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Edited Transcript of NNIT.CO earnings conference call or presentation 29-Jan-20 9:30am GMT

Q4 2019 NNIT A/S Earnings Call

Soeborg Feb 10, 2020 (Thomson StreetEvents) -- Edited Transcript of NNIT A/S earnings conference call or presentation Wednesday, January 29, 2020 at 9:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Carsten Krogsgaard Thomsen

NNIT A/S - Executive VP of Finance, Legal, IR & CFO

* Jens Binger

NNIT A/S - Head of IR

* Per Kogut

NNIT A/S - President & CEO

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Conference Call Participants

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* André Thormann

ABG Sundal Collier Holding ASA, Research Division - Analyst

* Poul Ernst Jessen

Danske Bank Markets Equity Research - Senior Analyst

* Yiwei Zhou

SEB, Research Division - Analyst

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Presentation

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Operator [1]

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Welcome to the NNIT financial reports for the full year 2019. (Operator Instructions) Just to remind you, the call is being recorded. I'll now hand the floor to our first speaker, Jens Binger, Head of Investor Relations. Please begin.

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Jens Binger, NNIT A/S - Head of IR [2]

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Good morning, and welcome to this NNIT call regarding our financial performance for the fourth quarter 2019, full year 2019 and outlook for 2020. My name is Jens Binger, and I'm Head of Investor Relations. With me today, I have CEO, Per Kogut; and CFO, Carsten Krogsgaard Thomsen.

I will briefly walk you through the practicalities for today's meeting before handing over to Per and Carsten.

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, we will open for questions.

Today's agenda can be found on Slide #3. 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 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 this 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 will hand over to Per Kogut and turn to Slide #5.

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Per Kogut, NNIT A/S - President & CEO [3]

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Thank you very much, Jens, and congratulations with your new job.

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Jens Binger, NNIT A/S - Head of IR [4]

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Thank you, Per.

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Per Kogut, NNIT A/S - President & CEO [5]

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Thank you and a welcome from me as well. Following the unexpected sudden announcement of our results last week, we're pleased to be able to provide you with the confirmed numbers today and present them during this call. And thank you for your understanding, and thanks for joining.

I will give you the overall financial highlights since Carsten will go through more details later on.

In Q4 2019, revenue decreased by 2.7% driven by a significant 27% decline from the Novo Nordisk Group. The decline was partly offset by a 35% growth in international life science and a 24% growth in the financial segment.

Operating profit before restructuring cost was DKK 81 million, equal to an operating profit of 10.1% compared to the 12.9% we had in Q4 '18.

Please turn to Slide #6 for the full year financials. Full year revenue from Novo Nordisk declined by 15%, but due to a strong performance and growth of 71% in international life science and growth of 24% in the financial segment, the full year revenue for 2019 increased by 1.7% compared to '18. Operating profit before special items was DKK 239 million, equal to an operating profit of 7.8% or 8% in constant currencies in line with our most recent guidance.

The operating profit of 7.8% is 2.4 percent points below 2018 due to the decline in revenue and lower margins from the business from the Novo Nordisk Group. Later, Carsten will provide you with more details on this financial element.

Please turn to Slide #7. In January 2020, we announced the prolongation of the existing agreements with 2 very important customers, Lundbeck and the Danish Pharmacy Association.

The 2 prolongation of long-lasting customers demonstrate that NNIT continues to create value for our customers by delivering stable IT operation, while at the same time, support the customers' digital transformation.

NNIT's capabilities within cloud transformation were also confirmed by the 2 contract wins with Radius Elnet and Bang & Olufsen, respectively.

Radius Elnet chose NNIT to implement and support a hybrid cloud solution for their SAP ERP system and other business-critical service platforms.

At Bang & Olufsen, NNIT will handle the cloud transition with focus on automation and activity.

We also continue to see solid growth in international life science where one key growth area is the Veeva platform solutions. Veeva offers a unified platform for clinical, quality, safety and regulatory affairs within the life science industry in a multi-tenant cloud setup.

NNIT is well positioned as the largest implementation partner in Europe as a consequence of the acquisition of Valiance some years back.

That combined with our extensive experience within regulated life science industry has led to a number of contract wins with large global life science companies during Q4 2019.

I will return to this on Slide #10. The cloud-enabling projects NNIT's renewed -- renowned series of life science specific solutions constitute important parts of our adjusted strategy, which I also will return to in the next slides.

