OSLO Apr 27, 2019 (Thomson StreetEvents) — Edited Transcript of Itera ASA earnings conference call or presentation Friday, April 26, 2019 at 7:30:00am GMT

Okay. Good morning, everyone. Welcome to the interim report first quarter for Itera. I will present the highlights of the quarter and the business review. And our CFO, Bent Hammer, will take the second part of the presentation with the financial review and the outlook.

So let’s look at the highlights first. Our core digital business, which represent about 75% of the business, show a growth of 10% in the first quarter and a EBIT margin of 12.8%. If I look at the total business, we had a revenue at NOK 143 million compared to NOK 131 million. That’s up by 9% in growth. And looking at the EBIT, it shows NOK 13.8 million compared to NOK 10 million last year — first quarter last year. That represent a margin at 9.7% compared to 7.6% last year.

As we have presented several times, we are transforming our data center business or related business to our data center, which amount for about 25% of total volume. That transformation is running quite well. We have shown a good cost reduction, which has been very successful. And we have also migrated our 3 data center into 2 data centers. We in fact closed down one of the data center during the quarter. And if we’re looking at order intake, it shows also very strong book-to-bill this quarter with book-to-bill ratio of 2.3.

So taking you into the business review section, I just want to remind you about what I’ve been talking about several quarters. As you know, every sector is going digital, and there is a lot of new devices coming into the Internet every hour, shown by 1 million new devices on net coming online by 2020. And that is because every physical assets, car, whatever, is getting digitized in some way.

And what is important is actually to also look at what is needed to develop this new society. We can’t — you know that the cloud has disrupted the data center, and the myth about that cloud is not that secure, that the traditional data center, that belongs to the past now. We see that cloud is more secure than the traditional data center. And we haven’t seen any kind of big hacks or failures from the new public data centers and cloud services, and that’s because they have redesigned the data centers for the future.

They are not only talking about their cloud because that’s also a new risk by centralizing everything because that every asset will also become some kind of data center. The capacity of the data processing power in a car is more or less as a data center in itself. So we are also talking about the new devices called Intelligent Edge, which also belongs to the total infrastructure. So not every part of the data will be transformed into the cloud. There will be also a lot of distributed data center in the physical assets that are moving around.

Our strategy for Itera. We have a position to be a specialist in creating digital business because every analog business are going to get digital business. And our approach is actually always think about the platform as how to enter it. And we have the 3 — 4 different entry model into the future. One is actually about looking for the new first-mover customer that are really taking or creating digital business at the core of the business. Especially we have a focus on smart building and smart energy as 2 new sectors for Itera.

But we also are looking at when we get new engagement hub, that we’ll also organize that into a DevOps on platforms as our first choice, which we also for some engagements start with the legacy solution and learn, get the knowledge about the existing system and then we start with the transformation into the digital business or platforms. We are also discussing existing projects. We have also large amount of existing projects running. And we are also moving this project into the — onto — into the cloud or using the platforms. And then last but not least is also that we’re taking our own data center and transforming workload from the traditional data center at Itera or some of our customer into the cloud. So that is the way we are operating.

And if you look at the competencies Itera have, we have the full fledge of competencies that are needed. It’s called today as a DevOps team consisting of the people, the digital business — the business consulting people and user experience people, all the developers but also the product owner, the people in the business side at the customer, et cetera. So we always talk about making some kind of very focused product-oriented, multidisciplinary teams. So Itera has all the competencies and capabilities that makes it easy to become a digital business for our clients.

Just to show you some examples, I run quite fast through this. There’s a lot of details that you can go into it. But just to show you, this is an example from an existing large bank where we, during 2018 — 2017, so actually started in 2017, 2018 and established the new architecture — application architecture for this client. So it’s very easy for the client to move into the cloud. So this customer are saying, in 2019, they will use cloud services instead of the traditional wholesale provider.

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So in this case, it’s a quite large case and consuming, I will say, 30, 40, 50 people from Itera. So it’s a quite large portfolio of different applications that we are working for this — that we are developing for this customer. And now they are ready to move this into the cloud. And then we can use the IoT and the machine learning and this new artificial intelligence that are built into this cloud platform. This is just only to show you some example.

Another example is Össur, which is an digital e-health. I will call it a digital health application. We have developed a SmartMeasure application, our apps. So it’s very easy to — for the specialists to go into the dialogue and take all the information, all the measures on the body, whatever, if you need a new brace or whatever. So then it’s actually some kind of order system that the specialists are doing by having all the measuring using the iPhone when you have the patient at your desk. And you can actually customize this brace for the clients or the patient. So this is another example that we are using the technology and the platform, in this case, the iPhone platform with all the functionality that is in the iPhone itself.

