Thoughtworks Holding, Inc. (NASDAQ:TWKS) Q1 2023 Earnings Call Transcript

Thoughtworks Holding, Inc. (NASDAQ:TWKS) Q1 2023 Earnings Call Transcript May 13, 2023

Rob Muller: Hello, everyone, and welcome to Thoughtworks earnings call for the First Quarter of 2023. We will be recording today’s call. [Operator Instructions]. Joining us today will be Thoughtworks’ President and CEO, Guo Xiao, and CFO, Erin Cummins. The press release was issued earlier today and is also available on our Investor Relations page at thoughtworks.com. Some of the matters we’ll discuss on this call, including our expected business outlook are forward-looking and as such are subject to known and unknown risks and uncertainties, including, but not limited to those factors described in today’s press release and discussed in the Risk Factors section of our annual report on Form 10-K, our quarterly reports on Form 10-Q and other reports we may file with the SEC from time to time.

These risks and uncertainties could cause actual results to differ materially from those expressed on this call. These forward-looking statements are made only as of the date when made. During our call today, we will reference certain non-GAAP financial measures. We will also provide growth rates in constant currency as a framework for assessing how our underlying business performed, excluding the effect of foreign currency rate fluctuations. We include non-GAAP to GAAP reconciliations in our press release furnished as an exhibit to our Form 8-K. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. Thoughtworks assumes no obligation to update or revise the information presented on this conference call.

I will now hand over to Xiao.

Guo Xiao: Thank you, Rob. Welcome, everyone, to our first quarter earnings call. I would like to start by sharing an overall update on our business and then Erin will take you through our first quarter results in more detail. I will then share some of our business highlights before Erin provides guidance and we open for Q&A. Let me start with a recap about Thoughtworks. We’re a global technology consultancy that integrates strategy, design and engineering to drive digital innovation. We marked a big milestone this week as Thoughtworks turns 30 years old. I joined Thoughtworks almost 24 years ago, and I’m proud of the impact we’ve had on our clients and the world at large. Our services have helped to transform industries, create new opportunities, and make people’s lives better, and that’s something to celebrate.

I’m pleased to report good results in our first quarter 2023, driven by the continued demand for our digital transformation services. We delivered revenue of $307 million in the first quarter of 2023, $3 million better than the midpoint of our guidance. We contracted with 47 new clients in the quarter, and our overall bookings at the end of Q1 on a TTM basis stood at $1.5 billion. We now have 39 clients with revenue greater than $10 million on a TTM basis, a 26% increase year-on-year. Though the demand environment is less bullish than a year ago, our sales pipeline is building well. Our proactive investments in sales and marketing are starting to show results, and we’re seeing larger deals in the pipeline. At the end of March 2023, we had 11,840 Thoughtworkers in 18 countries across 5 continents.

The number of Thoughtworkers employed at the end of the quarter factors in some phasing of employee reductions due to the Reduction in Force program we conducted in February and March 2023. The RIF program impacted approximately 4% of our workforce. We continue to hire specific skills. We are driving our business with rigor and discipline while managing supply and demand. As we exit the first quarter, we’re pleased that our utilization is now in line with our target operating levels. I would like to thank every Thoughtworker around the world for the extraordinary impact they create through our technology excellence and culture and for their commitment during this time. Global uncertainty continues in the first quarter. However, the recent volatility in the banking industry had minimal impact on Thoughtworks.

We continue to stay close to our clients, helping them to be adaptive to change and get better returns from their investments in technology. For many businesses, keeping up with technology can be a real challenge given how rapidly the industry changes. To address this gap, we publish our annual technology vision, the Thoughtworks Looking Glass, which identifies 6 mega themes. These themes represent significant opportunities for our clients and for Thoughtworks. This year’s themes, which we call Lenses, include platforms as products, making the metaverse and partnering with AI. With each lens, we categorize hundreds of trends in two dimensions, horizon scanning plus our recommendations. Looking Glass helps our clients make informed decisions about what technologies to prioritize to best capitalize on opportunities.

