Hello, and welcome to the NNIT Interim Report for the first nine months of 2022 call. My name is Lauren, and I will be coordinating your call today. If you would like to ask a question during the presentation, you may do so by pressing star followed by one on your telephone keypad. I will now hand you over to your host, Pär Fors, CEO, to begin. Pär, please go ahead.
Thank you, and thank you all for joining our Q3 earnings call today. We look forward to providing an overview of the result for the quarter before answering your questions. Please turn to slide two at the agenda. Firstly, we will provide a helicopter view of the third quarter's performance and the strategic progress we are making with the divestment of our infrastructure business and the consolidation of our global delivery capabilities among other things. Secondly, Pernille will present Q3 business unit performance and the group financials as well. Lastly, we'll take your questions after a short recap of the key takeaways for the quarter. Let's turn to slide three for the highlights.
We spent a lot of time and resources in the third quarter on the carve-out of our infrastructure business, which was initiated this summer and remains our key strategic priority to establish NNIT as a highly specialized IT services provider with two strongly positioned business units. The process is progressing based on constructive and thorough dialogue with our customers and other stakeholders. In parallel, we continue the efforts to streamline our outsourcing organization in the Philippines, and we expect the transformation to be completed by the end of this year with full effect from Q1 2023. While this move entails high stock costs during the quarter, it will strengthen the global delivery capabilities and contribute to ensuring lower salary expenses and improved profitability going forward. In terms of daily operations, we are reporting moderate revenue growth and higher earnings.
We certainly expect further improvement, but we are pleased with the progress that has been driven by acquisitions as well as stronger performance in the LSS and CDS business units, which constitute the NNIT of the future. During the quarter, we entered several new contracts, including a multi-year assignment for Lantmännen Unibake. The order backlog continued to increase with solid contribution for LSS and CDS as well. Please turn to slide four for a brief strategic update. As already mentioned, the effort to transform our company into a specialized IT services provider with two strong business units continued in Q3. The carve-out concerns half of the group revenue and it's not completed overnight. While this process is certainly progressing, it is crucial that we treat every customer with the greatest respect, and we have therefore entered into a lot of constructive and thorough dialogues during the quarter.
We're cracking on with this work while making targeted efforts to separate the discontinued activities from the new NNIT in our financial reporting as well to be able to provide new financial guidance for the continued activities. As always, please keep in mind that the transaction is subject to regulatory approvals as well as other customary closing conditions. The efforts made in Q3 and previous quarter had a positive impact on profitability as we were able to ensure continued progress. Cost reduction programs have been introduced across the businesses and business units to right-size the organization and improve capacity utilization. As we noted good progress in Life Science and CDS in particular during the third quarter. We also continued to build the order backlog with new contracts and a strong order intake within Life Science in particular.
After the balance sheet date, we continued this positive traction as we announced the Danish Agency for Higher Education and Science has awarded NNIT with a contract value exceeding DKK 300 million for the future state educational grant and loan payment system in Denmark. The positive development supports our expectation of improving capacity utilization in the coming quarters and also the coming years. Before we turn to the comments on business unit and group financial performance, I would also like to highlight that we are committed to the Science Based Targets initiative in Q3 as an important step on the long road to becoming carbon-neutral and part of the climate change solution. On the back of the commitment, we will set both short-term and long-term targets for the reduction of CO2 emissions and submit those within 24 months.
Finally, we also announced a change in the management as Pernille will take on a new role as Executive Vice President for Strategy, Transformation, and M&A. I'm very pleased that Pernille will be 100% dedicated to spearheading the transformation work based on her deep insight into organizational change, business transformation, and her profound understanding of the agreement with Agilitas. I'm also pleased that Carsten Ringius has agreed to join us as CFO no later than the 1st of December this year from a similar position in K.W. Bruun, bringing extensive experience from TDC and Maersk Line as well. I personally look forward to continue the cooperation with Pernille in her new role and of course, also welcoming Carsten. On this backdrop, I will let Pernille provide an overview of the quarterly segment performance and group financials one last time. Please, Pernille.
Thank you, Pär. I look forward to taking on the new role and continue our cooperation, also after the split of the organization divesting IO. Let's now proceed with a brief overview over the Q3 performance in the Life Sciences business unit. Revenue of Life Sciences grew 20%, driven by the acquisition of prime4services in Q1 this year and good growth in the international part of our business, ensuring a moderate 2% organic growth as well. We improved capacity utilization in the quarter after making capacity adjustments in late Q2. Following the growth in revenue and the adjustment of capacity, we lifted the gross profit to DKK 49 million and reported a continuation of the positive trend in profitability from Q2. We expect to continue this path in the coming quarters based on the positive impact of capacity adjustment and increasing activity.