Please turn to Slide #8. The strategy we presented in January 2019 was based on an in-depth review of the direction set at the IPO and included greater customer centricity and a new customer-focused organization. An important part of the strategy was the organic growth of our international life science business with a growth ambition of 20% per year, supplemented with life science acquisitions internationally and possible acquisitions within technology competencies in Denmark.

Our strategy was successful in several areas with a revenue growth outside the Novo Nordisk Group of 12%, driven by strong growth in the international life science and the financial segment, as mentioned.

We have also made 2 successful acquisitions within life science with the Valiance acquisition and Halfmann Goetsch Partner, HGP, and are now seeing synergies and strong backlog and pipeline related to these business areas.

However, 2019, we also saw an unexpected loss of business with the Novo Nordisk Group and an unexpected loss of the PANDORA agreement with impact in 2020 as well as increased price pressure within the infrastructure outsourcing areas and a faster adoption of cloud and hybrid cloud solutions.

This had 2 consequences on NNIT. In August 2019, we decided to implement a cost restructuring plan with a cost reduction of DKK 150 million in 2020, increasing to DKK 200 million in 2021. Carsten will also elaborate about this later. And secondly, we have adjusted our strategy. While we stick to our successful international life science and M&A strategy, NNIT has a new go-to-market strategy.

Please turn to Slide #9. I will now elaborate on the new way we go-to-market. We have identified 10 IT service areas characterized by high growth and high margins, where NNIT already had strong capabilities or have potential to build such capabilities. Within these high-growth areas, we focus on offerings and solutions where we can build proven standardized concepts that could be delivered fit-for-purpose and not least, first the right time. We call them winning solutions.

At present, we have identified 10 specific clusters of winning solutions that fit our ambitions of being a trusted digital transformation advisers to the life science industry and to Danish clients in private and public segments. We will develop these 10 winning solutions further and continue to identify even more winning solutions according to the market developments.

Please turn to Slide #10. Two very successful examples of winning solutions, partly powered by the acquisitions are Microsoft D365 with SCALES and Veeva solutions made possible by our acquisition of Valiance.

In SCALES, we have seen an impressive yearly growth of 26% over the last 4 years, and an operating profit margin increasing to 23% in 2019. Likewise, we see very strong cross-sell synergies in Veeva solutions after the acquisition of Valiance.

And now I will turn to you Carsten, for the financial details.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [6]

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Well, thank you, Per. And before I dig into the Q4 and full year numbers, I'll just give you a little more information on our cost restructuring plan that Per just touched upon.

As you know, our target was to take out DKK 150 million of costs in 2020 and a further DKK 50 million in '21. In the table you have in front of you, we have showed you how much was actually reduced already in 2019. As you can see, that was DKK 30 million. So in 2020, we expect it to take out another DKK 120 million, and then a further DKK 50 million in '21.

You can also see that our program is built on 4 tracks: the first track is on utilization, especially how to increase billable utilization with 4 percent points. It's not like we were placed poorly before, but increasing with a further 4 percent points will get us close to the top of the class. Remember, it's not always a question of just getting at the very top because you also need some resources to develop the business at the same time.

This part of the program, we are also focusing on resource management and capacity planning, so we ensure we have the right resources in the right places at the right time. This part of the program will yield a cost saving of DKK 75 million in '21, and it's an important part of that. And of course, it's important for increasing margins in our project business.

In the automation track, we will do further implementation of RPA, or Robotics Automation, on our internal processes. We will do more scripting of simple operational tasks. So we don't need so much manual work here. And we are also implementing network automation tools, which will also save costs.

A third task is external expenses. So here, we are very much looking at our external consultants spend to take this down by using more internal staff. We are also renegotiating our current vendor agreements and with a further focus on tender processes here. And we are also looking on expenses such as travel cost and other external activities to take these down to an appropriate low level.

And then finally, as you know, we have for some time been looking at staff reductions. We continue to do this, reducing management overhead, increasing the span of control, also looking at global sourcing, especially within the project business and then, of course, reducing staff positions as such.

So we believe that with this program, we will achieve the DKK 200 million cost reduction. You can also see that in 2019, we had restructuring costs on the special items of DKK 24 million, and in 2020, we expect a further DKK 15 million to DKK 25 million restructuring cost in implementing this cost program.

