TELUS International (Cda) Inc. (TIXT) Earnings Call Transcript & Summary

Thanks, everyone, for joining. My name is Tien-Tsin Huang. I cover the Payments and IT Services sector here at JPMorgan and really happy to have in person the TELUS International team, Jeff Puritt, CEO and President; Vanessa Kanu, CFO. And I was telling these guys like last time I spoke to them, they were, I think, in Central America, building houses and some housing improvement programs, and now they're stuck talking to me. So must be a little bit of a downer, but I'm really happy to have you guys here.

Not a downer at all. I was looking forward to finally meeting you in person. I know we've spoken dozens of times virtually over the last few years, but nice to finally seeing you in person.

No, likewise, and I've learned a lot talking to both of you in a short period of time. So we've collected some questions from investors. And we'll get a chance to have the audience ask questions as well, if that's okay.

Sure.

All right. So let's kick it off. I mean, it's not -- I'm assuming that most folks have some familiarity with the company. You've got some great clients, you're in some important themes in areas, visual CX, content mod. You see some clients and what's changing, and I think it was important maybe to start with the -- sort of the conversation, Jeff, what changes are you seeing in terms of client priorities here in the last 90 days? You went through some of that on the call. But I think it's important to go through that in front, if you don't mind.

So not surprisingly, I think fairly precipitously in Q3, a number of our larger tech centric clients, in particular, I'm pushing the pause button, as a result of their own uncertainty regarding how broad, deep, long this recession will likely be in some of our clients' cases. I think this is a relatively new experience for them, whether it's pursuing significant team member layoffs and just not enjoying the kind of double-digit growth that they have historically enjoyed, frankly, through their entire existence. And so unfortunately, precipitously, but not anything surprisingly somewhat elongated sales cycle, somewhat delayed decision making, as they all look to at first instance, try and shore up their current economic profile to address their own earnings cycle right now. And then hopefully, as they work through this, they, like we've seen in the past, will come to appreciate more so than ever, leveraging a trusted adviser, an outsourcing partner that has demonstrated scale and expertise and experience can continue to be a relief valve for them to continue to meet the demands of their clients.

Great to know that's the value of outsourcing. But have you seen anything? Or are there any interesting observations in terms of the breadth of what you're seeing in terms of client delays, whether it be through verticals or geographies?

Yes. I mean I think, clearly, Tech & Games, eCommerce & Fintech verticals have been more meaningfully pervasively affected in the dynamic I've just described, certainly less so the travel and hospitality, Communications & Media, banking, financial services and insurance. And from a geographic perspective, Europe for us has clearly been more meaningfully affected by this concern regarding uncertainty and how much longer is likely going to weigh heavily, and they have the added challenge, obviously, a proximity to the Russia invasion of Ukraine and the impact, among other things, on fuel prices, et cetera. So I think there's more exacerbated challenges in terms of elongation of the cycle and more pervasive hold before longer-term commitments are being made.

Okay. Good. So I get this question quite a bit post earnings. How much of your business is tied to your clients' transaction volumes? Like you mentioned Fintech, eCom, very clear, eComm slowed, and we're expecting a slower or softer fourth quarter. So is there anything that's directly tied to volumes?

Yes. I mean, again, it would depend on what service we're providing. In some cases, with some clients, it's not a transaction per hour relationship per se. So when it's project-based, when it's a more holistic longer-term engagement to build and transform something has nothing to do with transaction volume, and these are commitments that were made some time ago, and they're ongoing. In other cases, it is quite volume-centric. And so it depends on which client, which service line. And as you've seen, a long-tenure relationship, so a multitude of services serving these clients. Some parts are adversely affected as their volume decreases. In other cases, with the same client, other parts are not adversely effective.

Yes. Okay. Good. So thinking about clients changing here. I know vendor consolidation is another theme. We've heard it from other companies presenting today and throughout earnings season. So how broad-based is that? And how do you win in those situations where you're trying to get a gain or potentially get more business with existing clients?

So I think it's very pervasive, and we've seen over our existence in 17 years cycles where that's occurred, call it 2008, start of pandemic, specifically. How do we win has been really predicated on our value proposition to our clients in first instance. And so that has served us well. Each time there has been this exogenous driver behind do better with less and culling of the herd, if you will. So if you're the most expensive channel delivering the least value, you ought not to be surprised if you are in the cull. On the other hand, if you're delivering the highest value and you're perceived to be the most efficient partner, you ought to make the cut. And indeed, in our experience, we have always made the cut because it's consistent with our value proposition. We tend to be among the best or perhaps second best-performing provider of all of our clients. And so when they look across their supplier ecosystem, looking for areas of opportunity to drive better efficiency, whilst they go to their captive channel more often than not first because it tends to be the least efficient, most expensive when they turn their gaze to the outsourcing community. It's those that serve them leased well or deliver the lowest value intend to get excluded. Another lens through which they evaluate the group is single points of contact for a broader service set because there's inherent incremental cost, time, complexity and risk with each new supplier. So if you can get more of what you need from a single source in and of itself, that's more appealing, particularly during these more challenging times.

