Nagarro SE (NA9) Earnings Call Transcript & Summary

Good morning to those of tuning from Europe and North America. Good afternoon to those connected from Asia. On behalf of Nagarro SE, allow me to extend a warm welcome to you. You should have received a copy of the earnings release for Nagarro's third quarter 2021 results. If you have not received the press release, a copy of the release as well as of this presentation is available on the nagarro.com in the Investor Relations section. With me today on today's call are Manas Fuloria, Custodian of Entrepreneurship and Gagan Bakshi, Custodian of Strategic Finance. Before I pass you over to Manas Fuloria, I would like to remind those listening, that some of the comments made on today's call may contain forward-looking statements. These statements are subject to risks and uncertainties as described in the company's earnings release. Additionally, please also refer to the earnings release for the notice on recorded results that are non-GAAP measures. With that, it is my pleasure to hand you over to Manas.

Thanks, Christian, and welcome, everyone. I keep saying that at Nagarro, we don't think quarter-by-quarter. We are out to build a company that last and grows for years and decades, but a good quarter is always welcome. And this has been a good quarter. Of course, there's a long way to go to build the company that we dream of, but every week and every month and every quarter, we get result further down that path. As in recent times, even in quarter 2, these last 3 months have been fast-moving and complex. But we have sort of gotten used to this space, I think. We've done fairly well to tackle all the changes and challenges in these 3 months with our operational capabilities and our financial performance. Nagarro's revenues grew 33.7% year-on-year in quarter 3, 33.6% in constant currency. This was the second successive quarter of 10-plus percent quarter-on-quarter revenue growth, which is interesting. We added -- sorry, on the slide more back to 4. We added over 1,100 Nagarrians in this quarter. Not all of these additions are immediately productive since this number also includes many young trainees. But overall, I think it was a great hiring performance and a very tight job market. The competition for top engineering talent continues to drive wage inflation. We believe, as we have said this before, that the demand for our services is ultimately price-agnostic, but the billing rate increases can lag our wage increases and hence, there is margin pressure in the interim. A couple of words to post quarter 3 developments. We have acquired this company called ATCS, which we are excited about, and we expect the synergies for ATCS to kick in soon. We have also completed the last steps of the reorganization related to the spin-off from Allgeier with the rollover of the management participation up to the Nagarro SE level. This, we believe, better aligns the management goals with shareholder goals. And both of these are really significant milestones for us. We also upped our revenue guidance for 2021 earlier this week by EUR 10 million. A little bit more into the details for this quarter. We have already talked about revenue growth. Revenues were EUR 141 million, and the gross margin was 28.4%, adjusted EBITDA of EUR 21.7 million. The fastest-growing industries for us were the Horizontal Tech industry vertical, growing at 63% year-on-year, while the slowest growing or in fact, contracting industry vertical for us, was Mgmt. Consulting & Business Info. As we've said before, our verticals are still very small. So even the movement of a single client can drive business up and down. But that's the 2 extremes of the range of fluctuation. In segments, the rest of world segment is once again the fastest growing at 73% year-on-year. While Central Europe is the slowest growing at 15%, also weighed down by our exposure to travel and aviation in this segment. Our client concentrations remained roughly at prior levels, with 15% of our revenue coming from the top 5 clients. Our cash balance at the end of Q3 was EUR 110 million. Of course, some of this was deployed towards the ATCS acquisition. We added 1,149 professionals in this quarter. Our CSAT score was almost unchanged at 94%. And our guidance that we changed earlier this week was changed to revenues for 2021 being in the region of EUR 525 million and an adjusted EBITDA margin of 14%. Now looking at the results by industry. Our growth was relatively broad-based, but led by auto, manufacturing and industrial and retail and CPG. Retail and CPG is, of course, related to the growth in e-commerce and the need for e-commerce solutions by a large number of different players, trying to add new solutions and trying to address and strengthen existing solutions that they already had. And you can see on the right that our client concentration, both the top 5 clients and the top 10 clients remains mutually unchanged in this quarter. We have been continuing to serve opportunities globally. We think of ourselves as a global company. We look at opportunities around the world, and we find it very interesting and exciting to change these opportunities using talent from all across the world. You saw earlier that the Rest of the World grew fastest and North America also gained with respect to Q3 2020. On the right, you can see that we are now 12,082 professionals, which is a significant step up from the time of our listing with 11,116 professionals in engineering. Now moving on to the segment revenues and gross margins. We already referred to the segments a little bit. You can see that Europe is running a little bit behind the other 2 segments. We have also gross margin pressure that we have talked about earlier coming from wage inflation, and billing rates increases that are occurring, but lagging the wage inflation. Now Gagan, maybe you'd like to step in to speak a bit about the balance sheet and cash flows.