If you'll then turn to Slide 12, a few comments on our Q4 numbers. As Per already mentioned, revenue went down by 2.7%. This was due to the declining Novo Nordisk revenue of 27%.

Here, you do have to remember that Q4 '18 was exceptionally strong. We had quite a lot of hardware/software sale but also a large activity within transformation projects on the some of the big SLAs for Novo Nordisk.

When you look at the margin, we reached 10.1%, taken a little down by sales and marketing costs, but the increase of 13.8% here is more a reclassification of costs in the acquired HGP business where sales and marketing costs had, to some extent, been classified on the cost of goods sold. But after having integrated them fully into our own organization, we have done this reclassification.

When we then look at the full year numbers, we reached a revenue growth of 1.7%, again, very much taken down by a drop in Novo Nordisk growth of minus 15%, but a strong growth in international life sciences and the finance segment.

All in all, this led to an operating profit margin before special items of 7.8%, and that is in reported currencies. In constant currencies, that led to a margin of 8.0%. So that we were within our most recent guidance, both on revenue growth and on the margin.

When you look at the net financials, you can see an improvement of DKK 18 million. This is very much due to hedging gains, which I will elaborate on in a minute.

If you then turn to the next page on the life science part, again, you can see that in Q4, we had a decline in revenue of 12.4%, driven by the big drop in the Novo Nordisk revenue but an increase in international life sciences of 35% but also a nice growth in the Danish life sciences of 6%.

Full year, this led to an almost flat revenue development, again, taken down by Novo Nordisk drop of 15%, but a strong growth in international life sciences of above 70%.

When we look at the margins, then the full year margin went down from 18% to 13.1%, and this is entirely due to the drop in the higher margin Novo Nordisk business and also a decrease in the margins from Novo Nordisk, both on the project business and on the service level agreements.

Turning to private & public. We had a nice growth in Q4 of 9.4%, driven very much by the finance segment, again, of 24%, but also in the public segment was 18%. In the enterprise segment, as in the previous quarters, we saw, kind of, a flattish development. Here, we see our D365 business growing very fast, as Per showed you before.

And this is, however, countered by lower revenue on some of our big SLA customers in that area, and that is the same development we see for the full year. But all in all, I think it should be noted that the growth in our private & public is above market growth in Denmark.

Our margins for the full year increased by 1.9% to 2.4%, so we are beginning to see improvements of this margin, which we certainly need to get up. So the pricing pressure Per mentioned that we're seeing on our larger customers is being countered by the cost reduction measures that we have already taken, and which we will take further in 2020.

Turning to Slide 15. With the currency development and hedging, I would just say that the currencies right now do not have a significant impact on our financials, and we are almost fully hedged 14 months ahead. So I don't expect this to be an area to have a significant impact in 2020.

Turning to net financials on Slide 16. You can see, we have this improvement from minus DKK 2 million to DKK 16 million, driven by currency hedge gains of DKK 21 million here in '19. And I've explained this before, but I'll just say it again, this is not because CNY has been growing all that much against us but it's due to the large interest differential between the Danish krona and Chinese CNY, which gives this gain. So again, it has nothing to do with the currency speculation, it's just a question of these interest differences.

Our interest expenses are more or less unchanged despite a little higher bank debt. And then you can see we have a new line here, earn-out adjustments of DKK 10 million. This works in the way that when you buy or acquire a company, then the earn-out obligation is set up in the balance sheet as a provision.

You make your best estimate of that, always with the earn-outs being very, you could say, not optimistic, but still striving to get really good results. After having gone through the Valiance and the HGP numbers, we can see that we have set off a little too much on the provisions. So that is, kind of, taken down and then posted here under the net financials.

Of course, this doesn't have any cash flow impact right now. You can also see at the bottom of the page that when we look at the currency hedges part on equity, we still have a DKK 9 million part there, so we'll get a positive impact on that in 2020.

On the employee development, you can see a small decline of 0.2%. This is driven by a decline in Denmark and a small increase abroad. You had to -- when you look at these numbers also to look at the last sentence we have because with a cost restructuring program, we have sent a number of employees on garden leave. So they are not working in it [more]. We have taken the restructuring cost, but they still have to be included in our FTE numbers.

As you can see here, we had 41 FTEs in Denmark and 47 FTEs in China already terminated but on garden leave. So if you take that into account, the decline is bigger.