The strong order intake continued in the quarter as we grew the backlog by 10% following accelerated sales within production for Life Sciences and strong performance in Regulatory Affairs, as well as next generation testing and validation for current customers. Let us now turn our attention to slide six and the CDS business. We were pleased to see our CDS business unit returning to growth in Q3 as we lifted revenue moderately by 4% to DKK 207 million in the quarter. This is mainly driven by higher sales to Life Sciences customers, and we expect growth to pick up going forward. We adjusted our capacity back in Q2 to reduce production costs, and we have improved the utilization rate this quarter and realized a significant improvement of the gross profit to DKK 42 million.
On this backdrop, we were able to boost the gross margin to 20.3% after the sluggish performance seen in the recent quarters. We will maintain our focus on cost while ensuring that CDS is able to accommodate demand and drive growth in the coming period. CDS delivered strong order intake within custom application development in China and Denmark, in particular, combined with good traction within Microsoft solutions as well. The order backlog for this year continued to grow at a steady pace. Please turn to Hybrid Cloud Solutions on slide seven. The HCS business unit saw a slight decline in revenue in the third quarter to DKK 302 million, mainly due to the expiration of an SLA contract back in Q1.
We maintained our focus on cost savings in the quarter to counter the impact of slightly lower revenue and significantly higher electricity prices, as well as higher staff costs during the ongoing transformation of our outsourcing organization. These effects did, however, drive up production costs slightly, entailing a decline in the gross profit margin to 3% in the quarter. Efforts to improve the utilization rate continue, and we look forward to completing the consolidation of our global delivery capacity in the Philippines in Q4 to reap the benefits of the move. The order intake in HCS ensured a backlog of DKK 1.2 billion. Now let's move on to slide eight and an overview of the group financials. Group revenue grew by 5.7% to DKK 738 million in the third quarter on the back of acquisitions and moderate growth in Life Sciences and CDS.
This translated into a negative organic growth of 1.3% due to the development in HCS. Despite an increase in production costs following acquisitions, we lifted gross profit for the quarter by 11% to DKK 100 million, entailing a slightly higher gross margin of 13.6%. The positive traction in revenue and gross profit drove an improvement in group operating profit to DKK 30 million with a margin of 4.1% in the quarter. Special items amounted to DKK 50 million, comprised of restructuring costs related to redundancies and the transformation of our outsourcing organization, as well as the divestment of our infrastructure operations. All in all, we reported a net loss of DKK 22 million for the quarter. Please turn to slide nine.
We maintain the suspension of the 2022 outlook today in the wake of the announcement of the divestment of our infrastructure operations. While we are making progress in the carve-out process, it simply takes time to enter constructive and thorough dialogue with customers. We still need a more complete overview of the outcome of the process before we are able to split our financial reporting into discontinued and continuing activities. When we have the necessary overview, we will provide new guidance. We look forward to being able to leverage the sharpened focus on the two core business units after closing of the transaction, with the ambition to significantly strengthen revenue and profitability of the continuing activities from 2023. Now turn to slide 10 for a few closing remarks from Pär, followed by the Q&A session.
Thank you, Pernille. Firstly, I'm glad to say that we continue the strategic effort to carve out the infrastructure business and complete the relocation of our outsourcing organization. Secondly, we would like to highlight that we saw a pickup in revenue, in earnings as well as backlog growth in the continuing and discontinued business unit, Life Sciences Solutions and CDS. Finally, we are stating today that there is still some work to be done before we have the complete overview of the split between the continuing and the discontinued business. We're making progress, and we are looking forward to providing you with an update as soon as possible. Thank you for listening, and we now look forward to take your questions. Next slide, please.
Thank you. If you would like to ask a question, then please press star followed by one on your telephone keypad. If you change your mind, please press star followed by two. When preparing to ask your question, please ensure that your phones are muted locally. As a reminder, that is star followed by one to ask a question. Our first question comes from Yiwei Zhou from SEB. Yiwei, please go ahead.
Good morning, Pär and Pernille. Thank you for taking my question. I have two and do one at a time. Firstly, a question regarding your capacity utilization. It's good to see the improvement in Q3. But could you maybe comment on the current level, if you compare to what would be the normal level? That would be my first question.
