Telus International Cda Inc

TSX:TIXT

Earnings Call Analysis

Revenue and Profitability Challenges Amid Macro Pressures

TELUS Digital faced continued pressures in Q2 2024 with a challenging macroeconomic environment impacting profitability. Revenue reached $652 million, but competitive conditions and a decline in key client volumes—particularly in Europe—significantly affected margins. Adjusted EBITDA increased by 10% to $130 million, partly due to favorable income from business combination provisions. However, the company faces higher wage inflation and attrition costs. TELUS Digital has revised its full-year revenue outlook to $2.61-$2.665 billion and adjusted EBITDA to $465-$485 million, expecting margin stabilization in the second half.

Earnings Overview

In Q2 2024, TELUS Digital recorded revenues of $652 million, reflecting significant challenges due to a competitive macroeconomic environment and varying client demand. Notably, while revenues from their two major clients, TELUS and Google, saw growth, the overall demand was softer across the broader client base. TELUS Digital's leadership acknowledged these pressures but highlighted a positive 13% growth in their AI-related business, which offset some of these headwinds.

Profitability and Margins

The adjusted EBITDA for the quarter was $130 million, up 10% year-over-year, with an adjusted EBITDA margin of 19.9%, an improvement of 220 basis points. However, management indicated that if not for favourable adjustments stemming from business combination-related provisions, revenues were projected to decline in tandem with margins due to higher service delivery costs and wage inflation.

Challenges in Client Spending

Management recognized that customer expectations have increased dramatically, with clients demanding 'more for less.' This has resulted in reduced spending from major clients due to competition and tighter budgets. A key point emphasized was that while the company was seeing positive trends with top clients, these were insufficient to fully counterbalance the losses faced in other areas, particularly due to decreased spend from one of their major clients.

Strategic Cost Management

In response to the pressures, TELUS Digital initiated several cost management strategies, including hiring freezes and vendor renegotiations. The company is focused on optimizing indirect costs, with projected savings of about $30 million realized in 2024 from these initiatives, down from the initially planned $60 million.

Guidance and Outlook

Looking ahead, TELUS Digital revised their full-year revenue guidance to a range of $2.61 billion to $2.665 billion, indicating expected growth in the second half of the year. Adjusted EBITDA for the full year is now projected to be between $465 million and $485 million, with margins anticipated to hover between 17.8% and 18.1%. The adjusted diluted EPS guidance has been set in the range of $0.39 to $0.44.

Focus on AI Initiatives

TELUS Digital's AI-related business remains a focal point for growth, making up approximately 15% of their overall revenue and witnessing year-to-date growth. Upcoming initiatives like 'Fuel iX,' their enterprise-grade GenAI engine, are expected to drive future growth, with meaningful contributions anticipated from clients engaging in generative AI solutions starting in 2025.

Long-Term Strategic Direction

Despite the current challenges, the company’s leadership expressed confidence in the long-term viability of its strategies, particularly within AI and digital transformation. The management reshuffle, with a new CEO taking charge, signals a commitment to returning to sustainable, profitable growth.

Final Thoughts

In summary, while TELUS Digital faces immediate pressures from macroeconomic conditions and client spending, their growth strategies focused on AI and operational efficiencies provide a roadmap for recovery. Investors may watch for the execution of these strategies and the potential stabilization in revenues and margins as the year progresses.

Earnings Call Transcript 2024-Q2

[Operator]

Good day. Welcome to the TELUS Digital Experiences Q2 2024 Investor Call. I would like to introduce your speaker, Ms. Elena Lebac. Please go ahead.

[Elena Lebac, executive]

Thank you, Karl, and good morning, everyone. Thank you for joining us today for the TELUS Digital Second Quarter 2024 Investor Call. Joining our call today will be Darren Entwistle, Chair of the TELUS Digital Board of Directors, along with Jeff Puritt, President and CEO; and Gopi Chande, our Chief Financial Officer.



We also have Jason McDonell, Senior Vice President of Customer Service Excellence at TELUS and Tobias Dengel, President of Willow Tree. We will open with Darren Entwistle and Tobias, providing brief introductory remarks. After that, Jeff and Gopi will continue the call with an overview of the results. And Tobias will join them to answer your questions before we turn the call back to Jeff for his closing remarks.



For our cautionary statements and further context on certain non-GAAP measures used during today's call, please refer to the appendices of the earnings release issued this morning and the regulatory filings available on SEDAR+ and EDGAR.



With that, I will now pass the call over to Darren.

[Darren Entwistle, executive]

Thank you, and good morning, everyone. I'm participating briefly on our call today, and my role is the Chair of the Board of TELUS Digital to announce some important organizational developments. It is with immense gratitude and appreciation for his innumerable contributions to TELUS Digital over the past 2 decades and 24 years as a TELUS team member that we announced the retirement of Jeff Puritt, President and CEO of TELUS Digital, effective on the 3rd of September.



I'd like to take this opportunity to personally thank Jeff for his leadership in shaping our TELUS digital business since its inception from a single delivery center in the Philippines with fewer than 2,000 team members to an integrated global provider of AI, digital and customer experience services with over 75,000 employees, serving more than 650 clients from 32 countries around the world.



In recognition of Jeff's unwavering commitment to our global team throughout our company's journey, following his retirement, Jeff will assume his new role as Executive Vice Chair of the Board at TELUS Digital. Importantly, in this capacity, Jeff will be responsible for our corporate development activities given his expertise and experience in mergers and acquisitions.



Jeff's efforts will complement and amplify the company's return to profitable growth that we are so committed to seeing and delivering upon. In his role, Jeff will also support the government and Investor Relations functions within TELUS Digital.



TELUS digital strategy remains solidly rooted in proactively embracing the latest technology to drive excellence in customer service, harnessing the next frontier of digital innovation and AI to enable our talented team members to deliver successful outcomes for our clients and further strengthen TELUS Digital's brand leadership in the industry.



