TELUS International (Cda) Inc.
Q2 2023 Earnings Call Transcript

Published: 13 Jul 2023

[Operator:]

Ladies and gentlemen, welcome to TELUS International Investor Call. My name is Latif, and I will be your conference facilitator today.

[[Operator Instructions]:]

[I would now like to introduce Jason Mayr. Head of Investor Relations and Treasurer at TELUS International. Mr. Mayr, you may begin the call.:]

[Jason Mayr:]

Thank you, Latif. Hello, everyone. Thank you for joining us on relatively short notice. Hosting our call today are Jeff Puritt, President and Chief Executive Officer; and Vanessa Kanu, our Chief Financial Officer, who will discuss the preliminary view of our second quarter results and a revision to our full year outlook for 2023. After brief remarks from Jeff and Vanessa, we'll then open the line to questions from prequalified analysts before turning the call back to Jeff for his closing remarks. Before we begin, I'd like to remind you that the statements made during this call may be forward-looking in nature, including all comments reflecting expectations, assumptions or beliefs about future events or performance that do not relate solely to historical periods.

[These forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from our current projections. We assume no obligation to update any forward looking statements. Jeff and Vanessa will also discuss certain non-GAAP measures that the management team consider to be useful in assessing our company's underlying business performance.:]

[An explanation of these non-GAAP measures and a reconciliation to the comparable GAAP measures can be found in the news release issued today and filed on SEDAR and EDGAR. I would also like to remind everyone that all financial measures we're referencing on this call and in our disclosure are in U.S. dollars unless specified otherwise, and relate only to TELUS International results and measures. With that, I'll now pass the call over to our President and CEO, Jeff Puritt.:]

[Jeffrey Puritt:]

Thank you, Jason, and hello, everyone. Thank you for joining us on this call. I hope you've had a chance to read the news release we issued after the market closed today, which provides a preliminary view of our second quarter results and a revision to the full year outlook for 2023. The purpose of this call provide some helpful context and answer your questions.

[But just in case you haven't yet had the opportunity to review our news release, Vanessa and I will start by providing some summary remarks. During the second quarter, faced with significant global macroeconomic pressure, TELUS International has experienced a pronounced and unexpected reduction in service demand from some of our larger clients, particularly within our technology vertical. Several of our key clients are themselves dealing with similar challenges as they aggressively address their own cost structures creating significant delays and near-term reductions in spend commitments, which is having an impact on our Q2 results and on our expectations for the remainder of 2023.:]

[In this market backdrop where successive employee downsizing has become increasingly common. We've seen many of our clients to reprioritize spend in order to meet near-term financial expectations which has been converting new opportunities and define commitment challenging for us, particularly during the time when inflation remains elevated across the globe.:]

[It was our hope that patients would allow the dust to settle and for demand to rebound. But unfortunately, that has not happened as of yet. As we've discussed on prior quarterly calls, we face pressure within our European operations, but we continue to adjust our capacity levels as quickly as possible to better match the near-term demand environment. The challenge is exacerbated there at certain European labor requirements do not always allow us to move as quickly as we desire, which leads to excess costs being carried longer in the near term.:]

[This can have a compounding effect with programs from long-tenured clients that are already optimized from an EBITDA margin yield perspective, suffer a top line reduction, creating a disproportionate near-term impact on our profitability. We're also experiencing temporary demand in balances in some of our other geographies due in part to certain projects requiring more onshore delivery and resulting in a less flexible cost structure for us in the near term.:]

[All of these dynamics have impacted TELUS International's overall revenue and profitability to a larger extent than we anticipated, contributing to a more cautious outlook for the balance of 2023. We talked previously about our focus on what we can control. And in this regard, we've continued to push forward on reducing costs and being as efficient as possible across our entire organization.:]

[Again, while it was initially our hope that the macroeconomic landscape would stabilize and demand would return to normal more quickly, it became increasingly apparent that we could no longer wait and we, too, would have to more aggressively reduce staff levels across our organization to better match the shifting demand from the technology sector, in particular. To this end, we've actioned multiple cost efficiency programs that include both team member reduction along with accelerating automation and Generative AI initiatives within our internal processes and platform. While these initiatives do not -- excuse me, while these initiatives do provide in your cost savings and will favorably impact Q3 and Q4 this year, the full benefit are not expected to accrue until 2024.:]

