Tieto Oyj (TIETO) Earnings Call Transcript

Good morning, and welcome to Tieto's Third Quarter Earnings Webcast. My name is Tommi Jarvenpaa, the Head of Investor Relations at Tieto. In the third quarter, we saw continued pressure on our organic growth alongside with strong profitability development. We also updated our full year guidance last night in light of these developments, which our CEO, Endre Rangnes; and CFO, Tomi Hyrylainen, will discuss in more detail this morning. After the presentation, we will open the line for questions as usual. And with this, I would like to hand over to Endre. Please go ahead.

Thank you, Tommi, and welcome to Tieto's third quarter presentation. So I would say that Q3 reflects the year of transition Tieto has been going through. We have been through a comprehensive transformation agenda across the company, strengthening execution of the strategic priorities and then building a foundation for future growth. At the same time, market conditions have been a bit more challenging than anticipated, and that's about rapid changes in customer demand that has required a broader transformation of Tech Consulting, especially compared to what we communicated at the Capital Markets Day. So with major elements of this transformation now in place, we are accelerating investments to support future growth, and this means strengthening our sales capacity and then also selectively rebuilding delivery capacity in line with the market demand. In Q3, our transformation was visible in our consulting revenue development, while the actions to strengthen the company continued to support strong profitability. Organic growth was minus 11%, of which 7 points was related to known effects from the Banktech court ruling back in 2025. And then we also had some legacy contract runoffs during the quarter. Demand remained soft in parts of the consulting market, while revenue in Tech Consulting also was affected by our planned capacity adjustments, and we will come back to this during this call. Lower volumes in parts of Banktech and Indtech also impacted the growth. However, despite the revenue decline, adjusted EBITA margin remained strong at 18%, as you can see at the bottom here. So we continue to strengthen Tieto through portfolio simplification, including the announcement of the divestment of the Pulp, Paper & Fibre software business this morning. Then also during Q3, we appointed Juuso Pajunen as CFO effective from early 2027. So then reflecting our Q3 performance and the current outlook, we have, as you saw last night, updated our full-year guidance. So looking at Q3, we actually saw 2 different trends. Organic growth was a bit weaker than we had anticipated, while profitability was stronger. So the weaker growth was most clear in Tech Consulting, reflecting, I would say, both soft market conditions and the ongoing transformation and headcount reductions in that business. So lower volumes also in parts of Banktech and Indtech impacted the growth in the quarter. Then at the same time, our cost optimization actions continue to deliver strong results. So we are very pleased with the progress that we have made in strengthening profitability and the overall cost base of the company. So with this, we have reflected this in the 2026 updated outlook. So we have narrowed and slightly lowered the organic growth guidance to minus 6% to minus 5% from minus 5% to minus 3%, while also raising the adjusted EBITA margin guidance to 15.5% to 16% from originally 14.8% to 15.8%. So the strong profitability is one tangible result of our execution, and I will say that we are making good progress across our strategic priorities. Looking at the 4 strategic priorities, we continue to execute the priorities, strengthening our competitiveness and also then positioning the business for future growth. We are enhancing our commercial capability by adding now 70 new sales professionals. We are reskilling in Tech Consulting ongoing, and we will hire up to 1,000 consultants with AI and data expertise over the next 12 months. At the same time, we are simplifying the business and improving execution through a more efficient operating model. And we are also progressing on the international or European expansion, including Caretech entry into Germany in the third quarter. Then, of course, cost actions remain on track with EUR 125 million of annualized savings delivered by September; we are close to the communicated target of EUR 130 million. Then it's important also to underline that additional cost measures are being implemented to support competitiveness and our CMD ambitions. So together, these actions are strengthening the foundation for future growth, supported by a more systematic approach also to partnerships. When we look at the partnership side, I would say that historically, we have not developed the partner ecosystem as a systematic group-wide commercial growth channel. So we see this as a significant missed opportunity -- and then working more closely now with partners that will help us reach more clients, strengthening our offerings and also generate additional sales. So this year, we have made a great start in building the partnership business. We have introduced clear group-wide ownership, including the appointment of Group Head of Partnership in Q3. And we are putting more focus behind joint go-to-market strategies or activities also with our partners. So I would say that this is a long-term priority to make partnerships a meaningful source of growth across our businesses. And clearly, we are seeing this also as a market trend. The opportunity extends beyond AI. Of course, AI, data and cloud are important areas where partners are supportive for Tieto and our customers going forward. However, we are also partnering up to grow the industry standard software within the associated consultancy and services. Then I would say also that the Microsoft Frontier Partner and the Snowflake Premier Partner recognitions are recent examples of our partnership making good progress. Looking then at Q3 in numbers, I would add a couple of comments on the order backlog and the cash flow as we have already discussed growth and strong profitability. So the order backlog declined by 2% year-on-year, and this was mainly due to lower volumes in some of the volume-based businesses, particularly then in Banktech and Indtech. At the same time, the overall backlog remains at very solid levels, supported by the recurring nature of our software businesses. When we look at the cash flow, cash flow from operations was EUR 3 million compared to EUR 45 million last year. And then we need to keep in mind that the comparison includes around EUR 17 million from businesses which are divested and then a positive EUR 22 million impact