Earnings Call: Q4 2021

Feb 17, 2022

Summary

Core digital revenue grew 17% YoY in Q4, with an 11.5% EBIT margin and NOK 70 million FY operating cash flow. Strong cloud demand supported growth, while the data center wind-down and talent availability remained key considerations.

Good morning, everyone. Welcome to the fourth quarter interim report for Itera. My name is Arne Mjøs, and I will start with the highlights of the quarter and then continue with the business review. We also have Chief Financial Officer Bent Hammer here today, so he will walk through the financial review, some comments about the outlook, and also if you have some kind of questions, please return to either myself or Bent after this session. Okay, the highlights for the fourth quarter. I just start with Q4 in a brief, and when I'm talking about the figures now, it's only about the core business at Itera. We have talked with you for two years now that we are transforming our data center operation into the cloud. Today, and this quarter, we managed to grow our core digital business by 17% in the fourth quarter and also had an operating EBIT margin on 11.5%. We see the market is very good. It's a very attractive market driven by sustainability and digitalization in all industries. As you know, we have also invested in a Cloud Centre of Excellence. By transforming the data center, we also need to build a new one, that's the Cloud Centre of Excellence, and also establish a Digital Factory at Scale, and invested about NOK 18 million this year. We are also launching a new offering. It's a next-generation AI-based anti-money laundering solution, and we'll come back to that. We are opening a new office in Iceland for further expansion. We had a book-to-bill ratio of 1.5 in the first quarter and 1.1 last 12 months. The number of employees is increasing. We had 28 net recruited people in the fourth quarter and 113 employees last 12 months. The cash flow rolling 12 months is good. It's NOK 70 million, and the board of directors has proposed the ordinary dividend of NOK 0.20 per share for 2021. If I look at the figures in more details, we, as I said, had 17% in the fourth quarter in growth. We had 19% for the full year. If you look at the EBIT margin, it was 11.5% in the fourth quarter and 13% for the full year. You can see the figures here. Bent Hammer will come back to the details, but you see we had 159 million in the fourth quarter in revenue and also had an EBIT margin of 11.5%. Now we are 670 people for the core digital business in the fourth quarter, at the end of the fourth quarter. We will come back to the total business, but for the group, from the 1st of January, we will only focus on the core digital business because the data center will be fully discontinued at Itera. That is according to what we have reported earlier. Let's have a look into the business review section. Yes, this is to go back to the position at Itera. We are specialists in creating sustainable digital business, so that is the core part. We have competencies in terms of understanding the customer experience, the user experience. We have a strong understanding of the business for the customers, but also not at least all kind of new technology. We really believe that if you are going to become a really digital business, you really need to use technology in the cloud to approach these kind of opportunities. We are following customer in the Nordics. That is the core strategy of Itera. We have sourcing location in Eastern Europe that is fully integrated as one Itera, and we are delivering services to about 20 countries around the world. What has been very important for Itera and what we have seen as a change is actually that digitalization will be fully integrated in all kind of business and all kind of products. The product and the business is much more software-driven than in the past. In the past, we had some kind of some vendors on the infrastructure, some vendors at the application, or so customization and integration, and we have some vendor in terms of the strategy people, and that kind of companies. Today, because everything is actually melted together, we are working much more according to what we call the vertical, the full stack, combining business understanding, user experience, and all technology that are needed to really build this product, which is much more software-driven than before. We have a long history of transforming and supporting the customer, the digital agenda, but now we are also going into the full stack that also include the business and product agenda. Some are saying that Itera has become some kind of mini Accenture because we have the scalability, we have the competencies, so we manage to take the full stack and help the customer with their business and product growth agenda. Just to show you one example of this, because in the fourth quarter, we really launched a new offering within financial crime for the anti-money laundering, which has been a big challenge for all the financial institutions. What we have done is actually to establish an offering together with IBM and Red Hat, because IBM have a very interesting software in terms of new technology based on artificial intelligence that are very intelligent in order to embrace the customer, know your KYC processes, and also all kind of activity monitoring. We bring the customer lifecycle management and the customer activity monitoring and look at how could we really follow the activities and also put in more behavioral analysis to make some kind of dynamic trust index so you manage to look at the risk that the financial institutions are actually exposed to in terms of potential financial crime. Together with IBM and Red Hat, we are really having a very strong offering. How could we manage to take this, to leverage this, or to handle this kind of problem, challenge for the financial industry? What we also did was we are looking at a new area of solutions for fighting financial crime. What we did was also put together people from the industry and also from the tech, the innovators, to look at how could we really address this kind of financial challenges and fighting the crime with AI, and how could we really share data and algorithms across the banks. Because that is also important that the banks by themselves won't