NNIT A/S

CSE:NNIT

Earnings Call Transcript 2018-Q1

[Operator]

Hello, and welcome to the NNIT Q1 Report 2018. [Operator Instructions] I will now hand you over to Klaus Skovrup. Please begin.

[Klaus Hosbond Skovrup, Head of Investor Relations]

Good morning and welcome to this NNIT call regarding our financial performance for Q1 2018 and outlook for 2018. My name is Klaus Skovrup, and I'm head of Investor Relations. And with me today I have CEO, Per Kogut; and CFO, Carsten Krogsgaard Thomsen. I'll briefly walk you through the practicalities for today's meeting before handing over to Per Kogut and Carsten Krogsgaard Thomsen. Today's earnings release as well as the slides being used for this presentation will be available on our website nnit.com. The conference call is scheduled to last approximately 1 hour, the presentation is expected to last around 30 minutes and after the presentation is done, we open up for questions. Today's agenda can be found on Slide #3. Please note that this call is being webcasted live and a replay will be made available on NNIT's website after the call. Turning to Slide #4. I need to advise you that this call will contain forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause the actual results to deviate considerably from the outlook set forth. Furthermore, some of these expectations are based on assumptions regarding future events, which may prove incorrect. With these words of introduction, I'll hand over to Per Kogut and turn to Slide #5.

[Per Kogut, Chief Executive Officer and President]

Thank you, very much, Klaus, and [indiscernible] as well. Looking at our Q1 results, revenue declined by 2.3% to DKK 699 million due to an approximately 20% decline in revenue from the Novo Nordisk group as well as the timing of Easter. The large decline from the Novo Nordisk group was due to low project activity in Q1 '18 and a high comparison base in Q1 '17, which was impacted by infrastructure projects with a higher degree of hardware. This was partly countered by strong growth from non-Novo Nordisk customers. Currency headwind reduced the growth by minus 1.1 percentage points. Operating profit of DKK 61 million, equal to an operating profit of 8.7%, was 1.8 percentage points below Q1 '17 due to the timing of Easter. If you adjust for this, operating profit and margin would be at the same level as last year's '17. Net profit of DKK 46 million was down by 18% compared to Q1 '17, also because of the timing of Easter. Our backlog for 2018 stands around DKK 2.5 billion, which equals an increase of 2.8% compared to the same time last year. And finally, free cash flow was very strong at DKK 143 million in Q1 '18. Based on the free cash flow, we have with the board agreed to pay out interim dividends of DKK 2 per share in August '18. During the first 3 months, we have entered into a number of new contracts. The largest one was the new IT infrastructure operation and application maintenance outsourcing contract with STARK Danmark. This represents a lower medium-sized 3-digit Danish krone million amount over a 4-year period. STARK impacts our financials beginning March '18. I will elaborate on this on the next slide. Within the enterprise customer group, we have won a new infrastructure outsourcing contract with an existing enterprise customer, representing a midsize double-digit Danish krone million amount over a 5-year period. And within the public-customer base, we have extended an infrastructure outsourcing contract as well. Within life science, we have won a SAP implementation and operation contract with a large Chinese customer. This represents a minor double-digit Danish krone million amount over a 4-year period. And finally we have won our first SAP EUGDPR Phase IV implementation project. This contract is worth a high single-digit Danish krone million amount. After the end of Q1, we announced a new IT infrastructure operation contract with NNE, Novo Nordisk Engineering, which represents a high double-digit Danish krone million amount over a 5-year period. This contract will add limited revenue in '18 due to transition activities. Please turn to Page or Slide #7. The contract with STARK is the largest deal signed so far for NNIT in 2018. As part of the new ownership and strategy, STARK needed a change in IT partnership, and we were happy to support them going forward. We look forward to help STARK secure the IT robustness required and assist them in transforming their business digitally. They are in an exciting period of change in order to retain its leading position and we offer them our experience with delivery of international IT support. Flexible and scalable IT services while obtaining operational excellence and high security level were part of the winning criteria. Please turn to Slide #8. As mentioned, our backlog for 2018 is around DKK 2.5 billion, which represents 2.8% higher than at the same time last year. The backlog from non-Novo Nordisk customers is 12% higher than at the same time last year, while the Novo Nordisk backlog is 9% lower than at the same time last year. When interpreting the number, please note that the revenue reversal of DKK 26 million in 2017 -- late 2017 regarding a customer in the public sector had a negative impact on full year revenue for '17, but was not reflected in the backlog in the beginning of Q2 2017. Please turn to Slide #9. Our backlog for the following 2 years, 2019 and 2020, is 20% higher than at the same time 1 year ago. The increase is driven by the extension of a global infrastructure agreement with Novo Nordisk and the extension of the large Arla Foods deal. Note that the backlog is still impacted by the fact that a number of large infrastructure agreements expire during '18 and '19. These agreements have not yet been renegotiated or retendered. Renewal or replacement of these contracts will increase the backlog for 2019 and 2020 further. So with these initial comments, I would like to hand over to our CFO, Carsten, who will give you a more detailed walk-through of our financial performance. Carsten?

