Thoughtworks Holding, Inc. (NASDAQ:TWKS) Q1 2024 Earnings Call Transcript May 7, 2024
Thoughtworks Holding, Inc. misses on earnings expectations. Reported EPS is $-0.09572 EPS, expectations were $-0.02. Thoughtworks Holding, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Rob Muller: Hello, everyone, and welcome to Thoughtworks Earnings Call for the First Quarter of 2024. We will be recording today’s call and during the presentation, all lines will be on listen-only. Joining us today will be Thoughtworks President and CEO, Guo Xiao and CFO, Erin Cummins. The earnings 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 and anticipated costs and benefits of our restructuring actions are forward-looking, and as such, are subject to known and unknown risks and uncertainties. These include, but are 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, 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’ll 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. Hello, everyone. Earlier today, we announced that I will be stepping down from my role, and the Board has selected Mike Sutcliff as my successor, effective June 17. I have spent 25 years at Thoughtworks, starting as a software developer in 1999 before taking out various leadership roles around the world, and I’m grateful for the many opportunities I’ve had. It has been a privilege to be a Thoughtworker, and to be able to learn from the best and brightest in our industry. I’m proud of what we have accomplished together, growing this business and delivering extraordinary impact for our clients around the world. And now, it’s the right time to pass the baton. We’re expecting to return to sequential growth in Q2, and I know I’m leaving this business in very capable hands.
I will continue to support as an advisor to ensure a smooth transition. In Q1, we exceeded our revenue expectations. We delivered in the context of a macroeconomic environment that, though stable, isn’t yet showing signs of improvement. Our sales cycles are still elongated but our client portfolio remains steady. We’re having more client conversations around growth-oriented work and seeing strong demand for AI and data services, enterprise monetization and DAMO managed services. However, in Q1, we fell short of our adjusted EBITDA margin guidance. This is primarily due to the timing of our ongoing supply rebalancing program, which includes adjustments to our offshore/onshore mix. This has resulted in a lower-than-expected gross margin. Our ongoing restructuring program focuses on efficiencies, and we’re committed to improving our margin profile, and we’re executing our plan to achieve it.
Our client strategies are centered around technology. Our investments in sales and marketing, partners and new services are paying off, and we continue to focus on delivering extraordinary impact for our clients. Now let me share our first quarter results. We generated revenue of $249 million during the first quarter, with adjusted EBITDA margin of 2.7%. Our industry-based go-to-market is gaining momentum. We delivered strong bookings in the quarter and expect to return to sequential quarter-over-quarter growth in Q2 2024. We remain focused on growing our client relationships, as reflected in the 57 clients with trailing 12-month bookings of over $5 million at quarter-end. New client acquisition remains a strength. We contracted with 49 new clients in the first quarter compared to 46 in the fourth quarter of 2023.
We have seen traction from a vertical-based sales model with higher new logo acquisitions in our energy, public and health services, technology and business services. These are verticals that we have intentionally focused on. We have outstanding technologies and reputation for innovation and thought leadership. We’re well positioned to help our clients evolve their operations and harness the power of cloud, data and AI to adapt to future success. Now, let me hand over to Erin.
Erin Cummins: Thanks, Xiao, and thank you to everyone for joining our call today. We continue to invest in strengthening our client relationships, and we are driving engagement with clients across all verticals. Our focused approach to building demand continues to provide ongoing returns with 62% of quarterly bookings in Q1 coming from outbound efforts. Our teams are converting pipeline opportunities, helping us achieve top line results ahead of our expectations in Q1. Our team’s execution comes against the backdrop of a still challenged macro environment. That said, the macro remains steady and we have not seen the development of incremental client budget pressure since last quarter. Their digital needs remain intact, and we are partnering with our clients as they put their plans into action.