Consistent with this strategy and our best-in-class commitment to robust succession planning, Jason McDonell, a 20-year tenured member of the TELUS senior leadership team will succeed Jeff as CEO of TELUS Digital as well as take on the operational role of President, TELUS Digital customer experience.



Most recently, Jason served as Senior Vice President of TELUS Customer Solutions Excellence and President of TELUS Smart Security and Home Automation. Jason clearly has a proven track record of bringing the capabilities that TELUS has developed the lead in the industry in respect of client care, loyalty, cost efficiency and digital transformation excellence to all the business verticals that TELUS Digital addresses.



Additionally, Tobias Dengel, Founder and President of Willow Tree, will take on the elevated role of President of TELUS Digital Solutions. Tobias has both the industry-leading expertise and the entrepreneurial drive needed to ensure we continuously deliver best-in-class solutions across our digital, GenAI and AI modeling businesses. Both Jason and Tobias will report directly to the TELUS Digital Board of Directors.



We are clearly eager to see the significant leadership contribution and impact that they will make in returning TELUS digital to material profitable growth. On this call today, we have both Jason and Tobias joining us for a brief introduction. You can also count on having further opportunities to engage with each of them in the months ahead.



And on that note, Jason, let's start with you.

[Jason McDonell, executive]

Thank you, Darren. Hello, everyone. As you are aware, TELUS Digital has a tremendous history as a global leader in digital customer experience, carving out a meaningful market position to serve some of the world's most well-known brands and forward-thinking clients. I'm excited to carry the organization forward on the strong foundation of world-leading culture, innovation and leadership deeply fostered by Jeff and the TELUS Digital leadership team.



A little about me. Since joining TELUS customer service transformation and business growth have been core hallmarks of my experience. As the Senior Vice President of Customer Service Excellence, I led the organization responsible for millions of TELUS customers across mobility and home services. In this role and many others, I've worked extensively with the TELUS Digital Experience organization to couple advanced technology with innovative operational methods that drive material business value.



I'm pleased to join an organization that shares my passion for growth, customer experience, technology and transformation, and I look forward to working with our global leadership team to champion meaningful value for our shareholders, our customers and our global communities as well as providing industry-leading, digital-first outcomes backed by exceptional technology-supported human interactions.



Thank you for the opportunity to introduce myself. I look forward to meeting and working with many of you on this call in the near future, including my good colleague, Tobias. Tobias over to you.

[Tobias Dengel, executive]

Thank you, Jason, and good morning to everyone. Over the years, TELUS Digital has defined a new category in its industry, right at the intersection of digital IT and digital CX with technology playing a central role in the evolution of our company. I'm very excited to be part of bringing this company to the next frontier of our digital evolution, not least in the area of AI.



Our mission is to provide the tools and services that fuel our clients' ability to adopt and maximize the value of AI in order to deliver the best possible customer experience. While the promise of AI is real, the implementation of AI in most enterprises has lagged the vision, driven by a lack of data readiness, a lack of trust and a lack of control. Our solutions squarely address these core impediments to scale of enterprise adoption.



Data is foundational to every AI deployment and our capabilities uniquely position us to partner with our clients to responsibly design, build, implement, deliver and scale their AI and GenAI use cases. Our differentiated end-to-end approach across both the data and AI life cycles is a critical factor in helping us to address our clients' major points of friction in order to focus on innovation and growth. Flexibility, control and trust are the core facets of our AI offerings.



Trust is a crucial component as confidence in the model's performance and responses remain a major impediment for our clients launching GenAI solutions into production. And we aim to be a significant player in providing that solution. Our ability to test drive real use cases at scale with TELUS in the highly regulated industries where they operate, including telecommunications and health care before actually going to other clients is unmatched in our industry.



Indeed, our unique partnership with TELUS is a meaningful competitive advantage, a proven ground that competitors simply do not enjoy. Rest assured you'll be hearing more from us on that front as we continue to accelerate our lineup of GenAI product releases, showcasing our thoughtful and comprehensive approach in advancing our capabilities, both for our clients and internally.



With that and with my deepest appreciation for his legacy his ongoing support of our new leadership team and his mentorship and partnership over the last 18 months since I've joined the firm. Let me turn the call over to Jeff.

[Jeffrey Puritt, executive]

Thank you, Tobias. Thank you, Jason, and thank you very much indeed for those very generous comments, Darren. I'm very pleased for both Jason and Tobias to take on their responsibilities, and I'm fully committed to making sure they have a successful start in their new rules. I'm truly honored to have served as the President and CEO of TELUS Digital. And in my new capacity as the Executive Vice Chair of the Board, I look forward to the exciting future for our business.



I'd like to thank our Board of Directors for their continued support of our leadership team as well as the entire TELUS Digital team for their remarkable passion and dedication. As part of this transition, on behalf of the Board and our management team, I'd also like to sincerely thank Jose Luis Garcia, who has served as the company's Chief Operating Officer since May 2023. We're very grateful indeed for his valuable contributions and we wish Jose Luis continued success in his future endeavors.



So I appreciate for our audience. This was a lot to digest just in one morning. however, I'll now focus our call back on the quarterly results and the outlook provision we released earlier today. Our results in the second quarter reflect continued pressures on our business from the challenging macroeconomic and operating environment. Our management team and of course, I personally fully acknowledge the impact of how our efforts to address the challenges we experienced since last year and our resulting underperformance has put a tremendous dent into our longer-term track record of delivering sustained profitable growth.



While earlier in the year, we saw solid signs of the demand recovery on the horizon, including a record in new client bookings in the first quarter, the pace of new client bookings slowed in the second quarter despite continued strength in our sales funnel. Meanwhile, fierce competition on price and restricted client spending persisted. Similar to our peers in now not seeing improvement in the macroeconomic environment, we too no longer expect the magnitude of recovery previously expected for the second half of this year.