Let me share some examples of our technology vision in the context of recent client work. First, Platforms as products, designing and delivering platforms which are relentlessly committed to end-user value with our client. First Student, we’re working to deploy a digital platform to help address nationwide bus driver shortages and provide reliable, cost-effective transportation to students with special needs. First Student is North America’s leading school transportation solution provider, completing 5 million student journeys each day. Together, we created a digital platform on AWS. The platform enables First Student to work with third-party transportation providers to leverage their unused hours of drive time. Among the platform’s benefits is data analytics.

This matches student needs to specialized vehicles. For instance, those with wheelchair ramps, the platform helps provide timelier route efficient transportation, and it is having an extraordinary impact on experience of drivers, students and parents. The second example of our technology vision I’d like to talk about is making the metaverse, how extended and augmented reality enables new forms of connection. We’re working with Google public sector to digitally transform the visitor experience at the Abraham Lincoln Presidential Library and Museum. Our collaboration will use artificial intelligence, extended reality and augmented reality technologies. These will be hosted on Google Cloud to create accessible, engaging and interactive visitor experiences.

With this partnership, the museum will use XR to bring American history to life for millions of visitors. The third example I’d like to share is partnering with AI as machine intelligence becomes mainstream. We’re seeing this trend in the automotive sector around software-defined vehicles and autonomous cars. We recently won a new contract with existing client, one of the top 10 automotive companies in the world, to provide a fully managed offboard AI platform tool stack. This enables its data science team to provide AI connected services and products in its vehicles. Partnering with AI is a subject of great interest to clients. They’re asking us how they can capitalize on opportunities driven by ChatGPT and other large language models. What other themes we’re seeing from customers looking to partner with AI?

Let me share a couple. Alongside Thoughtworks 0-1 product innovation capabilities, we’re helping clients answer the question. How should I be thinking about using generative AI and large language models to support product and customer experience? And another theme is software development productivity. Our recent work with clients point to the productivity to be gained by using large language models as a junior partner in software development. A Thoughtworks engineer provides architecture guidelines and AI codes accordingly, showing its reasoning. Then the engineer and AI collaboratively work together to refine the output. Early tests are encouraging, and we have observed good productivity gains with AI-assisted software development. Working with our clients, we’re also embedding guidelines for the ethical and responsible application of AI.

You can read about our learnings in a recent article called an example of Large Language Model Prompting for programming by Martin Fowler, Thoughtworks, Chief Scientist. We also continue to see client interest in our propositions that drive productivity and cost efficiencies. For example, engineering effectiveness solutions, which boost the productivity and retention of critical engineering talent. Also, our DAMO managed services offering helps our clients achieve zero maintenance of their software by leveraging our strength in digital application management and operations. Five of our top 50 clients sign up for DAMO services in Q1. For all these reasons, we believe Thoughtworks is well positioned in the market. Now let me share some more details of our growth strategies.

At the core, our revenue growth is from deepening relationships with existing clients and winning new logos. We then supplement this with focused strategies around M&A, partners and geographic expansion. First, let me provide an update on partners. Our primary focus is to develop go-to-market partnerships with hyperscale cloud providers, including AWS, GCP and Azure. Directionally, our goal is to drive 25% of our revenue growth by working with partners. We continue to invest in our partner capabilities. In the first quarter, we achieved a swathe of certifications and specializations. These include AWS data and analytics competency, Google Cloud data analytics services specialization and Microsoft data and AI solutions partner designations. Turning now to our client portfolio.

