NNIT A/S

CSE:NNIT

Earnings Call Transcript 2022-Q2

[Operator]

Good morning or good afternoon, and welcome to the NNIT Interim Report for the First 6 Months of 2022. My name is Adam, and I'll be your operator today. [Operator Instructions] I will now hand you over to Par Fors to begin. So Par, please go ahead, when you're ready.

[Par Fors, executive]

Thank you very much, and welcome, everybody, to today's second quarter call, and thank you for your interest in NNIT. Pernille and I look forward to taking you through the results for the second quarter and answering all your questions. Let us move to -- on to Slide 2 and take you through today's agenda. We will start today's presentation with an overview of the highlights for the second quarter before we move on to strategic update with a few comments on the divestment announced back in June. Pernille will provide an overview of the business unit performance in the second quarter and the group financials as well. We will open up for questions after a few comments on our suspended guidance and a short recap of the key takeaways. Please turn to Slide 3 for the highlights. We were very busy in the second quarter as we took big and important step to reshape NNIT and see it's a great prospect for our business in the years ahead. We announced the transformative divestment of our infrastructure operation in late June, and I will provide a bit of color on that transaction and the process in a short while. In addition to the planning of the divestment of the infrastructure operation, we continued our effort to relocate our global delivery center to Manila from China. This initiative is progressing according to plan and we expect to complete the relocation during the third quarter of this year.

If we take one step down and focus on the financial performance for the second quarter, we were not overly excited to see only moderate growth. This was expected to some extent as we knew there would be an impact of the renegotiation of our infrastructure agreement with Novo Nordisk Group that was done in the summer of '21. And it's worth noting that we were actually growing our sales to Novo Nordisk Group in -- for our Life Science Services and our CDS services in the second quarter and also for the first half year. Still, overall sales were slower than expected in the second quarter, and we are focused on accelerating sales performance and improving our capacity utilization in the second half of the year.

On that backdrop, we were very pleased to announce a large contract with Danmarks Nationalbank back in June, probably the largest IT services deal in Denmark market for this year, and it's a great addition to a number of contract wins and renewals during the quarter. The backlog for the remainder of the year is solid, and we are pleased to take the new contracts for complex and demanding assignments. We will now turn to Slide 4 and a brief strategic update. We accelerated the effort to transform NNIT into a specialized IT services provider operating in growth market, where we signed the agreement to divest our infrastructure operation on June 22. We will divest Hybrid Cloud Solution and select part of Cloud and Digital Solutions comprising about half of the group's revenue. This will be a significant structural change of the group, allowing us to center investment, competencies and sales force around the 2 continuing business units. We are accelerating strategy execution with this move, and we will focus on boosting growth and profitability for the new NNIT once the transaction is closed. There is still a lot of hard work to be done before we get there, though. We are currently planning the separation and have entered into constructive dialogues with customers after the initial announcement. At this point, everything is progressing as planned. And the feedback from customers is positive and in line with expectations. Earlier this week, we established a legal entity which we plan to transfer the divested activities to later in the process. In other words, we are preparing as much as possible while proceeding with the carve-out process. When we have a more complete overview of the outcome of this process, we will also be able to separate the divested activities from the new NNIT in our financial reporting and provide new guidance. We're not there yet, but we still expect to have this in place in the second half of '22. Even though we are eager to move on, we should, of course, remember that the transaction is subject to regulatory approval as well as other customer closing conditions.

Our effort to accelerate growth and improve profitability included other initiatives during the second quarter. After introducing our new reporting structure with a clear profit and loss responsibility in each of our business units, we are on the right track. We have also completed new cost reduction programs across the business unit to rightsize organization and improve capacity utilization. As mentioned before, we also made progress with the consolidation of our global delivery center in Manila. This specific initiative will ensure compliance with EU legislation and strengthen our capabilities while driving sustainable cost reduction from 2023.

