Good afternoon to everyone. Welcome to Nagarro SE's H12023 earnings call. You should have received a copy of the earnings release for Nagarro's second quarter 2023 results. If you have not received the press release, a copy of the release, as well as this presentation, is available on nagarro.com in the Investor Relations section. Representing Nagarro on today's call are Manas Human, Co-Founder and Custodian of Entrepreneurship in the organization, and Gagan Bakshi, Custodian of Strategic Finance. Before I pass you over to Manas Human, I would like to remind those listening that some of the comments made in today's call may contain forward-looking statements. These statements are subject to risks and uncertainties as described in the company's earnings release. Please also refer to the earnings release for the notice on reported results that are non-GAAP measures.
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Thank you. Thank you, Dan. Hello, everyone, and welcome to this earnings call. First, a short word about Nagarro to those of you who are new to Nagarro. We are a leader in digital transformations for blue-chip clients. We listed in 2020 with a revenue of around EUR 430 million that year, euro, that year. We have grown rapidly in the meantime and have new guidance out for EUR 915 million in 2023. Now, in our first Capital Markets Day in 2020, we presented this slide. I'm sharing it now because I think it helps to understand our current context as well as our future opportunity.
In this slide, we show Nagarro as a company with a digital engineering DNA, but somewhat different from the other excellent companies in this group, in that we do have great engineering, but we have aspirations beyond that. You know, we really wanted to think enterprise, to build deep enterprise knowledge, to build deep industry knowledge, to be involved in a large number of industry-specific topics. In fact, to invest substantially and deliberately to diversify ourselves across many industries, across many geographies, with the ultimate goal of one day being one of the world's great companies, great global companies, and with an additional goal of de-risking that journey. As we said on the right, you know, we engage each client with a distinct, superior Nagarro way of working, with a lot of intimacy and an agile mindset and a lean, small team culture.
I'm saying all this, and I'm sort of showing this old slide from 2020, because I think this long-term lens of who we are and where we are coming from historically, helps explain Nagarro's current context. For example, this differentiation helps explain some of Nagarro's resilience and strength right now in the face of the environment confronting our digital engineering peer group. Some of the challenges do apply to us, but we also have some extra resilience and strength. It helps explain Nagarro's unique opportunity in the future around AI-led transformation and data-driven transformation, which I'm sure you all have a lot of questions about. With all the interest around AI on one hand, and Nagarro's intrinsic strengths on the other, which are listed here, these are very well-suited to AI interventions.
This gives us a great opportunity to get even more strategic for our clients with AI and move up to the next level with our clients to get to a better client engagement, move up the value chain. In fact, as many of you who have studied the company for some years may know, many of our flagship projects over the years have been around decision optimization and decision support with math and data. For example, factory scheduling and inventory optimization for pharma or supply chain optimization for fashion retail, which is very dynamic, or vehicle routing optimization for logistics, or ticket pricing optimization for airlines, or process informatics for jet engine manufacturing, and so on. These case studies, they reflect the backgrounds and interests of some of the early Nagarians, including myself.
My own academic and experiential background is in this, these areas, and they also reflect some of the latent capabilities in the company. Even internally, you know, our business operating system, called Ginger, that we talk a lot about, is around data-driven transformation, data-driven decision optimization, using data science, using AI. In fact, it's now getting traction at clients as they start to think about what AI can do for them. We have a lot of experience from the past that we are now finding is very relevant for decision AI.... with how the org dynamics of the client should be orchestrated, how the change management should be run, how data should be handled, how the UX should work, and so on.
Also, for many years, again, some of you may know this, we have been investing to build a great AI and big data team led by Anurag Sahay, who some of you may have heard. He's a total rock star. We have invested in many client projects to build serious technical capabilities and serious consulting capabilities around these topics. Then on top of that, we have our Thinking Breakthroughs innovation framework that we launched several years ago, which by now, almost all our accounts are using in some form or the other, which is easily extensible to the subjects of decision AI and generative AI. Today, the news is that we are bringing all this together, and we have launched a systematic program to take charge of the AI-related conversations at the CXO level at all our top clients.