from the court ruling in 2025. So excluding these effects and then prioritization of tax and financial items, cash flow was slightly better than last year. And then we need to keep in mind that Q3 is, I would say, always the weakest quarter in the year. Let me then focus on the business units. So we are starting off with Tech Consulting. And at our Capital Markets Day, we outlined the need to transform this specific business. First of all, to become more customer-centric, to strengthen the service mix and then build a more competitive operating model. So since Capital Markets Day, we have to admit that customer demand has changed rapidly, particularly as AI has advanced faster and market conditions have been more challenging than expected. This has made the transformation broader than we originally anticipated. So this year, we have introduced a new operating model with clear ownership, clear KPIs and accountability across 8 different geos. We have also made a substantial shift in our workforce. So over the past year, we have reduced the number of employees, meaning from Q3 last year until end of Q3 this year in Tech Consulting by 1,100 employees, including around 360 during Q3 of this year. And then, of course, at the same time, we have been reskilling our people to better align with the market demand. So by end of Q3, we have completed the reskilling of 2,700 out of the 5,000 people covered by the Microsoft upskilling program. So these changes, together with soft demand in parts of the consulting market, were reflected in the Q3 revenue. Organic growth was minus 11%. We had included in that the termination of a loss-making U.S. customer contract that had a negative impact of 2 points. We are deliberately reshaping capacity and skills to reflect the market conditions and where the market is moving, and this has affected also the revenue during the transition period. So despite the revenue decline, the adjusted EBITA margin improved to a solid 15.6%, and this comes from high utilization, lower G&A cost levels and then also supported with a high level of activity in terms of billable utilization. So this shows the impact of the actions that we have taken to strengthen this part of the business. So with the main elements of the reset in place, we are now building the next phase for Tech Consulting. We have increased sales capacity by 30% and more to come in terms of sales recruitment. We have continued to renew skills through reskilling and partnerships, and we plan to hire up to 1,000 consultants with AI and data skills over the next 12 months. So these are targeted investments in areas where customer demand is currently growing. So the customer examples then on this slide as well, including GN and Traficom and the Nokia Diamond Award offer future evidence of customer activity and then recognitions. Moving then to Banktech. We had organic growth of minus 18%. And of course, this reflects 2 specific effects: a negative comparison impact of 14 points from the court ruling back in 2025 and further -- sorry, 4 points negative from the legacy unprofitable contract runoff. So Q3 was the final quarter affected by these legacy runoffs. So from Q4, we will have a cleaner view of the business from a comparable point of view. Our underlying growth was flat. And as we noted in Q2, volumes in some of our volume-based businesses in Banktech were lower, and this continued in Q3. So I would say that we are not satisfied with this level of flattish growth. But looking then ahead, there are encouraging signs that order backlog is strong and is starting now to translate more into revenue. And in addition, the European sales pipeline has developed well; together, this supports our growth outlook as the legacy effects now are falling away. So adjusted EBITA margin came in strong at 18.1% in Q3. We have recent wins, including Handelsbanken Norway self-service Wealth Management portal, the NBX digital and physical card issuing for stablecoin users. So -- and of course, I'm also quite proud that we have now a Nordic Tier 1 bank that has selected Banktech's wealth management solution for the future wealth management in that bank, selected now in Q3. Then Caretech continued the strong performance in Q3. Reported organic growth was minus 1%, but that includes also a 5 percentage point impact from the decline in the legacy business. So excluding this effect, underlying growth was 4%, reflecting the continued strength in our modern Lifecare software portfolio. And then when we look at the profitability, coming in very strong with adjusted EBITA margin increasing to 33.1%. Also in Q3, University Medical Center Mainz selected Lifecare, making our entry also now into the German market. And in Switzerland, another market that we have expanded to, Caretech is co-developing a digital tumor board solution with University Hospital Basel, starting with lymphoma. Then moving to Indtech. Indtech's organic growth was minus 3% in the quarter, reflecting, I would say, several pressures with different characteristics. So the most significant one was continued weakness in our volume-based business as we discussed also in Q2. For example, in Multichannel & BIX and Nexus, which represents around 45% of Indtech's revenue, customers are increasingly bundling invoices that were previously sent separately, and this reduces print postage volumes and reflects a structural change in customer behavior. Then we had also data-driven services that was affected by softer activity in the Norwegian real estate market last quarter. We also saw a temporary slowdown in the professional services demand, particularly in Public 360. Then we expect some of these more temporary pressures to ease in Q4 and then during next year. Then when it comes to Pulp, Paper & Fibre, we would also say that that market remains weak, reflecting the long-term challenges for that specific industry. So early this morning, we signed an agreement to divest this business, which is consistent with our aim to simplify and focus our future portfolio. Then despite, I would say, these growth pressures, profitability remained solid with an adjusted EBITA margin of 17.9%. So while we have seen the volume trends continue to affect part of Indtech, we believe the remaining portfolio can return to a growth trajectory as temporary market pressures ease. So regarding our development with customers, we have seen Helse Sor-Ost selected Public 360 to modernize and standardize case management and records administration across 13 hospitals. In addition, eye-share will give INPEX Idemitsu Norway traceability from purchase order to approved invoice, while Tieto and Siirto are partnering to make e-invoicing easier for businesses and customers in Finland. So Tomi, that leaves the stage to you.