We are pleased to sign a number of new contracts during the quarter as well. Most notably, we announced a 6-year contract with the Danmarks Nationalbank with an estimated total contract value of DKK 1 billion which will generate revenues in HCS, but also in CDS from late November. We also secured new contracts and renewal within Life Sciences and CDS where I can mention that we won a 4-year contract with the Danish Health Data Authority for network detection and response solution to be implemented across the entire Danish health care sector. The new orders and the higher backlog support our expectation of improving capacity utilization in the second half of '22 and the years ahead. All in all, we are on the right track and executing on our strategy to improve our financial performance, define the NNIT of the future with 2 core business units, while at the same time, keeping an eye on the attractive NMA (sic) [ M&A ] opportunities.

Let's turn to the next slide and let Pernille provide an overview of segment performance and the group financials for the quarter.

[Pernille Fabricius, executive]

Thank you, Par. Our Life Sciences business grew reported revenue by 33% in the second quarter of the year. The positive development was mainly driven by the acquisitions of SL Controls in July last year and prime4services in Q1 this year. Adjusting for these acquisitions and currency effects, Life Sciences generated organic growth of 3.6% in the quarter. We saw a negative impact of the cancellation of a project in the U.S. in the first quarter, as expected, but the second quarter was also characterized by slower-than-expected sales. While we did improve capacity utilization and the gross margin from the first quarter this year, we are looking to improve further. We took steps to adjust capacity during the quarter and expect a positive impact of these initiatives and increasing activity in the second half of the year. We grew the order backlog by 10% on the back of acquisitions mentioned before and good traction with repeated Veeva Solutions sales to small and midsize customers, strong performance in Regulatory Affairs in Denmark and new contracts within International Pharma Production. Please turn to Slide 6 and our Cloud and Digital Solutions business. We are reporting a slight decline in revenue to DKK 206 million in CDS during the second quarter as sales to Public customers decreased from a high level in the same period last year. This was not fully offset by the moderate growth generated in other customer groups in the quarter. Our capacity utilization remained low in the wake of the postponement of a significant ERP implementation project in Q1, combined with the decline in sales. On this background, the gross margin fell to 9.1%. We have taken steps to reduce capacity and expect to see an effect of these measures in the second half of '22. As Par mentioned before, the CDS team won a contract with the Danish Health Data Authority representing a potential value of a low 3-digit DKK million amount over 4 years. The business unit extended other contracts with large enterprise customers and won a Microsoft Dynamics 365 implementation with a multinational industrial player. The order intake was solid in the quarter, and the backlog was only slightly down despite the effects of this postponement of the ERP implementation mentioned before. Let's turn to Hybrid Cloud Solutions on Slide 7. As expected, HCS revenue declined in the second quarter as the business unit was impacted by the renegotiation of our infrastructure contract with Novo Nordisk Group completed back in '21. To counter this development, we continued to reduce production costs in the quarter, but the decline in revenues still had a significant impact on the gross profit margin which declined to 2.5%. We are still working on improve -- to improve the utilization rate by shifting sales and further reducing costs. The efforts include the ongoing transformation and geographical relocation of our outsourcing organization, which Par mentioned earlier. We maintained good traction in terms of order intake as HCS won the important new 6-year contract for delivery of administrative IT systems and services to Danmarks Nationalbank. This is one of the largest contract NNIT has ever won, and it is a nice addition to the large contracts with Banedanmark that we won in Q1. These contracts play an important role in the efforts to improve capacity utilization and ensure a backlog of more than DKK 1.1 billion in the face of the impact of renegotiated infrastructure contract. Please turn to Slide 8 and an overview of the group financials. Driven by acquisitions, group revenue increased by 1.8% to DKK 723 million in the second quarter. The renegotiated infrastructure contract and slower sales entailed negative organic growth of 6.8%. Following an increase in production costs after the acquisition and lower revenue from the renegotiated contracts, the gross profit for the quarter fell to DKK 66 million corresponding to a gross margin of 9.1%. The operating profit margin was negative by 1.5% in the quarter before special items of DKK 36 million, comprised of restructuring costs related to redundancies and the transformation of our outsourcing organization as well as the divestment of our infrastructure operations. This entailed a net loss of DKK 47 million for the quarter, and we are working hard to return to profitability and growth. On that note, let's turn to Slide 9 and the suspended outlook. We suspended the '22 outlook when we announced the transformative divestment of the infrastructure operations in June and we maintained the temporary suspension of guidance today. As Par stated before, we are making headway in our dialogue with customers, but we need a more complete overview of the outcome of the process before we can split our financial reporting into discontinued and continuing activities. When that is in place, we will provide new guidance and we expect to be able to do so in the second half of '22. We will repeat today, though, that we will leverage the sharpened focus of the 2 core business units with the ambition to significantly strengthen revenue and profitability of the continuing activities from '23. Please turn to Slide 10 for a few closing remarks from Par before we turn to the Q&A session.