We are calling this the Fluidic Enterprise AI Initiative, with the Fluidic standing for agile, adaptive, experience-led, and personalized. I won't talk very much about it here, but just wanted to give you a quick taste of that. For our clients, this transformation to embrace AI is, we believe, not a three-month journey, not a 30-year journey, but perhaps, you know, a three or four-year journey. We want to be with them all the way and ideally lead the way with them, show the way for them, right?
Just like I'm showing you this slide from 2020, today in 2023, I hope in 2026, I can show you the same slide and, and just explain how we have achieved what we set out to achieve, how consistent we have been, and how this is able to transform not just our clients, but also Nagarro's place in the industry and how Nagarro is perceived in this world of technology services. That was the background and context setting. Let us get to the here and now. Let's talk about the highlights of Q2. We believe that it was Nagarro's diversification that allowed it to continue to grow. It grew 10.7% year-on-year in constant currency, of which 8.7% was organic.
Most accounts developed well, and we continued to score new wins, and the accounts generating over EUR 1 million in revenue over the trailing 12 months were up at 168 at the end of June from just 131 a year ago. Our Net Promoter Score was high at 63, which means the client satisfaction was excellent. By the way, this client satisfaction also comes out in every client conversation that we have been having. Even when clients have had to pull back on some projects, which has happened for some reason or the other, especially in Horizontal Tech and banking, the client relationships have stayed strong. We expect that we will be able to bounce back at most of these clients once demand returns.
Just as in 2020 and with COVID, we were forced to offer our clients at that time some pricing cuts and some concessions on payment terms. Things bounced back in 2021. Still, that said, the bounce hasn't happened yet. Our revenue expectations for 2023 have changed. Foreign exchange rates have also had an impact. We have revised our revenue guidance downwards last week. The changed revenue expectations, along with a sudden sharp drop in attrition, which is now less than 5%, have left us with more excess capacity, excess production capacity than we had expected. Now, we have taken a long-term view on this, and, being a growth-oriented company, we have really put a lot of emphasis on protecting our employer brand and also watching out for a potential resurgence in demand. We have avoided dramatic layoffs.
Instead, we have taken many small steps to rationalize cost and headcount to where they need to be. The benefits of this cost rationalization will mostly accrue in Q3 and Q4 because there is a little bit of a lag, and then, of course, they will carry through, carry over into 2024. To share one important example of cost rationalization, we actually renegotiated the contracts for nearly 14,000 employees to insert an EBITDA-linked organizational bonus into their existing compensation structure, which will give us considerably more flex in future years. The idea is to never waste a good crisis and to emerge systematically improved. Now, we could have cut deeper if we had made a temporary cut, but we decided instead to make a shallower cut and make it a forever thing, a flexibility asset for the future.
Now, on this slide, we have spoken about the Fluidic Enterprise AI Initiative already, so I won't go into that again. Let me talk a little bit about ESG. On ESG, we improved our efforts across multiple areas. Professor Vishal Gaur was voted onto our supervisory board. Vishal is the Dean of Cornell University's SC Johnson College of Business, and a professor of topics very relevant to Nagarro today, especially when it comes to creating solutions around data and AI for clients. For those of you who do not know the Cornell Business School, it was ranked by the Financial Times, the FT, as one of the top 10 business schools in the world, and Vishal is the dean there. The supervisory board now has four members, and three of the four are independent.
Also on ESG, we have been stepping up our engagement with ESG rating agencies such as CDP, EcoVadis, and ISS ESG, and also with industry initiatives such as Supplier Assurance for the Automotive Industry. We have just recently announced that EcoVadis has upgraded Nagarro to bronze medal status, and we expect other agencies to also reevaluate us in due course. Now, moving to the quantitative view of the quarter. Revenue for Q2 2023 was EUR 227 million. Gross margin was 25.3%, accounting for the excess capacity in the bench and in the business units. Adjusted EBITDA was EUR 28.9 million. In general, we felt that the more traditional industries did better. The rest of Europe grew fastest year-on-year on a small base, while North America was affected by its exposure to horizontal tech.