solve it. They also need to collaborate in some way and also exchange some kind of algorithms or exchange data in order to monitor and try to identify the suspicious transactions that need to be reported to the financial institutions for further follow-up. What we also did was actually establish a new report that you can go to Itera website and download, because here we have some point of view, how could you actually use AI and new approaches for these kind of challenges for all the banks. What we have also done during this, I will say, this year, is actually that we have also established what we call a Digital Factory at Scale for data-driven business. That's why we have invested in this Cloud Centre of Excellence, because how we really build the solution and how we operate the solution is totally different when you are in the cloud than in the past when you have the local data center. By having this Digital Factory at Scale, we are increasing the innovation, the speed, scale, and quality. That's the key benefits that we provide for the customer. To really become a sustainable digital business, you really need to also use these kind of new tools, but also embrace the data that are located on-premise or the old, the legacy systems. What we see, and not at least driven by the COVID-19, where a lot of people were using the cloud, is actually that we also see that a different trigger, because the transition to the cloud is really accelerating. There are different tactical trigger and strategic triggers that the customer are considering, when they and what they should move to the cloud in what order. So, it might be that the exit of the data center might be the trigger, or it might be that you have some infrastructure you don't want to renew. Instead of renew and make a large investment, you can actually use the same technology that are more sophisticated and more available in the cloud. Or it might be that you have a strong digital transformation, there's new business initiatives that's much easier to build in the cloud with a lot of more tools than doing that in the past. Not at least, it can also be some kind of security issues where the cloud is more secure than working on the classical data center. What we do with a lot of the customer now, and not at least after investing in our Cloud Centre of Excellence, is actually that we are helping the customer in the same journey that Itera has done. We are doing what we call a discovery and assessment analysis, where we analyze the system landscape by the customer and categorize the system into systems that we just lift and shift, move, and replace the hardware software to a system that we might optimize by not changing the application database by itself, but may just move it and containerize the software so it is easy to use some part of the services in the cloud. The last but not least is actually you might replace the existing system with an existing SaaS application already in place, or you start to build a new application that are really using the tools and the capabilities, including machine learning and AI, that are in the cloud. What we are doing more and more for both existing customer and for new customers, we are doing this kind of journey, this digital journey, according to the business driver, and we made some kind of digital roadmap to make sure that the system are actually supporting the business strategy. Just to show you some example on this is one example from Mastercard that we have been a customer to Itera for a long time. What we have done is actually to migrate and move and use the brand side and some part of the business-to-business core solution with all their integration in terms of third-party products, whatever. What we have done is actually to migrate and also some kind of modernize to make sure that this is managed in the cloud. We are taking more and more end-to-end relationship or end-to-end responsibility for the brand sites for customer like Mastercard. That engagement was started in Denmark, but now it is more and more cross-border because Itera is an international company that can follow this customer along their journey. Another example is actually, if I look at home, which is Denmark's best-known real estate agency with about 180 offices and 900 employees. They have been using Itera's local data center for a long time, and then we said to the customer that when Itera is sunsetting the data center, we also like to move the customer along the same journey. After a two years period of time, we now close down the data center in Denmark, and 95% of the system by home is now running in the cloud. Based on this relationship, we made this assessment, and we made a roadmap and managed to move home as a real estate agency. Then now they are moving, they are faster time to market and lower cost than it was in the past. This is very good example of a company that are moving to the cloud, becoming more a digital business, and Itera has supported and enabled this customer on this journey. The last example I just want to show you today is actually DNV, which is modernizing all the digital solution in the cloud for managing risk and improving safety and asset performance. They, we have a very strong relationship with the digital solution, and we are using our Digital Factory and Cloud Centre of Excellence that we have established through the investment to make sure that DNV are really accelerating the transformation to the cloud into a SaaS application. They have a lot of this local software that are running on desktop, on on-premise, but are now transformed into a SaaS application, SaaS solution, where we are also improving and then extending the services with more and more data-driven functionality, which is extremely important for most of the customer that are actually approaching the future of Industry 4.0. This is just to show you some examples, and I also would like to mention that we are opening new offices, very customer-centering. In this quarter, we have, after five successful years at Iceland, we are also establishing new office because we see there are all the kind of opportunities in Iceland. We are focusing on the Nordic-based customers. In this case, it was really the time to establish a local office and onboard more local people to support the industry