Nagarro SE (NA9) Earnings Call Transcript & Summary

Ladies and gentlemen, a warm welcome to Nagarro SE's webcast for analysts and investors presenting the 2021 annual results and Q1 2022 quarterly results. [Operator Instructions] Now I'd like to hand over to Christian Mastnak. Please go ahead.

Thank you, Beatrice. Good morning to those of you tuned in from North America. Good afternoon to those connected from Europe and 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 first quarter 2022 results. If you have not received the press release, a copy of the release as well as of this presentation is available on nagarro.com in the Investor Relations section. With me on today's call are Manas Fuloria, Co-Founder and custodian of Entrepreneurship; and Vikram Sehgal, Co-Founder and Custodian of Operational Excellence. Before I pass you over to Manas, 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. This call is going to cover both the FY '21 results that were released on April 29 and the results of Q1 2022 that were released just some hours ago. Let's start with the FY '21 results. You have probably gone through the annual report by now. So let me use this time to add some additional narrative to it, add some additional color to it. 2021 was, for us, a year of 2 parts. Quarter 1 was relatively slow. Demand had, of course, increased around the turn of the year, but we did not have the hiring pipeline to service it. We have been too absorbed and busy with the spinoff and listing in December 2020 to make the necessary changes in time to take our foot off the brake as it were and put it on the accelerator. But anyhow, after the slow start in Q1, we recovered rather smartly and Q2, Q3 and Q4 were 3 successive quarters of strong sequential revenue growth; 10% sequential growth in quarter 2, 11% in quarter 3 and 15% in quarter 4. We had to keep revising our guidance for 2021 upwards again and again, which was a little awkward, but frankly, a good problem to have. But just to be clear, this breakneck growth came with a lot of pressures on us, particularly in talent acquisition and profitability management because of the high wage inflation scenario. But as the year progressed, we've sort of got used to the relentless space, and it kind of became the new normal for us. And as usual, with Nagarro, we kept tweaking, we kept improving, we kept making organizational design changes and infrastructural changes to our systems and our processes to support this growth momentum. Because of this acceleration in the last 3 quarters of the year, Nagarro's revenues for the year 2021 grew 26.9% over 2020, which in constant currency translates to a revenue growth rate of 28.6%. Gross margin was 28.3%. Adjusted EBITDA for the year was 14.6%, which, to our minds, was a satisfactory outcome given the high wage inflation. As we have mentioned several times before, our focus in these years is not to maximize profitability but to maximize Nagarro's revenue growth and maintain an acceptable level of profitability. Talking of growth, we added over 5,000 net new Nagarrians in 2021. We also had the acquisition of ATCS with its significant presence in the U.S., in Germany and in India. I'm happy to report that the ATCS integration is proceeding very well. 2021 also saw us enter the SDAX and TecDAX indexes. We are particularly proud to be a TecDAX company, and we think this will also be very good for our business in the long run, especially in Europe. Moving from the FY '21 to the Q1 '22 results, we have carried our growth momentum from Q4 into Q1. Nagarro's revenues grew 60.3% year-on-year in Q1, which is 55.2% in constant currency. The sequential quarter-on-quarter growth remained high at 14.5%, which makes this the fourth consecutive quarter of 10-plus percent sequential quarter-on-quarter revenue growth. The gross margin came in at 27.1%, and the adjusted EBITDA was 15.6% of revenue. We added nearly 2,300 Nagarrians in quarter 1. Not all of these additions are immediately productive, I must warn you, since this number includes many young trainees. Also, some of these new Nagarrians came to us via the acquisitions of Techmill and RipeConcepts with slightly different profiles of skills and billing rates, but overall, our pace of growth and hiring has been reasonably good. Nagarro's employer brand is the strongest it's ever been. And it has been helped by our generous and quite bold work-from-anywhere policies. Meanwhile, we expect the job market to cool somewhat in the coming months, especially as the flow of cheap funds to startups begins to dry up. But that's in the future. We haven't seen any of that happen yet. In quarter 1, we continue to battle wage inflation. As we have said before, we believe the demand for our services is ultimately quite price inelastic since the digital product and the digital services we are building for our many clients are, in most cases, critical to their business and critical to their competitiveness and critical to their strategy. However, these billing rate increases that we can extract will typically lag our wage increases, hence there can be margin pressure in the interim. So this is just a general statement. In this quarter, quarter 1, we were joined also, as you know, by new colleagues from Techmill with a presence in Singapore, India and Australia, and our new colleagues in RipeConcepts with a presence in the U.S. and the Philippines. We also opened legal entities in Colombia and Ecuador. These last 2 are still very small at the moment, but may be seen as a sign of intent from us. We continue to innovate in quarter 1 around work-from-anywhere. I would not like to speak too much about the details of what we are doing, since it is a major competitive differentiator. But I can say that we have built, in many markets, -- in many job markets, a special positioning around this that is very helpful to attract talented engineers and to give them a nice working context. In fact, Nagarro's entry to the United Nations, GCNI's, Global HR, Best Innovative and