Well, if you take the capacity utilization, we have seen an improvement during this quarter, both in Life Sciences and in CDS. I would say that there is still potential to improve it further.
Yeah. That's absolutely correct. We are working on this in both the business units way. As you can remember, what happened in the beginning of the year was that we entered the year with full force, expecting higher growth in Life Sciences. Then we have adjusted it throughout the year to sort of right-size that level. There is a lot of opportunities still within that segment to utilize or within Life Sciences to utilize the capacity better and therefore improve the margins.
Great. Just one follow-up here. Is it possible to come and provide us an index level, if you compare to the normal utilization rate? For example, for the Q3 level.
What you are asking is that what would be, if it was full utilization, what would the margin be?
Exactly. Yeah.
Yeah, exactly.
Maybe just utilization.
Maybe just utilization. We are not giving a utilization as a number, so we don't do that here either. But I can say to you that the way it has been tackled, the manning within Life Sciences has been to still maintain quite a gap to be able to grow, because the people that have been brought on board in Life Sciences, they're not easily brought on board, so to speak. There's still a lot of margin improvement on that capacity to be had.
Okay. Very helpful. My second question here is on the wage inflation. We have heard some other IT companies talking about a wage increase in 2023. What is your expectation?
That's a very good question. I will say that wage inflation has a different impact to different IT companies here. It's a company with quite a mature staff that has been with the company for a long period of time and salaries have basically grown with the seniority of the people. What we have seen here has not been a very significant salary increase and wage inflation request compared to maybe competitors who have a very young staff base. We are quite holding that here and also expect to continue to do that in next year.
Of course, everything is sort of in what the development in the market is going to be. Another important element to that is also that prices to the customers are also going to reflect, in the new consultancy business are also going to reflect this wage inflation seen. Hopefully there won't be a lot of margin impact as a consequence.
The caveat to that, I also say that. I mean, given in this time, usually our clients are more open to exploit our global delivery capabilities because we are blessed with having highly competent people, both nearshore in Prague and also now offshore with our kind of reestablished operation in Manila. That will actually give the benefit of both providing better prices to our clients and actually higher margins to NNIT. I foresee that in 2023 more clients will be wanting to go down that avenue. While as Pernille said also at the, u sually when you have these processes, whether salaries goes up and inflation goes up, there's actually some latencies to get the clients to approve higher prices. We expect that to be able to happen in a more general extent in 2023, actually.
Okay, great. Thanks. Great comment. I jump back to the queue.
Yeah.
Thank you. As a reminder to ask any further questions, please press star followed by one on your telephone keypad. Our next question comes from Poul Jessen from Danske Bank. Poul, please go ahead.
Yes, thank you. I have a few questions. First on the CDS gross profit, which is more than doubling sequentially. Are there any special items in that or is that the level where we should stick to you performing going forward by increasing it further?
Thank you for that question. I'll take that. What has happened in CDS is, as we also have alluded to previously, is that they've actually adjusted the capacity quite significantly earlier in the year as a consequence of the revenue that they were lacking. That's that. That's kind of the initiative there. There will be also there possible further margin improvement opportunities, but they are not as near-term as the Life Sciences that I just commented on. They have taken quite a hit.
I think also, Poul, one comment is also, I mean, we're also now seeing the effect of the establishment of the new organization in January. As you recall, we then established three full P&L units. I would say that has especially helped our consulting unit to operate the way a consulting unit should operate, where you really connect the cost and revenue in the same unit and not having that split in two different universes as we had before. I think you start seeing the benefit of that, of both having more focus on your bottom line and thereby also be able to deliver better growth in business as well.
Okay. If we look at the growth in the CDS, you have announced several contracts this year, both at ATP and central bank and now the education. Shouldn't we see that your growth then should also pick up or are you terminating a lot of agreements at the same time?
I would say there's no... We see at least a continued modest growth going forward. I think it's really good to see if you're looking on Q3 for CDS, you see 4% revenue growth and 5% cost reduction. That's a beautiful picture, right? The wins that you mentioned, both ATP, Nationalbank, which contain a significant CDS piece, and then also of course SU, when it comes in, it's gonna be contributing a lot.
I think the conclusion is you can expect, judging from this that the growth is going quite higher.
Okay. More structural question on your setup. When the acquisitions made within Life Sciences in the past was announced, and part of that was that you would keep them as independent units, not to integrate them into NNIT and thereby destroy the culture and the entrepreneurship of those organizations. Recently, you've been announcing that you are now integrating these. Do you see a fear that you are more or less killing the entrepreneurship of these or should we just see that as picking out more costs?
