Nagarro SE (NA9) Earnings Call Transcript & Summary

Good afternoon to everyone. Welcome to Nagarro SE's Retail Investor Call following today's earnings release for Q3 2024. My name is Michael Knapp, and I'm part of the Investor Relations team at Nagarro. I'm delighted to moderate today's call. You should have received a copy of the earnings release for Nagarro's third quarter 2024 results. If you have not received the release, you can find a copy along with today's presentation in the Investor Relations section of nagarro.com. Representing Nagarro on today's call are Manas Human, Co-Founder and Custodian of Entrepreneurship in the organization; and Gagan Bakshi, Custodian of Strategic Finance and Head of Investor Relations. Before I pass you over to Manas, I'd 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 reported results that are non-GAAP measures. As in our previous retail calls, we will have a short presentation at the beginning and then move on to the Q&A session where you can ask your questions. Nagarro is happy to partner with NetRoadshow for today's call again. [Operator Instructions] And with that, it's my pleasure to hand you over to Manas.

Thank you, Michael, and thanks, everyone, for joining this call. This is the call that we have especially for retail investors. This is for Q3. And thank you again for joining. And as Michael said, we are happy that we have -- we are hosted on this call by NetRoadshow, which is a platform that Nagarro has helped develop over the years. It's a nice part of the Nagarro story, too, that we are actually working with a platform that's used in such calls throughout the world every day. Moving on to our quarter 3. Nagarro's quarter 3 performance was robust. Although there was no clear recovery in the demand environment for digital ID services, our existing clients continued to be loyal and our new clients were -- and new clients were acquired. We continue to push forward in cutting-edge areas of technology and continue to deliver business results. While some of you may have been on the analyst call, we see that a lot of you are -- were not on the analyst call. So let me just actually go through the numbers in some detail. Our revenue growth in quarter 3 was 5.6% year-on-year in constant currency, 3.7% in euro terms. Organic year-on-year revenue growth for the quarter was 5% in constant currency, roughly 3% organic year-on-year in euro terms. Compared to quarter 2, our revenue grew 0.5% in constant currency and reduced by 0.5% in euro terms. When we were growing really quickly in '21 and '22, there was a lot of talk about our cash flow. Our cash flow has really improved after our growth has moderated. Our operating cash flow in the 9 months till September end in 2024 was EUR 64.9 million. Our operating cash flow adjusted for changes in factoring was EUR 70.6 million in these 9 months as compared to EUR 61.7 million in 9 months 2023. So I think we have by now firmly put aside those investor concerns about the ability of the business to generate cash. And therefore, we also feel that the restrictions that we voluntarily placed on our own factoring programs can now be lifted to give us more freedom since those restrictions were purely in response to investor concerns. Due to our growth being slower than expected, there was some pressure on margins in Q3 which was alleviated to some extent by the cost-optimizing measures that we introduced in the last quarters to tide over these challenging times. Our accounts generating over EUR 1 million in revenue, a very important metric for us, EUR 1 million in revenue over the trailing 12 months, were at 186 at the end of September, up from 176 a year ago. Our Net Promoter Score in Q3 was 59, which is a slight drop from what it has been in the last few quarters, but it's still an excellent number. It's just a very small drop. We issued revised guidance for 2024 on October 15 based on September revenues and also on utilization trends and hiring trends. The new guidance was for approximately EUR 960 million for the full year in constant currency terms and not including any acquisitions that happened after that date of guidance. We guided for a gross margin of 30% under our new method of stating gross profit and 26% under the previous method. And we guided for a full year adjusted EBITDA margin of over 14%. Here's a deeper look at our key numbers. Revenue for Q3 was EUR 242.9 million, growing, as we said, 0.5% in constant currency quarter-on-quarter and growing 5.6% year-on-year in constant currency. Our gross margin number, as I said, is based on our new method of calculation of gross margins. This was 31.5%. And we still state the old -- the numbers under the old method of calculation, which is 27.4% under the old method. Our adjusted EBITDA was EUR 34.6 million. We had Public, Non-Profit and Education growing 38.8%, and it was our top-performing industry. While our worst-performing industry was Horizontal Tech, which as you know, we have been having some trouble with, which degrew by 11.3% compared to Q3 2023. North America surprisingly grew fastest year-on-year in Q3, helped also by currency trends, at 9.5%, while the rest of the world actually grew the slowest. In fact, it degrew, again surprisingly, by 5.4% over Q3 2023. We ended the quarter with a cash balance of EUR 141 million. We already spoke of 2024 guidance. Since we listed in December 2020, we have experienced real swings in the demand environment for digital ID services, sometimes up and sometimes down. And these swings have implications on our revenue growth and on margins. And it's been very difficult to predict how things will be. So while we continue to be optimistic about the eventual recovery of the demand environment, we cannot predict exactly when that will happen and exactly to what degree. And so based on a strategic review with some external sounding that we conducted at this time, and given the general uncertainty in the markets as we look forward into the next years, we request you to disregard our past statements of Nagarro's outlook beyond 2024. Instead, we would recommend that the consensus estimates of the financial analysts covering Nagarro should be seen as a fair estimate of how the company may perform beyond 2024. You know that we operate in a large number of industries. We really are committed to this diversification across industries. It has helped us in the past. And also, we see that the technology user experience expectations and the way ecosystems are being built, they are now cutting across the traditional industry silos. Our best-performing industry was Public, Non-Profit and Education, benefiting from good comps -- from weak comps in the last year. And a long way behind that, the next best-performing industry was Retail and CPG. The weakest performing industries were Horizontal Tech, that we talked about, and Life Sciences & Health Care. We have remained low in terms of client concentration right from the time we were spun off and listed in December 2020. In Q3, our top 5 clients, again, accounted for just 15% of our revenues for the quarter. And our clients 6 to 10 accounted for just about 9% of our revenues. In the quarter, North America accounted for EUR 88 million of revenues, the biggest; Central Europe for EUR 69 million; rest of world for EUR 57 million, close to Central Europe; and finally, rest of Europe are much lower than the other 3 at about EUR 29 million. We continue to expand our global footprint. In the past weeks, you must have heard about our partnership with the Japanese company, Marubeni, and the acquisition of FWD View in the U.K. These are both post the Q3 -- end of Q3, but they are very interesting. In terms of people, our head count reduced further by 363 this quarter, mostly by attrition that was not backfilled. And it's now 17,938 at the end of the quarter 3. Now over to Gagan to say a few words on our financial position at the end of Q3.