Right. So think about efficiency and value of work, we measure that, obviously, with margins and revenue per and things like that. You enjoy premium margins, and you've had premium growth for quite some time. I think on the call, Jeff, you talked about double-digit growth, right, being something that you strive for. So what gives you confidence in that double-digit outlook?

So both macro and micro dynamics and notwithstanding the current recessionary-driven pause, concerns about inflation uncertainty, et cetera, the nature of what we do and how we do it, I don't think is going away anytime soon. I think the digital transformation thesis has been proven out, accelerated and amplified through the pandemic. And virtualization, the adoption of virtual channels for every industry to be able to sell their products and services to consumers, I don't think that goes away. Everything I'm seeing, reading and hearing says people still recognize the criticality of they finding ways to leverage technology to drive better business outcomes, both reduce the cost to serve and a better client experience. So in totality, I think the macros are still in place. The micros, among other things are -- so right now, all people are paused and worrying about the uncertainty and not ready to make commitments. So what do we do? Well, as we've done historically and again, I think we do better because this is not a pivot for TI. This is not a new muscle memory we're developing. Our origin story are, do more with less, do better with less. So we drink our own champagne, eat our own gourmet cooking, leverage talent and technology, automation, so that we can continue to mitigate the inexorable inflationary dynamics of an operating cost structure. So we just have to do that even more so now and be ready as the trusted adviser as these clients finally get past this earnings cycle and realize longer term, you know what an outsourcing partner, a trusted adviser at scale with the expertise and experience they want, can actually be a source of salvation for them in long term.

Good. Good. So I know just staying with, if you don't mind, we talked about double-digit growth and going back to premium margins and operating expenses and being disciplined. I think you and Vanessa, you're very clear, right? You're not going to cut heads in a material way, culturally, that's not what you do, but you have slowed hiring. So as you think about managing OpEx here, given what you said earlier around your client demand changes, what kind of levers do you have on operating expenses that you're willing to pull?

So why don't you [indiscernible]...

Sure. As we said on the call, thanks for acknowledging that, clearly, we have to manage the spend profile to be -- to align with sort of the revenue outlook. And some of the levers that we pulled in Q3 and are continue to pull into Q4 as well, we look at the variable costs. We look at the discretionary costs. We look at where we've got opportunity with third-party spend. You're not going to see TELUS International announcing 10,000 or 11,000 team members being let go. Frankly, as you kind of look at our Q3 team member comp profile, we were fairly consistent in the team member count between Q2 and Q3. And part of that was actually just making sure that we moderate the pace of hiring. So we're not being forced down the road to do any sort of more dramatic changes as some of these other companies that are now in the headline doing so. It's managing the cost profile from that perspective and looking at the pace of new hires entering the company, but it's also looking at other levers, like third-party spending, other variable costs and contractors that may not be as fully utilized, et cetera.

Got you.

More sustainable ways.

And Jeff, I know you've mentioned, right, the short-term nature of probably this happening because companies have work to do and the digital agenda is so high on the priority list. So we're seeing all these tech layoffs in the news and whatnot. At what point does that start to drive up the demand for outsourcing as you see it? Because inevitably will happen. And if companies want to flex up and down, they can flex up and down very easily with TI. So how do you see that?

So indeed, historically, again, where that has occurred, where that captive channel got constrained early on in the efforts to try and mitigate the slowing revenue growth profile, it was very quickly followed with increase in demand for our services because we are purpose built to mitigate the implications of that captive channel being under-indexed and indeed, to your point, exactly. One of the main reasons why outsourcers exist is because we can, indeed, we are expected to be that flex option without sort of taking on massive fixed costs that then carry a whole bunch of residual obligations that a company doesn't want to have to deal with, particularly around labor and talent.

Yes. So as we are preparing for the session and asking investors what we should hone in on and looking back at questions we received, content moderation was definitely high on the list. It's a newer area to some degree, even though it's been around for a long time. But given everything you just said there, how does the demand for content moderation work change here, given what you see in the demand environment?

