Nagarro SE

XETRA:NA9

Earnings Call Analysis

Nagarro Shows Steady Growth Amid Challenging Environment

In Q2 2024, Nagarro reported revenues of $244 million, a 2.1% increase quarter-over-quarter in constant currency. Gross margins improved to 30% under a new calculation method. Despite a slow recovery in demand, client satisfaction remains high, and accounts generating over EUR 1 million increased to 184, up from 168. The public, non-profit, and education sectors saw a 40% year-on-year growth, while management consulting declined by 3.5%. The company maintained a healthy cash balance of EUR 121.4 million and a net leverage ratio of 1.5x. Nagarro reaffirmed its guidance of approximately EUR 1 billion in revenue and a 14% adjusted EBITDA margin for 2024.

Nagarro's Resilient Performance Amid Market Challenges

Nagarro SE recently shared their earnings call for the second quarter of 2024, revealing a resilient performance amidst ongoing market uncertainties. Despite the relatively slow recovery in demand that the company has faced since last year, Nagarro's revenue for Q2 2024 was reported at $244 million. This reflects a modest growth of 2.1% sequentially in constant currency and a similar growth year on year. The leaders at Nagarro, co-founder Manas Fuloria and Gagan Bakshi, highlight that while the demand environment remains subdued, there are emerging signs of recovery that they believe will soon materialize.

High Client Satisfaction and Focused Growth Strategy

As part of their strategic initiatives, Nagarro has prioritized enhancing client satisfaction, which has shown promising results with a Net Promoter Score of 62, indicative of strong client loyalty. Additionally, the firm has seen an increase in the number of high-revenue accounts, now totaling 184, which is a notable increase from 168 a year prior. This focus on client relationships directly contributes to their growth strategy, as Nagarro positions itself to tap into upcoming data-led and AI-led transformations across various industries.

Profit Margins and Adjusted EBITDA

In terms of profitability, Nagarro is recalibrating how it reports gross margins. They recorded a gross margin of 25.6% under the previous reporting method and 30.0% under their new methodology for Q2 2024. Furthermore, an adjusted EBITDA of EUR 35.5 million reflects a consistent upward trend in operational efficiency. Nagarro’s last guidance advocated for an overall revenue target of approximately EUR 1 billion in constant currency, alongside a trajectory for a 14% adjusted EBITDA margin for the year.

Geographic and Sector Performance

Regional performance highlights a differentiated growth pattern, with North America contributing 36% to the company's revenue, primarily driven by retail and public education sectors. Conversely, performance in Central Europe saw contributions from automotive and manufacturing but was offset by weaker results in telecommunications and media. Importantly, while Nagarro experienced a 2.5% revenue decline in some sectors, their adaptability and diversification continue to mitigate risks in this complex environment.

Financial Health and Cash Position

Nagarro's financial health remains resilient, with a solid cash balance of EUR 121.4 million at the end of Q2 and healthy working capital of EUR 236.9 million. Notably, the company's net leverage stood at 1.5x, highlighting a manageable debt situation relative to earnings. This results from prudent cash flow management, evidenced by a significant increase in operating cash flow to EUR 27.6 million, demonstrating improved financial agility compared to the previous year.

Looking Ahead: Cautious Optimism

Looking to the latter half of 2024, Nagarro remains cautiously optimistic yet realistic, acknowledging the challenges posed by fewer working days in Q4 and other uncertainties in the economic landscape. There is an awareness of wage pressures impacting the margin, and while they project steady but gradual growth, a precise guidance update is currently not available. However, the leadership emphasizes that the groundwork laid today will poise Nagarro well for a swift rebound when market conditions improve, indicating a robust belief in the company’s long-term potential.

Earnings Call Transcript 2024-Q2

[Operator]

Good afternoon to everyone. Welcome to Nagarro SE's H1 2024 Earnings Call. You should have received a copy of the earnings release for Nagarro's second quarter 2024 results. If you have not received the press release, a copy of the release as well as this presentation is available on nagaro.com in the Investor Relations section. Representing Nagarro today on the 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 hand you over to Manas, I would like to remind those listening that some of the comments made on today's call may contain forward-looking statements. These statements are subject to risks and uncertainties as described in the company's earnings release. Additionally, please also refer to the earnings release for the notice on reported results that are non-GAAP measures.