Moving on to the balance sheet review. In the left-hand chart, we are showing the net liabilities position. The bars on the left shows the position at December 31, 2020, and the bar on the right shows the position as of September 30, 2021. In that chart, the green box shows the lease liabilities, which were at EUR 56.9 million compared to EUR 55.2 million at year-end 2020. The blue box shows the financial liabilities, and this includes a drawdown on syndicated credit facility, working capital facilities and bank loans. At September 30, these financial liabilities were at EUR 180.6 million, slightly lower than the EUR 182.6 million at year-end 2020. The gray box shows the cash position for the 9 months at EUR 109.6 million, just slightly higher than the cash position of EUR 107.7 million at year-end 2020. This totals to a net debt position of EUR 127.8 million, which is coming out slightly lower than the EUR 130 million at year-end 2020. Net leverage on a net debt-to-EBITDA basis is now at 1.6x, which is, again, a bit improved from 1.7x at year-end 2020. Moving on to the cash flows on the right-hand chart. For the 9 months, the total cash flow was negative EUR 0.8 million. The operating cash flows were at EUR 21.1 million. The reduction in operating cash flows can largely be ascribed to the one-off payment for spin-off in listing costs of EUR 8.4 million and increase in trade receivables and contract assets by EUR 5.6 million and EUR 14.1 million, respectively. This is offset by funds seeded from factoring of EUR 5 million. Cash outflow from investing activities was EUR 6.7 million, and this was mainly to meet contractual payment obligations from older acquisitions of EUR 4.2 million and CapEx of EUR 2.5 million. And lastly, the cash outflow from financing activities, which was EUR 15.2 million. There were 2 outdoors and 2 major inflows that we talk about here. The 2 major items of cash outflow were lease payments of EUR 13.7 million and repayment of principal for bank loans of EUR 4.2 million, and this was offset by an increase in cash flow from a EUR 3.2 million contribution on exercise of stock options and a EUR 2.9 million cash received from holders of diversified noncontrolling interest. Having said that, overall, the company's liquidity position at the end of 9 months was comfortable.

Thank you, Gagan. Moving on to the outlook. Those of you who have joined previous calls, there are some changes to our outlook slide. One, of course, is a numeric change we have revised the guidance, as I have mentioned, but we've also revoked our statements on the medium-term outlook guidance. I'll just explain why we removed them. We used to say -- we have been saying since before the spinoff that we expect to grow revenues at 20% organically in the medium term and have a 15% adjusted EBITDA margin. And there was a context to that. There were -- these statements were appropriate at the time of the spinoff when our revenue growth was slowed due to the early impact of COVID. And our EBITDA margins were actually exceptionally high due to the temporary cost cutting measures, including temporary salary cuts. Now neither of those seem relevant any longer. And with our quarter 3 revenue growth at over 30% saying that we expect medium-term revenue growth to be 20% sends an unintended and income message. So we are withdrawing the statements related to our medium-term guidance. We expect our Q3 2021 revenue, as you know, to be EUR 525 million in that region, gross margin at 28% roughly, and adjusted EBITDA margin at 15%, roughly. Finally, a reminder on the investment highlights for Nagarro. We have been traditionally ending every call with this. The content is largely unchanged since the Capital Markets Day last year before the spin-off. But it is satisfying to see that we continue to grow these claims line by line. We are -- been cashing on our positioning as the engineering DNA digital leader with a special enterprise agile approach. We continue to grow with a large global blue chip customer base. Our organizational design and culture have stood up especially well to the COVID changes and the work from anywhere environment. We continue to -- we, in fact, now start to post the kind of revenue growth that we always felt we were capable of and with decent margins and upside potential. And we continue to demonstrate that by the side of organic growth, we can grow with synergistic M&A. So that's the presentation. Thank you all for your interest in Nagarro and your interest and participation in our growth story. We will now take questions. And for this, I will hand the call back to the operator.

[Operator Instructions] First question comes from Florian Treisch of ODDO BHF, who says congratulations for the strong growth acceleration in Q3 and an anticipated continuation in Q4. How much of this is driven by existing clients recovering and/or new client ramp-ups? Do you expect recent quarterly onboarding run rate of greater than 1,000 Nagarrians to continue into coming quarters? Given that your employee growth rate is likely double as high as your revenue growth, is it fair to say that 2022 organic growth will end up being higher than your midterm target of 20%?