[My team and I are disappointed indeed with these results and truly recognize that this disappointment is shared with our investors and stakeholders. However, while these near-term pressures are certainly a challenge we remain confident in the market opportunities ahead of us. The crown jewels of TI are still very much present. Our business fundamentals are still intact and our ability to help our clients to drive better customer experiences together with better economics, particularly leveraging our prescient investments in AI are in the early innings.:]

[I believe that we have the right mix of global talent and end-to-end digital capabilities to quickly get back on track and deliver on our growth strategy. I'll now pass the call over to Vanessa to discuss the financial details of our preliminary Q2 results and the revisions to our 2023 outlook. Vanessa?:]

[Vanessa Kanu:]

Thank you, Jeff, and hello, everyone. Thank you for joining us today. While our second quarter financial close activities are still ongoing, the shortfall compared to what we originally expected is important enough to warrant an update at this time. For the second quarter of 2023, we expect revenue in the range of $660 million to $668 million, reflecting year-over-year growth of 6% to 7% on both reported and constant currency basis.

[When excluding revenue earned from WillowTree, this reflects a year-over-year decline of approximately 1%. These year-over-year revenue growth rates are lower than previously forecasted due mainly to higher-than-expected demand pressure primarily within our technology vertical. We expect adjusted EBITDA for the second quarter to be in the range of $117 million to $120 million, representing a year-over-year decline of 20% to 22% and adjusted EBITDA margin of 17.7% to 18.0%. As Jeff mentioned, we faced considerable headwinds in Europe, carrying excess costs that we were not able to rightsize as quickly as we would have liked.:]

[We have also been operating through a short-term period of demand imbalance across certain higher cost regions, which has added to the pressure on our cost base. And despite significant cost efficiency programs that are already in progress, the demand challenges stemming from some of our longer tenured client is exacerbating the impact on profitability as many of the programs impacted were EBITDA margin yield optimized.:]

[Adjusted diluted earnings per share for Q2 are expected to be in the range of $0.15 to $0.17, reflecting largely the aforementioned adjusted EBITDA view flowing through. In addition to the key drivers I've already mentioned, there is also higher interest expense compared to the prior year associated with the WillowTree acquisition. Despite the challenging year-over-year decrease in adjusted EBITDA, our net debt to adjusted EBITDA leverage ratio as for our credit agreement is expected to remain at just under 3x.:]

[These preliminary results and the expected impact for the remainder of this year from all of the headwinds Jeff outlined moments ago prompted a revision to the full year outlook for 2023. What we've released today reflect our updated expectations. For the full year 2023, we now expect revenue in the range of $2.7 billion to $2.73 billion, including $205 million to $215 million from WillowTree, representing year-over-year growth of 9% to 11% on a reported basis and growth of 1% to 2%, excluding WillowTree.:]

[This assumes an average exchange rate of EUR 1 to USD 1.9 (sic) [ USD 1.09 ] for 2023. From a seasonality perspective, we expect second half revenue to be split roughly 48% and 52% between Q3 and Q4. We now expect adjusted EBITDA in the range of $575 million to $600 million, representing a year-over-year decline of 1% to 5% and adjusted EBITDA margin in the range of 21.3% to 22.0%. This implies an improvement in our adjusted EBITDA margin in the second half, which is primarily attributed to our in-progress cost efficiency program as we both rightsize our team to match demand and implement further automation and Gen AI solutions internally.:]

[Indeed, certain of the actions already completed to date will yield in your savings benefit of approximately $40 million the impact of which will be seen more meaningfully in the second half. To this end, we're expecting a roughly 46% and 54% split across Q3 and Q4 based on the timing of the benefits I've just referenced. And while our adjusted EBITDA margins in Q2 were below what they have been historically, with our already completed and in-progress cost efficiency programs, we expect our Q4 exit EBITDA margin to be back up to the 23% ZIP Code. And finally, we expect adjusted diluted earnings per share in the range of $0.90 to $0.97. And again, from a seasonality perspective, we expect a roughly 46%, 54% split in terms of Q3 and Q4.:]