Then turning to the balance sheet, I won't go much into details with that. But you can see, as in previous quarters that intangible assets or goodwill has increased due to the HGP acquisition. Our lease assets have declined. This is due to the shortening of remaining leasing period, and it's quite natural. Contract assets are declining, and this is due to runoff of existing transition projects and then a lower impact from new transition projects.

On trade receivables, you can see an increase. This is, to some extent, due to transfer mason projects, which used to be classified under work in progress in '18, have now been classified as trade receivables. And if you look at the benefits, employee benefit obligations under equity, you can see an increase there. That is due to the new Danish speculation legislation where you have to make a reservation for future obligation.

And besides this, we also have pension obligations regarding HGP employees.

Turning to Page 19. Just a few words on how we are optimizing our net working capital. Having large customers with a high credit profile, it makes good sense for us to sell our receivables to a bank. That way, we get our receivables into our own pockets almost at once. And the interest that we are paying to the bank this way around is actually lower than our own funding interest.

So we are making money while collecting the money faster than that.

We're being very open about this. You can see, it has a positive net impact of DKK 120 million on our working capital. But this is the reason for why we're doing this.

Turning to cash flows. You can see that our free cash flow has increased compared to last year, where the acquisition of Valiance had a significant impact, a bigger impact than the acquisition of HGP. At the same time, net profits were smaller in '19, taking down our cash flow from operating activities. This was, however, accounted by a large increase in reversal of noncash items. And again, this has to do with the -- this employee payments obligations from litigation registration. Also, employees obligations in our earn-outs, which do not have cash impact and our depreciations are increasing somewhat.

If you'll then turn to Slide 21, on our proposed dividend, you can see that we proposed a dividend of DKK 4 per share. This is equivalent to a payout ratio of almost 54% and a dividend yield of 3.6%.

We are paying out this dividend despite a year with falling profits since we still have a very strong balance sheet and strong cash flow generation. I think our financial gearing is still low with a net debt-to-EBITDA of only 0.9. So we still have quite a lot of acquisition power left with a strong balance sheet.

Turning to Page 22 and our backlog numbers. You can see that our total backlog decreases 6%, which is in the middle of our revenue guidance of minus 4% to minus 8%. This backlog drop is entirely due to a drop in the backlog regarding Novo Nordisk of 26%, which, of course, again, is due to the loss of this maintenance -- application maintenance agreement but also a drop in project business. This is countered but not fully, by a strong growth in our life sciences, where, again, it's international life sciences, which is really driving the growth.

But you can also see that private & public customers, here the backlog actually increases with 4.4%, despite the loss of the PANDORA business. So this shows that we have strong traction, building an order backlog for other private & public customers.

Turning then to some key assumptions in the outlook for 2020. We're a little more detailed on this than normally through so many moving parts. So in order to understand what lies behind our outlook, I'll just give an outline of this. Of course, it's based on the backlog that I've just gone through. This backlog is impacted by the termination of the application maintenance agreement with Novo Nordisk, and this has impact already from the 1st of January.

We also get impacted by the termination of the business with PANDORA, where we expect a revenue corresponding to 1/4 of the revenue in 2019. So I think you can look at this more or as less as we have PANDORA in almost fully in the first quarter, and then it drops off.

One new piece of information is that we have a large operational maintenance agreement with Novo Nordisk. This agreement expires at the end of 2020, but we do expect, and we are assuming this to be renegotiated already and prolonged during the first half of this year. And thereby, it will also have an impact from the time of signing. This renegotiation will imply a price reduction, which is incorporated in our guidance for this year.

At the same time, we have, in our guidance, incorporated DKK 150 million cost reduction this year. And remember DKK 30 million of the DKK 150 million was already realized in 2019. So the net impact is DKK 120 million.

So with these assumptions (inaudible) the outlook you can see on Page 24, this is unchanged to the outlook we came out with last week. So we expect a revenue growth of minus 4% to minus 8%. It will be around 0.2 percent points higher in reported currencies.

On the operating profit margin, we are forecasting 6% to 8% margin before special items, and we expect this to be between DKK 15 million to DKK 25 million. We expect a little headwind on the currencies. So in reported currencies, the margin will be 0.2% lower. Remember that the hedging gains we're giving do not impact operating profits, they are classified on the net financials.

And then finally, our CapEx share of revenue is expected to be 5% to 7%, which is in line with the previous years. These years where we are not making investments in data centers and such.

So with this outlook, Per, over to you for the closing remarks.