Nagarro is happy to partner with NetRoadshow for today's earnings call again. [Operator Instructions].

With that, it is my pleasure to hand you over to Manas Human to begin.

[Manas Fuloria, executive]

Thank you, Harry, and hello, everybody, and welcome to this earnings call for Q2 and H1. Thank you all for joining us. The headline news today is that Nagarro has had a fairly good quarter given the circumstances, but we are still waiting for a proper recovery in the demand environment. Our Q1 numbers had indicated some hope for such a recovery. Q2 again indicates some hope, but the recovery is not fully here yet. All indications are that it is imminent, but when exactly it will arrive is difficult to predict.

In the meantime, we continue to utilize this slow period to develop the company along various dimensions. We are happy to share that we continue to deliver high levels of client satisfaction and consequently continue to expand our footprint and influence at our clients. With this expanding scope, we feel well positioned to take advantage of the upcoming data-led and AI-led transformation that we believe will certainly take place across various industries in the years to come.

We also continue to develop Nagarro qualitatively, deepening our leadership in various areas. I would just like to highlight 1 example today, the Life Sciences and Health Care industry. Last week, the Everest Group put out a report of the life sciences digital services space, what they call the peak matrix assessment for mid-market enterprises. For this report, they surveyed and analyzed 26 different companies, including Nagarro. It was a very rigorous process like an audit. And as a result of this thorough analysis, the group has placed Nagarro in the top right of their assessment metrics as a leader in this space.

With respect to the vendor's vision and capability, which was a part of their assessment which in their words, translates to the ability to deliver successfully services in this area, they rank Nagarro as the second among the 26 companies surveyed. This is a matter of great pride for the Life Sciences and Healthcare BU, but it's also not really a surprise. Our model of BU-led entrepreneurship and BU-led initiative continues to deliver such exceptional results. we see our BUs as engines of growth that will continue to push forward and develop Nagarro into one of the world's great companies.

On to the key numbers, revenue for quarter 2 2024 was $244 million, growing 2.1% Q-o-Q in constant currency and growing year-on-year in constant currency. Just as in Q1, the gross margin number here, the 30% that you see, it needs some explanation, and you have to read it with the footnote. Since quarter 1, we are presenting a revised method for calculation of gross margins where cost of GBU management cost of consultative sales within the BUs cost of thought leadership at the COEs that in various practices in the BUs, they all have been reclassified to SG&A.

Through 2024 through this year, we will continue to present the gross profit and margins with both the current and the previous method to allow for better year-on-year comparisons. So the gross margin for Q2 2024 was recorded at 25.6%, under the previous method of reporting gross profit and at 30.0% under the new method. Adjusted EBITDA for the quarter was EUR 35.5 million. Our top-performing industry on a year-on-year basis was public, nonprofit of education, which grew 40%, mainly because of easy comps from Q2 2023. Our most challenged industry was management consulting and business information which degrew by 3.5%. In terms of the regions, the rest of the world grew fastest year-on-year at 11%, while rest of Europe was in last place and degrew by 2.5%. We ended the quarter with a cash balance of EUR 121.4 million.

The number of accounts generating over EUR 1 million in revenue over the trailing 12 months, a key metric for us because we tend to retain these accounts was 184 at the end of June, up from just 168 a year ago. Meanwhile, our Net Promoter Score in the Q2 customer satisfaction survey was 62, which is a very good number. Our last guidance for 2024 issued in February -- on the 20th of February, was for approximately EUR 1 billion revenue, constant currency calculated and 14% adjusted EBITDA margin, we have no guidance update at this time. As before, our diversification continues to shield us in this rather complex environment.

As mentioned in the previous slide, the best-performing industry on a year-on-year basis was public nonprofit and education and it was followed by energy utilities and building automation. The weakest performance was in management consulting and business information, as I just said, and then in financial services and insurance and the share of both of these industries in our revenues has dropped a little.

We have remained low in terms of client concentration, as always. Our top 5 clients account for only 14% of our revenues for the quarter and clients 6 to 10 accounts for just 10% of our revenues. One observation here since 2019, we have more than doubled in size, but our largest 10 clients made up only about 1/4 of our revenue back then, and they make up only about 1/4 of our revenue now. This shows that we have continued to grow our scale at each client quite proportionately as the company itself has scaled. For quarter 2, North America accounted for 36% of revenue. The growth in the region was led by retail and CPG and by public nonproperty education.

