility on second half in terms of the backlog. The impact in second quarter, while we came in a bit short relative to expectations on Banktech and Indtech was mainly related to some of the volume-based business, which is part of those software entities. Looking at second half for both of them, we are quite confident that they will deliver underlying solid growth. Tech Consulting. When you're talking about postponement of your second question about postponement of investments. I would say that still, there is a level of uncertainty how AI is impacting the processes and the different kind of industries and companies. Still a bit wait and see how is this going to affect us? What should we invest into, what is happening month by month with the new launch of different softwares impacting the development through AI tooling. And again, I think it's also still a level of uncertainty what will be the cost program that you do with AI tooling what's the hardware effect of that and what's the total cost effect of that. So still a bit wait and see from the clients. I think it's also important to say that -- when you look at overall, and this was communicated also in connection with Q2 -- sorry, Q1 from my side is that we still are coming into 2026 with a too high level of time and material in Tech Consulting and that is where we clearly see the market turning down, and then you see the more kind of agile project through smaller teams jointly developing with clients. That is the market not growing and not necessarily time in material. So that is also part of why we explained at Capital Markets Day that 2026 will be a year of transition and transformation, especially in Tech Consulting. When it comes to the cost optimization program like...

Maybe Endre, i will take that question. So that's a good question. So we're now EUR 150 million into EUR 130 million. This translates into EUR 10 million quarterly impact from the structural cost reset of in total EUR 50 million. So when we are maxed with the EUR 50 million cost reset program, we delivered EUR 12.5 million on a quarterly basis improvement. Now we're at EUR 10 million, which is roughly 2.5 percentage points impact to the company's profitability. Then when we think about going forward, obviously, all successful companies need to grow the top line in order to protect the margin and improve the margins going forward.

Yes. But I think there's also one more element into that is that -- I mean, we are coming from a situation starting off in June of last year, where we had north of 20% SG&A in the company. That is what we have taken down massively. And my point is that this needs to be monitored closely unit by unit based on market demand, based on how are we delivering the top line to ensure that this is not part of the cadence, monthly cadence of the company to monitor revenue and the cost and the bottom line. And if the revenue is not coming, we need to have the discipline in the company to reduce the cost. That is a very simple equation in this business.

I got 2, please. One is on Indtech. Basically, just wondering what gives you the confidence to expect growth going into Q3 and the second half of the year. I think you were quite confident previously about Q2 as well, thanks to the backlog. So just wanted to hear about the puts and takes on that and how much of that business is actually volume based where the weakness was in Q2. . And secondly, as you think about your 2027, 2028 revenue growth target of over 5% as a CAGR, do you think that's realistic if the market doesn't improve? And if not, what you sort of prepared to do to generate earnings growth and incremental shareholder value.

Very good, Felix. Thank you. And first of all, on Indtech, I would say that when we look now at Q3 and Q4, we have, as I said, very good visibility on the backlog, which is a contracted backlog. Part of what happened in Q2 is that the projects that we were kind of expecting to come in effect in Q2. So that's why we have very high visibility on the backlog. And then on top of the backlog, of course, we have the pipeline, which we are monitoring also quite closely for all the businesses. So that's why we are confident about second half of Indtech. When it comes to the 5% CAGR, '27 '28, we are still looking now at the backlog that we have for all the software businesses, especially Banktech going also into '27 and '28. Looking at the comparables for Tech Consulting, there is no reason to adjust the CAGR target that we communicated at CMD at this stage. Like you said, if something extraordinary should happen, more than 16% margin by end of '28 and a CAGR of 5% by '27,'28 stands.

The next question comes from Sami Sarkamies from Danske Bank Markets.

I have 3 questions. We'll take this one by one. Firstly, on Tech Consulting, you're expecting a slightly weaker top line development in the third quarter. Do you have any visibility on improvements thereafter?

Improvements in terms of top line or...

In terms of top line, yes? .

Yes. So we give guidance quarter by quarter and then we have the full year guidance. And if you factor in the minus EUR 3 million to minus EUR 5 million any factor in what you have said about the software businesses, you can understand that we are still expecting a negative Q4 year-over-year in Tech Consulting. Having said that, we are also looking at the bottom line, which we delivered 12.7% in Q2. And we are quite comfortable that we will deliver solid margins also going forward based on the outlook we have for the top line and based on the cost measures that we have already implemented.