Another example is a large retailer. We were using a Kafka platform, which is actually a technology from LinkedIn that you all know about. We are using the LinkedIn technology that’s actually available in the market as Kafka. And in this case, we are handling 1 billion transaction per day, so this is a large amount of data that we are processing through this platform, running on Amazon, running on Azure and also 1 or 2 of their on-premise data centers. This is a large, large global corporation. It is impossible to do this kind of functionality in a traditional way. Again, the platform is the way to do it.

Another example is Loomis. It’s the cash-handling company based in Sweden where we are building anti-money laundering solution. We’re looking at some kind of abnormal change in the amount of cash that Loomis collects. And then we are — in this case, we are building the full application, front- and back-end user experience, whatever.

And this is a quite cooler case. It’s based on our subsidiary, Compendia, where we are making a intelligent chatbot, digital assistant for our customer. We call — where we are using AI technology to make more intelligent answer to the customer — the employees when they are asking for some kind of specific topics about condition as an employee, so then they get fast response on this and will learn on the request that they have and then will get more and more precise information, relevant information for the employees. So this is some kind of digitizing the HR department for different customers. This has become a very interesting, new technology for a lot of the customer, large and also smaller companies.

And the last but not least, we’re also using AI technology with a partnership with a local startup called Mito.ai, where we’re actually using the technology to analyze a lot of news articles, job ads, whatever, to make some kind of — to rate different banks, how they are looking at the Race of Artificial Intelligence. There’s a full report here where you can more — have more detailed information. So we are normally doing this kind of analysis based on manual analysis, but now we are also using artificial intelligent technology that are actually improving, that getting more information that we can put into the report and enhance the report itself.

All in all, we had a quite good book-to-bill ratio of 2.3 in the first quarter of our digital business, 1.7 overall. And also if you look at the customer development, we show also good change in terms of new customer, which represent about 10% of the volume this quarter. And also if you look at the top 30 customers, it’s going down by 3%, but it’s still very high. So this is according to this stats. We would like to build new customers that really build a new growth for Itera because we have a lot of existing customer very happy with Itera. But we now also look at new customers who can drive the new growth. And then last one from my side is also looking at the nearshore capacity is to represent 45% of total capacity of the group.

So that was all from the business review. So please, if you can go into the financial review.

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Bent Hammer, Itera ASA – CFO [2]

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Thank you. I will do that. Good morning, everybody. As Arne mentioned, we had a growth in the quarter of 9% in Q1, and the growth was actually higher on a gross profit level, where we achieved 11% growth. And this is because we had a higher growth on the consulting business with obviously no cost of goods sold compared to the other business.

Our personnel expenses were up by 10% in the quarter. And roughly about 1/4 of that increase is related to less capitalization on product development for our IPR. And the rest is a reflection of a very hot labor market for technologists in the Nordics.

Other OpEx is seemingly down by NOK 3 million, but that’s entirely related to a new accounting standard called IFRS 16 leases, which puts all the rental costs of our facilities and so forth from OpEx and over to depreciation. I will come back to the impact on the balance sheet that this accounting standard has entailed. But it’s then also a driver for the growth in EBITDA, which is up NOK 7.1 million to NOK 22.3 million. So roughly NOK 3.5 million of that is related to this accounting change.

We had an EBIT of NOK 13.8 million, which is up 38% from the corresponding quarter of last year; and an EBIT margin of 9.7%, also up by a couple of percentage points. From our cash flow, we generated a negative NOK 8 million from operations, which is the same as in Q1 of last year. Both those quarters ended on a weekend, and that’s where we have most of our receivables coming due. So there was a spillover to April on invoices due end of month there. Ended up with a cash balance which is more or less unchanged from last year as well. And equity ratio is down 2.4 percentage points from last year to 22.3%, but this is where we’re really hit by this new accounting standard, which effectively took care of 5.5 points from our equity ratio due to the inflation of the balance sheet.

We had a stable number of employees year-over-year, but there is a change in mix. So we have about 15 FTEs less in the data center operations and related overhead and sales personnel. So these 15 have been then consumed by the consulting business, the digital business, so a slight change in mix there.

And this split in our business for the core digital business versus the data center that we are transforming into a more cloud-based offering shows the difference in both the growth rates as well as profitability. And we had a growth rate of 10% in the digital business area and a healthy EBIT margin of 12.8%.

In the data center transition, we had some growth of 6%, and that’s a reflection of the huge increase in the amount of data that we’re processing on our existing customer base mostly. We have 1 or 2 new customers year-over-year as well. But for the most part, yes, this growth comes through the consumption of our existing customers using more and more data power.

The result from this area was more or less a breakeven. Well, that’s a solid improvement from last year where we lost NOK 2.8 million with a negative EBIT margin of 8.3%. So this will — yes, so the traditional data center capacity will be transformed into more cloud-based. And when we’re done with the initial investments and transition of the cloud business, we will gradually encompass that into our core digital business as it is.