That's a bunch of very good questions. Thank you for them. Just as we have said before as well, quarter 4 for us is generally a slower quarter, because of a lot of holidays for Diwali, for Christmas, for the year-end. And we also have several leaves that people have banked in the earlier part of the year, because of COVID that they might end up taking. So there's some uncertainty around that, that I do want to mention. In terms of our growth being driven by existing clients versus new clients, I think existing clients are slightly more than usual in terms of the drivers of growth. And this is not because we don't have new clients. I think the new client acquisition pipeline has been very strong. It is just that in a supply-constrained environment, you feel more loyal to your existing clients and you are more -- you have a biased sort of tendency to prioritize their needs over the needs of new clients. So I think that's the short-term situation. But in general, the situation is largely unchanged in terms of the addition of new clients. On quarterly onboarding, I would not like to predict any numbers, because we are in a very dynamic job market. And we would rather just see each number from quarter-to-quarter prospectively. It's -- we like to be agile organization and try to do the best that we can and that's what we are doing. But yes, we continue to hire in reasonable numbers at this point. Of course, there is some seasonality to the hiring of people from universities and so you will not necessarily see every quarter look the same. Your last question is also very interesting. Yes, we are adding more people than our revenue numbers would indicate. And yes, that is a signal for our expectations for organic growth, but I would not quantify that, if you will allow me to not quantify that. So thanks for those questions.

Next question is from [ Advanti of Statistician ]. Could you please elaborate on the synergies you see with respect to ATCS? How is the process of integrating the asset work and in what time frame?

Okay. Great. So ATCS is very interesting for us. As we said, we were always interested in expanding the footprint in the U.S. market. We have, as a company, have a long history with the U.S., but we have, in recent times, been more focused on Europe in terms of acquisitions and ATCS brings us back into the U.S. Although with an interesting European twist in the sense that they also have some business in Germany and some in other parts of the world. So this is also interesting from the perspective not just on the U.S. and German markets, but also in different verticals. They have a large automotive client, which, where they do multiple things with respect to the digital or transformation of this client, and that's very interesting for our automotive practice. They also have a strong sales force, digital, marketing, analytics practice, which is very interesting for us, and they have a couple of major life sciences clients on that. And given the interest in life sciences and given the interesting and rather hot area of marketing analytics, this is also of great interest to us. They also apart from these, they also have a few other clients in different industries, a beverages company, a financial company for the marketing analytics piece, which is really of interest to us. In terms of integrating the asset, I think we have, by now, a lot of experience in both the acquisition of such assets and the integration of such assets. And we have a team that's so dedicated on that. And this integration starts with the focus on business synergies, revenue timing synergies. And at some point, there is the cultural sync up. Of course, we're already selected our culture in the first place. But the actual engaging of the gears, if you will, there is this IP and sync up after that and brand sync up. And that process has already begun there. There are already at least 4 or 5 conversations where we are trying to see what we can do together in terms of bringing more value to our clients. So -- and the time line for that, I think integration is an infinite thing in a sense that it takes many, many years for something to be fully integrated. But bulk of the work is done in the first year or the first 18 months. So we do expect this to be fairly integrated in the first 18 months. That said, they do have an earnout. The sellers have an earnout in 2024. And therefore, there will be some aspects that we will give sufficient freedom to the sellers to operate, so that they are able to meet on our goals.

Next question is from Adrian Pehl. Travel & Logistics appears to pick up in terms of vertical exposure. Could you elaborate on this a bit more, i.e., what do you see going forward here?

Yes. So travel is -- and logistics goes well beyond aviation, and we are seeing a lot of focus on logistics, for example. And I don't have any long-term view on the future aviation, but definitely, logistics with all the world is running into, both in terms of opportunities for logistics as well as the constraints posed by logistics. I think these are interesting problems to solve and there is suddenly a heightened awareness of these problems and heightened attention to these problems. So we do expect this to continue to grow. I mean that said, there are aviation models that are also expected to bounce back. And we are starting to see some of that, but it's difficult to predict how it will look like in the medium term.

Next question is from Martin Comtesse of Jefferies. Can you please shed more light on why you withdraw the medium-term guidance? Does this imply that revenue growth will be higher, but margins will be lower than previously expected? Will you publish a new medium-term outlook at some point soon?