Thank you, Manas. Hello, everyone. A quick look at our financial position at September end shows financial liabilities of EUR 280.5 million. Cash balance increased materially to EUR 141 million, implying a much lower net leverage of nearly EUR 184 million, as well as a lower net leverage ratio of 1.3x. The company's liquidity position at the end of this 9-month period was comfortable with a working capital of EUR 248 million. Now a few words on our cash flows for this 9-month period. Our total cash flow was an inflow of EUR 33.1 million, which is a big improvement versus a cash outflow of nearly EUR 16 million for the comparable period last year. Operating cash flow for the current 9-month period was a strong EUR 64.9 million, which is an increase of EUR 23.5 million. The higher cash flow was mainly due to an increase in EBITDA by EUR 11.9 million. We were also able to reduce the utilization of funds under the factoring program by EUR 14.7 million during this current 9-month period. This reduction is also reflected in the slight increase in our days of sales outstanding, which have increased slightly from 84 days at the end of last year to about 86 days at the end of September. Kindly note that DSO is calculated based on quarterly revenues and includes both contract assets and trade receivables. Cash flow from investing activities for this period was an outflow of EUR 6.2 million, mainly due to payment of EUR 9.7 million towards contractual obligations from previous acquisitions. CapEx came in at EUR 3.8 million, which at only about 0.5% of the 9 months revenues, reflect our asset-light model. Cash outflow from financing activities for the current 9-month period was EUR 25.5 million, which was attributable to outflows of EUR 18.9 million for lease payments and EUR 13.6 million for interest payments. These were offset by cash inflows from bank loans of EUR 7 million. From a capital allocation perspective, we're happy to report the acquisition of FWD View on October 30. A U.K.-based company, FWD View is recognized for its expertise in delivering data-driven solutions to the financial services industry. This strategic acquisition enriches Nagarro's portfolio in the financial services sector and further solidifies our market position in the U.K. We have consolidated FWD View from November 1. With this, I hand over back to Manas. Thank you all.