Oh boy, oh boy, it's there in the news right now, 20 minutes ago, more news on sort of a fairly dramatically changing landscape on content moderation globally. I think the profile follows quite closely the thesis we just discussed. I think we're seeing more and more complexity from a regulatory perspective. We're seeing more and more risk from a labor perspective. And I think it's becoming more and more obvious that this is a subsegment of the services industry that is not for amateurs. I think you need to know what you're doing, and you need to be willing to invest meaningfully in an end-to-end resiliency framework that ensures that you can mitigate to the largest extent possible, some of the more obvious implications of this not insignificant undertaking. I mean unless and until we decide we're just going to stop letting anyone post anything to an Internet endpoint, there is going to be a need for moderating activity. And so not dissimilar from firemen and women and police men and women. I mean there is a certain type of individual that I think is attracted to doing important work and keeping the Internet safe for our children, safe for our spouses, safe in general and not just safe from some of the more salacious base elements, but even safe from reliable, predictable, honest interactions. I mean the moderation has become quite broad now, and the challenge of ensuring that those activities are undertaken on a sustained basis is not easy. So when we see people like cognizant a few years ago self-selecting out and 20 minutes ago TELUS performance self-selecting out, I think that's emblematic of a recognition that it takes a particular kind of effort, and it's not for everyone. We believe, at TELUS International, that our unique and caring culture that we've talked a lot about, sets us up favorably to be the right home for content moderation more pervasively because we've over-indexed on focusing on employees at first instance. So how we recruit our digital first responders. It's a different profile than I think a lot of our competitors. It's not just looking for people with hero complexes. It's not just looking for people who want to help, but it's also based on experience, recognizing that in order to do this kind of work sustainably, you have to be the kind of person who is willing to ask for help yourself. Instead of bringing them on, on a transaction basis at volume, at scale, which I think is the heritage, the legacy of a lot of older BPO, CRMs, it's being a lot more thoughtful and targeted in taking the time, not just to have the right recruiting profile, but then psychometric testing, then ensuring that you're onboarding them in a thoughtful, comprehensive patient way. And if you're transacting and you're rushing, you don't have time for that. You invest more, it's more expensive, but then you get a better outcome and then throughout the life cycle of these digital first responders, it's not optional for them to participate in mental health touch points. Again, back to our caring culture, we don't match up women, digital first responders working in Turkey, with occupational health therapists in Nevada, who are middle-aged white guys. So again, just in every facet of our ecosystem, taking the time to intentionally thoughtfully focus on the care of the human being digital first responder, that has paid huge dividends for us already. And that's why we're going to step into the opportunity that our competitors stepping out of creates. And so far, it would seem that our customers also appreciate how we do, what we do as they continue to come to us to grow that opportunity with them.

Well said. And I think you've always said, right, you're going to be all in or not on this. And when we did the diligence, the all-in was a lot of what you said, you have mental health wellness programs on staff right there to help people. It's not something that you just staff and deliver against. I mean you have some dedicated force trying to service need. So it's an all-in?

For sure. And I don't think the opportunity is shrinking anytime soon. I mean even when we read about slowing growth for incremental subscribers on certain social media platforms, well, I think most people would agree that much of what had been their growth is now being picked up by a different social media platform, who also happens to be my client. So in and of itself, if it was only a zero-sum game, we still feel really bullish about it, but user-generated content is going up. So even if there are fewer subscribers on the platform, we all seem to have more to post every day. And so that means the opportunity to challenge the responsibility to deal with it is not going away, and then overlay that with the continuing evolution and complexity of the regulatory frame work as governments and regulators around the world continue to struggle with how best to moderate, manage, mitigate the inherent risks associated with this, right, free speech, not free speech, moderating free speech. I mean gosh, look at just what's happening at Twitter right now. I mean it will be interesting to see what opportunities arise as a result of where that ends up.

Yes. It's a fun so far, but watch though...

Like I said, not for amateurs.

Yes, definitely not. Here you let them clear you're bullish on it. If I could hire a content moderator manage my...

But Tien-Tsin, I know you know this. But I think one of the underappreciated things about content moderation is the fact that 95% of the content that gets moderated is actually quite benign, right? And I know you know this, but I just want to make sure others appreciate that as well because I think because of what makes the headlines, it tends to get the -- there's a perception that this work is just nefarious, it's bad, it's always the most awful of content, and it's 5% of the overall content. So it's a fairly small portion, but of course, that's what makes the headlines.

Yes.

And even of that of that 5%, 95% of the 5% is already identified by AI. And so it's 5% of the 5% that's really left behind for our digital-first responders. That is still mega volume just given what I've described. But in totality, the ecosystem, we believe is quite attractive because of those proportions.

