Nagarro SE

XETRA:NA9

Earnings Call Analysis

Nagarro Reports Steady Growth and Cautious Outlook for 2024

Nagarro's Q3 2024 results showcased a 5.6% year-on-year revenue growth in constant currency, reaching EUR 242.9 million. A modified cost structure improved margins, yielding a gross margin of 31.5%. Operating cash flow rose to EUR 70.6 million, reinforcing cash generation abilities. The company revised its 2024 revenue guidance to approximately EUR 960 million and projected a gross margin of 30% and adjusted EBITDA margin over 14%. Despite market uncertainties, North America led growth at 9.5%, while slow demand persists in Europe. Although client loyalty remains strong, the management is cautiously optimistic about recovery, urging stakeholders to monitor analyst estimates for future performance.

Overview of Financial Performance

Nagarro SE reported a robust performance for the third quarter of 2024, with revenue increasing by 5.6% year-on-year in constant currency, although only 3.7% in euro terms. The organic revenue growth was 5% in constant currency and 3% in euro terms. Compared to the previous quarter, revenues grew by 0.5% in constant currency but decreased by 0.5% in euro terms, highlighting a slight moderation in growth. The total revenue for Q3 reached EUR 242.9 million.

Cash Flow and Margins

Despite the slower demand environment impacting revenue growth, Nagarro's operating cash flow showed significant improvement, totaling EUR 64.9 million for the first nine months of 2024, with adjusted cash flow increasing to EUR 70.6 million, compared to EUR 61.7 million for the same period last year. This implies that investor concerns about cash generation have been addressed. However, margin pressures were noted due to slower growth, alleviated by cost optimization measures.

Guidance and Outlook

Nagarro revised its guidance for 2024, estimating approximately EUR 960 million in revenue (in constant currency) for the full year and projecting a gross margin of 30% using a new calculation method, compared to 26% under the previous method. The adjusted EBITDA margin is anticipated to exceed 14% for the year. This conservative guidance reflects market conditions and the uncertainty surrounding client spending.

Industry Performance Insights

The company reported varied performance across different sectors in Q3. The Public, Non-profit, and Education industries led growth with a year-on-year increase of 38.8%, whereas the Horizontal Technology sector faced a decline of 11.3%. North America showed a year-on-year recovery with a growth of 9.5%, while other regions saw a contraction of 5.4%.

Client Base and Diversification Strategy

Nagarro maintains a low client concentration risk, with the top five clients contributing only 15% to total revenues. The company continues to focus on diversifying across industries and markets, recently announcing a partnership with Japan's Marubeni and acquiring the U.K.-based FWD View to enhance its offerings in financial services.

Human Capital and Cost Management

The company downsized its workforce by 363 employees, ending Q3 with a total of 17,938 employees, primarily due to attrition and not backfilling positions. This reflects an ongoing effort to manage costs amid a challenging demand environment.

Long-term Perspective

Management expressed optimism about future recovery but acknowledged the ongoing uncertainty in the demand environment. They recommended ignoring past statements about future outlooks beyond 2024, suggesting that analyst consensus might be a more reliable indicator moving forward.

Earnings Call Transcript 2024-Q3

[Michael Knapp, executive]

Good afternoon, everyone. Welcome to Nagarro SE's Q3 2024 Earnings Call. My name is Michael Knapp, and I'm part of the Investor Relations team at Nagarro. I'm delighted to moderate today's call.

You should have received a copy of the earnings release for Nagarro's third quarter 2024 results. If you have not received the press release, you can find a copy along with today's presentation in the Investor Relations section of nagarro.com.

Representing Nagarro on the call today are Manas Human, Co-Founder and Custodian of Entrepreneurship in the organization; and Gagan Bakshi, Custodian of Strategic Finance and Head of Investor Relations.

Before I pass you over to Manas, I'd like to remind those listening that some of the comments made on today's call may contain forward-looking statements. These statements are subject to risks and uncertainties as described in the company's earnings release. Additionally, please 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.

Let me briefly explain how you can raise your questions. [Operator Instructions] Please note that we will accept questions from sell-side analysts as well as institutional investors. Nagarro's retail investors will have a chance to ask questions in a separate call scheduled today at 2:30 p.m. CET. [Operator Instructions]

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

[Manas Fuloria, executive]

Hello, and welcome to this earnings call for Q3 2024. Thank you for making time to attend this call. We really appreciate your support. We are also very happy, as Michael said, to host this call on NetRoadshow, a platform that Nagarro has, in fact, helped build.

Nagarro's Q3 performance was robust. Although there was no clear recovery in the demand for digital IT services, existing clients continue to be loyal, and new clients were acquired. We continue to push forward in cutting-edge areas of technology and deliver business value to our clients.

Our revenue growth in Q3 was 5.6% year-on-year in constant currency and 3.7% year-on-year in euro terms. Organic year-on-year revenue growth for the quarter was 5.0% in constant currency, which translated to 3.0% organic year-on-year revenue growth in euro terms. Compared to quarter 2 of 2024, revenue grew 0.5% quarter-on-quarter in constant currency and reduced by 0.5% quarter-on-quarter in euro terms.