Thank you, Gagan. Thanks. We're now going to move to Q&A, but before we begin, there's one important caveat. Some of you may be aware that about a month ago, a Bloomberg article had reported that some private equity firm is considering a buyout of Nagarro. That same day, Nagarro had issued an ad hoc statement with clarificatory information. So we have said all we wanted to say via that statement and nothing more must be stated today. So I would abstain from answering any questions related to this topic and hope for your understanding and forbearance on that. With that, we can get on to the questions, Michael, whenever you're ready.

Great. Thank you, Manas. [Operator Instructions] And our first question today comes from Francisco. I wanted to ask if, given the information published today, the growth target projection of 20% and 18% margins for the medium, long term -- medium to long term from 2026 onwards is therefore invalidated.

Well, that's a good question. And I think that when we made this projection was in the beginning of 2023, and 2026 was a long time away, and we were quite confident that the markets would bounce back. What we see is that recovery in the demand for digital ID services is very gradual, and we are not there where we expected to be. And with 2026 starting just 14 months away, we think that it's very difficult to predict how it will be, and to be able to move our margins to the levels that we expected is going to be difficult in the slow growth scenario. Therefore, our new guidance is the analyst estimates being an accurate representation of the revenues and earnings for the next years. So yes, the previous comments should be disregarded.

Great. And Francisco had a second part to his question. He'd like to ask about the status of the potential acquisition pipeline. Is it healthy? Or are you finding difficulties in making more progress on the M&A front? I believe that perhaps the current sector weakness is not being fully leveraged to deploy capital, both in M&A and, if applicable, in share buybacks. Appreciate the clarification on that.

Thanks, Francisco. Francisco, I think the main question with -- the big challenge with the slow environment is, of course, how much risk you are also willing to take. But it's also got to do with the sellers, the comfort that they have in selling out in a more difficult environment, or they want to hold on for a point of time when they can command a better price. So I think that all of these are factors that are playing in the M&A market. I think we do see a fair number of targets. And yes, I think the pipeline is fairly healthy. I think in short, the pipeline is healthy, but it's not as though there is a tremendous appetite for very large acquisitions anywhere in the market. I think everybody is a little bit cautious on both sides. That's at least how my sense is. And I'm speaking only from personal experience. I'm not really an expert on how the sector as a whole is performing on M&A.

Great. The next question comes from Arturo. Could you comment a little more in detail on the acquisition of FWD View Limited? What is the rationale behind this acquisition in the U.K.? And whether it is a company you've known for a long time.

Well, I'm glad to answer that question. It's a delightful acquisition for us. We're very happy to have the FWD View colleagues as part of the Nagarro family in the Nagarro playground. Yes, we have known them for a while. We have been collaborating, at least 1 client. And we have found this company to be -- to have the kind of spirit and the kind of client relationships and the kind of experience that make it a very good fit for us. So yes, we are delighted to have them over. And I'm actually in Gurgaon today, and one of the co-founders and a couple of the top people are here as well visiting. And it's really a pleasure always to have -- to be with them and to think about what we can do together. So yes, good stuff.

Great. Thanks, Manas. We have a follow-up question from Francisco. I would also like some clarification regarding the significant drop in employee numbers given that it was previously communicated that the strategy was to maintain the number of employees in preparation for the return of demand even if margins were affected. Is there any change in this aspect?

So it's proving to be a lot more dynamic than we -- than just gross numbers. There are areas where we have still demand and there are areas where we have less demand. And there are areas where we see less attrition and there are areas where we see more attrition. So it's a complex picture. And I think that any broad statement would be probably a simplification, a gross simplification. I think in general, we are finding that the hiring market is relatively competitive for a slow-growth environment. And I think that this is coming -- especially in India, which is one of our largest hiring markets. And I think it's coming a little bit from the fact that there are a lot of global capability centers of large companies coming up. So it's not -- I won't say it's a big, big challenge, but it's -- it just means that it's not very easy to backfill attrition quickly. And these numbers, although they look large in totality, spread across 3 months and across a large organization, they're not very, very large, right? So yes, we don't -- we expect that -- let me not predict the future. But it's -- yes, it's just some more granular readjustments, I would call it.