Our top five clients accounted for just 14% of revenues. We ended the quarter with a cash balance of EUR 99 million. Last week, we put out a revised guidance for 2023 of EUR 915 million, revenue, 26% gross margin, and 13% Adjusted EBITDA margin, and we will come back to this later. The best performing industries on a year-on-year basis were energy, utilities, and building automation, followed by automotive, manufacturing and industrial, and life sciences and healthcare. The weakness in Horizontal Tech, we have already spoken about. You will may notice some changes in public, nonprofit, and education, but these are mainly due, in our opinion, to some lumpy demand timing kind of thing and should not be systemic. We remained low in terms of client concentration, as always.
Our list of top clients from the, from a year ago is more or less the list of top clients now, barring the one special client situation we have described in the H1 report. In this top clients list, there has been very little movement. There's been some movement up and down. All these relationships are very good, very strong. So if you think about it, we keep adding more clients, you know, at, at one end of the funnel, but the existing ones also keep growing, and the churn is very low. You can see that the development of the different client regions has, for us, been more or less driven by the dynamics of the industry, the verticals.
North America has lost its place because of its exposure to Horizontal Tech, also, as I said, because of some demand timing in the public sector, and accounted for just 35% of revenue in Q1. We all know that business in North America bounces back rather quickly. We are waiting for that bounce. In terms of people, we have had almost zero net hiring because we already have significantly excess production capacity, and the increase in headcount in this quarter is almost totally due to acquisitions. Over to Gagan to say a few words on the balance sheet and cash.
Thank you, Manas. Hello, everyone. Let's first review the balance sheet. In the left-hand chart, you can see the balance sheet position on June 30, 2023. We reported financial liabilities of EUR 273.6 million, which consists of our syndicated credit... These liabilities stood at EUR 52.2 million, and with a positive cash balance of EUR 99.3 million, our net leverage was EUR 226.4 million. Given our LTM EBITDA of EUR 139.7 million, our net leverage ratio came out at 1.6x at June 30. The company's liquidity position at the end of June was comfortable, with a working capital of EUR 167.1 million. Now, on to our cash flows, which are shown in the right-hand chart.
For the six-month period ended June 2023, our total cash flow was negative EUR 16.2 million, as against negative EUR 26 million for the comparable period last year. Let's break it down further. Our operating cash flow for the six-month period ended June was EUR 15.4 million, as against EUR 15 million for the comparable period last year. There was a reduction in net cash manufacturing of EUR 11.5 million, and an increase in trade receivables and contract assets of EUR 7.8 million relating to new acquisitions. Days of sales outstanding, which are calculated based on the quarterly revenue and include both contract assets and trade receivables, were at 79 days at the end of June.
Cash flow from investing activities for the six-month period into June, were EUR 51.2 million, and this outflow was mainly due to payment obligations for new and old acquisitions. The outflow of cash in the comparable period last year was EUR 39.2 million. We also reported a CapEx of approximately EUR 2.5 million for the six-month period, which is only about 0.5% of our six-month revenues. Finally, our cash inflow from financing activities for the six-month period ended June, was EUR 19.6 million, as against a cash outflow of EUR 1.8 million in the comparable period last year.
Major items of cash inflow were net proceeds from bank loans of EUR 52.7 million, which were offset by cash outflow of EUR 12.2 million for lease payments, EUR 5.2 million for interest payments, and EUR 16.4 million for share buybacks. A quick update on our ongoing share buyback program, under which we have approval to purchase up to 350,000 shares in three tranches of EUR 10 million each, and subject to a EUR 30 million limit overall. We're glad to announce that two tranches of the buyback have been completed, and the third tranche is well underway. Also, as mentioned earlier in the presentation, we're happy to report that the accounts for the three latest acquisitions, Infocore, MBIS, and APSL, were consolidated in Q2. With this, I hand over back to Manas. Thank you, all.