Thanks for pointing that out. I do want to ask about WillowTree, but before we do that, let's do the data annotation business, of course, another acquisition, another fun area. Is demand fairly resilient there as your thesis changed at all since buying Lionbridge?

Thesis unchanged, and we're still very, very pleased with that transaction. Boy, Oh boy, I feel blessed sometimes about how pressing some of our inorganic investments at scale have been and when made them continuing to take share from the competition, continuing to see that in conjunction with a broader service offering that just seemed to be a more attractive alternative to shared clients versus those who are more single-threaded on the annotation front. And the peanut butter jelly, hand in glove combination of annotation and moderation, again, continues to bear itself out. So you should expect to see us continue to push on that thesis.

Okay. Good. Let's do WillowTree. Based on my hometown, I think I told you [indiscernible] big [ EVA ] guy and a lot going on there. But why is now the right time to acquire WillowTree?

So I mean M&A is inherently opportunistic interim. And so when opportunities present themselves, one has to make a decision of whether or not it's the right time. And so notwithstanding these recessionary uncertain times, assets like WillowTree don't come around often, scaled, profitable, fast-growing, $190,000 per team member per year, high-value work and perhaps most excitingly, a whole bunch of folks that seem to think and act and value the same things we value at TELUS International. So we don't feel like it's going to be culture clash in terms of the alignment and integration. We kind of hit it off at the original management presentation. We hosted site visits, they hosted site visits, and even though management owned a minority of the company circa 40%, they had a meaningful say in where their future home would be. And so they chose TI, and they told us they would tell you if you asked, I'm sure, it's because they see in us a real affinity in terms of how we think about treating employees, treating our communities, working with our customers. And so it gave us even more confidence as to our ability to realize the revenue synergies that are really what underpins our confidence in 1 plus 1 equals 3 or more. They're selling their services into our customer base. We're selling our services into their customer base. I mean, there's already as part of our post-merger integration planning, like a laundry list of opportunities, starting with not surprisingly, [indiscernible] TELUS, TELUS' own digital transformation, TELUS Ag and Consumer Goods, TELUS Health and LifeWorks, opportunities for us to put to work immediately these WillowTree capabilities at scale. And so when management put their money where their mouth is, if you will, it wasn't just we want the highest bidder and, where we feel we have a home, but we think this home is so exciting, we're going to reinvest $160 million plus of the purchase proceeds back into TELUS International plus take $125 million of TELUS International equity, rather than cash in the purchase price. All of those attributes lend themselves favorably, I believe, to confidence that now was the right time to get an asset like this. There are no other assets that I'm aware of at this scale with this growth rate, with this profitability profile, with this capability set to get what we get from WillowTree. I think we would have to do 3, 4, 5 smaller deals at the same time and then deal with the execution risk of a roll-up of all of them and integrating them. This felt like a much safer, less risky way to achieve our objectives.

Okay. Good. Before I open it up, just to stay with that, I know Vanessa you talked to me a lot about the whole valuation framework around M&A and in the criteria, accretion and dilution, funding, that kind of thing, of course, the cultural fit. But anything else to call out from a philosophy standpoint? I know keeping management is very important and tension packages are very important. Anything else to underline?

Yes, I mean, this is our 10th acquisition. And so there's pretty good DNA, I would suggest, with in TI in terms of what makes a successful acquisition. The diligence phase is difficult because we want to make sure that we go through all the right steps before we get to ultimate decision, and we want to proceed with the specific candidate. But you called out the key things because we talked about these things before culture being such an important element of the final decision making. But as you can imagine, the financial model, the business case has to hold together. So we look at all sorts of rigorous metrics. We don't just use our weighted average cost of capital. We add incremental hurdle rates to the equation. We pressure test the model. We look at the overall discounted payback period. What's the IRR pressure adjusted cash flow model. We look at what does the deleveraging profile look like, combined cash flows of the organization post acquisition. Integration planning starts very early as well because we know that to make a successful acquisition requires an even more successful integration, frankly, because that's where a lot of M&A, that's where most of them end up failing. And so we start that integration process as early as we are allowed to. And I say allow to because clearly, there are certain regulatory requirements that we have to adhere to, but getting those early planning in place and looking at how can we quickly start to cross-sell, joint sell, go-to-market, et cetera. All of those are pretty important elements of all of our acquisitions. I mean if you look back, CCC, which we spent a lot of time talking about content moderation today, we were already doing content moderation, but that brought the ability to do better at scale. Lionbridge AI. Again, we talked about AI today. Again, that has also brought us the ability to do that at scale to the point where we're the #2 scale player. So all of our acquisitions have been highly accretive thus far, and we certainly anticipate WillowTree will be as well. And again, it's a long term, right? These are long-term investments. We're not measuring success in 3-month increments. But overall, as you look at the longer-term model, certainly, they've all been accretive, and we expect WillowTree to be as well.