Great. Next question comes from Heron. Has something changed in the last 3 months to now think that the analyst estimation for next year -- the next years are in line with the Board opinion? Last quarter we were waiting for a recovery sooner rather than later.

Yes. What we have is 3, 4 things. One is that we are conducting a strategic review, which we have talked about. We are actually talking to various parties that have a wider view of the market, that talk to more of our competitors. And they have a lot more insight at the industry level, whereas we are more sort of focused on our own company. We are also starting to do a bottom-up predictions for next year. And as we look at -- and as I said, we sort of issued our changed guidance based on what happened in September. And similarly, we look at what's happening in October. And so on, right? So I think based on the latest review, strategic review and sounding of external parties, we have come to the conclusion that the big return of demand that we were expecting is still not here yet and still unpredictable. This has been the longest -- perhaps the longest slow-demand period in the industry that I can remember. So I think it's most advisable to sort of align with the analysts who also have a very broad view of the market. And yes, that's the major -- these are the major contributors to this revised view. Of course, as I said in the last call, towards the end of the year, as we always do, we will have a better view into 2025. And we will share '25 guidance with you at that point.

Thank you. Heron's second question, what are your expectations for the automotive market in Europe?

That's a complicated question. I think that -- and I'm not going to be able to give you a single answer -- a single sharp answer. I think there are multiple factors at play. On one hand, the automotive market, for us, the automotive players are really long-term thinkers. They have long-term programs. They have a lot of money to deploy. They have great ambition. They have great capabilities. They have just a lot of transformation that they are into. So there's that side of it. Of course, we all read the press and we all read the challenges in the industry, in the sector. So it's very difficult to predict what -- how it will play out eventually and who will be impacted and how much, both on the -- in the industry side and then on our side as vendors to this industry. But in general, we are not -- we don't have extremely strong, clear trends that we can see today. But we are aware that this is a complex environment to operate in.

Great. Pedro had a question. How will the Marubeni partnership translate into revenue? And is there any estimate in the amount of revenue?

There is no estimate at the moment, but Marubeni is very interesting. So I think what we're going to be trying to do as part of this first phase is trying to do some test, some go-to-market testing, and see if we are able to provide solutions to Marubeni companies or partners in different countries. So I think it's going to start relatively small and relatively slow. But I think that what is very exciting for us is that this is a very large company with a global reach and global presence and very intimately connected with Japan ecosystem, which is an interesting ecosystem for us and for a lot of our peers. So it's quite an interesting step forward for us.

Great. Our next question is from Evian. There has been a sequential decrease in NPS recently. I'm curious what factors do you attribute to this.

So I have to go back and analyze it in more detail. But I think that the most likely is a combination of some statistical noise. And it also depends a lot on what -- as you get more adoption in different types of customers, for example, maybe newer companies that are joining Nagarro, or companies with different business models that are joining Nagarro with maybe smaller client engagements. And so there is some of that, which is possibly a reason for some of these changes. So it could be noise. It could be some of the response pool that we are getting. But it could also be something more fundamental. And we're thinking a bit about that. I mean, is it that folks are now at a point where they're trying to milk their every euro they spend for the maximum impact? So we will do some analysis. I mean, I say that we haven't done all of it. We have started doing it, but we will have more information in a bit.

Okay. Our next question comes from Ryan. You mentioned we are not seeing the expected recovery we were waiting for this year. How much of this weakness is really due to the macro environment? Or are there any observations that customers may be shifting IT spending elsewhere?