[Carsten Krogsgaard Thomsen]

Well, Thank you, Per. And please then turn to Page 10 in the slide deck. As Per mentioned, we saw a decline in our revenue of 2.3%, driven by a larger than expected decline in revenue from Novo Nordisk of 20%. With this unexpected larger decline, we have not been able to lower our cost of goods sold equally, and this has given us a decline in our gross profit of around 12% and a lower gross profit margin of 1.8 percentage points. But please be aware that if you adjust for the timing of Easter, then the gross profit margin is actually at the same level as last year. You see sales and marketing costs and the administrative expenses going down, a consequence of the initiatives we took late last year. Operating profit margin as a consequence of this development declines were 1.8 percentage point to 8.7%. But again, if you adjust for Easter then we are actually at the same level as last year. You may ask, how can Easter have such a big impact? But having all of Easter placed in March this year means that there were quite a lot of working days where -- quite a lot of days where the people were not at work and our customers, but also our own employees need to have some vacation. So that's simple, fewer days out delivering on hourly rates and so on. On the bottom line of our net profits, again, impacted by the above development. But again, if you adjust for Easter then there is actually a small increase of 1.4%. Please turn to Page 11. Here you can see, that again, Novo Nordisk, of course, is driving this decline in revenue, but I think, on the positive side, we see other life sciences increasing with 12%, and if we take the international part of that, then we see an increase well above 20%, continuing the positive trend from previous quarters. We also see enterprise increasing with 24%. This is driven by PANDORA, the new STARK customer, but also by SCALES. And when you look at SCALES, that has actually been a very successful acquisition. We see SCALES growing revenue by almost 30% and with growing margins at the moment. The public segment is also increasing, part of this is due to the settlement we had last year where we had to reverse some revenue on a public customer where we had a dispute. Finance segment is decreasing and this is due to the loss of a finance customer midway through last year. So they're still in the comparison base here in Q1. As you get into Q3 and Q4, you will not see this negative impact on the finance segment. Then please turn to Page 12. Looking at IT operation services, then this is the business unit that is really being impacted by the lower Novo Nordisk revenue, declining with 25%. This is, again, to a large extent, due to a high-comparison base last year with the large hardware sales, but also lower project activities. Non-Novo Nordisk customers are growing with 3.2%. Now, with this total decline of 10%, which is higher than expected, costs have not been able to go down at the same speed, but we are reducing costs below almost 7%. And all in all, this gives a lower operating profit and a lower operating profit margin, which was also at a very high level of 10.8% last year. If you then turn to Page 13, IT Solution services. We again see the solution services being impacted by a 10% decline in revenue from Novo Nordisk Group, this being partly impacted by the timing of Easter, but also by lower project activities. On the other hand, we see a strong growth of 28% from non-Novo Nordisk customers. This is being fueled by SCALES and also by a strong growth from other customers. Costs are not growing to quite the same extent and actually, again, being impacted by the unexpected large decline in revenue from Novo Nordisk. But all in all, we end up with an operating profit margin of 10.4%, up 0.5 percent point compared to last year. And of course, solutions is being positively impacted by the positive development in SCALES. But also by, I would say, some very successful project implementations, we are not seeing any black swans at the moment in this area. If you then please turn to Page 14, on currency development, I'll do this very briefly. You can see that after a period with a declining Chinese yuan, we see a stabilization of this, whereas we see a continuing decline in the Philippine pesos, which is also of importance to us, while the Czech koruna is increasing. The total impact of this development is a positive currency tailwind on our operating profit of 0.3 percent points in Q1. If you then turn to Page 15, on net financials. I would again say very small changes in net financials. They do not have an important role in our accounts. We have some small gains on currency hedges. And then we also get an improvement in our results from the Novo Nordisk shares, which we were previously holding for the long-term incentive programs, which gave us a loss last year and whereas it's neutral this year. Going forward, we will not be having any impact from the Novo Nordisk shares since our long-term incentive programs are in NNIT shares from now on. Turning to Page 15 (sic) [ 16 ], on the employee development. We see a growth of 8%, only 2.5% in Denmark and this is entirely driven by our acquisition of SCALES and also taking over employees from STARK. So if we adjust for these 2, we actually see a decline of 7% in Denmark, which is in line with our drive to offshore as much as possible. And as you can see, we see our offshore destinations growing with 15% and thereby lowering our cost. If you then turn to our balance sheet, this has previously been rather boring, but for once you actually do see some movements in this. We are seeing impacts from our acquisition of SCALES, but also from our pre-implementation of IFRS 16 regarding leasing. So when you see our intangible assets growing from DKK 32.9 million to DKK 210 million, this is due to goodwill on our SCALES acquisition. And when you see our tangible assets going up from DKK 856 million to DKK 940 million, this is our investment in a new data center. When you look at the cash and cash equivalents, you see a decline from DKK 262 million to DKK 7 million. This is, again, due to the acquisition of SCALES and the investment in our data center. On the liability side, you can see that we now have a contingent consideration of DKK 54 million. This is the SCALES earn out, which is placed here in this balance sheet. If you then turn to our cash flows, you still see a strong development in our free cash flow. Our trade receivables are decreasing quite significantly in Q1 due to payment of project milestones and hardware contract back in Q1 '17. Cash flow from investing activities are lower, primarily due to timing of hardware purchases, but also the fact that we're not investing in a new data center. Our cash flow from financing activities was minus DKK 117 compared to DKK 74 million last year, and this is due to purchase of treasury shares to hedge our long-term incentive program. Finally, our free cash flow was at DKK 143 million, a little lower than last year, mainly due to the development in the mentioned working capital. If you then turn to Page 19. Our outlook, based on the declining revenue in Q1 due to the drop in Novo Nordisk revenue of 20%, we have lowered our guidance on revenue growth from 4% to 7% to 3.6% (sic) [ 3% to 6% ] in constant currencies. And in reported currencies this would be 0.3 percent (sic) [ percent point ] lower. We maintain our guidance on operating profit margin of 10% to 10.5%. And with the process of currency tailwind, we expect this to be 0.2 percent point higher in reported currencies. And finally, our CapEx share of revenue is unchanged at 6% to 8%. These were my comments. Please, turn to Page 20, where Per will close off.