[Although this is a difficult near-term update to share, our view on the critical importance of digital transformation has not changed. As shared at our Investor Day earlier this year, TI has demonstrated a consistent track record of strong revenue growth, profitability and cash flow growth over the past 5 years with historical compound annual growth rates across revenue, adjusted EBITDA, adjusted diluted earnings per share and free cash flow growth each being well over 30%.:]

[Indeed, we see meaningful opportunities being amplified by generated AI adoption and believe in the continuing critical importance of differentiated digital customer experience solutions in the market that will be a tailwind of TELUS International's long-term growth and profitability. Let's now open the line to questions, please. Over to you, Latif.:]

[Operator:]

[Operator Instructions]

[Our first question comes from the line of Aravinda Galappatthige of Canaccord Genuity. Your question please.:]

[Aravinda Galappatthige:]

I wanted to sort of drill down a little bit more into sort of the guidance. I know you've given a lot of detail. Given that you were starting to see sort of spend being held back with your larger -- from your larger clients. To what extent have you sort of extrapolated that to sort of maybe other segments of your clientele when you think about your guidance? I'm trying to get a sense of how much more how much of a cushion or how much of a buffer are you built into sort of the second half expectations within your full year guidance.

[Jeffrey Puritt:]

Thanks, Aravinda. I'll invite Vanessa to top up, but I think you should expect that we've done our best to balance the risks and opportunities reflected in our outlook at this juncture with half the year behind us now. I think that gives us a slightly better visibility into the back half of the year. But as you can imagine, there are still puts and takes. It is still a somewhat uncertain environment. We've done our best to risk rate those opportunities and upside downside challenges across the entire customer landscape that we're supporting, and we're feeling reasonably comfortable that what we reflected at guidance is appropriate.

[Operator:]

Our next question comes from the line of Keith Bachman of BMO.

[Keith Bachman:]

Sorry, what was the name?

[Operator:]

Keith Bachman, go ahead.

[Keith Bachman:]

Okay. Yes. Sorry, I didn't hear my name. This is Keith Bachman from BMO. I had a similar question. Vanessa, I know off the last call, you had indicated and we had some discussions about this. that you improve some improvement in the macro. So I think what -- obviously, that forecast proved too optimistic. And so I think investors are sitting here wondering are you embedding the same thought process as you look at the back half of the year that the macro will improve? Or when investors want to know, did you -- similar to the previous question, did you cut enough? And then I just -- I want to sneak in something else as you talked about the EBITDA margins going back to -- I think you said 23% by Q4. Is there any comments you could make as it relates to the expectations on EBITDA margins and how we should be thinking about cash flow.

[Vanessa Kanu:]

Thanks, Keith. So maybe in answer to your first question, I'll reiterate, I guess, just response to the previous question. which is absolutely we were rather optimistic. But at the time, we were basing that on what we were seeing ourselves from clients. And we were working with clients and based on that, that is exactly what was framing our previous guide. Have we cut enough from the revised guidance. I would again, reiterating Jeff's prior comments, I would characterize our current guidance at cautious. Given the demand environment, we have taken a cautious view of the second half. And it's not -- we haven't limited it to just the tech sector.

[While certainly, it's the tech sector that we're seeing a disproportionate impact on in terms of expectations versus what we're seeing now, we have not limited the guide caution to only the technology sector. We've reduced our expectations of revenue from new logos. The level of incremental revenues previously anticipated from some of our larger existing clients across different sectors, I think we've taken a fairly cautious view. But that being said, I mean there are also -- there are -- I'll just say there are also some positive signs. We've actually -- we're seeing some really early green shoots in terms of some verbal awards across some notable clients, not in the tech sector that we haven't particularly built into our guidance just given the timing of when those came through, but also the requisite project planning detail to be able to validate the exact India revenue contribution. So it actually isn't all demand glue. So I would say exactly what Jeff just said, which is we do think that on balance, it strikes the right expectation as we look into the second half. And then on the EBITDA...:]

[Keith Bachman:]

Just to be clear -- or sorry, is just to be clear, you've taken out the expectations of an improving macro backdrop. Can you just confirm that.