As a result, our financial outlook for the full year 2024 is revised to better reflect the current balance of risks and opportunities. Later on, this call, Gopi will share much more detail on the outlook and our assumptions while I want to emphasize that our revised outlook implies stability and incremental improvement in the sequential half year revenue as well as stabilization in margins, aligned with the second quarter when normalized for impacts associated with the Willow Tree earn-out.



To turn back to the quarter and share with you some of the positive signs and trends, our AI-related business remains a highlight, with revenue growing 13% in the first half of the year, offering some offset to the headwinds experienced elsewhere. At the same time, our business yielded free cash flow as a percentage of revenue at 15%, both in the quarter and the first half of the year. Our capacity to generate consistently strong cash flows will continue to support reinvestment into the business.



Our top 2 clients, TELUS and Google, which collectively accounted for 39% of our total revenue in the first half of the year continue to provide a meaningful level of support. Our revenue streams with these 2 clients are diversified and growing, supported by our long-standing relationships with both companies as an enabler of their business success. Overall, however, the positive contributions from our top 2 clients were not enough to offset the pressures that persisted into the second quarter of 2024, with softer demand volumes across much of our broader client base.



I'd like to spend a few moments sharing my thoughts and observations on our profitability, including the broader trends impacting our performance to date this year and the actions we're pursuing as we seek to return our business to robust top line growth and desired sustainable long-term improvement and profitability.



Since the second quarter of last year, one of our top 3 clients reduced spend with us not only had a significant impact on our revenue trajectory, but also had an unfavorable flow-through to our margins. Our efforts to stabilize and return this account to growth, which are now starting to show success, have unfortunately come at the cost of a meaningful margin rerate for 2024.



While we continue to work diligently on optimizing our global operations with many initiatives already underway, we're equally dissatisfied with the pace of our progress in transforming and reducing our cost structure. In retrospect, we may have underestimated the time it would take to see more meaningful outcomes from our actions. These include deploying more automation inside our business and across our global footprint with the sheer scale of our organization, introducing complexity and the need for more time to implement our plans.



I believe this is a particular area of opportunity for Jason McDonell to make a meaningful impact, leveraging his proven expertise in transforming customer service operations through cost efficiency and digital innovation. We're also working to decommission legacy tools and systems and migrate to a more GenAI-enabled environment using the same technology we're bringing to our clients like Fuel iX before our own internal use. And we're standing up and amplifying right short centers of excellence with a goal to tap into our established global footprint to optimize and improve the quality of our operations delivery and support functions.



These are a few examples, and we commit to sharing more details with you as we make progress in the remainder of this year and into the future as this is not a one-and-done set of initiatives, but rather a path to continuous improvement of our operations to make our business even more resilient for the future. I'm hopeful that we will see better progression over the remainder of this year and that it will yield a more significant improvement in our cost to serve and further optimize our global operations into next year.



From a broader market perspective, the macroeconomic environment over the past 18 months, in particular, has fueled our clients' expectations of receiving more and better for less, something that will likely persist for all players in our industry. Nevertheless, I continue to believe that we have a much better capacity to solve for this than most with our digital-first mindset and growing capabilities in areas like Generative AI. As we continue to evolve TELUS digital towards a more technology-centric and specifically AI fuel business, this fundamental change will also help to future-proof our business model.



In the near term, however, this transition necessitates some cannibalization of our tenured and higher-margin CX work historically in the mid-20s to mid-30s EBITDA margin range with still nascent and relatively lower margin AI revenue streams. We believe this near-term margin dilutive trade-off will be resolved as our GenAI-focused offerings continue to achieve better scale, generating a much-improved level of profitability, which will bolster the acceleration of our overall enterprise margin profile.



We've already achieved meaningful scale in AI as one of the largest providers of AI data solutions, including data collection, annotation, creation and validation. With the strength of our platform, we're able to source very specific talent globally for our clients to tackle the ever more complex data sets used to train and optimize GenAI and other AI models. Our AI-related business currently generates 15% approximately of our overall revenue or about $200 million year-to-date. And as I mentioned, grew 13% year-over-year in the first half of 2024.



As you've heard from Tobias just now, data is at the core of AI implementation. And our team provides solutions at scale for clients who need to clean and optimize their vast data sets to training their custom models via RAG, which is Retrieval Augmented Generation as well as other implementations that enhance the accuracy and reliability of Generative AI models.



As I've discussed on previous investor calls, Fuel iX is our enterprise-grade GenAI engine that serves as the foundation for us to help clients move their GenAI use cases from pilots to production at scale quickly and safely. We expect to start seeing meaningful revenue contributions from Fuel iX in 2025. Again, this is an area where Tobias and his team will be instrumental in growing our scale and positioning in the market.



Competition in the AI space continues to intensify with various partnerships being formed to accelerate the transition and market share gains. In our case, we see our AI capabilities increasingly resonating with clients despite facing competition from the pure-play AI vendors backed by many of the same hyperscalers we pursue with clients.



We're also working directly with AI model developers and collaborating closely with each of the 3 leading hyperscalers as our Fuel iX capabilities are typically complementary to their offerings. In fact, Fuel iX is both LLM and cloud agnostic, enabling our clients to easily switch between AI models and cloud services as needed to avoid vendor lock-in and future-proof their GenAI investment. To date, we've developed customer agents and employee-facing bots.



I'm particularly proud of our work to help TELUS launch the world's first ISO privacy by design certified GenAI customer support tool powered by Fuel iX, the chatbot provides customers with secure, fast and intuitive responses to their queries, providing them with a more convenient and seamless digital experience. TELUS' SPOT copilot, a single point of contact IT support bot also operates on the Fuel iX platform. This GenAi fueled copilot has revolutionized the IT support experience for the company's employees, providing a high-quality, self-serve channel that's driving cost savings and instilling a digital-first mindset across the organization.