Moving on to Central Europe, which accounted for 28% of revenues. The stronger industries were public nonproperty education and automotive, manufacturing and industrial. The rest of the world accounted for 33% of our revenue in the quarter. Growth was led by automotive, manufacturing and industrial and energy utilities and building automation. In rest of Europe, 13% the industry most under pressure was telecom, media and entertainment, while public nonprofit education showed the most growth. In terms of people, our head count increased marginally by 33% this quarter to 18,301 of which 16,772 were professionals and engineering.

Now I'll hand over to Gagan to say a few words on our financial position at the end of the quarter.

[Gagan Bakshi, executive]

Thank you, Manas. Hello, everyone. The chart on the left shows the financial position on June 30, 2024. We reported financial liabilities of EUR 284.6 million, which consists of our syndicated credit facility, various working capital facilities, bank loans, and liabilities from factoring. Our lease liabilities stood at EUR 46.7 million. And with a healthy cash balance of EUR 121.4 million, our net leverage was EUR 209.9 million. Given our LTM adjusted EBITDA of EUR 140.4 million, our net leverage ratio at June 30 was 1.5x. The company's liquidity position at the end of Q2 was comfortable with a working capital of EUR 236.9 million.

Now a few words on our cash flows. For the 6 months period ended June 30, 2024, our total cash flow was EUR 8.8 million as against negative EUR 16.2 million for the comparable period last year. Operating cash flow for the 6-month period ended June was EUR 27.6 million as against EUR 15.4 million for the comparable period last year, which is an increase of EUR 12.2 million. The main contributor was an increase in EBITDA by EUR 10.7 million from EUR 58.1 million in H1 2023 to EUR 68.8 million in H1 2024. Further, we were able to reduce the utilization of funds under the factoring program by EUR 7.3 million during H1 2024.

Days of sales outstanding calculated based on the quarterly revenue and including both contract assets and trade receivables have increased slightly from 84 days at the end of 2023 to 87 days at June 30, 2024. The Cash flows from investing activities for the 6-month period ended June was an outflow of EUR 5.1 billion, mainly due to [indiscernible] of EUR 8.7 million to meet contractual payment obligations from older acquisitions, which was offset by an inflow from maturity of a fixed deposit of EUR 4.5 million. For the comparable period last year, i.e. H1 2023. Cash outflow from investing activities was EUR 50.4 million. CapEx came in at EUR 2.9 million, which is only about 0.6% of the revenues for this 6-month period.

And finally, cash outflow from financing activities for the 6 month period ended June was EUR 13.7 million as against a cash inflow of EUR 18.8 million in the comparable period last year. This cash outflow of EUR 13.7 million was primarily from lease payments of EUR 11.9 million, interest payments of EUR 9 million and repayment of bank loans of EUR 3.7 million offset by cash inflow from bank loans of EUR 11 million.

With this, I hand over back to Manas, and thank you all.

[Manas Fuloria, executive]

Thanks, Gagan. That is, in fact, the end of our presentation. We can now move to Q&A. So I'll request NetRoadshow to open up the floor for questions.

[Operator]

[Operator Instructions]. Our first question today is from the line of Andreas Wolf of Warburg Research.

[Andreas Wolf, analyst]

I have a question on personnel expenses. If you look on the sequential development of the number of employees, so that was plus 33%. The personnel expense, however, grew by, if I'm correct, EUR 10 million. Could you provide more insight on the development inside personnel expenses?

And then following the first look on the results I was quite positively impressed with the development in surprised, however, that the share price rate negatively and some investors pointed towards somewhat higher working capital and that it is basically it's basically the same amount as revenue growth more or less. Could you also provide some insight on project development here that might be causing this parallel development.

[Manas Fuloria, executive]

Andreas, thanks and thanks for the feedback on the results. So a quick confess to your 2 questions. On personnel expenses, We, of course, continue to have people go through appraisal cycles and incremental cycles. And that is potentially a big part of the increase in the personnel expenses. And typically, this is -- we are able to adjust this with increase in billing rates over time, and we expect that this will happen in the same way in the future.

The second question on the working capital. There is no systematic change in the nature of our working capital. Every quarter, there is some noise based on what -- which invoices we were able to collect on and stuff like that. So I think there is no fundamental change in the nature of our business with respect to working capital. Thank you, Andreas.