Thank you, Endre, and good morning, everyone. So Q3 highlight was strong profitability in all businesses with approximately 2 percentage point operational improvement compared to prior year. Our improvement is a result of successful execution of the cost optimization program and continued cost discipline across the company. As discussed earlier, our growth of negative 11% was impacted by known headwinds of 7 percentage points from Banktech and Caretech with underlying growth being negative 4%. Large contributor to this negative growth was Tech Consulting growth of negative 11%, which came in slightly weaker than our expectations. Our one-time items in Q3 were in line with our expectations of EUR 7 million. However, we're increasing our expectation for the full year to approximately 2% of revenue from 1.5%. This increase is a result of further G&A optimization and specific capacity reductions to address the revenue decline. Other Q3 events include our updated guidance, which Endre discussed earlier, and concluding of our EUR 150 million share buyback program in August, after which we started the buybacks for the announced EUR 90 million program. We expect to complete this EUR 90 million program by mid-January. Q3 is a seasonally weak cash flow quarter, as mentioned, which is also reflected in our operative cash flow of EUR 3 million. Our working capital increased by EUR 57 million due to normal seasonality, mainly due to vacation accruals, but also from the utilization of restructuring provision following the execution of our cost optimization program. Note that Q3 '25 cash flow includes contribution also from discontinued and divested businesses as well as SB1 compensation. On a comparable basis, including timing differences in tax and financial items related payments, our operative cash flow is slightly better than prior year. So overall, cash generation foundation remains healthy. Our reported net debt to EBITDA was 1.3x at the end of Q3. The increase from Q2 is in line with the expectations and is a result of the execution of the share buyback programs. On a fully adjusted basis, our leverage at the end of Q3 is at 1.9x. So at targeted levels being slightly below 2x. Then a few words on the cost optimization program. We have reached EUR 125 million run rate savings at the end of Q3 and will successfully complete the program by end of '26. As communicated earlier, this program aims for a permanent cost base reset of approximately EUR 50 million while mitigating the cost burden from Tech Services divestment and reducing overcapacity primarily in the consulting business. The one-time cost from the program will land to approximately EUR 55 million, of which we have incurred EUR 53 million at the end of Q3. On employee matters, LTM attrition continued at very low levels being 7.2% at the end of Q3. These low levels are market-driven with normal healthy attrition being around 10%. During the quarter, we've continued with planned personnel reductions impacting primarily Tech Consulting with 360 net FTE reduction. Group personnel reduction year-on-year has been significant with negative 14%, of which approximately 4% relates to acquisitions and divestments. Consistent with Q2, we expect our group salary inflation for the year to be between 3% and 3.5% compared to 4% in 2025. Next, some outlook remarks for Q4. As you can calculate from our updated growth guidance, the midpoint reflects negative 3% growth for Q4. Growth remarks per business are following. We expect Tech Consulting growth to slightly improve from Q3 level, supported by our transformation efforts despite the continued soft market demand. Banktech is expected to turn to growth with structural headwinds behind us. The positive momentum is supported by increased order backlog conversion to revenue. Caretech continues to be impacted by legacy contract runoff with negative 4%, so 1% less than in Q3. Good performance in the modern software portfolio and strong order backlog supports underlying growth. In Indtech, we expect to improve from Q3 as we expect the temporary pressures in professional services and customer decision-making to ease. Softness in PPF and in volume-based businesses will continue into Q4. On profit remarks, cost optimization program continues to contribute to profitability in all businesses. And on other remarks, there is minor positive impact from working days. Then as usual, Q4 profitability outlook per business. We expect Tech Consulting to be at or below prior year level. Banktech is expected to be below prior year. Caretech is expected to be at or above and Indtech above prior year profitability level. Overall, we continue to deliver strong profitability in Q4. However, we have reached higher comparables, and that's visible also in this outlook table. As the year '26 includes some specific headwinds, we created this growth dynamic slide to help everyone navigate the growth expectations on a quarterly basis. After significant headwinds in Q3, the Q4 headwinds include only continuation of the Caretech legacy contract runoff with 4 percentage point impact at Caretech level and 1% impact at group level. Back to you, Endre.