Now let’s turn to more detail about the first quarter. Revenues were $249 million, representing a year-over-year decline of 19% in both USD and constant currency. Acquisitions completed in the last 12 months were immaterial to the revenue growth rate in Q1. During the quarter, we saw year-over-year declines of 11% in APAC, 21% in Europe, 23% in North America and 31% in the LATAM. Among our industry verticals, revenue declined by 8% year-over-year in automotive, travel and transportation; 12% in technology and business services; 19% in retail and consumer; 25% in energy, public and health services; and 29% in financial services and insurance. Compared to Q4 of 2023, we saw sequential growth in automotive, travel and transportation; energy, public and health; and technology and business services.
During Q1, as a percentage of total revenue, our top 5, top 10 and top 50 clients generated 18%, 29% and 68%, respectively. As of the end of Q1, we had 27 clients with TTM revenues greater than $10 million. On a TTM basis, around 95% of our business came from existing clients. As of Q1 of 2024, our annualized average revenue per employee was $92,000. We continue to believe that this metric, which remains above the industry average reflects the strategic importance of our work. On a trailing 12-month basis, we finished Q1 with bookings of $1.2 billion, down 20% compared to Q1 of 2023. Our year-over-year TTM bookings reflect the change in client behavior that developed over the prior year, which pressured contract length and sizing. However, we continue to see relative stability among our clients and TTM bookings were unchanged sequentially from Q4 of 2023.
As Xiao mentioned, our Q1 bookings were strong. Adjusted gross margin was 31% for Q1 compared to 36.4% during the prior year. Our Q1 adjusted gross margin continued to be impacted by lower onshore utilization and high single-digit pricing declines on a like-for-like basis. In the first quarter, our adjusted SG&A as a percentage of revenue was 28.3% compared to 25.1% in the prior year. We’ve seen a year-over-year reduction of $7 million in adjusted SG&A through proactive cost management while still investing in demand generation. Adjusted EBITDA was $7 million for the first quarter from an adjusted EBITDA margin of 2.7%. Q1 GAAP diluted loss per share was $0.10 compared to $0.03 in the prior year period. Our adjusted diluted loss per share was $0.02 compared to adjusted diluted EPS of $0.03 during the first quarter of 2023.
Free cash flow was negative $20 million during Q1 compared to free cash flow of $31 million in the prior year period. The timing of certain items in addition to year-over-year revenue headwinds impacted cash flow in the quarter. We expect positive cash flow in Q2. As of March 31, 2024, our term loan balance stood at $294 million. We continue to have good liquidity, ending the quarter with a cash balance of $73 million and an undrawn $300 million revolving credit facility. Our outstanding employees make our achievements possible, and we continue to believe that we have the best technologists in the industry. Our attrition rate remains below industry averages. In Q1, voluntary attrition on a TTM basis was 12.4%, slightly up sequentially from 12% in Q4 2023, and an improvement year-over-year from 13.1% in Q1 of 2023.
At the end of Q1 2024, our headcount was around 11,000. We are hiring selectively focusing on specific skill sets, such as data and infrastructure. Now let me hand the call back to Xiao to share a broader update on the business.
Guo Xiao: Thanks, Erin. We’re making steady progress and we’re pleased to receive recent recognition from Forrester, a leading global market research company. Thoughtworks was named in Innovation Consulting Services Landscape Q1 2024 report by Forrester Research. We were pleased to be the only listed service provider with a geographic focus on four continents. We continue to execute our vision to deliver extraordinary impact for our clients. Let me share some of the client stories to bring this to life. Foxtel Group, Australia’s leading subscription television company, has worked with Thoughtworks since 2021. We actively engage with Foxtel Group to integrate their innovative streaming services, aggregator platform, Kayo Sports, BINGE and Hubbl.
We also aim to shape the future of Kayo Sports, a thriving sports streaming service under the Foxtel Group umbrella that is affiliated with American conglomerate News Corp. Autotrader is the UK’s largest automotive marketplace, providing access to over 80% of UK’s automotive retailers. Autotrader brings together the largest and most engaged consumer audience with the largest pool of vehicle sellers. Autotrader partnered with Thoughtworks seven years ago on a major transformation. Today, Autotrader is working with Thoughtworks to realize their aspirations to provide an industry-defining connected customer experience. And our client, Total Wine & More were building upon our enterprise monetization focus and expanding to drive broader organizational change with a product thinking approach.