[Par Fors, executive]

Thank you, Pernille. Looking at the second quarter, we made a couple of important strategic move with the divestment of this infrastructure operation and our continued effort to sharpen the outsourcing organization. We are making progress on the path to high growth and increase profitability one step at the time. We were also able to maintain momentum and secure a number of good contracts to build a solid order book the remainder of '22 and for the years ahead. Finally, we are focused on progressing the carve-out process for our infrastructure business in the best positive way to ensure a transparent a view -- overview of NNIT of the future.

Thank you very much for your attention. We look forward to taking your questions. And next slide, please.

[Operator]

[Operator Instructions] Our first question today comes from Poul Jessen of Danske Bank.

[Poul Jessen, analyst]

Yes. Good morning. I have a few questions. Let's start by the divestment of HCS. You talked about the client feedback. I think that's one of the most important issues here. So has there been anybody out there who has sent the message back that they are not willing to move towards the new ownership? Or is it performing in the right direction all the way around?

[Par Fors, executive]

I will not comment on all the details of that process. But I think the strong overlaying message is that the feedback has been very positive. They understand the logic behind this transaction and they think it's the right move for NNIT and that it also will provide value for them as clients. And then of course, there's also about questions about how the transaction will happen in that. So we are open and having a lot of dialogues to make them fully informed about how the process will look going forward.

[Poul Jessen, analyst]

So there are no warning signs that you have to also make a strategy, that you are keeping the HCS business?

[Par Fors, executive]

No.

[Poul Jessen, analyst]

Okay. Then coming to the operation, I think it's only Life Sciences and CDS that's important to talk about for now. Life Science, the capacity reduction that you're implementing, that could also be read as if you are not expecting coming back to the growth rates, which you -- as a group, we're expecting to be more than 20% organic just a year ago. So what's the thoughts behind reducing capacity right now?

[Par Fors, executive]

I mean I think the big thing, and Pernille can comment a bit also, but yes, my view on it is, I mean, when you have unexpected cancellation or delay of projects, you basically have 2 decisions. Either you need to reduce capacity because you don't see the pipeline going forward or you see the pipeline going forward and you decide to maintain the capacity.

And in this case, to a very large degree, we saw demand picking up in the second quarter and especially in the second half. And thereby, we decided to maintain the large majority of that capacity in order to position us for growth in the future.

However, we did some reduction. We did execute a reduction program, but that was not substantial. But there was some reduction in overhead capacity and also in some people to at least address part of that idle capacity. But the majority -- the vast majority of capacity, we decided to keep to position us for growth in the future. I don't know, Pernille, if you want to add?

[Pernille Fabricius, executive]

I completely agree. Absolutely.

[Poul Jessen, analyst]

I was just thinking given the current market conditions that you have there, a tough fight to get the resources and competencies, then reducing capacity by qualified people, if you assume that the market will pick up again, could then be a limitation of your opportunities actually to fulfill all that increase?