Looking at the quarterly development, we have as a consulting business seasonal variations that are related to the number of days worked. This was done in hours. And then that’s obviously a big factor in that sense. That means that Q3 is traditionally low due to the vacation periods, and Q1, Q2 usually have some shifts due to Easter falling in either of the quarters.

I should say that we have in our Ukrainian operations, Easter is a week or so later than in the rest of Europe, so there might be some slight changes there as well. Now in 2019, Easter is obviously falling in Q2 for our entire operations. When we have more or less fixed monthly salary costs, which is the dominant cost factor, our EBIT and EBITDA will reflect this in more or less 1:1, where we — if we lose approximately NOK 1.5 million per day less of work time, then that more or less floats down to the bottom line as well. So it’s very volatile in that sense.

Looking at the revenue split in terms of service lines. Our own service revenues from consultants increased by 11% up to NOK 95 million in the quarter, whereas the subscription revenue increased by 7% to NOK 35 million. The latter is also driven by this HR Henry that Arne presented to you, which is the intelligent digital assistant that we have embedded in the HR solutions that our subsidiary, Compendia, is offering as a Software-as-a-Service type of revenue stream.

Third-party consultants that we use in our projects to — either due to lack of the right competency in our organization or lack of capacity in some areas, that grew by about 5 — 4% to NOK 9 million. And other revenue, including hardware and software sales, were down 17% to NOK 4 million. This will go down further in the quarters to come as we have decided to close this web shop we had for our customers to order certain soft — sorry, hardware that they use in their business. It’s not a huge amount but, yes, maybe close to NOK 1 million per month.

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Cash flow. As mentioned, our cash flow from operations were some NOK 8 million negative in the quarter, as it was last year. We invested NOK 2.5 million with own cash, but we also invested more through leasing of NOK 3.2 million. So those 2 combined was approximately the same year-over-year. The leasing that we assumed was mostly related to the consolidation of our 3 data centers down to 2 and upgrade and modernization of the equipment in those.

Nothing much on the financing activities, some repayments of leasing. But we ended then the quarter with a cash balance of NOK 43 million, which is more or less unchanged from the year before. 12-month rolling cash flow from operations was up to NOK 57 million, which is the highest, I guess, we have achieved any time. So that’s satisfactory.

In 2018, we saw a huge spike in our share price in Q3 along with some peer companies as well. There was a rally in the Norwegian stock market for those shares in Q3. It fell back again to old levels, I would say, in Q4 also with the global tech shares dipping at the same time. And since then, it’s been fairly flat since then. So we’re actually now back to a share price which is just north of what it was a year ago.

The board yesterday upheld its decision to propose a dividend of NOK 0.25 per share, which will be probably ratified by the Annual Meeting on May 21, which means the share would go ex dividend on the 22nd if it goes through. I’m happy to say that we have managed to get as many as 130 of our employees, so more than 1/4 of our global employees, have taken shareholding in the Itera share. And they combined own 36% of the shares.

Obviously, highly skewed in terms of the holdings with Arne Mjøs, who’s our CEO, owning or controlling just over 30% of the shares. And the rest of management have approximately 5% of the shares. But it’s — I think it’s very good for the company and for the combined incentives of our employees to have this share ownership.

Looking at the balance sheet, this is where this IFRS 16 lease accounting standard really shows its effect. We — at January 1 when adopting the standards, we capitalized NOK 54 million of lease commitments in our balance sheet, so both on the asset side and the liability side. This is more or less entirely related to our facility lease agreements. So the value that we have put on the balance sheet is the discounted value of our future lease obligations in that respect.

So that means if we have like 4, 5 years left of our lease at the head office, for example, we have to capitalize this whole future cash flow to the balance sheet. So that — at the end of Q1, that represented so-called the right-of-use assets of NOK 50 million that we wouldn’t have under the previous standards. And that’s — the opposite of that you will find partly as current liabilities with the next 12 months of lease obligations in there. And then the remaining lease obligations are in the noncurrent liabilities then obviously.

Yes, so that was it from the financial section. On the future outlook, we don’t guide the market specifically, but we can reiterate the story from the last quarterly presentation really that the market is attractive. Every business is going digital in some way or another or at some speed or another. So there’s a lot of potential business there also in taking the traditional data center services to the cloud and migrating the applications.

We experience a very tough labor market in the Nordics because there’s just not enough capacity in the marketplace to fulfill all the client demands that we have. So there’s — it’s tough to attract sufficiently number of new talents, and we obviously see that also being reflected both on the salary side but also gives us an opportunity to shift these added costs over to customers. We’re well positioned in the sense that we have almost half of our capacity in nearshore, Ukraine and Slovakia, where there’s a lot more IT consultants available and, as such, a lot better scalability.

So yes. So that’s pretty much it. We will return on August 21 to report on our Q2 figures. Until then, I wish you a nice Friday and a nice weekend when that comes and look forward to seeing you back then in August. Thank you.



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