Okay. Good. I've held up a lot of time. We have 4.5 minutes left, any questions, happy to take them. [indiscernible] keep going. Yeah.

[indiscernible].

So we've not guided for 2023 yet, but we certainly will be as soon as we can. So I need to be cautious about how much color I provide to you at this juncture on that topic. Suffice to say that as I discussed moments ago, we continue to see tremendous opportunity both from a macro demand perspective and micro vis-a-vis our incumbent base. Remember that although Tech & Games, eCommerce & Fintech make up 60% of our client base, and there where we've seen most of the current pause, travel and hospitality, BFSI, coms and media, we haven't seen nearly as much of a slowdown there, very, very healthy double-digit growth still, and we are anticipating even more so, particularly from travel and hospitality and from healthcare, going into 2023. So hopefully, if we're back together virtually or face-to-face early next year, you'll hear from us, I hope, a pretty exciting plan for continued growth in 2023.

Real quickly, can you talk about data annotation services? Can the growth rates in that business stay strong, like they are right now, in an event of macro recession?

Well, I think they can. I sure hope they do. We are planning for them to. There's no question that given the hyperscalers represent 80%, 85% of global demand today and many of they are the ones that are in the news right now, trying to figure out how to manage sort of a change in growth profile more broadly. And there's no question, in some cases, some of these projects that require annotation at scale are perhaps perceived to be discretionary. I think they would tell you, they, the hyperscalers tell you that in the fullness of time, they see AI continuing to proliferate. And by definition, 70% of the ground truth of machine learning algorithms is data annotation. And so unless and until they're willing to abandon continuing to leverage AI more broadly, I don't think they can, even if they want to, walk away indefinitely from annotation activity. Equally importantly is the relative growth rate of AI proliferation down market, if you will, and not down far, but literally now at enterprise, never might majors and emerging, there is more and more demand and opportunity. The use cases for AI continue to be exploding. And so whilst the relative growth rate of the current hyperscaler demand that may slow or perhaps you could pause, we're hoping, we're expecting that we're going to see a substitution by virtue of the enterprise adoption of AI more broadly. And there, we have an opportunity to actually do more than just the annotation where we can actually help with the actual development of those algorithms and the deployment of them. So we think there's still pretty exciting growth attributes in that space.

One more question. If any? Maybe just close to that, if you don't mind, with some customer concentration going to TELUS, obviously, the big client there, visibility or any considerations that may impact your midterm growth for some of your larger clients beyond the macro?

So we've talked about the challenge and the blessing that having these monster clients in our top 10 represent right. Even as much spend as we enjoy with them today, we still don't have meaningful share of wallet relative to their overall spend such that even if they diminish their spend meaningfully in totality, we believe the opportunity to win share away from the competition still represents significant upside potential for us within those incumbent accounts. And there, back to my earlier comment, how we think we win is by delivering better value, better service quality. And generally, they would tell you we are among their best performing providers. So as long as we can continue to demonstrate incremental value add on a relative basis, it's like that old bad euphemism, right? You don't have to outswim the shark or outrun the bear, you just got to outswim or outrun the other guy. If we can do better than our competitors inside these accounts, there's still significant growth potential. We recognize that there's philosophically, mathematically, risk in concentration. And so we're obviously always working to continue to improve the client concentration profile of the business. And the one thing to be mindful of is who's in our top 10, is not the same 10 all the time, right? In fact, one of the clients we were just inferentially referring to before wasn't a client at all 3 years ago. Now they're not even in our top 10, they're in our top 5 by revenue in less than 3 years. There's lots of those kinds of clients out there still, and we're excited about the opportunity to continue to grow them and then add new logos to the platform, if you will, growth to existing and variably is sort of 85% to 90% of where growth in 1 year is. But as we continue to invest more in our direct sales channel, I think the opportunity to win new clients, who then have the potential to scale consistent with our land and expand thesis. Hopefully, we'll continue to improve and mitigate the inherent risks of an undue concentrated client profile.

All right. Great. Half-hour went by quickly.

Just like.

Yes. Vanessa, Jeff, thank you so much, enjoyed the conversation.

Thanks very much.

Thank you, Tien-Tsin.