[Vanessa Kanu:]

That is correct. And then really just to answer on the adjusted EBITDA front, as I mentioned in my remarks, based on the cost reduction actions that we've already taken, you'll see based on the guide that we're not forecasting a significant revenue improvement second half versus first half. There's a bit of an improvement, but you'll see that it's not over the top. And so the margin improvement that we're seeing in H2 versus H1 that's implied in the guide is really being driven by several factors, most importantly the cost efficiency programs that we mentioned.

[And some of the ones we've actually already completed to date, as I mentioned, will generate at least $40 million of in-year savings in addition to many other programs that we have in place. So that is what's going to take us to, again, zip code of 23% exit EBITDA margin, which is around the same place that you've seen us historically, but exiting the year at fairly healthy margins relative to where we just closed in Q2.:]

[Operator:]

Our next question comes from the line of Divya Goyal of Scotiabank.

[Divya Goyal:]

Jeff and Vanessa, if you could help us understand what can the company do in future, to work closely with the clients to then better improve forecasting future revenues and workloads. And I understand macro is a pressure that nobody really anticipated at the extent at which has -- it has come to be honest. But if you could help us understand this one specific factor here.

[Jeffrey Puritt:]

Thanks very much, Divya. As we've shared previously, the nature of our business and the nature of the relationships we enjoy with our clients is such that we have a fairly regular and robust dialogue with them with respect to demand requirements. And so frankly, we were disappointed, frustrated. As I suspect. Our clients have been as well that on a relatively unexpected basis, certainly contrary to any previous period that I can recall, it was a fairly precipitous decision and impact in terms of reduced demand.

[We will continue to work closely with our clients to try and get as much visibility into their forecasted service requirements. But part of the biggest challenge is the nature of the work we do and the relationships we have, if the clients aren't giving us more notice on potential decline and we're relying upon for the previous agreements, previous forecast, volume locks, service requirement, it's difficult for us to be any better prepared when at the 11th hour, all of a sudden, the landscape has changed. And again, unfortunately, to a large extent, it's the nature of our industry where our agreements provide our clients with a high degree of flexibility. Indeed, in many cases, that's why they work with partners like Lee to provide them with that variable workforce that variability in expense management to help mitigate their own challenges.:]

[But that means, of course, we underwrite a lot of that risk for them, and it's an incumbent upon lease that much more nimble and flexible in managing our own cost structures, which are so labor intensive in some cases, as I shared in my earlier remarks, in Europe, in particular, the regulatory landscape there is that much more difficult for me to move more quickly and making changes. But the best I can offer is we will continue to work more closely with our clients to better understand those needs as they evolve.:]

[Operator:]

Our next question comes from the line of Kate Kronstein of William Blair.

[Kathleen Kronstein:]

This is Kate Kronstein on for Marg Nolan. I wanted to touch on what you're seeing across other segments beyond technology as far as demand? And then did you see an impact on some of the projects that you expected to come as a result from the WillowTree acquisition?

[Jeffrey Puritt:]

Yes. I think once again, I won't live in as I'm going to top up because I'm sure I may miss something, but tech sector is certainly the most volatile for us right now, some additional challenges in BFSI, for example. Project work indeed for WillowTree and for TI has absolutely been impacted. Principally, again, it's delayed, not cancellations, just a pervasive elongation further still that we've been speaking to over the last couple of quarters, in fact, about decision-making on projects for transformation, revitalization and leveraging the capabilities that TI and WillowTree together bring to bear for our business customers to do better with less.

[And again, frustrating disappoints, we see ourselves as a potential enabler for these business clients to try and help themselves better mitigate the very challenges that we're all navigating. But unfortunately, we're working with them as closely as we can to try and find ways to help them allow us to help them even more so through this project.:]

[Operator:]

Our next question comes from the line of Cassie Chan of Bank of America.