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Per Kogut, NNIT A/S - President & CEO [7]

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Thank you, Carsten, for a comprehensive walkthrough of our financials. Let me just reiterate that we experienced a revenue growth full year of 1.7% and an operating profit margin before restructuring of 8%, in line with the latest outlook for '19.

Revenue growth was driven by international life science as well as our financial segment. Novo Nordisk Group declined by 15%, and there is still uncertainty attached to the Novo Nordisk Group going forward.

I expect 2020 to be a transition year, even a tough one with a declining revenue due to loss of business from Novo Nordisk and PANDORA.

For other clients, we expect to see a strong growth. And with our new focused go-to-market strategy, I'm confident that we are well positioned for the future.

With these words, we conclude our presentation, and we are ready for questions. Operator, we are ready to take the first question, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Poul Jessen of Danske Bank.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [2]

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I have few questions. Some of the more detailed ones as we've got more numbers now. On Slide 11, that's the cost cutting overview that you are now providing and that's very helpful. Just to be very certain, when you say DKK 30 million end of '19 and DKK 150 million end of 2020, is that the impact for the year? Or is it the run rate by the end of the year we are talking about here?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [3]

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So the DKK 30 million, that is the impact achieved during 2019. So it's not the run rate at the end of '19. And the same goes for 2020, the DKK 150 million, it's the total impact for the full year and the run rate would be higher at the end of the year.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [4]

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So that would be maybe closer to the impact for 2021 at the end of 2020?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [5]

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It will be closer, but not up at that level.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [6]

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Okay. Then a question about the composition here. I can see you're very well through the cost cutting coming from employment, the DKK 20 million, that's to double to DKK 40 million. But the majority of what's ahead of us is coming then from optimization or higher efficiency in the business. How confident are you that you can achieve those targets? Because I guess that must also be the more challenging part of the process.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [7]

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Yes. So we do, of course, for each of these tracks have detailed plans for each of the initiatives in the different parts of the organization. So we feel confident about this. But of course, a lot of work still has to be done. But I think when you look at the utilization part, as an example, here we're already in Q4, so a good growth in our billable utilization.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [8]

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Yes. I was just trying to compare to the KPIs you publish. And looking at these, then the service target has moved down quite a lot versus where it's been stable in the previous years and by a lot, it's 3 percent points. And is that coming at the end of the year, or is it something that is going on? I'm just comparing this that lower service target and then you're going to do these initiatives at the same time?

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Per Kogut, NNIT A/S - President & CEO [9]

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It is correct. And actually, when we have digged into the 93.5% KPI results, it actually includes a couple of projects that are still not in full operations for clients. So actually, we have to come back on that number in specific. It might be somewhat higher. We have included a couple of transition projects that is still not delivered to the clients. So the numbers are -- we're measuring apples with bananas, but...

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [10]

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Okay. Then 2 questions about the new entities. You have SCALES there. You give the numbers. But if I try to subtract SCALES from enterprise, then I get -- and I also adjust for the one-offs you had in the third quarter, then I get still that you're doing more or less 0 earnings on the remaining part of public & private. How do you see that going forward? Or is it a tough job to improve the profitability in that section?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [11]

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I think you can look at it in 2 ways. The new go-to-market strategy in itself focuses on high-growth areas in the private & public where we see good margins. So that should in itself, increase our margins in that area. At the same time, as you are pointing out, we see that on some of our older, large infrastructure outsourcing contracts, here, the margins are very low. As we improve our costs with a cost program that will improve the margins in this area. And we're also specifically looking into our contract management, and the way we deliver on these in order to improve that. So I would say, what we are doing is both new things and improving the old ones.

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Per Kogut, NNIT A/S - President & CEO [12]

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And Poul, there is a huge focus in the organization, especially in the private & public, of course, to fundamentally increase the profitability, and that will continue going forward.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [13]

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And now you show the SCALES numbers, you also did that last year, but it's not as easy to try to do any conclusion on the Valiance numbers as that factory gate numbers since you acquired it. Can you give some numbers on what's the profitability and revenue in 2019 for Valiance?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [14]

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So Valiance actually looks pretty much like SCALES. They also have margins in the mid-20s, and they are growing close to 20%.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [15]

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And what's the actual number?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [16]

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On the margins...

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Per Kogut, NNIT A/S - President & CEO [17]

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(inaudible)

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [18]

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I haven't got that right here. Do you have -- just a minute, Poul.