[Par Fors, executive]

Yes. But I think it's really important to say, I mean, we are, at the moment, in the total company, 3,000 people, and the number of people that will be affected in this activity was actually very limited. So I do agree with you that there is a great demand of people. But when you go down to the details, I mean, it's a wide range of competencies out there. And it is not always the perfect match about where -- which areas are growing and where you have the capacity. So having been in this industry for many decades, even though the industry has been growing, you have seen many companies needing to reduce capacity because it's not always -- the capacity demand is changing. And it's not always possible to change people to fit that demand. So that means that you're continuously in the IT services, not just NNIT, you see that across companies, even though it sounds a bit strange that you need to reduce capacity in an IT company, but in reality that is what is happening.

[Poul Jessen, analyst]

So looking across the acquisitions you made in the recent year within LSS, is there any specific areas of those where you're doing the reduction? Or is it across the board?

[Par Fors, executive]

Well, I would say that the group companies, which we call -- there are no reductions whatsoever. And you can also see that the group companies performance, both in terms of organic growth and growth is really positive. So -- and I think it's also worth mentioning, Poul, I mean in the acquired companies, the last 2 acquisition, which was SL Controls and prime4services, which is in the production IT, are really in the centerpiece of where analysts foresee the greatest demand, which is production IT. A lot of pharma companies is transforming their production and changing it and modernizing it, requiring a much higher technology component. And there, we are really well positioned to capitalize on those growth opportunities, not the least through the acquisition of SL Controls and prime4service.

[Poul Jessen, analyst]

Okay. And on the CDS, you have an ERP project that's been postponed. That was also in the first quarter. What's the likelihood that, that will actually come back now?

[Par Fors, executive]

I mean that specific project will -- has not come back yet. We hope that will come back at a later phase but of course, we see other projects substituting that for the demand. So in the Microsoft area where we only today work with Danish companies, we are really well positioned. And I would say we are one of the leading actors with Microsoft ERP, and we are very happy about that position. But when you have a really big project that was of different reason postponed, it takes some time to fill those holes even though we are in a very good position.

[Poul Jessen, analyst]

Okay. And the final question from my side is about the global delivery transition to those Philippines. How much of the resources in the Philippines will stay in NNIT after the divestment?

[Par Fors, executive]

I mean the global -- the change of the global delivery center is that we are moving our global delivery capabilities from China to the Philippines. The gross number involved is 400 people. But when we set the operation up in Philippines, it will not be an exactly 1 to 1 move, we're, of course, going to infuse some efficiency improvements in that. But total number we are in the Philippines after the move will be -- I know you have that exact number Pernille?

[Pernille Fabricius, executive]

I don't have the exact number. But, I think, yes, it's less than the 400.

[Par Fors, executive]

No, it will be -- no, we will be moving -- there are 400 people that is moving. But we were -- I think we are at 600 people in the Philippines after the move, I think that's Poul's question. After the move, I think we'd be around 600 -- 650 people.

[Pernille Fabricius, executive]

Then I think Poul's question is how many will be in HCS and how many will be...

[Par Fors, executive]

Yes. And I would say about 2/3 of the people we have in the Philippines will belong to NewCo and 1/3 will be...

[Pernille Fabricius, executive]

And that's HCS, Poul.

[Par Fors, executive]

Yes, that's HCS. So HCS will be about 2/3 and what would be NNIT going forward is a bit at south of 1/3.

[Poul Jessen, analyst]

Okay. Perfect. That's all for me.

[Operator]

[Operator Instructions] As we have no further questions, I'll hand back to the management team for any closing remarks.

[Par Fors, executive]

Okay. With that, I just once again want to thank you all for investing your time in having a discussion with us. And we wish you all a great day and look forward to talk to you again in the next quarter. Thank you very much.

[Pernille Fabricius, executive]

Thank you very much.