in the Icelandic market. Yes, when we are talking about Itera, we are quite organic-driven company. As I showed you, we are growing by 22%. That is 130 people we onboarded last year. That is net, but we may be in gross number onboarding more than 200 people. In order to make sure that we are one company that can work across border, we really need to have the same introduction of the employees from anywhere, so make sure that they understand the strategy, they understand how we are working, they understand the practices that we have, so make sure that from anywhere we can collaborate instead of having some kind of fragmented departments of Itera. That has really become the main part of Itera during 2021 to have the foundation for the scalability. By onboarding 130 people net this year or last year, 2021, I really would like to see this number increase. That is why we have established a foundation to make sure that we are increasing faster and faster and onboard people from different location, but working as one Itera. As you know that we also are located in Ukraine, and I think also would like to share what we are doing in Ukraine today, because we see everywhere there is a very tension between Russia and Ukraine. But Ukraine is not alone anymore. They are really a part of the global security agenda, the NATO security agenda, the European security agenda. What we see in Ukraine, this is a picture of the people sitting in Kyiv, and we have a complete normal operation activity level at our office in Kyiv. We are really taking care of the people. We are really a part of their challenges or their concerns, but we also continue to delivering our services to our clients. Our clients are also embracing our employees and make sure that we have established very strong business continuity plan. This is not something that we just established for this situation. This has already been in place for eight years, because this tension between Ukraine and Russia has been there for eight years, more or less, since the Maidan, as you remember. What is also important is actually that we have also flexibility. We are not only dependent of the location or the facility or the office. People can sit and work from everywhere because of the Digital Factory that we have established. It is very easy to work cross-border, cross-location, from home, et cetera. So we can move around all our people. We have also established and increased the office capacity in Lviv, which is really close to the Polish border. We can move some people there if they would like to go there, or we can take them to Slovakia office, or we can take to the Nordics. Some customer also saying, "Why don't you also come to U.S.? We have some engagement in U.S." So we are really taking care of our employees, but also make sure that they are a part of their families, so they also are concerned for their families, which always try to find the best solution in any way. So actually, I will say that our distributed model and also the mobility of the consultants that we have in place in Itera, we are really focused on take care of the people. That is the most important thing. But also make sure that we can deliver the services during this kind of challenges time in Ukraine, but not at least also in Europe. If I look at the order intake, I mentioned that early in the beginning, it was a book-to-bill ratio of 1.5 in the fourth quarter and 1.1 for the last 12 months. These are some represented customer, existing and some new ones, that I just want to mention in this quarter. What I also feel is important to talk about is that we have a high number of existing customers, represented 86.6% of the revenue in the fourth quarter. When we measure a new customer, it is actually that the customer that didn't have any kind of revenue to Itera the last 12 months. So new customer is a customer that was established from 12 months ago. That represented 13.5% share of the revenue. That is, I think, is very good that we are also focusing to win new clients because we should grow, continue to grow, and we would like to have even more clients to make sure that we have the foundation for growing even more. You also look at the revenue from the top 30 customers, 76%. It was quite high last quarter, the last year, with 80%. So I also very satisfied that we managed to take it down because we are also onboarding new customers. So that is quite correlated. The last part of the business review before I hand over to you, Bent, I just want to say that we are 670 employees in the core digital business. It was up by 28 in the quarter. For the last 12 months, in 2021 actually, it will increase by 113 people net, and compared to 55 during 2020. We are really increasing the net recruitment. As you see, the nearshore ratio from Eastern Europe is about 53% compared to 49% at the end of 2020. I think that was all for today, Bent. Maybe you can take us through the financial review. Absolutely, Arne, and good morning to you all. As Arne mentioned, we have been reporting on the core digital business as a primary focus for 2021 due to the fact that we are discontinuing the data center operations. From 2022, we will report as one segment as such, but the discontinued business will be netted as a separate line. It will be more or less the same type of reporting as we have done in 2021. Going into the figures, we had a 17% growth on our top line, 19% year over for the full year. The cost of sales were a bit up by NOK 1.1 million, and that is due to more usage of subcontractors as we had to use external subcontractors in order to fulfill the customer demand that was very strong in this quarter as well. Our personnel expenses were up by 18% in the quarter, and that is mostly related to a higher degree of accruals for variable compensation, as we met or surpassed our targets for the year in that regards. Other operating expenses up by NOK 1.6 million. Some of it is from the new and extended office that we have in Bratislava, Slovakia, as we have grown quite considerably there over the last year or so, almost surpassing 100 people there now, and still growing. We have also had to make a reclassification of what we had previously put in the balance as an asset related to the implementation cost of our new ERP system. Under the correct accounting