Sustainable Practices Championship placed first runner up, it was titled Work From Anywhere You Decide, and this made us quite happy. Moving on and getting a little more into the details for the quarter. We have touched some of these numbers already in terms of growth. We ended the quarter with EUR 186 million in revenue and EUR 29 million in adjusted EBITDA. Our fastest-growing industry year-on-year was Automotive, Manufacturing & Industrial, which grew 88%, aided by -- also by the acquisition of ATCS, whose largest client is a European car company. Our slowest growing industry was telecom, media and entertainment, but even that wasn't too bad at 20%. Among the segments, the Rest of the World has been growing very rapidly for Nagarro, it continued to grow very rapidly. And this quarter, it was joined by North America. Europe was relatively weaker, but this is also a function of where we decided to deploy scarce and expensive engineers as the U.S. dollar strengthened. Our guidance for 2022, as you see on the bottom right, updated on April 20, is a revenue of EUR 770 million, gross margin of 28% and adjusted EBITDA margin of 14%. We routinely monitor our industry exposure and our client concentration, and I'm happy to say both of these were still comfortable. We remain quite diversified by industries. And our top 10 clients made up only a little over 1/4 of our revenues in this -- in these 3 months. Here is some more detail on our segments, which are the client regions for us. North America and the Rest of the World have been taking share away from Europe. But I can safely say that there is a lot of pent-up demand in every region that we just don't have the engineers to service. We ended the quarter with nearly 16,000 professionals, of which roughly 14,800 were professionals in engineering. Here is another view on the segment performance, we have covered most of this already, but you can see that North America and the Rest of the World have grown very rapidly, whereas the growth in Europe has been relatively subdued. Coming to our balance sheet and cash flows. On the left here, you can see our net liabilities and the net leverage, which is defined as a multiple of the trailing 12 months adjusted EBITDA, our net liabilities have gone up in this quarter from EUR 166.0 million to EUR 191.1 million. Net leverage remains at 2.1x, which we think is quite comfortable. On the right, you see our cash flows for the quarter compared year-on-year with quarter 1, 2021. There's really nothing dramatic here, except the increased cash flow in investing activities related to the acquisitions that we have made. So now we are nearing the end of the presentation, as a tradition, we have this reminder on the investment highlights for Nagarro. This content is largely unchanged since the Capital Markets Day in 2020 before the spin-off, but it's just nice to revisit this slide every quarter, and it gives me some satisfaction to see that we continue to prove these claims, to validate these claims of positioning, of great clients, of a great organization and culture, of great financials and strong growth, just to keep validating them line by line. I'll just give you a couple of seconds to go over it. But the important thing here is the last line, which is growth. Growth is key for us, yes? And we have had a quarter of good growth. But I would like to tell a little story here, even 8 years ago in 2014, when Nagarro was less than EUR 100 million in revenue, we had this -- our first global management meet as a significant company, and we set our sights at that time on becoming a $1 billion company, a $1 billion revenue company, which was a growth goal for us of 10x. Now the 10x goal, the $1 billion revenue goal is close to being achieved if the current trajectory holds. So we have started thinking on how we will get the next 10x of growth in the next 10 years. For this 10x growth in 10 years, we have been working hard, as always, at Nagarro, we always are working for the future, we are working hard to build out the infrastructure of the company to be hyperscalable. And this work-from-anywhere environment that we have sort of come into because of the pandemic, it incidentally helps a lot with this hyperscalability, while it adds some other challenges. But this design with this promising opportunities from work-from-anywhere as well as the challenges, this design for the future is tricky and fun and exciting and actually quite promising, right? So this is what we are working on at the moment. We are also thinking about what Nagarro should be known for. Besides the business success, what Nagarro should be known for 10 years from now. We believe it will have something to do with our mission statement, which, although more than a decade old, seems more and more important today in today's troubled world. We will speak for this some other day on some other forum perhaps, but this aspect of what we want to achieve as a company is very important for us. And you will see us act in the coming months and years in this direction and take our core value of gearing to the next level along the lines of this mission statement. Finally, I would like to take this opportunity with a strong quarter to reemphasize that at Nagarro, we don't see this as a quarter-by-quarter play. We don't think of the company that way, we don't think of our numbers in the quarter-by-quarter way. We are rather out to build a company that will last decades and will grow for decades. And that takes some hard work and it takes some investment into the future. And from time to time, you have to have some good luck. And sometimes you have some bad luck. But through all of this, we are very thankful to you all for your participation in our growth story and hope you'll be committed to the company equally through good times like this time and through tough times. But in short, thank you all very much for your participation and support in this journey. We will now take questions. And for this, I will hand the call back to the operator.