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Per Kogut, NNIT A/S - President & CEO [19]

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Let's come back to that, and we can take some other questions. We'll revert to that Valiance revenue, Poul.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [20]

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Okay, and the last one for now is then, on the change due to the provision for the earn-out, have you concluded that the performance is below what you look for since you now assume you should pay lessen [or not].

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [21]

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I think when we made the earn-out provision, we were being, I would say now, overly optimistic. So we still see a strong performance in both companies, but we were being too optimistic. So still in line with the original business cases when we bought.

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Per Kogut, NNIT A/S - President & CEO [22]

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And we have the number now, Carsten, for Valiance.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [23]

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Yes. So the full year numbers last year was around DKK 95 million.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [24]

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Okay. Perfect. I could get that.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [25]

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Yes, and now that I have the precise margin, it was actually 27%.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [26]

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Oh, that's quite nice.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [27]

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Yes.

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Per Kogut, NNIT A/S - President & CEO [28]

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Very nice.

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Poul Ernst Jessen, Danske Bank Markets Equity Research - Senior Analyst [29]

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And the final one, that is on the factoring. When did you start using factoring? Because I just -- while you spoke, made a search in the last many reports for factoring and it was nowhere.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [30]

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No, we -- that was started in Q4, right, Per?

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Operator [31]

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And our next question comes from the line of André Thormann of ABG.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [32]

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So just the first one because I got bit in doubt after Poul's question. These DKK 150 million in 2020, that is including the DKK 30 million, right? So the net potential of cost reductions is DKK 120 million in 2020.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [33]

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Exactly.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [34]

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Okay. Super. I just got a bit in doubt. And then also on the cost program, I just need to be sure on how the split is in terms of -- I mean you laid out this cost program with these 250 positions -- reductions in positions. I just need to be sure, if this -- if we take the contract losses from Novo Nordisk and PANDORA, will be -- will cost reductions from those lost contracts come on top of this program? Or is it included in it?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [35]

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So the DKK 150 million and DKK 200 million, these are cost reductions independent on losses of customers. So when we lose customers, of course, we take out the cost delivering through them.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [36]

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Okay. And is there an approximate number of how much you will reduce your COGS with when you lose -- when PANDORA and Novo Nordisk goes out of the numbers?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [37]

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I think you can make the calculation yourself by looking at the size of the 2 customers, and then you know that both have above average margins, then the rest is COGS.

And to some extent, you can't take out all the costs because part of that is on -- based on shared infrastructure.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [38]

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Okay. But most of it is on top?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [39]

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Yes, yes.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [40]

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Okay. Okay. And then in terms of these employee reductions on the 250 million, reduced, and then than 300 on top of that, it's correctly understood that you are -- what -- you have reduced by 88 people in 2019, right? And, yes, so my question is basically, why do we -- why is there so little effect from staff and other cost reductions? Is all these employee reductions in that line on Slide 11? Or is it also in some of the other lines?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [41]

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No, no, no. It's spread all over. The major part is on the utilization and automation.

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Per Kogut, NNIT A/S - President & CEO [42]

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And it's not 250 million André, it's 250 FTEs.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [43]

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FTEs, Yes. Okay. Okay. Yes, but that -- maybe I said it wrong.

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Per Kogut, NNIT A/S - President & CEO [44]

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No, no, that's fine.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [45]

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But there will still be 300 on top of the -- of this from the PANDORA and Novo Nordisk contract, right?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [46]

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Yes. And these are not terminations, but the reduction in positions.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [47]

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Yes, yes, yes, reduction in positions, yes. And then in terms of the utilization, you said that you will increase it by 4 percentage points. And there -- that's the major potential in cost reductions. How much did you improve your utilization in 2019? And what is your utilization rate currently?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [48]

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Sure. So in the beginning of 2019, in the first half, our utilization was low. And that was one of the reasons for the poor results in the first half of the year, getting less project business from Novo Nordisk suddenly left us with too much staff in some of these areas.

So our utilization in the first half of the year was low, then it's been picking up and got really strong in Q4. And we are tracking this very detailed in the -- here in 2020.

We've got an app, which all employees are using, so they can, at any point of time, make their time registration timely and correctly, which in itself should also ensure that everything that should be built is actually being built.

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Per Kogut, NNIT A/S - President & CEO [49]

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And there is a lot of seasonality André in the utilization element. But last year, we did increase it a full year from the mid-70s to the low 80s. And now we just have to keep it at the above 80.