Tomi, thank you so much. So then looking forward and then summarizing where we stand now into Q4, looking into also 2027. I would say that '26 has definitely been a year of transition for Tieto like we also communicated at our Capital Markets Day. And it's about changing market dynamics, customer requirements is also then kind of, I would say, expanding the transformation beyond the original plan, especially then in Tech Consulting. We have simplified the portfolio. We have reshaped our cost base and operating model. We have renewed competencies and our portfolio and then also the cost shape and operating model is completely renewed. So I would say that, when we look now going into '27, looking at our software businesses, we have a strong order backlog, particularly in Banktech. This is expected to translate increasingly into revenue. Legacy contract headwinds come to an end this year. And then selective European expansion is backed by a developing sales pipeline. In Tech Consulting, we are strengthening our AI and data offerings, sales capabilities and then also the consultancy capacity by an increase of up to 1,000 people. And then when it comes to the AI opportunity, our domain expertise and mission-critical software combined with AI, cloud and data competencies in addition to partnerships with Microsoft and others, that is positioning us to help customers embed AI in business-critical workflows. So we believe we have reached the bottom of our organic growth trajectory. Recovery will be gradual, but we expect solid organic growth in 2027. So this transition year is building a stronger foundation for sustainable long-term growth for Tieto. Then we are opening up for Q&A.