And lastly, on Wednesday this week, we launched Fuel EX and Enterprise safe GenAI employee assistant to support productivity, creativity and research. Fuel EX is the first public launch of an application built on Fuel iX. Fuel EX is currently in operation at scale within TELUS, where it's used by 35,000 employees.



The app provides a single point of entry for employees to access an intuitive interface where they could select from more than 20 large language models from multiple vendors to help them with everyday tasks in clean knowledge searches, summarization, copywriting, image generation and code writing.



Fueled by our evolving capabilities in the second quarter of 2024, our Willow Tree sales team on GenAi jump-start consultancy engagements with one of the largest non-profit organizations in the world, one of Canada's provincial government departments and with TELUS Agriculture and Consumer Goods. Our team is also actively engaged in exploratory discussions with several other clients.



Willow Tree also won new clients in the quarter, including Wiley, one of the world's largest publishers and a global leader in research and learning specifically to modernize their marketing technology stack. With a well-known New York business-focused daily publication and with a U.S. based fitness chain among other notable new logo wins.



Our Willow Tree team further expanded their engagement with Inspire Financial, an American financial services company in addition to winning more business with CEATI, the Center for Energy Advancement through Technology and Innovation, which is a membership-based provider of shared cost R&D, training and networking services for power industry professionals. The team also expanded their engagements with a large marine boat and propulsion manufacturer, one of the world's largest hospitality brands and an American Financial Corporation, among others.



Our global TELUS digital sales team also won new clients across several sectors, including health care, transportation and consumer packaged goods. And we captured further opportunities to expand our engagement across our existing client base, not least with our third largest client, a leading social media network, along with North America's leading financial institution, an international online commerce platform and the largest food delivery platform in the United States, among others.



To reiterate, our relationship with Google remains very strong, driven by our AI Data Solutions division, in particular, and we continue to see meaningful growth across diversified work streams within our parent company, TELUS Corporation, enabling their successful digital transformation across all areas of their unique business portfolio. Overall, our sales funnel as of the second quarter end remains approximately $2 billion with approximately 10% thereof in AI-related opportunities.



With that, I'll now invite our CFO, Gopi Chande, to share details of our financial results, and I'll return at the end of the call to answer your questions. Gopi, over to you.

[Gopi Chande, executive]

Thank you, Jeff, and good morning, everyone. Thank you for joining us today. In my review, I will principally focus on our quarterly results, as most factors that influenced our second quarter had similar impacts on our results for the first half of the year.



TELUS Digital generated revenue of $652 million in the second quarter of 2024, reflecting an impact from a stabilizing yet still unfavorable year-over-year comparison of revenues with a leading social media network client, along with pressures from a broader and persistent and challenging macroeconomic environment, including competitive conditions in our industry.



Looking at our key industry verticals, while our revenues from the tech and games and e-commerce and fintech remains soft, our continued growth with other clients, notably Google, helped offset the overall impact. With Google, which remains our second largest client, quarterly revenue grew by 12% year-over-year. Our AI data solutions line of service continues to drive growth with this client.



Revenue in the Communications and Media vertical grew 1%, driven by higher revenue from TELUS Corporation, partially offset by softer volumes with certain other telecom clients. Health care vertical grew 27%, primarily driven by additional services provided to the health care business of TELUS. Overall, revenue with TELUS grew by 22% year-over-year.



Our TELUS Digital and Willow Tree teams continue to drive meaningful and diversified revenue streams, enabling our parent company's digital transformation, not least in the area of GenAI implementation as illustrated in the use cases shared today. Another area of growth was our BFSI vertical, up 5% year-over-year, driven by certain Canadian banks and smaller regional players in North America.



Among key components within the all-other industry vertical, which includes clients from various other industries. While we saw unfavorable year-over-year comparison, notably due to lower revenue in travel and hospitality, this was offset by good growth with clients in energy and utility as well as retail and consumer packaged goods, which had year-over-year growth of 4% and 18%, respectively.



Looking at our revenue profile by geographies, declines in Europe and North America were partially offset by growth in Central America, South America and Africa, which grew 12% in the quarter, reflecting expansion with existing clients in communications and media, BFSI and certain technology clients. Meanwhile, Asia Pacific delivered stable volumes with revenues increasing by 1% driven by sustainable volumes with clients we serve in that region, along with incremental growth with new clients.



Moving on to operating expenses. Salaries and benefits in the quarter were relatively steady year-over-year at $426 million. We lowered our average team member counts as part of our cost efficiency efforts that began in 2023 to rightsize operations. However, these savings were offset by higher training costs due to elevated attrition levels and higher average salary and wages, the latter driven by fierce competition for talent.



Our total team member count was 74,617 at June 30, a decrease of 3% year-over-year and consistent with the revenue change. Goods services purchased in the quarter were $117 million, a decrease of 3% year-over-year, also consistent with the revenue change. Changes in business combination-related provisions generated other income of $31 million in the quarter, arising due to amendments to the terms associated with the Willow Tree earnout and related provisions for written put options, resulting in a reduction in this provision.



Our renegotiated agreement with the Willow Tree management team is now based on revised performance targets of the combined Willow Tree and TELUS Digital success. It incentivizes a holistic growth approach across our entire business and drive an even deeper level of further integration. It also includes incentives to grow our Fuel iX offering in particular, where Willow Tree has deep expertise, ownership and accountability. You can find more accounting details related to the renegotiated agreement in Note 4 and Note 12 to our financial statements.



Share-based compensation in the quarter was $10 million, an increase of $8 million, primarily due to timing of award grants and associated expense recognition and higher expense associated with the share-based compensation awards granted in relation to our acquisitions.