[Operator Instructions] First question was submitted by Martin Jones. What percentage of engineers are employed versus freelance consultants?

The vast majority of our engineers are employed. We don't disclose the numbers, but it's really the absolute vast majority. We do have some freelance consultants, but it's like a small rounding error.

Second question, again by Martin. You've managed to protect margins well. Do you expect to be able to pass through all wage cost inflation over the longer term?

Yes. And I will think this even for the last 15 years, we have seen wages increase in many of our service regions. We have seen how clients are able to adjust to these wage increases. So we do expect that in the longer term, we will be able to pass all wage increases to our clients.

Again, Martin Jones, do you plan on large M&A or more bolt-on -- sorry, do you plan on large M&A or more bolt-on to add capabilities?

So we -- I guess you never say never, but our primary focus is on bolt-on acquisitions, mainly for client access because by now, we have this huge asset of case studies and testimonials and many regions and industries and types of solutions, and we want to leverage it as much as possible. So client access is typically what we will do at M&A for. But once in a while, there is some niche capability that a nice acquisition can bring us and that we will obviously stay open to that. Transformative M&A is not a key priority at the moment.

Two more questions from Martin. Given the opportunity in the share price and strong cash generation, would you consider a buyback of shares?

I would -- these are always considerations, and we discuss these all the time. But I don't have any plans -- we don't have any plans at the moment.

Last question before we jump to other questions, Martin Jones. Will you hold the Capital Markets Day this year?

We don't have one on the calendar yet, but we will -- so we don't have a firm idea yet.

Next question is from Adrian Pehl. Are there any remaining acquisition-related expenses, cash outs resulting from your recent acquisitions to be booked in Q2?

I do not think so. I do not think so. I think all the -- I mean, of course, there's -- but I could get back to you with a firm answer, but I do not think so. Vikram, do you want to add to that?

I agree with you, Manas. I don't think there are any expenses that are not booked at this time, but we'll send a confirmation.

Second question by Adrian, why have you decided to keep the outlook unchanged after 60% growth in Q1, which is way above the 40% run rate you see for full year '22? What are the risks you see here?

Yes. We call it as we see it, and we are very careful with revising guidance, and there is always a certain quantum of change that we need to have before you revise guidance as per the rules of the road. But we will keep an eye on this. And when we feel that we are at the point where we can and should revise guidance, like we did last year, we will do so. At the moment, we have challenges in hiring, we have challenges expected in the economy. So we are just being cautious.

There are still a lot of questions. So I'll take the next 2 from Adrian and then switch to another listener. Operating cash conversion has been weak 10% of EBITDA in Q1 due to working capital. How will working capital play out in the rest of the year? Which conversion do you target?

Vikram, do you want to take that?

Yes. So we did have a lower conversion. This was mainly due to increase in the receivables and the working capital. But also because of the -- some of the revenue was unbarred for a new customer that was onboarded. So we hope to get improvement in this figure.

We don't actually state any particular target for this cash conversion, but yes, we keep an eye on it.

All right. Adrian's fourth question related to M&A that was already answered. Next set of questions come from Nicolas David. Could you share the like-for-like growth in Q1 2022? Also, specifically the like-for-like growth in [indiscernible] and in North America and rest of the world? What was the organic net staff hiring in Q1?

Could you repeat the question? So the like-for-like in North America...

Like-for-like in Q1 overall and then more specifically for North America and rest of the world.

So the like-for-like, I assume that to mean over Q1 2021, is that correct?