Having grown into the largest independent retailer of fine wine in the U.S. operating 265 stores, Total Wine prioritized applying this approach to its ERP systems for impactful business outcomes. Total Wine applied product thinking to internal systems, supporting the buyers’ response for reviewing and acting on extensive and intricate data sets, while adhering to a tight schedule for product to get it on store shelves in time. Using a product-led approach, Total Wine aims to improve the ERP experience for buyers and streamline buyer tasks, making them easier and more efficient. The initiative is also expected to cut down tedious work and reduce operational costs. Together with our partner, Google, we have enabled Brazil’s leading communication entertainment group, Grupo Global to migrate one of its key products, Global Play from a legacy system to Google Cloud platform in just nine months.
This project was driven by the need to increase efficiencies, reduce costs, optimize processes, integrate teams and linked to ESG commitments. Through this migration, Global saw a 78% cost reduction in marketing and commercial intelligence and better financial transparency. The streamlined reuse of data and code allow it to reduce the size of its data set by 34% and improve scalability and processing efficiency. In these examples, you can see that our technologies are intensely focused on solving our clients’ toughest challenges by harnessing our expertise with cutting-edge technology. Now let’s turn to AI. Client interest and demand for our AI and AI-related work remains strong, and our team of world-class service professionals is working to bring clients’ AI ambitions to reality.
At the end of the first quarter, we were working on over 50 AI-related projects. We’re delighted to announce the successful acquisition of the talented individuals, IP and technology from Watchful. Watchful is a San Francisco-based company that helps organizations accelerate the creation, enhancement and deployment of AI models. This acquisition enables Thoughtworks’ strategy to become a leading AI transformation partner globally. The integration of Watchful’s technology into Thoughtworks’ suite of data and AI services will expedite client AI deployment, moving projects from proof of concepts to production rapidly and effectively, thereby providing clients with faster returns on their AI investments. Our clients are still early in the AI journey.
We’re pleased that some are moving from proof of concepts to operational deployment and we see a long runway of direct and indirect opportunities. In the first quarter, we powered up our services launch engine, launching eight new AI services. For example, AI-first software delivery, AI-powered digital products and AI platforms, we believe these AI technologies and services, covering a wide range of use cases, will be a source of value for our clients and followers. We’re also seeing AI increased demand for our enterprise monetization and data service offerings as clients focus on improving their systems and data to harness AI’s potential. Let me share a few client examples. We have worked with a global top 10 bank to streamline its customer compliance process.
We have been working with this bank for a decade on data platforms and more recently, large language models. The bank’s complaint team faced many challenges, resulting in a poor customer experience. We built and delivered a system to extract and summarize complaint tax in the audio based on large language models. Additionally, we delivered a web page summary for complaint analysis and a customer web chatbot. To minimize hallucinations, we employed keyword techniques, conducted structural analysis and filtered out irrelevant and harmful information. We achieved 75% of efficiency improvement and agents can now save approximately 40 seconds per customer complaint interaction. We use data modeling to reduce maintenance costs in one of the world’s top 20 airlines by revenue.
We built an optimization algorithm to find an optimal maintenance sequence to reduce the number of days airplanes are grounded due to maintenance activities. We integrated this with the airlines internal system to visualize and update the maintenance chain in real time. We developed data models to evaluate – optimize the trade-offs between operational disruptions and holding inventory costs. This ongoing program has already delivered double-digit million dollar cost savings ahead of schedule. All this is built on our expertise in and commitment to ethical technology. More than ever, this is critical to our clients as they look to deploy and scale fast-moving AI technology in complex, often regulated environments. Diversifying our service portfolio is a priority.