[Per Kogut, Chief Executive Officer and President]

Yes. Thank you, Carsten. And I would like to conclude on our presentation. First of all, it's obvious that I am not satisfied with Q1, but I strongly believe in our new guidance. But I am encouraged by the continued strong growth from, particularly, the enterprise and the international life science customer groups. The decline in revenue from the Novo Nordisk group was larger than expected in Q1. And we have, therefore, adjusted our revenue growth guidance for '18 to 3% to 6% growth. Under these circumstances, I am pleased that we have maintained our operating profit margin guidance of 10% to 10.5%. Investment will still be around the 6% to 8% of revenue. And as mentioned, based on the strong cash flow in Q1 and the remaining year, we will pay out an interim dividend of DKK 2 per share in August 2018. And finally, it should be noted that we'll continue to seek uncertainty regarding revenue from Novo Nordisk. With these words, I conclude our presentation. And we are now ready for opening up for questions. Operator, we're ready for the first question. Thank you.

[Operator]

[Operator Instructions] And our first question comes from the line of Andrew Carlsen from ABG.

[Andrew Carlsen, Lead Analyst]

This is Andrew. With regards to say your new guidance range and then combined with this statement of still increased uncertainty regarding revenue from the Nordisk group, how should we interpret? It's kind of contradictory, and in my world, so can you kind of elaborate on how, say, Novo revenue could come out and surprise negatively, giving, say, the contract major and the visibility? Just basically to understand how we should, say, view your relationship with Novo and how the business is conducted? And then bridging over to, say, your guidance -- your new guidance but still the statement of increased uncertainty?

[Per Kogut, Chief Executive Officer and President]

Yes. Good question. And we have, of course, given this a lot of thought. But Q1 is done, it's over and we saw this drop of around 20%. And we, of course, as you know, seeking information from Novo Nordisk on where they are heading and how their buying pattern will look going forward. We do see strong growth in some of the other areas to compensate for the lower Novo Nordisk. We do not believe that we will continue with a minus 20% in Novo Nordisk quarter after quarter. So that's why we have taken the stance that we do think we will recover part of it. But Q1 was weak and that's why we have slightly lowered the guidance from 4% to 7%, to 3% to 6% and that's how the thought process has been in NNIT and with the board and that's why we have made this lowering of the guidance. We do not have anything specific, positive or negatively from Nova Nordisk right now.

[Carsten Krogsgaard Thomsen]

And maybe just a supplementary comment regarding, when we say increased uncertainty, then it is due to the lack of clear signals regarding the IT spent in Novo Nordisk. And after having seen an unexpected large drop in Q1, which we are, of course, incorporating into our guidance. We do want to point out that Novo Nordisk revenue is more uncertain. But of course, this is incorporated in our guidance.

[Andrew Carlsen, Lead Analyst]

Okay, and just one follow-up. So just for fully understanding, given that you say you renewed your contract with Novo, a 5-year extension contract, DKK 1 billion. How much is fixed and how much is discretionary? I'm just trying to capture the magnitude of certainty that can be in your contract or your relationship with Novo. That's something that would be really appreciated, if you could help me get some...

[Carsten Krogsgaard Thomsen]

But I think standing at the start of the year, then it's not like 90% is secured by service level agreements. It's may be around 60%. So it's the last 40% of the revenue, which we need to get in our books as projects during the year, and it's that part that is uncertain. You can see that the backlog growth at the end of Q1 shows a growth of minus 9%, so if you just look at that, that says minus 9%, but then that does not take into account any kind of budget flush in Q4 and so on. So it is uncertain whether and at what point of time Novo Nordisk may release further funds for projects.

[Operator]

[Operator Instructions] And as we currently have no further questions from the telephone lines I'll return the conference to our speakers.

[Per Kogut, Chief Executive Officer and President]

Good. But we would like to thank you for this presentation of the Q1 2018 results from NNIT. Thank you very much for participating.