It's a very good question. You know, M&A is probably the most challenging area you can devote your time to. I mean, I think that the strategy for M&A in this company is actually brilliant, because the strategy is clear when we meet this new company, that the end state is actually integration with NNIT. We are communicating that clearly to the company. We are taking this in a very, very cautious process where we have to start, do not do anything. We keep the company, keep the names, and then we start to collaborate in delivery, start to collaborate in sales.
When the maturity reaches a certain level, then it's actually a push from the company that has been acquired to actually join NNIT, not the other way around. I think it's also important to what kind of full integration means, and it is no drama. I mean, take for instance Valiance, they are keeping their offices. They are keeping the premises. They are operating with as much freedom as they had before. We are not killing the entrepreneurship in the company. We are just reaping some synergies, especially on the revenue side. I would not say that we are fearing any killing of any entrepreneurship.
It's just the kind of cautious process we have in an IT in order to drive growth, profitability and also benefits all other stakeholders of the business.
Okay. If you look at the number of employees in the international offices, it's up by about 30 people in the third quarter versus Q2. It was down in Q2. Are these companies then very aggressive on hiring right now, or have you transferred people from other units into the international offices? Are the numbers wrong?
Honestly, there hasn't been any strategic changes. Apart from, of course, I don't know how in your opinion, have you been demonstrating-
I.
'Cause Valiance is now part of an IT brand, so maybe that's one change.
Yeah. You know, I think this has something to do with certain integrations and people who've been moved around as a consequence of that, those numbers. There's definitely not been added this amount of people to the offices. If you allow me, Poul, then I'll come back to you on that specific question to just take that offline.
Okay. About the final one for now is about HCS. When you were announcing the sale, you were mentioning that some of the costs would stay with you when you carve out HCS. If we look at their production costs and they have a gross margin of 3%, should we see part of the production cost of HCS being moved to the true continuing business so that we can not just build on the existing gross margins of these at the closing or how should we look at that?
It's difficult at this point to give you a proxy of how continuing and the discontinuing business look on the cost base, just because it has an element of what you are saying there, Poul. The divestment is, as we've said previously, a divestment with a lean cost base. The remaining company is going to basically as a start carry that cost base, but then there'll be a plan to take that out. To answer your question, the gross profit margin in both of those units will be kept intact.
As a start, there will be sort of a plan to take costs out as a consequence of this. To give you an example, it could be a building cost where the division between those business units is going to be different as a start. Then there's going to be action on that, and then it's going to normalize.
That means when we see the separation of the financials-
Yeah.
... then we should see a hit to the gross margins of LSS and CDS.
Yeah. As a start, you will. Yes.
Yeah. Being taken out throughout the next year.
Yeah. Yeah.
Okay. Last question here. On the HCS sale and carve-out, the electricity prices that move up right now, can you give a little color on how that's gonna impact-
Yeah.
... this adjustment of the sale price?
Yeah. Luckily, they're moving down now, Poul, aren't they?
Yeah.
That's actually quite helpful to them. I think they're moving up and down all the time at the moment. The way the mechanism work, I can tell you, is that we basically have to give the buyer a company where we sort of adjust the price for price levels as they sit the last two months of the trading before they take over. Depending on where the prices sit, there's going to be an adjustment as a consequence. That's quite how this works. Again, they're moving down and maybe just as an add on to that, there are also other adjustments in this that are moving the other way.
You can't just take, you know, this as a one line adjustment.
You have an interest in pushing the closing as late as possible in this year to get out of the September, October crisis?
If the world was just so simple, Poul, but it really isn't.
Yeah.
I think we have, and Pär's also looking at me here. I think we have a joint interest, both the buyer and the seller, to close this deal, as fast as possible so that everyone can start managing the two separate businesses. This won't be guided by the electricity prices.
Oh. It was a small matter. A funny comment. Okay. Thank you.
I know, but I had to answer it, Poul.
Yep.
That's good.
Thank you. As a final reminder, to ask any further questions, please press star followed by one on your telephone keypad. Okay. We currently have no further questions, so now I'll hand you back over to Pär Fors for closing remarks.
Yeah. Thank you for all your great questions, and also that was all from us today. Thank you for your participation and look forward to meet you next quarter again. Thank you very much. Have a great day, a great afternoon.