[Operator Instructions] The next question comes from Mark Hyatt from Morgan Stanley.

I got a couple of questions, please. Just to start with your comments around AI. You said that AI is causing some customers to reassess project timing and scope, while some customers expect productivity gains to be reflected in pricing. Could you tell us a little bit on what specific types of projects you're seeing that being most impacted today? And how are you already seeing those pricing expectations translate into lower contract values for comparable work? Is that causing some shifts in the competitive landscape in other providers coming in at lower cost to undercut? And then just a follow-up on the guide, Tomi, thank you for confirming my math. So I think you said minus 3% exit rate implied for Q4 at the group level, I suppose, if we ex out that 1 percentage point legacy contract headwind that implies still minus 2% on an underlying basis. And you've reiterated your confidence that you should get back to solid organic growth in 2027. And of course, we all have the 5% revenue CAGR target for '27, '28 in mind. So could you just talk a little bit about what gives you the confidence in terms of the bridge between that minus 2% and back to solid organic growth? Is that supported by contracts that you're already seeing on the software businesses? And how much is contingent on a recovery in the consulting business or international expansion?

It's actually, I would say, a combination of all those 3. I would say that -- I mean, looking at underlying growth in Q3, we are at minus 3.6%, minus 4%. And then when you look at the guidance update, it's not rocket science to say that this will be slightly better in Q4. And then we are hopefully on the right trajectory. Also from a comparable point of view, when we look at Tech Consulting, based on the shift that we have now been through, based on deploying more sales resources, based on also now recruiting more people, we should increase the capacity having also an effect on the top line of that specific business. When it comes to the software businesses, we have a clear view on the backlog, especially in Banktech, ramping up now signings that we did back in '24, '25 in terms of mergers and migrations of especially the core bank clients. This is now coming through materializing during Q4 and especially into 2027, where we also have some specific win backs in Banktech and Core Bank solutions. And then we had several signings also in Q3, materializing in Q4 and into '27 in Banktech. And then we have also -- I would say that, when it comes to the international expansion, international growth, we have seen now several examples of revenue-generating contracts in Caretech in several countries. I would say that, yes, maybe we have more contracts with in the end, slightly lower-than-expected revenue currently, but this is expected to ramp up also in Caretech going into 2027. So I would say that we have pretty good visibility going into '27. But as I said also in my CEO remarks is that this is not going to change quickly in one quarter. This will be a gradual ramp-up during Q4 and into 2027. So we are still comfortable about the CMD targets that we have communicated. When it comes to AI, your first part of the question is that we don't see a lot of price pressure in AI. I would say that, the projects and the character of the projects that we are currently running, we have seen several of them now replatforming using AI to replatform legacy systems into new modernized SaaS solutions or cloud solutions, whatever. We have seen that more of these projects, complex large projects have been broken up and ending up in smaller pieces driven by AI technology. We have seen new wins in Banktech, for example, winning the deals based on AI competencies also in terms of automating and improving legacy systems, which has a huge effect also for the clients and a big impact for the clients. So I would say that, yes, AI is reshaping the industry from many aspects. But again, looking at the DNA of Tieto, looking at what we're coming from, we have really, really complex software in complex businesses with a high level of integration and high level of dependencies also on the regulatory elements, which gives us an advantage if we are able, which we are, to apply the technology for renewing the existing platforms, including then replatforming if that is necessary.

The next question comes from Daniel Thorsson from ABG Sundal Collier.