I think -- and again, this is more of -- I'm not an expert on the macro itself. But what we see, and that we have been seeing consistently for the last year or 2, is this sort of waves of issues, right? So it could be a wave that ripples through, let's say, companies in a particular sector. Like Horizontal Tech, where there was a sudden focus on profitability because venture-funded companies had to be profitable for once. So there was that wave, right? And then there was a wave, maybe the banking mini crisis that we had. And then all of a sudden, the banking spending starts to slow down. Or energy issues and the Ukraine war. And so just these sort of ripples have been flowing through different industries. Maybe the fact that office buildings are not occupied, so the knock-on effects on building automation, for example, and so on. And I was in Singapore some days ago, and a client there has exposure to the Chinese consumer market, which is now buying much less of higher-end goods. So it's a complicated picture. I don't think I would call it a macroeconomic topic. And maybe it is. But in general, it's more of local issues all around the world. And unfortunately, the world is not uniformly -- running at a uniform high base. It's just got all these little issues. And from time to time, they affect some of our clients, and then that affects us. That's how I would characterize it. At least that's how we see it from our point of view, from our vantage point.

Thank you, Manas. Next question comes from Alejandro. It seems that Q3 results are almost the same as Q2 results. Is it possible in your opinion that we have seen the worst in the cycle and we are starting a new virtuous cycle with renewed strong revenue increases and a return of big EBITDA margins?

See, we would really like to hope that it's somehow been a period of false dawns, if I may. We have -- we were having a difficult '23. And in '23, we felt that this industry has never seen more than a couple of quarters of slow growth. And everyone thought that Q4 will come back and then Q1 '24 will be strong, and then if not H1, then H2, and so on. So I find it very difficult to predict the future. And it's very unfortunate that we have to try at least once a year to give out some guidance. If you look at Gartner's numbers, for example, I mean, if you see their predictions for how IT global services spending will go, they have had to revise it again and again and again. So I would not guess at what we are going to see next quarter. I would just say that the company is a very robust and strong company. I think we have done a very good job in building out this company in the right way. And yes, we will just do the best we can. Whether the winds are with us or against us, we will just do the best we can.

Great. Our next question comes from Andreas. I would like to know more about the current behavior you were seeing in Central Europe and the rest of world. What are the main drivers for the weaker performance? And have there been talks about potential projects in 2025?

So it's difficult to pinpoint these drivers. We have a lot of clients and we have a lot of different industries in which we operate. And it's not necessary that the trends are immediately visible. So I cannot make any overarching comments on what we are seeing in Central Europe or rest of the world. I do see, in the rest of the world, maybe it's a little bit of a pullback from relatively high spending levels and relatively loose spend on IT services. But it's difficult to generalize at this point, right? In terms of 2025, you know that a lot of our business comes from existing clients. A lot of our business, we have a decent visibility into by the end of the year, and I think this next year appears to be no different. But as I said, it doesn't appear to be a rapid recovery, but it does appear to be just nothing to be very worried about. It's nothing -- it's just a slow environment. I think that's just the best way to characterize it.

Okay. And we have a follow-up question from Arturo. Any update regarding generative AI projects?

Yes. As you know, we don't call out generative AI projects in terms of revenue or in terms of number of projects because I think it's very difficult to say when a project becomes a generative AI project. I think today a lot of projects have some aspect of generative AI in some way or form. But in general, we see that the topic still has legs. And as I said before, the changes that it's driving are largely on the data side, and I think that companies like ours will benefit in time over -- for those data topics that are triggered by GenAI. But yes, I think everyone in the industry is going through the same experiences, and I don't see that Nagarro's experience is fundamentally different from that of any of the other companies that are reporting the results and talking about GenAI. I think it's a topic that is clearly everywhere. And at the same time, it's not the singular topic that clients are talking about. It's more of -- it's more like a utility that is part of the solutions that clients are building for the most part, except where it's influencing data strategy and data engineering topics. That's where it becomes more directly linked to client spend.

Great. Thank you, Manas. And as we've run out of time, we'll be sure to follow up with any unanswered questions via e-mail. Let me turn the call back to Manas to close.

Okay. Great. Thanks, Michael. And thank you all once again for joining this call. We really appreciate it. And just have a great rest of the day. Thanks. Bye-bye.

Great. Thank you, everyone. This concludes Nagarro SE's Retail Investors Call. Thank you all for joining in, and you may now disconnect your lines.