Moving on to profitability. Adjusted EBITDA in the quarter was $130 million, an increase of 10% year-over-year, primarily due to other income arising from business combination related provisions, which were partly offset by a decline in revenue outpacing the decline in operating expenses and higher share-based compensation expense.



Adjusted EBITDA margin in the quarter was 19.9%, an improvement of 220 basis points year-over-year. If not for the favorable impact of the business combination related provision, our adjusted EBITDA declined and margin compressed year-over-year, reflecting lower revenue flow-through as well as higher service delivery costs. Some of the more notable pressures included higher attrition and absolutism in certain regions, notably in Europe that we are actively working to resolve.



Moreover, we are subject to the industry-wide higher cost delivery, particularly due to wage inflation across our footprint. Applicable to both the quarter and half year, we also incurred some upfront training costs and offer some strategic discounts for certain clients, items that put further pressure on margins but are meant to drive revenue growth for those accounts in the longer term.



Adjusted diluted EPS in the quarter was $0.16, consistent with the same quarter of the prior year. We generated free cash flow of $95 million in the quarter, an increase of 44% year-over-year, driven by higher net fee flows from working capital and lower income taxes paid, partially offset by lower operating profit and higher capital expenditures as a percentage of revenue, free cash flow was 58%.



Turning to our outlook. While we're not pleased with our results, our updated targets reflect 3 key items. First, similar to our peers and overall industry sentiment, we are not seeing any meaningful improvement in the macroeconomic environment. Now that we're halfway through the year, we no longer assume the magnitude of the broader demand recovery, specifically as it relates to previously assumed upside through the second half of the year. Second, we expect margins to stabilize in the second half, aligned with the second quarter when normalized for impacts associated with the Willow Tree earn-out. We'll continue to reduce and optimize our indirect costs with travel curtailment, hiring freezes, vendor renegotiations and the like.



And third, we have reduced the in-year financial benefits from our ongoing efficiency and transformation initiatives to reflect our revised expectations for what can be achieved in 2024. Of the $60 million planned in-year savings that we disclosed earlier this year, we now assume half or approximately $30 million can be realized in 2024 with 1/3 already implemented and a reasonable assurance of achieving the other 2/3 by the end of the year.



With that in mind, we expect our full year revenue to come in the range of $2.61 billion to $2.665 billion, implying growth in the second half from the first half of this year. For adjusted EBITDA, we now expect a full year range of $465 million to $485 million, with margins in the range of 17.8% to 18.1%. On a per share basis, our outlook assumes adjusted diluted EPS in the range of $0.39 to $0.44. We expect our 2024 cash taxes to be in the range of $45 million to $55 million. While we don't issue a quarterly outlook, I can share that on a sequential quarter basis, we expect the fourth quarter will show stronger growth in revenue and further stabilization in margin.



Our confidence in delivering on the revised outlook for the full year is supported by our rebound we're seeing in the Willow Tree demand and client engagement. At the same time, our targeted investments in sales and marketing will fuel our ongoing efforts to support growth in certain larger accounts and across our broader client base and our prospective pricing competitiveness. And overall, we continue to be encouraged by the composition of our sales funnel with a growing part of AI-related opportunities.



Our business continues to generate strong cash flows, not least as supported by our deep relationship with our parent company. Our use of capital will remain focused on paying down our debt and reinvesting into the technology-centric evolution and longer-term growth of TELUS Digital.



With that, let's move on to questions. I kindly ask you to please keep it to one question at a time so that everyone can participate. Karl, over to you.

[Operator]

Thank you. [Operator Instructions]. Our first question is from Ramsey El-Assal from Barclays.

[Ramsey El-Assal, analyst]

My question is, are any of the headwinds at your third largest client coming from them using Generative AI to supplant or replace work functions that you had been providing them previously? Are they getting more efficient, and that's led to some of the outcomes that you're seeing?

[Jeffrey Puritt, executive]

Thanks for the question, Ramsey, and for the kind comments. Indeed, I've enjoyed working with you as well. I hope that will continue. In a word note, whilst there's no question that AI continues to enable additional opportunities for moderation activity, the seemingly unending increase in user-generated content continues unabated. And it continues to be about 5% of the total volume that requires human moderation or digital responders as we call it. Our real headwinds historically have been because as you may remember, as we've talked about many times now, we're Europe-centric only in our support for that client and they'd looked for opportunities to reduce their spend in that most expensive delivery area.



And again, thankfully, as we noted, we seem to be on the rebound there, but the challenge for us right now is continuing labor centricity is eating into our margins significantly. But excitingly, we're looking forward to now diversifying our support for them across other service lines that in the fullness of time, we believe will both get us back to a more meaningful revenue growth and margin expansion.

[Operator]

The next question is from Daniel Perlin from RBC Capital Markets.

[Daniel Perlin, analyst]

I just wanted to talk about the kind of degradation that you see kind of outside of the top 3 clients, I know 2 of the 3 are doing really well. But it does suggest kind of like double digits decline in the quarter, and that was similar, if not maybe a little bit better than what we saw in the first quarter. But the deterioration, it seems like it happens so quickly for you guys. And so how do we kind of reconcile that in terms of like the visibility that you guys have with the model and how that can't just kind of change on a dime, which it feels like this wasn't the first time, but it feels like the magnitude of this change was quite a bit worse.

[Jeffrey Puritt, executive]

Thanks, Dan. Indeed, you're right, and it has been frustrating to see the volume declines happen on such short notice. You'll recall that the nature of our agreements with our clients provides explicitly that kind of optionality. That's why our clients look to us to sort of provide them with flex opportunities, both up and down as their own volume demands increase and win. It has been a source of frustration for myself and the team that we've not had better notice, if you will, around that kind of fluctuation so that we could be better prepared.