[Operator]

And our next question, apologies for the delay, is a written question submitted by [indiscernible] of [ Mora ] Bank Company. And the first question is, in H1, you finished with a 15.5% adjusted EBITDA margin. Based on your guidance of 14%, do you assume a deterioration of EBITDA margin in Q3 and Q4 to arrive at 14% global EBITDA margins. Based on your revenue guidance, is it fair to assume more growth in the upcoming quarters what are the seasonality on Nagarro revenues?

[Manas Fuloria, executive]

Thank you very much for the question. Let me answer the questions. Let me answer them one by one. So in terms of our EBITDA trajectory in the coming quarters. We have -- we are taking the line that we will end the year at something around 14%. And this has got to do also with increases in our wage costs and some lack of visibility into how the revenue side will develop, both in terms of utilizing the excess capacity that we have in the company today and in terms of billing rate increases. So we are sticking to that 14% number.

In terms of revenue guidance, we have, in general, seasonality of weaker Q4 because of fewer working days. but we are hopeful that there will be a continuing trend of a gradual increase of the base from quarter-to-quarter, the per day base from quarter-to-quarter. But it's, of course, difficult to predict in an environment where a single week of market upheaval can really just reset everyone's view on how the economy is progressing. But at the moment, that's where we stand. Thank you for your questions.

[Operator]

And our next question is another written question from [ Stefano Grasso ] of Advantage PTE Limited who asks, congratulations on the consistent results. Can you speak to the cyclicality of [ Novero's ] business versus the general economy -- sorry, Nagarro's business versus the general economy. We are expecting a slowdown or recession in the next quarters? How would this affect Nagarro? How confident are you that the business will turn around countercyclically?

[Manas Fuloria, executive]

Thanks for the question. It's -- I would say that in general, the performance of the company does depend on the larger economy. But it's fairly robust on the downside. And when the economy bounces back, it is usually very quick to bounce back as we have seen in all past slowdowns and recessions. And I believe we're in the middle of a slowdown right now in pretty much every aspect. So -- but I think that, that's how we see it. We expect us to have resilience on the downside and quick bounce back on the upside with the economy. Thanks for the question, Stefano.

[Operator]

[Operator Instructions]. And we have a follow-up question here from the line of Andreas Wolf again from -- my apologies, go ahead. Your line is now open.

[Andreas Wolf, analyst]

I'll take the opportunity to ask 2 more questions. So one would be on AI. Manas, could you update us on your initiatives in this field, whether you're developing any new tools that might be beneficiary for Nagarro and efficiency going forward? And the second is on pricing out there in the market. So apparently, many IT service providers have difficulties with utilization, et cetera. you are feeling some price increases as you alluded to, you're observing them. So maybe but also comment on pricing in the current environment. Obviously, there will be a need to increase prices, but it doesn't seem to be the right environment for that right now.

[Manas Fuloria, executive]

Maybe I'll start -- first, thanks for the questions, Andreas. Maybe I'll start with the second question first. I think there is there is some pressure on price increases being -- it's not as easy to increase prices today as opposed maybe in '21 or '22. But for us, we feel it's much more due to the circumstances of the client rather than the competition. So we don't feel -- or internally, we don't have the conversation that we are in competitive -- in a very competitive price cutting environment. it's more based on client budgets and what they can afford to do and what they want to do with the money that they are willing to spend. So that's on price.

On AI, we have talked a lot about what we were trying to do, and I think some of that still continues and all of that still continues. There's not very much new from the last quarter, but we are working on all aspects of it. So we are working on the client side on getting the data ready for AI. This is a very big topic. You know that we were -- we had announced a couple of years ago that we were working with Dublin Airport, for example. So we are working -- taking that example and working with other airports, we are working in pretty much every industry there is an effort to try to use -- bring more data to bear. So that's a big part of that effort.

And then on the AI side, whether it be you're trying to create better experiences for customers, whether it's been -- it's better forecasting, better pricing of energy or pricing of tickets or pretty much every topic that where human intelligence is used or has been used. AI is getting more and more used. So I think that that's on the client side. There's also, of course, a lot that we are doing internally to see where we can use AI for added efficiency and also to bring more flexibility, we call it the fluidic enterprise. We believe that not just us, but all our clients will start to use data and AI to become better internally and thus be able to offer better services to their customers and better partnerships with their partners and so on.