Okay. So no, so let me just clarify. The -- we are in this interesting position now where our revenue growth is already higher than our medium-term revenue guidance, right? So it's a bit odd, because when we started off, we had revenue growth that was lower and we were saying we think we can climb up to 20%. Now it looks like we are saying we think it will go down to 20%, which is not really the mood or projection of the company, at least in the short term. And definitely, the medium term now is difficult to quantify. And it is a couple of years out and what happens a couple of years later. So at the moment, we see really rapid growth. So I think that we felt that, that medium-term guidance was doing a bit of a disservice to our view on the future. In terms of margin, again, it was the other direction. We were coming at that time for margins of 18%, 19%. And we were saying that we expect 15% to be kind of a target for the medium term. And now our margins are nearly 15%, I mean more or less. And we are -- yes, so it doesn't add up its value. I think that whether we come out with a revised medium-term target or not, we have to consider. We don't have a decision on it yet. But what we are basically saying is that, yes, our growth trajectory at the moment is -- it does appear to be one where neither of these medium-term targets are carrying very much value or information and maybe they're giving the wrong signal to investors, right? So -- but there is nothing here. Please don't read it as us saying that our margins will be lower than 15%. That's not the intent. The intent just is that we don't think that the combined guidance is adding value, and we will consider whether we can state it or not. And in fact, will be also discussing it internally to see whether that makes sense.

Next question is from [ Giacomo at Sycamore ]. How do we think about growth from here, especially for 2022? I hope that's reskill. What are the hiring plans for 2022? How do we think about pricing catch-up versus wage inflation?

All good questions, right? So we don't have our -- so as part of our formal process, we do need to have plans for 2022 that are in our model, with the Supervisory Board. We haven't done that yet. So we will come back to you later in this year with the 2022 plans. But in general, the outlook on the growth side looks good. Our hiring plans are at the moment supply constrained. So we are hiring as fast as we can go. So we don't have any particular plans as such. We're just trying to hire as many people as we need to deliver the services that clients are asking for, and these are currently far more than we have. In terms of our pricing versus wage inflation, we have been able to negotiate price increases, some of which are coming on stream now and some of it will come on stream in the first quarter of next year. We also, as I discussed, have hired a lot of youngsters, who will come into billing rates -- into individual positions fairly soon, which will also help drive our overall cost down. So there's a bunch of different things that we are doing to tackle this. So again, I don't have a sharp answer on the pricing versus wage inflation thing. In general, we are comfortable looking out at Q1 and Q2 that we have this under control. We also are starting to see, and maybe this is very early, the beginnings of the turning of the tide perhaps, where the runaway inflation has slowed down, the runaway job hopping is slowing down just a little. This is mostly anecdotal at this moment, I don't want to draw strong conclusions from it. But yes, there is -- there are some minor changes in the market, and we hope that this -- this will be -- will have us returning to a more traditional job market in the coming quarters.

Pehl was also asking for a gross margin view for 2022, Manas, and is asking whether there is the 15% EBITDA margin as a floor?

We are not in a position to come in 2022. Yet, as I said, this is a sacred thing for us. We would like to go from Supervisory Board and on our plans before we start to comment on the 2022 plans. The Board deserves to know before and have -- we need to have a discussion internally before we talk about it externally.

Next question is from Andreas Wolf of Warburg. Congratulations on the strong performance. Manas, could you please elaborate on current order intake for the periods beyond 2021 and your view on next year's wage development, medium-term development? Is middle management incentivized with regard to margins or mainly with regard to absolute profitability levels?

Okay. So Andreas, thanks for the questions. We have a lot of our business or most of our business comes from existing clients and existing projects. So we have fairly good visibility into 2022. And again, without getting the specifics, I can just say that things look fine and good there. In terms of wage development, it's difficult to have a crystal ball and predict what is going to happen in 2022. Again, as I said, our key pillar of our company for the last many years has been that the work we do is -- the demand is fairly price inelastic, as long as our clients are doing okay, right? So if there is a macroeconomic crash or something then it's slightly different. But in a general positive environment, the demand for our services is price-inelastic and especially after COVID, I think everybody is well aware of the pressure on margins and the need for driving this digital transformation. So I think that we would have -- we have the recourse to our clients. But again, it lags the wage increases. And yes, that's how we see it. In terms of our incentives for middle management, I think there is a thin layer that is definitely -- has some incentives on margins. But in general, our focus continues to be to incentivize client satisfaction. That's really our largest contributor to incentives and then to align senior management incentives to the value generation in the company. So many of the people or most of the people at senior management are also shareholders or in some ways, connected to the shares in the companies, so that they can take a longer-term view on the eventual development of the company.