We’re pleased that Thoughtworks’ DAMO managed services are getting good uptake with 16 new deals in Q1. Thoughtworks’ AI-powered DAMO managed services go beyond simply sustaining client applications. We help them continuously enhance and transform and we expect to deliver 10x the productivity that labor-intensive managed services providers offer. DAMO managed services is strategic for Thoughtworks to shift to longer-term contracts and for service expansion. Our clients often tell me that our technologies and thought leadership differentiate Thoughtworks. They look to us to help them make the right technology decisions, which is arguably never been more challenging. Clients turn to us because we write the books that shape the future of technology.
This quarter, Thoughtworks luminaries published two new books. Software architecture can be a tricky area to get started with, even for relatively experienced software developers. The book, Head First Software Architecture, takes a radically different approach to technical books, bringing the key concepts and ideas behind software architecture to live in a visual and engaging way. Demand for machine learning solutions has grown significantly in recent years. The book, Effective Machine Learning Teams, bridges the gaps between software engineering, lean product practices and machine learning models. It is an essential guide for practitioners who want to better understand how to deliver machine learning backed products. I’m also proud to share that we published the 30th edition of the Thoughtworks Technology Radar.
This twice yearly snapshot of tools, techniques, platforms, languages and frameworks is based on the experience of Thoughtworks global teams working with the clients. Through a series of blips, it highlights the clients what they should adopt, trial, assess and hold. Edition 30 includes over 100 blips and a third relates to AI. Back to you, Erin.
Erin Cummins: Thanks, Xiao. Now let me discuss our business outlook for Q2 2024 and the full year. We are seeing stability among our client base and the macroeconomic environment is unchanged. Clients remain focused on achieving more with less, but we did not see incremental budget pressures developed during Q1. Our teams are focused on converting pipeline opportunities within the framework of client budgets. We are seeing the benefits of our vertical focused approach, which help drive faster conversion in Q1 and into Q2. For the second quarter of 2024, we expect revenues to be in the range of $250 million to $255 million, reflecting a year-over-year decline of 13% to 11%. At current rates, guidance incorporates an immaterial FX impact in Q2.
We expect adjusted EBITDA margin for the second quarter to be in the range of 5.5% to 7.5%. For the second quarter, we expect adjusted diluted earnings per share to be in the range of negative $0.01 to positive $0.01, assuming a weighted average share count of approximately 323 million diluted shares outstanding. Turning to our full year 2024 outlook. We now expect revenues in the range of $995 million to $1.02 billion, reflecting a year-over-year decline of 12% to 9% in USD and 12% to 10% in constant currency. Additionally, for the full year, we still expect adjusted EBITDA margin of 8% to 10%. We remain focused on driving efficiencies in both our supply and our G&A functions, and we continue to expect margin expansion as we progress through 2024.
As of March 31, we have realized $87 million in annualized cost savings since we began our restructuring program last August. As we have undergone the process of improving our cost profile, we have identified further savings opportunities. Accordingly, we are raising our targeted range of total cost savings to $100 million to $115 million from our initial targeted range of $75 million to $85 million. With the increased cost savings target from our restructuring program, we now expect total pre-tax charges of $26.5 million to $33 million, of which we have already recorded $21 million through the end of Q1. Importantly, we do not anticipate any disruption to client service as we execute upon these incremental savings opportunities. For the full year, we now expect adjusted diluted EPS of $0.02 to $0.08, assuming a weighted average share count of approximately 330 million diluted shares outstanding.
For the full year, we expect share-based compensation will total $42 million. Altogether, we believe that we are at an inflection point and are seeing signs of stability. Our expected growth into Q2 is encouraging. We are intensely focused on improving results and driving margin expansion. We are building a more resilient company while delivering client impact through our thought leadership and technology excellence. Before we get into Q&A, I would like to say thank you to Xiao for his many years of leadership. You’ve seen this business through many changes and your passion for the work and for all Thoughtworkers has never wavered. We greatly appreciate all that you’ve contributed throughout your time here. It’s been an honor to work with you.
And with that, let’s move to Q&A. Operator, will you please provide instructions for those on the call?
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