The depth of our expertise and breadth of our capabilities means that we can help clients address a broad range of challenges. We assist from strategy right through to business outcomes. Our clients appreciate the value we create with them and increasingly look at Thoughtworks as a strategic digital transmission partner, able to scale new technology across their enterprise. This is reflected in the 9-year average tenure of our top 10 clients at the end of 2022. For example, Thoughtworks has had a long-term digital partnership with MYOB since 2019. MYOB is a leading provider of business management solutions. We’re pleased to have signed a new contract cementing the partnership for another 5 years. The signing position Thoughtworks to continue to work with MYOB’s most important digital initiatives.

And Thoughtworks has been working with Singapore’s Government Technology Agency, GovTech for around 6 years. In 2019, we began our partnership with GovTech on Singpass, Singapore’s National Digital Identity initiative, NDI. NDI is a government strategic national project to drive and adopt digital technologies to support the City state’s digital transformation into the world’s first smart nation. The evolution of Singpass focuses on 3 goals: first, to build a trusted, secure and innovative platform. Second, to offer entire ecosystem of services to Singapore residents; and third, to be cloud native to provide flexibility, scalability and reliability. Singpass is now one of the world’s leading NDI platforms used by more than 4.5 million Singapore residents.

Transactions that previously took days or hours to complete, offer requiring physical visits, now take minutes. They can be performed from anywhere with Internet connection. As of March 31, 2023, Singpass offers seamless access to more than 2,000 services from 700 organizations. It supports more than 350 million personal and corporate transactions every year. Its evolution as a trusted, all-in-one services app is ongoing. Now turning to new clients. We have a focused approach to new clients, helping the organizations will work with to deliver rapid business value from digital transformation. We see continued momentum in new logo acquisition, and we have contracted with 47 new clients in the first quarter. We’re working with new client Total Wine & More, TWM, North America’s largest independent retailer of fine wine, spirits, beer and related products.

We have a multiyear agreement to apply the building blocks of a modern digital business. We’re working on TWM’s enterprise resource planning applications with Microsoft Azure by embracing a product-centric delivery model. The engineering team will be able to innovate and evolve legacy applications. This includes those that support the merchandising and supply chain processes, helping to drive productivity and effectiveness. You can find details of some of these customer successes on news section of our website, thoughtworks.com. I’m now going to hand over to Erin, so that she can take you through the numbers in greater detail.

Erin Cummins: Thank you, Xiao, and thank you to everyone who has joined today’s call. We are pleased to announce our Q1 results with both revenue and adjusted EBITDA margin exceeding the guidance that we provided in February. Revenues in Q1 declined 4% year-over-year to $307 million. In constant currency, revenue declined 1% compared to the prior year period. Acquisitions contributed 3 percentage points to revenue growth in Q1. Adjusted EBITDA for the quarter was $35 million, equating to an adjusted EBITDA margin of 11.4%. I am thankful for our team’s ability to execute in the midst of a difficult macro environment. As we previously outlined, remaining close to our clients is a core strategy while we navigate today’s landscape, and our sales efforts are driving results.

We are partnering with our clients as they undergo their long-term digital transformations, and we are working closely as clients weigh short-term decisions within long-term programs. Our clients recognize our thought leadership and value working with Thoughtworks. We see this reflected in our annualized average revenue per employee, which was $100,000 for the first quarter and remains above the industry average. While some clients still exhibit caution in their buying patterns, our solutions remain highly strategic. Now let me share some additional details about the quarter. Our overall bookings at the end of Q1 on a TTM basis stood at $1.5 billion. We have a well-diversified revenue base across geographies, industry verticals and clients.

Europe was our best-performing region on a year-over-year basis, followed by APAC, North America, then LATAM. Due to the diverse nature of our business on a geographic basis, 65% of our first quarter 2023 revenues were contracted in non-USD currencies. As a reminder, our primary revenue-generating currencies alongside the U.S. dollar are the euro, Great British pound and Australian dollar. Turning to our industry verticals. Automotive, travel and transportation continues to be our fastest-growing vertical, rising 22% year-over-year. Energy, public and health services saw solid growth at 9%. Financial services declined by 6%. Technology and business services declined by 13%, and our retail and consumer vertical decreased by 23%. For the first quarter, on a TTM basis, around 89% of our business came from existing clients.