But there are seasonality into it. There is a lot of vacation in the spring -- is also depending on the composition of contracts. Do we have long engagement with clients, or do we have small weekly engagements. So -- but we are on the right track, and it is a significant explanation factor for our profitability going forward.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [50]

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Okay. But just to be sure, over the years -- average, over the years, that was the low 80s?

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Per Kogut, NNIT A/S - President & CEO [51]

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No, no, no. Average was -- in full year was in the 70s.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [52]

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Yes.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [53]

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Okay, okay. And that is -- I mean it's that level that you need to improve at low percentage points?

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Per Kogut, NNIT A/S - President & CEO [54]

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Improve it up to the low 80s. But if you have 3,000 people who are delivering 3% or 4% more that means a lot.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [55]

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Yes, yes, definitely. And it's also a hard one, I guess. And I mean is there more flavor on what you will do differently in terms of improving this utilization?

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Per Kogut, NNIT A/S - President & CEO [56]

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That's the whole beauty of consultancy. You have to work with your manning and the assignments with your clients. And in Novo Nordisk, we had -- historically had very long engagement, meaning that people are almost utilized 100%. And suddenly, we saw a drop in that, and they are on the bench. And then you have to resell them out to smaller task. And by that, we saw a drop. And by that drop, we saw an impact on our profit.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [57]

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Okay, okay. So is it primarily with Novo Nordisk that you need to improve your utilization on again?

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Per Kogut, NNIT A/S - President & CEO [58]

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No, no. The explanation factor was the people who we had to move from Novo Nordisk tasks to other tasks with shorter engagement cycles. So...

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [59]

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Okay. That makes sense. So just in terms of guidance then on this 6% to 8% EBIT margin before restructuring, is there -- I mean if you manage to reach these DKK 120 million in cost reduction in 2020, will that imply an 8% EBIT margin? Or is that a wrong conclusion?

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Per Kogut, NNIT A/S - President & CEO [60]

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I think in that case...

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [61]

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You can't just put it like that. Our guidance, of course, depends on getting cost reductions done. It depends on the backlog and the revenue get and the margins we get on that. It depends on to what extent we have bad projects with losses.

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Per Kogut, NNIT A/S - President & CEO [62]

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And uncertainty in Novo Nordisk.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [63]

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Yes. So the 6% to 8% covers all these different factors that might impact us.

Of course, the cost program is an important one, but it's not the only one.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [64]

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Okay, okay. And then on restructuring costs, your guide is DKK 15 million to DKK 25 million for 2020. Again, I mean, I understand that there is small position lay downs in 2020 than there was in 2019. And then you reached DKK 24 million. So why is it not higher in 2020? And is that including these 300 positions from PANDORA and Novo Nordisk?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [65]

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So PANDORA runs also in the first quarter. So that had no impact in 2019. On this application maintenance contract with Novo Nordisk, which was terminated at the end of the year, there we have taken out a number of positions in China at the end of '19. So -- and that has impacts on the restructuring costs of '19. So that's the reason.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [66]

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But still, there must be a much larger number in 2020, just considering these position reductions that you have guided for.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [67]

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Yes, it depends on where in the world it is because if it's Chinese and Philippine FTEs, then it's 1 quarter of the wage in Denmark. So again, that's part of the explanation.

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Per Kogut, NNIT A/S - President & CEO [68]

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And with the cancellation of the contracts with PANDORA and the Novo contract, we have had time enough to reshuffle the people, and of course, also to terminate people and have them working during the resignation period, and that will not cause a restructuring cost. It gives us simply more time to plan.

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André Thormann, ABG Sundal Collier Holding ASA, Research Division - Analyst [69]

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Okay, okay. And then just one last one. In terms of the backlog, at least when I calculate, it looks like your coverage and assuming midterm guidance of secured revenue is somewhat lower than what you had last year. So I mean are you more uncertain about the guidance this year due to the smaller backlog?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [70]

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It's quite natural that what you've seen in '19 and you will see in 2020 is that the project part of our business is growing very fast, and our service level long-term contract revenue is declining quite rapidly. So it's quite natural that as we get more and more on projects, the backlog percentage will decline.

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Operator [71]

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Our next call comes from the line of Yiwei Zhou at SEB.