Part of this, I think, is a sign of the times. Again, as you've heard from our peers and from ourselves of late, with ongoing expectations from clients that we find a way to match their expectations on more or better for less. And our job that, frankly, I've not managed as well as I should have, is to be out in front of these kinds of adjustments and to do a better job on either preventing the decline and/or finding substitutes, whether in other areas of those clients' business or winning other accounts. And we just need to do better on that front in order to better inoculate ourselves from that kind of variation.

[Operator]

The next question is from Tien-Tsin Huang from JPMorgan.

[Tien-Tsin Huang, analyst]

Jeff, we'll definitely miss our interactions here. Grateful to have learned from you. I ask another sort of education question. If you don't mind, just thinking about the pricing pressure you described. I'm just curious, is this driven at this stage on an incremental basis, more by competitive actions in your mind? Or is it a cyclical issue more so or a secular one?

[Jeffrey Puritt, executive]

Good questions as ever, Tien-Tsin, I too will miss our interactions. But hopefully, given my new role, I'll still have the opportunity to spend time learning from you. I think it's all of the above, candidly. I think as I mentioned before, there is this pervasive persistent expectation of more and better for less. The customers are driving a lot of this but as well our peers are willing to pitch up at a price point that is considerably lower than what we've seen.



And I think interestingly, one can bifurcate the CX and the AI universe a little bit in terms of the pricing dynamic. On the latter, on the CX front, I think because of the opportunities for technology substitution and enablement, there is this pervasive downward pressure and expectation, well, with more technology in the solution and less labor, you should be able to deliver more cost effectively. And indeed, whilst we're making progress on that time, it has not been, as I said in my earlier remarks, as quick as we should have been.



On the AI front, remember, a lot of our competitors are either private companies or companies that are clearly not targeting the same kind of profitable margin yield as we and as a consequence, their focus on price has been considerably less important. They're looking for the land grab and just revenue growth. And so it's plus in this annual position of, well, do we allow for this complete eradication of margin yields in order to enjoy the revenue upside or do we try and find that elusive balance. And that's really been the challenge over the last few years.



And I think as you heard from our comments and reflected in our revised guidance, we're going to have to take it on the channel a little bit in terms of our historical margin profile so that we can enjoy the upside on revenue and then rely upon scale and our own, eating our own [indiscernible] internally, as I said, in order to create a headwind in to enjoy the margin yield that we've historically benefited from.

[Operator]

The next question is from Stephanie Price from CIBC.

[Stephanie Price, analyst]

I just wanted to touch on the cost efficiency initiatives, taking more time to yield meaningful results. Just hoping you could walk through the puts and takes here. Gopi, I think you also mentioned that average salaries were up due to fierce competition for talent. Just curious if that's AI related or more broad and how that's kind of playing into the cost efficiency initiates here.

[Gopi Chande, executive]

Stephanie, good to hear from you. So 2 parts to that question. One, on our cost efficiency program itself. So there are several components to it, some that have taken flight and are going to continue to support Q2. So with regards to some of our facility consolidation, vendor renegotiations, those are being flight.



The ones that have taken us slightly longer than expected are ones that we're looking to roll globally and with some of the nuances that we have in each of the regions, working through the systems and the processes there is taking a little longer than expected, but will ultimately be rolled out and help support some of the visibility we'll have into our workforce management, which will support in terms of reporting to our clients on absolutism, and it will help us be able to manage attrition. So those are the ones that are a bit forward to roll out, but we expect to come through.



To your second question, Stephanie, certainly wage inflation is something like our peers that we are dealing with. And we do think that ultimately, that is addressed in several different wins that we're attacking. One is collaboratively working with our clients, our customers in terms of where we deliver those services. And then secondly, as while moving to provide a more efficient automated service ourselves so that we could reduce the overall cost base to absorb some of that deflation. So it is all related. Certainly, we're looking at how do we reduce our cost and then how do we partner with our customers to reduce overall costs.

[Operator]

The next question is from Aravinda Galappatthige.

[Aravinda Galappatthige, analyst]

Jeff, all the best to you enjoyed discussing the business over the last 1.5 years. My question is back to margins. Last year, when we had some of these revisions, TI was able to kind of build back its margins back over the 20% level fairly quickly. Recognizing that you've already given guidance for fiscal '24, how should we think about the recovery in margins, notwithstanding some of the comments that Gopi made? Maybe any additional help, that would be appreciated.

[Jeffrey Puritt, executive]

Thanks very much, Aravinda. I too have enjoyed our interactions, looking forward to more, hopefully. I think, candidly, the challenge has been that we've had to rely historically on too many one-timers in order to make sure that we were able to continue to meet expectations set for ourselves and for the Street with respect to the well above 20% EBITDA ZIP Code. And the challenge has been over the last little while, we just keep losing opportunities because of price.



And so when both CX and AI opportunities are still quite available, but we're told in the postmortem that we were just too expensive and the competition we're willing to provide a similar solution. We would argue an inferior solution. But nonetheless, more or better for less, as I said before, is the desire out there, we just decided that we can't keep missing out on opportunities.



So we're going to have to intentionally lower expectations in the near term to the levels that are reflected in the guide that you've seen so that we can get back on track for revenue growth and thereafter in the fullness of time as we continue to see better progression on our cost efficiency efforts that will create the headroom to get our margins back up to where we want them to be is where we think they could be.



I think I'll invite Tobias to comment on the AI front. But just as a setup, as I mentioned a moment ago, right now, it's still this land grab period where, again, the price competition is quite fierce. And so we need to once again focus on winning opportunities, getting in the door with these clients. And then when we demonstrate the capability set that we have, we can then look to expand the margin yield derived from that.



But Tobias, why don't I invite you to top up a little bit on our ambitions on the AI margin yield front in the fullness of time.