We now have 39 clients with revenues greater than $10 million on a TTM basis, 8 more than the first quarter of 2022, a 26% increase year-on-year. We have a balanced customer portfolio with relatively low client concentration. In the first quarter, our top 5, top 10 and top 50 clients generated 17%, 27% and 67%, respectively as a percentage of total revenues. Adjusted gross margin was 36.4% for Q1 compared to 45.6% during the prior year period. Utilization was primarily responsible for the yearly decline, but I am pleased to share that we exited the quarter with utilization in line with our target operating levels. In the first quarter, our adjusted SG&A as a percentage of revenue was 25.1% compared to 22.6% in the prior year period. Adjusted EBITDA was $35 million for the first quarter, and adjusted EBITDA margin was 11.4%.

Adjusted EBITDA margin declined year-over-year from lower utilization and the recognition of approximately $6 million in severance-related expenses. Q1 GAAP diluted loss per share was $0.03 compared to a loss of $0.14 in the prior year period. Our adjusted diluted EPS was $0.03 compared to $0.13 for the first quarter of 2022. Free cash flow for the quarter was $31 million compared to negative free cash flow of $11 million in the prior year quarter. We have ample liquidity with a cash balance of $109 million as of March 31, 2023, alongside an undrawn revolving credit facility. We continue to reduce our outstanding term loan, which stood at $301 million as of March 31, 2023, following a $100 million prepayment in February. Now I would like to hand back to Xiao to share additional updates on our business from the first quarter.

Guo Xiao: Thanks, Erin. Let me start with our amazing Thoughtworkers. With the long-term focus on diversity and inclusion, our community of 11,840 Thoughtworkers included 43% women and underrepresented gender minorities, WUGM as of March 31. Our voluntary attrition of 13.1% on a TTM basis demonstrates the strength of our employee value proposition. We believe that Thoughtworks has the best digital talent in the industry, and this positions us well to create extraordinary impact for our clients. In the first quarter, we’re pleased that Thoughtworks have active Great Place to Work certification in 13 countries with an average trust index score of 90%. Our priority is for Thoughtworks to be a place for talented technologies to grow and have impact.

Our global Glassdoor rating is a measure of the progress we’re making. In the first quarter, our overall rating was 4.08, which is higher than the rating for the IT services sector of 3.91. We’re delighted to be ranked ninth on LinkedIn’s top companies 2023, the best workplaces to grow your career in the U.S. LinkedIn ranked companies based on 8 pillars that lead to career growth using data from LinkedIn Talent Insights. The pillars include ability to advance, skills growth, external opportunity and gender diversity. The ability to advance pillar tracks employee promotions within the company and when they move to a new company. Skill growth looks at how employees are gaining skills while employed at the company. Now let me hand back to Erin.

Erin Cummins: Thank you, Xiao. Turning to ESG. I am pleased to update that in the first quarter, Thoughtworks science-based climate commitment targets were validated by the science-based targets initiative. You can find details of our SBTi targets in our investor presentation. As a co-founder of the Green Software Foundation, Thoughtworks is committed to helping our clients adopt sustainable technologies, while we reduce our own carbon footprint. In the first quarter, Thoughtworks undertook a sustainability tech assessment for zero to explore how technology can accelerate achievement of its sustainability goals. At the end of the engagement, a road map was developed categorized into now, next and later horizons for helping to achieve tech-enabled organizational sustainability goals.

Now let me move to our business outlook for Q2 and for the full year 2023. Both new and existing clients continue to engage with Thoughtworks to drive their digital transformation journeys. These needs remain intact, and our pipeline continues to grow. For the second quarter of 2023, we expect revenues to be in the range of $300 million to $304 million, reflecting a year-over-year decline of negative 10% to negative 9% or negative 9% to negative 8% in constant currency. For the full year, we expect a revenue decline of 3% to 1% or 3% to 1% in constant currency. We expect acquisitions will contribute approximately 2 points to revenue growth in Q2 and 2 points of growth for the full year. We expect adjusted EBITDA margin for the second quarter to be in the range of 15% to 16%.