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Yiwei Zhou, SEB, Research Division - Analyst [72]

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I have 2. And firstly, just a follow-up Poul's question on public & private segment. Given outside of SCALES, you're already breakeven. So in the future, when you implement a new strategy, and what is your plan to -- what is your plan with those nonprofitable contracts? Is it fair to assume you would give up in terminating some of the contracts?

And then secondly, given the -- you have a large resource in China, and now the emphasis virus impact, could you give an indication of potential financial impact on you?

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Per Kogut, NNIT A/S - President & CEO [73]

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Very good questions. We -- of course, we have a focus on making the public & private segment and contracts more profitable. We have no expectations to cancel any of them, but more that increased new contracts we will attract, has to be more focused on what we call winning solutions that has a higher win chance for NNIT, and we are more knowledged about it, and then by that also higher margins.

So no cancellation of contracts. Your second questions about China. Of course, we're following the situation in China and the guidance from authorities, both in China and of course, also the Danish Foreign Ministry and whoever guide on it. And right now, we are in a situation as repeating the obvious that we are in the Chinese New Year that has been prolonged for a number of days.

We are daily in contact with our people who work. We have no people from NNIT that are impacted by it. And the city in which we are have so far, and I got the numbers this morning, only had around 20 cases. So we are confident that this will have, for now, no financial impact on NNIT.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [74]

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And I think it's important also that we can run our operations from China, from the Czech Republic and from Denmark. So we run it in 3 shifts. Being in China, when it's day time in China, then in Europe, when it's night in China. So we're not as vulnerable as you might think on that, should even the worst happen.

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Per Kogut, NNIT A/S - President & CEO [75]

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And actually, just to give you an example that some weeks back, 2 or 3 weeks, we had this volcano thing around the Manila area where we closed down the office because that was the authorities' recommendation and our operations just came out of China, Czech Republic, Denmark and some other units. So I think we are well aligned to handle the situation. But of course, we hope and pray that it will be under control soon.

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Yiwei Zhou, SEB, Research Division - Analyst [76]

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Okay. Can I just follow-up the first question. So it was mentioned you're getting a general price reduction every year on some of the older contracts, but I mean now you're already breakeven. If you continue to gather those price reduction and then in some point of time it will be loss-making. Are you still willing to keep those loss-making contracts?

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Per Kogut, NNIT A/S - President & CEO [77]

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We -- this is different from contract to contract and what kind of services involve and other ingredients. Of course, we're not interested in having loss-making contracts. And we, to my knowledge, don't have any significant loss-making contract in that area. And the whole solution to this is to increase profitability in existing business and attracting new business with a much better profitability going forward. We are not looking upon any contracts, in particular, that has a decline in profitability or that we will cancel or the client will cancel. That is not the plan.

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Yiwei Zhou, SEB, Research Division - Analyst [78]

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But could you elaborate a little bit on how do you increase profitability with the existing low profitable contracts?

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [79]

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Yes. I think that was...

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Per Kogut, NNIT A/S - President & CEO [80]

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We never answered that.

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Carsten Krogsgaard Thomsen, NNIT A/S - Executive VP of Finance, Legal, IR & CFO [81]

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Yes. With the cost reduction plan we have, a large part of that cost reduction is in the operations area, and that will increase the profits on these existing contracts.

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Yiwei Zhou, SEB, Research Division - Analyst [82]

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Yes. I mean do you -- just looking ahead, if you get another 10% price reduction, for example, in 2022 then does that mean you will keep cutting people? That will be the solution.

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Per Kogut, NNIT A/S - President & CEO [83]

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But that is, through our notice, not the case. So in that -- with that hypothetical question, we're not aware of any contracts that suddenly lose a 10% drop.

It would be within the areas that Carsten has mentioned. We will automate more. We will be more efficient in delivering services, we will introduce more robotic parts to also to increase quality. And of course, also the net result of the public & private sector. It's, of course, also impacted by the overall cost structure of the company like staff functions and so on, which we have addressed in the cost program as well. So all that, the specific contracts, the overall cost situation will positively impact the public & private sector in NNIT. And I strongly believe that that will continue going forward.

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Operator [84]

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And as we run out of time, I'll hand back to our speakers for the closing comments.

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Jens Binger, NNIT A/S - Head of IR [85]

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Okay. This concludes our conference call. Thank you for participating in today's webcast and feel free to reach out to us if you have further questions. Thank you.

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Per Kogut, NNIT A/S - President & CEO [86]

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Thank you.