[Tobias Dengel, executive]

Yes. Thanks, Jeff. So one thing to think about is that in the popular mind, the AI use cases are all around replacing human beings and answering the questions. And I think we all know that that's going to take quite a while to get there in terms of risk mitigation, et cetera, et cetera.



The use of AI in the near term is going to be to enhance the agent experience and the agent productivity through tools like translation tools like summarization, all targeted at more efficiency, reducing average handle time, allowing agents to get information much more quickly and really this concept of humans in the loop.



So that's where a big part of our near-term Fuel iX investment is aimed at and so if we do that right, you should really see some improvement in margins due to the efficiency we can drive in the system.

[Operator]

The next question is from Cassie Chan from Bank of America.

[Jinli Chan, analyst]

I just wanted to ask a quick question on headcount. So it looks like it was flat quarter-over-quarter, and you guys are implementing some hiring freezes, et cetera. So I guess, what are you expecting in terms of the back half of the year in terms of headcount growth there? And what's the geographical mix of headcount now versus revenue mix, particularly in Europe and the U.S.

[Gopi Chande, executive]

So headcount maybe I'll put that into 2. So in terms of our indirect nonbillable headcount, that's one we've continuously been looking at and looking to operate more efficiently. So I would expect to see either flat or declining on that front. And then the remainder of our headcount, as you well know, is related to billable resources.



And so that will match the revenue uptick that we will expect to see. In terms of the geographical breakdown, Cassie, I'll come back to you on the specifics of the breakdown there. In general, we are seeing a slight reduction in North American team count and revenue. As I mentioned in my script, offset by increase in Central America and Africa, but I can get you those specific numbers offline.

[Operator]

The next question is from Divya Goyal from Scotia Bank.

[Divya Goyal, analyst]

Jeff, thanks a lot for your partnership. It was a pleasure working with you. I wanted to actually get some more color on the Fuel iX discussions that you had. I wanted to understand what gives you confidence in this AI deployment? And what is the-- for the lack of a better would guarantee that these revenues will create a recurring revenue stream? And just to tag on that, you also said there was a meaningful revenue contribution from Fuel iX. So if you could provide some context on that.

[Jeffrey Puritt, executive]

Thanks very much, Divya. Once again, perhaps I'll invite Tobias to speak directly to both aspects of your question. Tobias?

[Tobias Dengel, executive]

Yes. So first of all, in terms of revenue, I don't think we said that there was a meaningful revenue contribution of Fuel iX, I'll let Gopi elaborate on that, I think, much more broadly, we had meaningful revenue contributions from our AI services and our traditional data annotation business. But I would say it's early days in the sense that there's a lot of competition, and we are very cognizant of that. But I would say we have a unique ability to work with TELUS to really test these deployments.



And when we talk to analysts in the tech industry space at places like Gartner, et cetera, they feel that what we are doing at TELUS and with some of our early clients is very unique and provides us with an ability to test in a highly regulated set of industries that very few of our competition have.



I think the second piece that I would add on is that we have, especially in Canada, relationship with thousands and tens of thousands of initial potential customers that are looking for a Canadian solution that we can provide that is model agnostic and allows those customers to switch models over time in search of the best price and confidence in the results.



The final point I would make is that these are recurring revenues, right? So as we add clients to this system, these revenues will grow and accrue over time in much more of a SaaS business model. and we will be packaging services around it. We will be packaging CX around it. So it's extraordinarily synergistic with the set of services that we already provide to our clients.

[Operator]

The next question is from Keith Bachman from BMO.

[Keith Bachman, analyst]

I wanted to ask about how your strategy related to M&A may be evolving, given all the dynamics in your business? And to be more specific, outside of perhaps some tuck-ins, do you think it's appropriate to tap the brakes on larger deals as you're structurally trying to optimize or improve the operations of the business. And related to that is, can you just describe you said there was a performance payment to Willow Tree, what was the metric that caused the trigger of a performance payment to Willow Tree?

[Jeffrey Puritt, executive]

Thanks, Keith. Maybe I'll take the first question. I'll invite Gopi to speak to the second. We have always had a fairly well-defined strategy with respect to when and how we leverage M&A to supplement, complement, amplify and accelerate our business, and it is truly one where we absolutely focus on the core business first and foremost. And M&A is not a strategy. It's an enabler, an accelerant for the realization of our strategy. It has been since the Willow Tree deal that we've done a large transaction, and we have indeed, as you've suggested, correctly, top to breaks in terms of incremental transformative acquisitions as we look to focus on continuing to get our own house in order in terms of organic growth.



Prospectively, as we have always done historically, I think it's fair to say that you shouldn't expect to be seeing us out there making blockbuster acquisitions other than on perhaps an opportunistic basis, but for the most part, probably focus where there's opportunistic tuck-in activity that we think fills a gap helps us access the capability, a market that we don't otherwise already access or don't think we can get there fast enough organically.



But you're absolutely right. We will continue to focus on getting our house in order and getting the organic growth engine humming as a condition precedent to earn the right for continued meaningful supplementary M&A activity.



Gopi, over to you on the next question.

[Gopi Chande, executive]

Keith to clarify, there wasn't a payment related to the Willow Tree earnout. The amount that went through this quarter was a true-up of the provision. So there was 2 reasons for that. One, every quarter, we look at the forecast as expected from Willow Tree and treat that up. The provision and earn-out is working as planned. So as we see a lower forecast than originally expected, that does true up what the ultimate earnout payment is. So that's working as expected. That was one of the contributing factors.



And then secondly, as I mentioned, we renegotiated the agreement. And so again, that was factored into rebalancing where our provision is at. We do not expect currently that there would be a huge future adjustment to that provision. I mentioned that in that renegotiation, there are some good win-win opportunities between us and Willow Tree. It is based on combined Willow Tree and TELUS Digital performance. And we also have the benefit of that continued deployment of the Willow Tree management team. So you will see some decreased stock-based compensation associated with that amendment, Hopefully, that clarifies Keith the accounting from this quarter.