Yes. I have 2 questions. First one related on '27 organic growth comment here to be solid. Does that also refer to Tech Consulting organic growth? And additionally, the hiring of 1,000 people in Tech Consulting with AI and data capabilities, does that put organic net recruitment negative, flat or positive in '27 as best guess for Tech Consulting?

So we can comment the '27 such that we don't give now business-specific commentary. This was the group commentary, and we rather stay at that level at this point in time. As for the 1,000 recruits, so we are looking at net 500 to 600 FTE increase through this 1,000 recruitment plan.

And keep in mind that -- so first of all, I would say that those -- so back to Capital Markets Day, we have given a clear guidance on Tech Consulting as well, CAGR '27, '28. Looking at now what we have been through in 2026 in terms of reskilling, in terms of now taking out 1,100 people year-over-year Q3 and then deploying now relevant competencies being through end of year more than 3,000 on AI reskilling, we are positioning Tech Consulting in a completely different way. And to be clear, this is also now visible when we look at the CRM and the pipeline in Tech Consulting. This is now ramping up, and that is why we have the level of comfort we have currently in terms of the Capital Markets Day CAGR growth.

Okay. Perfect. That's very clear. I have a short one after that as well. The Volvo Cars profit warning earlier this month will be followed by heavy headcount reductions in Sweden. Can you say something about your exposure to either Volvo Cars or the automotive industry in general?

We have close to 0 exposure in that part of the industry. No impact for Tieto.

The next question comes from Sami Sarkamies from Danske Bank Markets.

I have a couple of questions. We'll take this one by one. Starting from third quarter developments. Can you still explain how come despite clear lower-than-anticipated revenues at Tech Consulting, you exceeded your earlier profitability expectations? And then secondly, what were the surprises at Indtech during the third quarter?

Yes. So let's take Tech Consulting first. I mean, we have taken out a lot of capacity in Q3. So that is, of course, impacting the top line. So we took out 360 FTEs during Q3. And as I said, 1,100 since Q3 of 2025. When it comes then to the margin, that's an effect of, of course, scaling significantly down in terms of FTEs, but also the main part is related to people on the bench and then G&A resources. So we're ending up with billable utilization in Q3, close to 90%. And then, of course, we get the effect of the G&A reductions, and that is basically why you see this solid margin coming through. When it comes then to Indtech, I would say that we had a couple of elements which were partly a surprise or kind of market fluctuations in Q3. One was related to -- as you know, we have also a certain level of services or professional services related to the software implementation. So we had a couple of areas where the market was quite soft in Q3 for professional services, which is now changing going into Q4. We had also one specific project related to professional services, but a quite large project, which was also postponed. This was signed back in Q4 of '25, but this was also postponed start-up into Q4 from Q3 of 2026. Then we have communicated several times that also Nexus being approximately 45% of the total revenue of Indtech is that we have seen now also some of the players in that space I mean, mainly in the consumer space, have also had reductions in number of invoices. And on top of that, we have seen also players now bundling more and more -- if they had the opportunity to do it, to bundle more and more to take down the cost, so bundling invoices, which impacted us in Q2 and Q3 from post and printing point of view. So that is kind of the -- I would say, we expected that to kind of come up again from Q2 when we went into Q3. So from that point of view, I would say it's a slightly negative surprise. But as I said also in my comments to Indtech is that we are now seeing this now both professional services improving in Q4 and then also the volume business slightly coming up, but not a big change in the volume business.

Okay. Then I have one question regarding Q4 outlook and then a small one after that. So regarding Banktech margin guidance in Q4, I think you should start to see finally growth. How come this is not visible in margins. So you're not sort of seeing any margin expansion in Q4?

So Sami, if we look at the level we reported Q3, so 18.1%. You know that Q3 is typically the highest profitability quarter of the year. Q4 is slightly lower. That's seasonal for us. And then when you look at last year comparable 18.3%, so we will be slightly below that. So that's the logic. And yes, you're right, the growth obviously makes the profitability improvement agenda easier.