rules, we need to put it as a prepaid expense rather than as an asset. It has no impact on the quarterly amounts amortized as such, but it is taken as an operating cost rather than as a depreciation cost. Depreciation is also down by NOK 1.3 million. That has nothing to do with the before mentioned, but it is more to do with some R&D assets that had been fully depreciated, as well as the sublease that we have entered into in Kyiv for close to half the office space during this COVID-19 lockdown. That reduces our expenses. With a total increase of 15% on operating expenses, we saw a growth in the earnings before income and interest and taxes from NOK 13.6 million to NOK 18.3 million. That gives a margin of 11.5% versus 10.0% in Q4 of 2020. For the year as a whole, the EBIT margin was 13%. A good performance there. We are most pleased, I would say, with the growth we are able to achieve on the employee side, having grown 22% up to 617 people in this core digital business. Looking at the sequential growth, we see that Q4 is traditionally a quarter with many working days, at least on paper, because this year we had four working days falling in the Christmas holidays week, which is a bad week for working because most people will either take some excess time off or they will take some vacation days. There is little revenue to be generated in those weeks, or that week. Also, with Christmas Eve falling on a Friday, there were a lot of people who kind of slowed down before Christmas as well. If we look at more the bigger picture, we have seen an average cumulative growth rate of 14.5% over the last two years, and we also seen a 1.1% margin improvement in the same period. That is very good. Back to the data center operations. If you have been following us, you know that our largest customer exited this data center as of January 1, 2021. There was a massive drop in revenues at that point in time. Then we started the migration of the remaining portfolio either to cloud or to other vendors, and we see the tail end of that now. We have a couple of smaller clients that will complete their exit in April, May of this year, whereas the rest of their portfolio is expected to be completed by the end of the quarter. I think we will expect to start reporting this as discontinued business as of Q1. The data center operations only constitute NOK 9 million in revenue this quarter, so that is only 5% of the total. It is a negligible part of the business now. The downsizing in volume now is now well below critical mass, so to speak. It is not possible to run that in a profitable manner. We see that we have incurred a loss of NOK 4.6 million in Q4. We are looking forward to stopping that loss after the next few months. Cash flow, we delivered close to NOK 33 million in cash flow from operating activities in Q4, so slightly down from 2020. Also, for the full year, we have approximately NOK 70 million generated from operations compared to NOK 99.2 million in 2020. That it follows more or less the EBITDA figures we have in those periods. We invested NOK 7.8 million in R&D and tangible assets during the quarter, some to complete the Cloud Centre of Excellence that we have been investing quite heavily in during 2021, and also into the SaaS solution that our subsidiary Compendia has. We distributed a dividend of NOK 0.10 per share in early December, so that was approximately NOK 8 million in cash. We had some other lease payments, et cetera. All in all, we ended up with a balance of NOK 37.5 million, down from NOK 54 million in 2020. Looking at the dividends and our shareholdings, Arne Mjøs mentioned that the board of directors last night had decided that they will propose a dividend on the 2021 figures of NOK 0.20 per share. It will also request that they get a new authorization to decide on an additional dividend during the year, as we have been accustomed to in the last several years. We expect the total amount of dividends based on 2021 figures to be well within the stated dividend payout policy of, excuse me, distributing between 50% and 100% of earnings. The share price had not moved significantly during 2021, only 2% or 4% if you include the dividend payments. It is obviously down quite a bit since year-end as well now, as you will know. We held 1.6 million of our own shares at year-end, which was then valued at NOK 25 million. That is also sort of a liquidity buffer that we have if we were to need that at any point in time. In the balance sheet, there is no material movement on the total asset side, just a minor reduction of 3 million. We had an equity ratio of 18% versus 15% of last year, and another 3% on top of that if you exclude the so-called right-of-use assets, which are the future lease payments on our office leases. As mentioned, we had a cash balance of 37 million. We see that the receivables are growing by NOK 10 million. We will see this obviously grow further as we have a continued high growth in the company. Which brings me on to the outlook lastly here. Not much new to disclose in terms of how we look at the market and our future performance. We see that there is a very, very strong market out there with access to talents as being the minor, sorry, major impediment for even stronger growth. Luckily, we have a very well-functioning distributed delivery model, which enables us to source from other locations than the very pressed Nordic market. We do expect to outperform our competitors that are purely Nordic-based. As mentioned, the other major thing is the final close-down of the data centers, which enable us to fully focus on growing the core business. We will do that also through some Nordic expansion. Arne Mjøs mentioned setting up some local presence in Iceland. We are about to sign a new office lease agreement in a town south of Oslo, where we have started slowly building up since last summer. We are now at the point where we can invest in our own offices. We will continue to pursue expansion through our Nordic offices. I think that is it for me today. Arne Mjøs and myself are certainly available for anybody who would like to have a one-on-one conversation about Itera. Feel free to contact us by mail or phone, and we will set up some meetings for you. We will see you again on April 29th when we present the fourth quarter. Thank you. Bye-bye.