So there's a lot of that thinking both at the high-level, philosophical level. and then drilling it down into what does that mean for enterprise architecture. What does it mean for data architecture and so on. So there's a lot of traction. And that's what is actually the exciting part of being where we are today. Even if the revenue numbers are not very exciting. The conversations are still very exciting. And we that's why I say we feel very well positioned to take advantage of this transformation, which we can see is imminent, is really imminent.

[Operator]

And our next question is a written question submitted by [indiscernible] of [ Amati ] Global Partners, who asks, you mentioned the impact from underutilized software engineers, but we have an increased small head count this quarter. Does this suggest you have reached a comfortable cost level given the outlook and current activity levels?

[Manas Fuloria, executive]

I did not fully understand this question. The small head count, I -- sorry, if you just read the question one more time.

[Operator]

Certainly Sorry, my apologies. The question is as follows. You mentioned the impact from underutilized software engineers, but we have an increased in [indiscernible] small head count this quarter. Does this suggest you have reached a comfortable cost level given the outlook and current activity levels?

[Manas Fuloria, executive]

Thanks, Graham, for the question. Actually, the context is quite complex because you -- while we like to see a lot of our engineering as being able to be deployed across technologies even, but even across countries, there are certain reasons why our clients are rejigging their exposure to certain countries, for example, geopolitical reasons. So we have increased head count in countries which are deemed to be a little bit more risky from geopolitical reasons.

We see that we have an increased interest in more senior engineering colleagues rather than people who are really at the start of their careers because a lot of our programs or projects are not necessarily scaling so fast that you can add younger resources to them. So there is some of that. And then there are technologies that are hotter than other technologies. So as is complete as a whole, you have the mismatch to some extent of what you have in terms of engineering capability and the -- what you need in that at this particular point in time. And a bunch of this is related to this slowdown and a bunch of it is related to the geopolitics of the current environment. So there is definitely room to control the cost basis. That's the short answer. Thank you for the question, Graham.

[Operator]

And our next question today is from the line of -- sorry, it's a written question submitted by [indiscernible], who asks, why do you feel less optimistic about demand, that you referred to as recovery is still imminent today compared to the last quarter. What has changed that you have changed your tone.

[Manas Fuloria, executive]

I think it's psychological. I think for all practical purposes, this quarter was a more positive quarter than last quarter. But somehow the end of last year, I think there was a psychological belief that across the industry that the following year, that is this year, 2024 would be when everything would turn around dramatically, and that has not happened.

So I think I'm more optimistic -- more comfortable, I should say, this quarter than I was last quarter. But the optimism of a sharp turnaround just from the corner is perhaps a little bit subdued. And thanks for the question.

[Operator]

Our next question is a written question submitted by Liana Abraham of RBI, who asks, I see the company was able to build up EUR 121 million cash on balance. How much cash on balance is needed for the company's operations?

[Manas Fuloria, executive]

Gagan, would you like to answer that?

[Gagan Bakshi, executive]

Our working capital is $236.9 million. So that should give you some sense of how we sort of look at this. Does that answer your question? Sorry, it was a written one, isn't it.

[Operator]

[Operator Instructions]. We have a follow-up question here from the line of Andreas Wolf.

[Andreas Wolf, analyst]

One follow-up, Manas, on the prospects for H2. Could you also comment on the pipeline? So just taking H1 times to will not exactly get us to the EUR 1 billion. Is there anything else that we should bear in mind when looking at H2? I know it's a number of additional working days that we have in H2, anything else that we should bear in mind when looking at H2.

[Manas Fuloria, executive]

So I think that our guidance always has a certain margin of error on either side, right? And we're always trying to predict the future, and that's part of what is at play. But also, we are looking at how we are exiting the quarter. And on the basis of that, we are just not issuing any guidance at the moment. Thanks, Andreas.

[Operator]

And we have no further questions in the queue. So this will bring us to the end of the Q&A. And I would like to hand back to Manas for any closing remarks.

[Manas Fuloria, executive]

Thank you, Harry, and thanks, everyone, for joining us, and thanks for supporting Nagarro. We continue to believe in the real potential that the company has, even though this is a slow environment. So please continue supporting us. Thank you very much.

[Operator]

Thank you, everyone. This will conclude Nagarro's H1 2024 Earnings Call. Thank you all for joining, and you may now disconnect your lines. Goodbye.