[Jinli Chan:]

I guess First, I just wanted to ask, can you just help us walk through and understand the cadence of organic revenue growth throughout the course of the quarter. So I know you guys are expecting around 1% to 2% for second quarter. During the earnings call in May. So I guess, relative to the June or July rate the volumes and the demand that you've seen, have we seen the trough in organic constant currency revenue growth? Or are you expecting growth to decelerate further before improving in the fourth quarter or maybe in 2024?

[Vanessa Kanu:]

Cassie, so yes, absolutely. As I mentioned in my prepared remarks, the revised sea of organic revenue growth is 1% to 2% based on the guidance that we -- that we just shared. Clearly, as we mentioned, Q2 was down about 1%. And so what that means is an expected nominal increase. So Q1, we were about 5% organic revenue growth, just about 7% constant currency. We just went through the ranges, the expected preliminary close figures for Q2. So to close that 1% to 2% range does imply organic growth in Q3 and Q4, nominal obviously not high single digits, but sort of in the flat to slightly up overall year-over-year growth to average out in that 1% to 2% range for the full year.

[Jinli Chan:]

Okay. That's helpful. And then just wanted to ask, you guys talked about volumes slowing down, but have you seen any impact or changes in terms of the pricing environment that you've been able to pass on with clients as well?

[Jeffrey Puritt:]

The pricing environment has continued to get more and more competitive. Frankly, in my career here, I don't know that I can recall a level of sensitivity around pricing that is so pervasive. And that's -- historically, the challenge was there was a whole bunch of competitors in our space whose value proposition was really your mess for less and their margin yields reflected that price positioning. And we were able to demonstrate at scale with those customers that we're focused on quality and the value for that quality to protect our pricing and our margin yields.

[And so in this heightened price-sensitive environment, it's becoming more and more of that [ Sofie's ] Choice challenge of just how much of a trade-off on margin yield through price reductions are we willing to tolerate in order to preserve revenue and revenue growth. And so it has been -- and I anticipate it will continue to be an ongoing challenge, and we anticipate that because of our unique differentiated AI and part enable capabilities that are really focused on delivering a superior client experience, but we think there's value for money to be recognized in that we'll continue to be able to distinguish ourselves from the competition, but it is absolutely getting more challenging.:]

[Operator:]

Our next question comes from the line of James Faucette of Morgan Stanley. James.

[James Faucette:]

I just wanted to follow up on two quick things. First, Vanessa '23 exiting 4Q, should we imply that 23% for the entirety of 4Q or just literally exiting 4Q? And then my real question is, I think, Jeff, you talked about for the WillowTree projects, they were delayed, but not canceled, et cetera. And so that's encouraging to hear. On your tech clients and broader though, as they're reevaluating can we characterize the projects the same there that they're kind of delayed?

[Or are they do you feel like you're probably going to have to go back and reevaluate and reengage even on different types of projects down the road as they're ready to start to get back to normal operations and growth.:]

[Jeffrey Puritt:]

Vanessa, why don't you take the first part first, and then I'll take the second.

[Vanessa Kanu:]

Thank you. So James, I expect again, as I said, in the 23% top code, and that's for the full quarter Q4, so not just exiting but for the full quarter. So that would be our exit rate out of 2023. Over to you, Jeff.

[Jeffrey Puritt:]

And to the second part, James, you know what? I mean it's hard to know with any certainty whether the projects that have been delayed and/or deferred and/or canceled are likely to be resuscitated sooner or later. But thankfully, it's a preponderance of deferral and delay and few cancellations. In both cases, it is absolutely my and my team's intention to continue to stay in contact with those existing or prospective customers around those opportunities and see how quickly we can demonstrate to them that the value of those projects actually will be well worth at the client's investment sooner than later, given the outcome that are expected in terms of improving their ability to serve their customers and retain share of wallet, grow share of wallet, so on and so forth.