[Operator]

The next question is from Maggie Nolan from William Blair.

[Kathleen Kronstein, analyst]

This is Kate Kronstein on for Maggie. Jeff, wanted to wish you good luck on behalf of our team and your next chapter. My question is, I understand there are clearly macro impacts, but are there any changes that you guys think needs to happen on the sales force front to help ramp up new client wins?

[Jeffrey Puritt, executive]

Yes, we are not satisfied with the success of our sales activity to date. You may recall from previous quarters, we talked about making meaningful incremental investments both in terms of the scale of our hunting and farming community as well as embracing adopting and proliferating PSO framework and methodology to ensure that we get better bank for the buck, so to speak, from that sales organization.



You'll recall also that and as I referenced again in my prepared remarks this morning, first quarter this year was a record for new sales for the team. Unfortunately, that tailed off a little bit in the second quarter. But again, as I mentioned, the funnel continues to be very robust, and we're hopeful that we can get better conversion, but there's always room for improvement. And absolutely, Brian Hannon leads our sales effort. I think has brought a tremendous level of discipline and rigor and really reenergize the team, and we're looking forward to continued improvement in that performance and trajectory in the weeks, months ahead.

[Operator]

The next question is from Johnson from Guggenheim Partners.

[Unknown Analyst]

I just want to follow up. What gives you confidence in the back half uptick? Are there any assumptions or changes in the current backdrop that's kind of needed?

[Gopi Chande, executive]

Thanks for the question. I think if I understood it correctly, was just sort of how do we have faith in the revised outlook. Did I hear that correctly?

[Unknown Analyst]

That's correct.

[Gopi Chande, executive]

Okay. Perfect. So definitely some time spent understanding on the changes macroeconomically. What does give us confidence, I'll start with revenue is we are seeing a turnaround as Jeff and I both mentioned in Willow Tree demand, positively seeing that now exceeding supply. So working hard on hiring to meet that demand. So that's one factor. The second one to build off of Jeff's comments just now on our PSO investments and the structure we've put in place that is a full force for Q3 and Q4 and gives us incremental coverage in different geographies and verticals and a more structured focus. So we're expecting a good returns from that.



Overall, we're really confident in our funnel. You've heard about some of our AI growth opportunities. So that reflects revenue growth in half 2 compared to half 1. We're seeing stabilization as Jeff mentioned off of the first question with our third largest clients and good growth with our first and second and then again, good initiatives underway to address some of the attrition we're seeing wage inflation, et cetera. So looking for gross margins essentially to stabilize in half 2 compare to Q2.



And then cost transformation, while, as I mentioned, some of the projects are delayed. We do expect to get 2/3 of the remaining $30 million of savings in Q3 and Q4, and those are programs that are already kicked off in flight. So we've got good certainty around those deliveries.

[Operator]

The next question is from David Koning from Baird.

[David Koning, analyst]

I guess my question is surrounding just TELUS as a client. I know it's like 24% or so of revenue. It hits a much tougher comp in Q4. And actually, what happened last Q4 is your total revenue is up $29 million and your TELUS client revenue is also up $29 million sequentially. So I guess my question is, in Q4 of this year, do you get a nice sequential run in TELUS again like you did last year? And maybe just discuss a little the dynamics of that contract.

[Gopi Chande, executive]

So our current plan assumes that we are stable with TELUS throughout the year. So you are correct. We did see an upside in Q4 of last year, as we maintain that through the year. Realistically, what we're seeing is a diversification of the work that we do with TELUS. So while we continue our routine CX work and grew into servicing TELUS Health as well, the growth of the year that we have this year will sustain is also the digital transformation work that to be spoken to and Jeff has spoken to. So we're expecting a fairly consistent support from TELUS on the revenue front without a major pickup in Q4 this year.

[Operator]

Thank you. There are no further questions in the queue.

[Elena Lebac, executive]

Thank you, Karl. I will turn the call over to Jeff for his closing remarks. Jeff, over to you.

[Jeffrey Puritt, executive]

Thank you, Elena. Thank you, Karl, and thank you all for your participation today. To reiterate, everyone on our management team and I fully acknowledge that our performance continues to miss expectations, both our own and those of the Street. Clearly, we must do better. While I'm in no way dismissive of the near-term sentiment, I do want to conclude with a comment on the fundamental longer-term drivers of success for this company.



The portfolio of capabilities and talent that we've assembled here at TELUS Digital are in my estimation, unparalleled in our industry. Our devoted team members, our brand and reputation built over almost 2 decades in the industry with our clients and partners, our technology-centric capability and solution set that we've continuously evolved to proactively address industry shifts and clients' needs, our diverse customer base, our balance sheet enabled a few.



It's on the strength of these assets that I believe we have the opportunity and most certainly a clear need to course correct on our own and Street expectations regarding our growth and profitability profile in the near term due to the myriad of current market challenges and fundamental shifts I've spoken about earlier today, not the least of which is unprecedented ubiquitous price sensitivity that we anticipate will persist in the near term.



Generative AI fuel disruption brings a more fundamental and long-term implication for our entire industry. TELUS Digital's continued progress in bringing to market our own GenAI solutions, should give you confidence that we're actively participating in this market shift and will emerge as a beneficiary with strong prospects to generate value for our stakeholders. I trust that we've answered all of your questions today, and we'll continue our discussions at investor and industry conferences and in direct conversations with many of you.



Jason, Tobias and Gopi will host our quarterly investor call that will take place in early November. Until then, thank you all for your continued engagement, and goodbye.

[Operator]

This concludes TELUS Digital's Q2 2024 Investor Call. Thank you for your participation, and have a nice day.