Thank you, Gagan. now, this is our guidance again, we have already referred to it, and I expect there will be a fair number of questions around it. this is a slow year, for sure, but we remain very bullish for the medium term, we would like to reiterate our expectation that this company can grow at 20% organic revenue growth in a typical year, in, in the medium term. we reiterate our commitment to push towards 18% Adjusted EBITDA in 2026. now, this guidance slide, I think, sets us up very well for the Q&A, which I expect you all will be waiting for. let me hand these things back to the moderator to run the Q&A. Over to you, Dan.
Thank you, Manas. I'm just going to allow a short moment for questions to accumulate, then I will introduce or read out the first question. Okay, our first question is from Retaras Jovan, who is an individual investor: "Hi, Manas and the team. I was wondering if you are considering any new potential acquisition target during the second half of the year. Thank you.
Thank you for the question. Yes, we continue to look at interesting companies that can add value to Nagarro's growth story, and we don't have any concrete plans, but we do have several companies in the pipeline that we are evaluating.
Thank you. The next question is again from Retaras Jovan: "In the press release, you said that you will defer salary increments from August to the end of the year. How do you expect this to impact your ability to remain attractive in order to keep and recruit new talented people?
I think there, there won't be a significant impact. The labor market is a little bit, more employer-friendly than it has been. As we said, attrition is at an all-time low, almost, with just, below 4%, actually. we do think that, we will retain the ability to attract talent and, people will understand that we are in a tight position as an industry, and they, we are all just sharing the pain in some way.
The next question is a phone question. It's from Andreas at Warburg Research. Andreas, your line is unmuted. Please go ahead.
Thank you. Congratulations on achieving, on achieving growth in difficult environment. my question is regards visibility for the remainder of the year. I would assume that given the fact that we are already in August, visibility should be pretty good, and clients should have committed to the projects that they would like to carry out with Nagarro. That's my first question. The second is on the type of discussions that you've had over the last ... headwinds or is it mainly large clients being more cautious? If I look ... Mainly bigger-
Andreas, I think you'll have to repeat the second question because your voice was fading in and out. If you can just repeat the second question, please.
Okay. That you are having with your clients. Is it, is it mainly the bigger clients cutting back their IT spending? If I look at your one to 10 biggest clients, it seems like it's mainly the big clients who are cutting back. Then, and then in general, on the EBITDA link that you have now implement-.
Dan, I think we will have to, maybe wait for Andreas to call back in. In the meantime, maybe I can answer the questions that he has raised, that I think he has raised, that I could fully grasp. The first question is around visibility for the remainder of the year, and, you know, we think we have good visibility through the remainder of the year, but, you know, there is, of course, the uncertainty around, you know, how the project staffing levels will run. I would say we have fair visibility. I would not emphasize this too much, that we have, you know, superb visibility, but it's fair. In terms of our-... you know, which clients are cutting back?
As I mentioned in the first slide and in our H1 report, there is a very specific case of a inherited build, operate, transfer clause with one of our clients, one of our big clients, that came to us through an M&A. We don't typically do such clauses, but we had this one with this particular client. This client had a, also a particular situation, a pre-IPO situation, where they wanted to pull in their team. This has impacted us in a way that is not actually - you know, there's no other client in our portfolio that has that. In general, what we are seeing is it's more of a vertical thing.
It's more a Horizontal Tech thing or a banking thing, typically, but not so much in a large client versus small client. I think that pattern is not so easy to discern. Andreas, sorry, I think I got your questions. I'm not totally sure I got them all right, but, Dan, maybe we can move to the next question.
The next question is from Nicholas David. He actually has two questions. The first question is: Could you please comment on SE sequential evolution of the demand in Q3 versus Q2, generally speaking, and more specifically, in the tech sector? His second question is: Should we expect some exceptional changes, charges linked to the measures taken in order to reduce the production overcapacity? Thank you.