[So I'm not sure it would be an accurate characterization to say all of the WillowTree projects are delayed and some of the TI price weeks are canceled. I think there's a couple in both buckets on the cancellation front and then many, many more in both buckets on the deferral and delay front.:]

[Operator:]

We have a follow-up question from the line of Keith of BMO.

[Keith Bachman:]

Yes. I wanted to go back to

[Any thoughts on any communications on what they might do as it relates to the share position and ask it more directly, might there be some support or buyback in, you think, given the valuation levels, the initial thought was TELUS International was going to be spun out because you could use a higher multiple currency to do M&A and now you're going to have the multiples under duress. Just any kind of comments you could give on both of those threads.:]

[Jeffrey Puritt:]

Thanks, Keith. On the first point, we continue to see very strong support from TELUS, our largest clients and more and more opportunities continuing to be identified and progressed seemingly every day. And as we'll share on our earnings call on August 4, you'll see more detail around the yield, if you will, the contribution coming from TELUS and TI. And as I mentioned on last quarter's earnings call, there really is a counter cyclicality to the relationship TI enjoys would tell us had the opportunities to continue to enable TELUS in its own digital transformation journey now more than ever using our AI capabilities and then thereafter to take those referenceable instances on the road, so to speak, continue to be a real source of optimism and confidence, frankly, for the continued future success of TI.

[On the public markets front, I'll invite Vanessa to offer a more detailed response than I. But suffice to say I'm not sure we know yet what TELUS' plans are around whether or not to go back into the market, buy up our stock, so on and so forth. I can tell you that [indiscernible] TELUS for over 20 years, and I have never seen Darren do anything that it's simply a new jerk reaction to short-term market, I don't know [indiscernible]:]

[Vanessa Kanu:]

I think when we have lost Jeff's audio.

[Keith Bachman:]

I'm getting a lot of clicking to Vanessa, if that...

[Vanessa Kanu:]

Yes. So we lost Jeff's audio. So let me see if I can pick up where he left off where he was really going is, and he's absolutely right. We don't expect TELUS to make a knee-jerk reaction. TELUS is we've been with TELUS from our inception, and we'll -- we don't foresee that changing anytime soon. And you may have seen TELUS actually issued concurrently a press release as well this afternoon. And in Darren's quote, he actually reiterated his optimism for the long-term outlook for TELUS International.

[So, yes, the shares are currently not where we would like them to be. If frankly, they're not anywhere -- the entire market is not where any one of us would like it to be, and we're definitely not pleased with the current share price performance, but we are managing the business for the long term. We do consider ourselves that we've got long-term shareholders like TELUS, like some other long-term investors who are looking at the 3- and 5-year outlook for TI and not making decisions solely on what happened in Q2 or where the share price might be sitting at this present time.:]

[Jeffrey Puritt:]

Keith, I'm back. I have no idea what happened there. I just got thrown out of the call. I guess, anyway, I hope Vanessa managed in my absence. And if you didn't hear all that you needed, please feel free to follow up with me directly afterwards.

[Operator:]

Thank you. There are no other questions at this time. I will now turn the call back to Mr. Puritt. Mr. Puritt, the line is yours.

[Jeffrey Puritt:]

Thank you, Latif, and thank you all once again for finding the time to join us for this call on short notice and for your questions. Although the update shared today is frankly disappointing, frustrating and challenging. Please note that my management team and I are working tirelessly and thoughtfully to get back to the consistent execution that we've demonstrated for so many years.

[We've done so through an unwavering focus on building for the long term. And while there will at times be bumps in the road, I have complete confidence that TI remains well positioned to continue executing on our profitable growth strategy. Indeed, consistent with [indiscernible] regarding our historical CAGRs. It's my plan for TI to return to perpetuate and to amplify that same growth and profitability profile.:]

[Our unique and differentiated asset medics, including our highly talented team members and technology-enabled solutions, including AI, in particular, underpin my certainty in this regard, yours as well. To conclude, a reminder that our full second quarter release and investor call is scheduled for the morning of August 4, and we look forward to reengaging with you at that time. Thank you.:]

[Operator:]

The call has ended. You may now disconnect.