As our growth has moderated, given the slow demand environment, our cash flow has predictably improved. Our operating cash flow in 9 months 2024 was EUR 64.9 million. Operating cash flow, adjusted for changes in factoring, including interest on factored amounts, was EUR 70.6 million in 9 months 2024 as compared to EUR 61.7 million in 9 months 2023.

I think we have, by now, firmly put to rest some investor concerns around the ability of the business to generate cash, which arose during the years when the business is growing very fast. Therefore, we also feel that the restrictions that we have voluntarily placed on our factoring programs can now be lifted since these were purely in response to investor concerns.

Due to growth being slower than expected, there was some pressure on margins in Q3, which was alleviated, to a considerable extent, by the cost optimizing measures that we have introduced to tide over these challenging times. Accounts generating over EUR 1 million in revenue over the trailing 12 months were at 186 at the end of September, up from 176 a year ago. This, as you know, is a very important metric for us. Meanwhile, our Net Promoter Score in the Q3 customer satisfaction survey was at 59, which is a slight decrease but still an excellent number.

We issued revised guidance for 2024 on October 15 based on September revenues but also on utilization and hiring trends. The new guidance was for approximately EUR 960 million of revenue for the full year in constant currency terms and not including any acquisitions subsequent to that date. We guided for a gross margin of 30% under our new method of stating gross profit and 26% under the previous method, and we guided for a full year adjusted EBITDA margin of over 14%.

Here's a deeper look at the key numbers. Revenue for Q3 was EUR 242.9 million, growing, as we said, 0.5% quarter-on-quarter in constant currency and growing 5.6% year-on-year in constant currency. 31.5% is the gross margin number based on our revised method for calculation of gross margins. For now, we will continue to present the gross profit and margin with both the current and previous methods to allow for better comparisons. So while the gross margin for Q3 was 31.5% under the new method, it was 27.4% under the previous method.

Adjusted EBITDA for the quarter was EUR 34.6 million. Our top-performing industry in Q3 on a year-on-year basis was Public, Non-profit and Education, which grew 38.8% although off a lower base. Our most challenged industry in Q3 was, somewhat predictably, Horizontal Tech, which degrew by 11.3% compared to Q3 2023.

In terms of regions, North America was a surprise recovery. It grew fastest in year-on-year in Q3 at 9.5%, while the rest of the world was the slowest, for once, degrowing in Q3 2024 by 5.4% over Q3 2023.

We ended the quarter with a cash balance of EUR 141 million.

We already spoke of 2024 guidance. Since we listed in December 2020, we have experienced huge swings in the demand environment for digital engineering services in both directions, up and down. These swings have had, of course, an implications on revenue growth but also on margins. While we continue to be optimistic about the eventual recovery of the demand environment, we cannot predict exactly when that will happen and exactly to what degree.

So based on the strategic review with some external sounding that we have conducted at this time and given the uncertainty that we see in our markets, we request you to disregard our past statements on Nagarro's outlook beyond 2024. Instead, the consensus estimates of the financial analysts covering Nagarro are currently seen by the Management Board as a fair estimate of how the company may perform beyond 2024.

We remain committed to diversification across industries since we believe in the convergence of technology and user experience and ecosystems and solutions across the traditional industry silos. The best-performing industries in the quarter on a year-on-year basis, as we said, were -- was -- the best performing was Public, Non-profit and Education, and a long way behind that was Retail and CPG. The weakest-performing industries were Horizontal Tech and Life Sciences and Health Care.

We have remained low in terms of client concentration, as always. In Q3, our top 5 client accounts were only 15% of our revenues for the quarter, and clients 6 to 10 accounted for just 9% of our revenues.

For quarter 3, North America accounted for roughly EUR 88 million of revenues. Central Europe accounted for roughly EUR 69 million, then came rest of the world in third place with roughly EUR 57 million, and finally, rest of Europe with about EUR 29 million.

We continue to look to expand our global footprint. In the last few weeks, after the end of the quarter, we have announced a partnership with the Japanese company Marubeni and the acquisition of FWD View in the U.K.

In terms of people, our headcount reduced further by 363 this quarter, mostly by attrition that was not backfilled, to 17,938.

Now 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. A quick look at our financial position at September 30, 2024, shows financial liabilities of EUR 280.5 million. Cash balance increased materially to EUR 141 million, implying a much lower net leverage of EUR 183.9 million as well as a lower net leverage ratio of 1.3x. The company's liquidity position at the end of the 9-month period was comfortable, with a working capital of EUR 248 million.

A few words on our cash flows for the 9-month period ended September. Our total cash flow was an inflow of EUR 33.1 million, which is a big improvement versus a cash outflow of nearly EUR 16 million for the comparable period last year. Operating cash flows for the current 9-month period were strong, EUR 64.9 million, which is an increase of EUR 23.5 million versus the comparable period last year. The higher cash flow was mainly due to an increase in EBITDA by EUR 11.9 million.

We were also able to reduce the utilization of funds under the factoring program by EUR 14.7 million during this 9-month period. This reduction is also reflected in the slight increase in our days of sales outstanding, which have increased slightly from 84 days at the end of last year to about 86 days at the end of September this year. Kindly note that the DSO is calculated based on quarterly revenues and includes both the contract assets and trade receivables.