As a policy, we are trying to minimize adjustments to our EBITDA. Where we just have a two-month notice period, we don't plan, at the moment, to take exceptional charges for that. Where it involves further restructuring, more deeper restructuring, we might take those charges. At the moment, we have not factored any of those in. In terms of the evolution of demand from Q3, Q2 to Q3, this is typically quite consistent, and there are no significant trends. What is more important is the number of working days in each month and things like that. We don't see any particular trend from Q2 to Q3 that is worth highlighting here. Thanks, Nicholas.
The next questions are from Martin Jones at Liontrust PLC. Says: Hi there. Can you please give some additional color on the particular geographies and sectors where you are seeing weakness? Given your past experience, could you see these areas recovering? The second question is: On capital allocation, can you reiterate your thoughts on future debt reduction versus further share repurchases?
Okay, sure. I have addressed the demand patterns in different sectors, especially the ones that are not living up to expectations, Horizontal Tech and banking, for example. In terms of geographies, what we are seeing is that the vertical play is dominating, and the vertical effects are dominating. A geography like the U.S. is a little bit slower because Horizontal Tech has a disproportionate presence there. So or at least the clients which are pulling back are disproportionately in the U.S. sector. In terms of capital allocation, I would not like to, you know, just rule out any further share buybacks. At the same time, I can say that the share buybacks that we had planned are almost over.
Yeah, we don't have any in our future plans at the moment. That's all I can say. Thanks, Martin. Thank you.
Okay. Borg, the written question. Perhaps that will fill in what we missed on the last one. If we look at the future development of personal expenses, what will be the fixed component, and what could the variable component in percentage look like?
Okay, sure. The variable component that we have introduced is at the moment, not across the entire company, but it covers around 14,000 people, and it is a few percentage points. I would rather not disclose the exact way it's sort of distributed across the 14,000 people. But it does give us some flexibility in future years when we hit a, you know, a slower period, to also automatically reduce our costs. I think it's a great asset for the future, in terms of cost control whenever we... revenue slows down, so it's an automatic kind of system. Thanks, Andreas.
Okay, the next question is a verbal question from Lukas Spang at Tigris Capital. Lukas, we are now activating the microphone. Please go ahead.
Yes. Hi, good afternoon, Manas. I have actually three questions. Concerning the outlook is the first question. If I got it right, the outlook on revenue side is still just about organic growth. You did this M and As, which come then on top. There's the question: How much revenue do you expect from the M and As you already did this year? The second question, also a follow-up on the questions from Andreas versus, concerning visibility. It seems to be that the ability is a little bit limited when we look at your ad hocs, which is very close to your reporting date. First, what do you think what's behind this maybe limited visibility?
Is there a way to have better visibility in the future, and maybe concerning client behavior? Third question is about this special client, you mentioned also in, in your previous answer, and which is also mentioned in the report. Is there a chance to get back business with this customer, or how do you see this going forward? Thank you.
Thank you, Lucas, for these questions. The first answer, or the answer to the first question is that our outlook as revised is it includes the acquisitions that we have already made. It doesn't include future acquisitions, but it does include the acquisitions we already made. You can estimate the impact of those acquisitions from the data in the annual report, but my guess is it's just a little bit over EUR 20 million. Don't hold me to that. It's somewhere in that range, expected in this, within this guidance that we have given out. The second question is regarding visibility, and why we had to ad hoc. You know, we have had scale backs in certain projects, as you have said, and this can happen from day to day, you know?
That's why I'm a little bit hesitant on visibility. It's not that the projects are not, not continuing, but just the ramp-ups of the that were expected, are being delayed or the ramp downs may be temporarily incorporated. We are seeing some of that, right? We also had some, as I said, some, some demand shifting, a change in demand timing. The public sector, which is actually not affected by the slowdown at all, but it's just a matter of sort of coincidence. As I said, you know, these delays in, in orders, we even have some RFPs, which we have won, but we don't have the project start yet. All of this is creating some sort of uncertainty around the demand that has affected us in the past.
We hope this is the last of it. We are- we have more visibility, or our visibility proves to be, our demand proves to be strong and solid for the future. It's not. There's no easy way to improve visibility, because what you do have is a changing environment, and people are all reacting based on their company's context. I, I think that, as Nagarro, we have decided to be focused on digital transformation kind of opportunities on, and now AI-led opportunities. That the kind of work we do, it's not like the 100 million AMS kind of project. We're doing more of the digital work, and this work is a little bit more discretionary for our clients, and we have to live with that.