For the full year, we expect adjusted EBITDA margin of 17% to 18%. For the second quarter, we expect adjusted diluted EPS to be in the range of $0.03 to $0.04, assuming a weighted average share count of approximately 329 million diluted shares outstanding. For the full year, we expect adjusted diluted EPS of $0.31 to $0.34 assuming a weighted average share count of approximately 333 million diluted shares outstanding. Our Q2 guidance incorporates share-based compensation of $18 million. For the full year, we expect share-based compensation will total $76 million. As a reminder, beginning in 2024, we anticipate annual stock-based compensation to range between 2% to 4% of revenue. Now we would like to provide some context that is informing our guidance for Q2 and the rest of the year.

First, the general contracting environment is similar to what we noted last quarter, but there are incremental green shoots. Clients are discussing larger, more widely encompassing projects compared to earlier in the year. We still see elongated sales cycles and clients continue with more incremental ramp-up, but the size and scope of our pipeline is strengthening. However, pipeline conversion is moving more slowly than previously anticipated and we are therefore seeing a slower ramp-up in certain projects. This has led to our revised full year guidance. Secondly, we are seeing resilience in Europe and early signs of recovery in China as we enter Q2. We continue to see caution exercise in Australia, while continued strong growth in India serves as a positive offset within APAC.

The environment in North America remains relatively in line with last quarter. Third, and consistent with recent quarters, we still see strength in our automotive vertical, while technology and retail verticals face pressure. Lastly, we continue to build our outbound sales generation capabilities, and we are seeing progress. We saw strong bookings in the quarter while also bringing in 47 new logos. In 2023, we remain focused on executing against a robust and expanding pipeline while managing our costs, balancing supply and demand and investing into our growth initiatives. We continue to believe that our talent represents the best in the industry, and I am extremely thankful for the efforts of all Thoughtworkers as we navigate this macro environment.

We will remain close to our clients as our services remain a key element of their multiyear digital transformation journeys. Our renewal rates are strong, and we are growing the number of $10 million annual revenue clients, underpinned by our highly relevant service offerings. Now let me hand back to Rob.

Rob Muller: Thanks, Erin. You can find our investor presentation on the Thoughtworks Investor Relations website. We will now move on to Q&A. I would ask that you each keep to one question and one follow-up to allow as many participants as possible to ask a question. Operator, would you please provide instructions for those on the call?

Q&A Session

Operator: [Operator Instructions] Our first question comes from Tien-tsin Huang with JPMorgan. Your line is open.

Operator: Our next question comes from Maggie Nolan with William Blair. Your line is open.

Operator: Our next question comes from Matthew Roswell with RBC. Your line is open.

Operator: Our next question comes from David Koning with Baird. Your line is open.

Operator: Our next question comes from Bryan Bergin with Cowen. Your line is open.

Operator: [Operator Instructions]. Our next question comes from Moshe Katri with Wedbush Securities. Your line is open.

Operator: Our next question comes from Ryan Potter with Citi. Your line is open.

Operator: Our next question comes from Jason Kupferberg with Bank of America. Your line is open.

Operator: There are no further questions at this time. I’d like to turn the call back over to Xiao for any closing remarks.

Guo Xiao: Well, thank you, and thank you for joining us for our Q1 earnings call. I would like to acknowledge the continued support of our Board and our shareholders. In closing, I want to thank all Thoughtworkers, clients and partners for the extraordinary impact we’re delivering every day together. Stay well, and we look forward to catching up with you next quarter.

Operator: Thank you for your participation. You may now disconnect. Everyone, have a great day.