Cash flow from investing activities for the current 9-month period was an outflow of EUR 6.2 million, mainly due to payments of EUR 9.7 million towards contractual obligations from older acquisitions. CapEx was EUR 3.8 million, which is only 0.5% of the 9-month revenues and reflects our asset-light model.

Cash flow from financing activities for this period was EUR 25.5 million, which was attributable to outflows of nearly EUR 19 million for lease payments and EUR 13.6 million for interest payments. These were offset by cash inflows from bank loans of EUR 7 million.

From a capital allocation perspective, we're happy to report the acquisition of FWD View on October 30. A U.K.-based company, FWD View is recognized for its expertise in delivering data-driven solutions to the financial services industry. This strategic acquisition enriches Nagarro's portfolio in the financial services sector and further solidifies our market position in the U.K. We have consolidated FWD View from November 1.

With this, I hand over back to Manas. Thank you.

[Manas Fuloria, executive]

Thank you, Gagan. We're now going to move to Q&A. But before we start, some of you may be aware that about a month ago, a Bloomberg article had reported that some private equity firm was weighing a possible buyout of Nagarro. That same day, Nagarro had issued an ad hoc statement. We have said all we wanted to via that statement, and nothing more must be said today. So I would abstain from answering any questions related to this topic and hope for your understanding and forbearance.

With that, we can get into the questions.

[Michael Knapp, executive]

Great. Thanks, Manas. [Operator Instructions] And the first question today will come from Andreas Wolf.

[Andreas Wolf, analyst]

It seems like the audio works. So here's my question. If I look at your full year guidance, Manas, or your targets and look at Q3, which, against the recently revised outlook, was pretty favorable. I'm just wondering if there are any special topics that we should bear in mind going into Q4. At least in Germany, we have many working days in Q3. That's not the case globally. So at least from that perspective, Q4 shouldn't be that much different from Q3. Anything else that we should bear in mind with regard to the last quarter?

And then, Manas, as we are approaching 2025 pretty quickly, you have already issued your thoughts on the analysts -- the analyst estimates. Do you already see more traction from the customer side with regard to projects for next year? And are there specific industries that are already raising their head and saying, okay, we want to invest more next year? And maybe in that context, you could also comment on Horizontal Tech, which, in the last quarter, if I saw it correctly, was still in the degrowth mode.

[Manas Fuloria, executive]

Thank you very much, Andreas. Thanks for your questions, as always. So in terms of the quarter 4, what we see is that we have a fair number of holidays in different regions. You may be right that in quarter 3, there were not -- there are not so many maybe working days in Germany, and quarter 4 may not be so different. But in many regions, Q4 is significantly heavier in terms of holidays than Q3 is.

Also, we have an increasing trend of clients actually turning off their entire sourcing and projects for a couple of weeks to the end of the year. And this is not very many clients, but you can imagine that if some clients turn off everything for a couple of weeks, it does have an impact.

So I think that's the usual thing. Nothing out of the ordinary this year. But Q4 is generally a little bit challenged in terms of the number of hours we can put in and the amount of work we can do.

Coming to your question on 2025, we have -- we just -- I expressed some thoughts about the analyst estimates. We also, of course, will start and run a -- we have started and we are running a bottom-up estimation for 2025. And as usual, we will give out some guidance towards the end of the year for the next year.

But in general, what we see more than horizontal trends, I think we see -- it's not an uncomfortable position, but we don't see a recovery in the way that we are -- have been waiting for a while now for a step recovery. I think it's not very -- it's not -- nothing to be too nervous about, but it's -- at the same time, the recovery is still not fully there. So I think we wait and see how things shape up. But at the moment, I think the analysts are pretty much where we are in terms of sentiment of where revenues and earnings will trend in the coming years and especially for next year.

[Andreas Wolf, analyst]

Just a quick follow-up. What is clients holding back of being more optimistic and more resolute? Is it the geopolitical situation right now that they might not know whether they will be impacted by tariffs, whatsoever? Or are there other topics that they are bringing forward?

[Manas Fuloria, executive]

This has been an interesting period where everyone has a different story. And we've talked in the past of this rolling effect across different industries and so on. At the moment, for example, I was in Singapore earlier this week meeting a client, and their bigger challenge is coming from just a general slowdown in their revenues due to consumer spending in China and elsewhere.

So I think it's just -- it's a very complicated world situation with a number of parts that are not in the -- at the best levels of performance. And I think that each client has a slightly different story. So we don't see broad trends, but just we don't see that big jump back into spending.

[Michael Knapp, executive]

There are no additional questions at this time. Great. And with that, why don't I turn it back to Manas?

[Manas Fuloria, executive]

Well, thanks for joining us on this earnings call. We have another retail investor call in a little bit and really appreciate your support. And thank you, and have a great rest of the day.

[Michael Knapp, executive]

Great. Thank you, everyone. This concludes Nagarro SE's Q3 2024 Earnings Call. Thank you all for joining in. You may now disconnect your lines.