It's a, it's a great thing when they are out to build new stuff, when they are really cutting back, then maybe it's a little bit easier to cut back on. The third question on the special client that you mentioned, can we get back with this client, back up again with this client? It is theoretically possible, but I wouldn't bet on that. I think that we have, anyway, a lot of other places in Horizontal Tech, where I think we can get back on, and, and sort of grow, bounce back at these clients very rapidly. This particular client, I would not put too much store, set too much store by that. Thank you very much, Lukas, for your questions.
The next question is a written question, once again, from Retaras Jovin. He asks: "Could you please provide some color as to why are DSO growing quarter-on-quarter from 69 days in Q1 to 79 days in Q2? Thank you.
Thanks. In the last, one of these calls, I don't remember which one, we showed the evolution of DSOs over several quarters. If you refer to that, you will see that the current level of DSOs is actually not that unusual. I will. It's within the band where DSOs tend to fluctuate for us. There is also a special technical impact of a certain of M&A, which maybe, Gagan, you can say a few words on. We just lost Gagan, I can say it. Okay. It, it's that we have, we have consolidated these acquisitions in the last month of the period, we have taken on the receivables and the contract assets. The revenue that we have consolidated is only the last month revenue, which also has an impact.
That, that's the technical thing, that is also affecting DSOs. Thank you very much for your question.
The next question is from Emilio Jose Rodrigo Parra, an individual investor. "Hi, Manas. I would like to ask about debt and factoring. You are reducing the use of factoring as working capital needs are reducing, but debt is still increasing. Are you seeing further M&A opportunities down the road? Should we expect more debt increase?
Thanks for the question, Emilio. We, of course, are also generating earnings, but we are not likely to do any large transformative acquisitions, but we are fully open to smaller acquisitions that add a lot of synergistic value to Nagarro. As if you look back over the last years, the 15 odd acquisitions that we have done have brought great talent to us, have got great capabilities and client access to us, and we do see the need to continue to do this. We will, of course, keep an eye out on our leverage ratios, of course. Thank you for your question.
At this point, we do have no further questions. I will just pause for an additional 15 seconds to ensure that we do not have any further questions. Okay, we have received another question. This is from Antonio Carazo, a private investor. Good evening, Manas, and congratulations on the hard work. As we progress through the second half of 2023, could you please give an update as to whether the tender process for the auditing of the 2024 financial statement is progressing smoothly? Is there any possibility that the deferral of the salary increases programmed for 2023 will have an impact on the attrition rate? Thanks a lot.
Thanks for the question, Antonio. Yes, you know, we are, as we have said before, planning to effect a change in our auditor ecosystem, both for 2023 and for 2024, and the process of evaluation is continuing. The supervisory board is seized of it and working on it, and we are, we are talking to the top four auditors and getting proposals and things like that. All that is in action. In terms of our, the impact of our salary changes on our attrition, we have been very cautious. You know, we are expecting demand to bounce back. We are very keen to be leaders in this space, and we are not going to give up our growth ambitions because of a few slow quarters.
All the steps that we have taken, we have taken them very, very carefully. We have explained them very transparently to our colleagues. I believe that this will not make any significant dent in terms of our ability to staff our projects, to hire new people, or in terms of our attrition. You can be sure that we are very, very careful about how we are steering through this with a view on the long-term future of the company.
Thank you, Manas. I can confirm that there are no further questions, I hand back to you to conclude the call.
Okay, great. Thank you all for attending this call and for, being supporters for Nagarro for, for through these years. Let me just add that we have a couple of conferences that we are gonna show up at. I, I would like to call out, especially the Commerzbank conference on the 5th of September, and then in November, the Eigenkapitalforum, Forum or the German Equity Forum, we'll be there as well. Hope to meet some of you there, and, have a good day, all of you. Thanks.
Thank you, everyone.