Q3 2023 Ci&T Inc Earnings Call

Participants

Bruno Guicardi; Director of Operations; CI&T Inc

Cesar Nivaldo Gon; CEO & Director; CI&T Inc

Eduardo Galvao; Head of IR; CI&T Inc

Stanley Rodrigues; CFO; CI&T Inc

Ashwin Vassant Shirvaikar; MD & Lead Analyst; Citigroup Inc., Research Division

Carlos Antonio de Legarreta Diaz; Research Analyst; Itaú Corretora de Valores S.A., Research Division

Ernesto Gonzalez; Research Associate; Morgan Stanley, Research Division

Puneet Jain; Computer Services and IT Consulting Analyst; JPMorgan Chase & Co, Research Division

Presentation

Eduardo Galvao

Good morning. And welcome to CI&T Earnings Call for the Third Quarter of 2023. I am Eduardo Galvao, Head of Investor Relations at CI&T and it's a pleasure to be here again to talk about our operating and financial results.
With me on today's call are Cesar Gon, Founder and CEO; Bruno Guicardi, Founder and President for North America and Europe and Stanley Rodrigues, our CFO. This event is being recorded and (Operator Instructions) The presentation is available on the company's Investor Relations website and the replay will be available shortly after the event is concluded. Some of the matters we'll discuss on this call, including our expected business outlook are forward-looking statements, and as such, are subject to known and unknown risks and uncertainties, including, but not limited to those factors described in our earnings release and discussed in the Risk Factors section of our annual report on Form 20-F.
These risks and uncertainties could cause actual results to differ materially from those expressed on this call. We caution you not to place undue reliance on those forward-looking statements because they are valid only as of the date when made. During this presentation, we will comment on certain non-IFRS financial measures to evaluate our business. Please refer to the reconciliation tables of non-IFRS measures in the appendix for more details. Our agenda for today includes an update of our quarterly highlights, followed by some of our business cases. We'll then talk about our people and our quarterly financial results. Now I invite Cesar Gon to begin our presentation.

Cesar Nivaldo Gon

Thank you, Eduardo. Good day, everyone. It's great to be here again to talk about our results and achievements. Based in London for the past few months have superbly positioned for global travel. I've had the opportunity to visit many CI&T teams around the globe. This is a routine I have always valued. I'm now able to resume in this post-pandemic world. Our team is in spirit, reach global culture and enthusiasm for our vision and plans are truly heartening.
These trips have been focused on introducing CI&T/FLOW, our AI platform for hyper digital in cities like New York, London, Sao Paulo and Melbourne. These events presented our value prop of rather enhanced productivity and customer experience through AI. It's been remarkable to witness the evolution of our platform since its July launch. We are proud to report that over [10] of our largest clients are now engaged with more than 2,000 active users from CI&T and our co-build clients, utilizing the beta version of CI&T/FLOW. We are at the beginning of this exciting differentiation journey, yet the early results have been very promising.
Now let me comment on our operating and financial performance. Our net revenue written BRL 529 million in the third quarter of 2023 compared to BRL 559 million in the same quarter last year. The number of clients with annual revenue above BRL 1 million in the last 12 months continued to expand, reaching 187 in this quarter and serving as a strong growth driver once the overall market conditions improve. The adjusted EBITDA margin reached 18.5% in the third quarter of 2023, which demonstrate our commitment to maintaining a lean organizational structure and optimizing our operations during a period of lower growth. In addition, we generated BRL 254 million in cash from operating activities in the 9 months of 2023. This is a strong cash generation, further strengthen our financial position and provide us with the flexibility to invest in strategic initiatives that will drive future growth. Stanley will deep dive into these figures later.
Now let's take a look at some examples of our client engagement and business highlights for the quarter.
(presentation)

Cesar Nivaldo Gon

I hope you enjoyed our selection of client stories, news and highlights. Now I would like to invite Bruno to discuss our global talent strategy.

Bruno Guicardi

Good morning, everyone. It's a pleasure to be here again. Throughout this year, we have diligently balanced the supply and demand of skills with prevailing market conditions keeping a streamlined organizational structure while preparing ourselves to resume growth in the near-term. We ended up the quarter with 6,100 CI&Ters and our voluntary attrition rate continues in a downward trend.
Above all, our leadership turnover rate remains at 4%, which plays a vital role in continuity of our high-quality service delivery and our ability to develop a new generation of CI&T leaders. Diversity and inclusion is a cornerstone of our organizational culture. And in the third quarter of 2023, we made progress by introducing some key initiatives. For instance, we hosted a month of People with Disabilities in September, welcomed the fresh cohort of students into our career acceleration for Black people program and provided inclusive leadership training.
Additionally, we organized numerous workshops, training sessions and events centered around enhancing culture awareness and promoting emotional wellbeing.
Now let's shift our focus to our environmental initiatives. CI&T is fully committed to championing social environmental responsibility. Our primary objective revolves around generating a positive and lasting impact on society and environment. This quarter, brought forth exciting news. In our first year on the Public Emissions Registry, the leading platform for reporting corporate greenhouse gas emissions in Latin America. The Brazilian GHD protocol awarded us the Golden Seal of quality.
In our sustainability journey, we achieved a significant mile this year by publishing our greenhouse gas emissions inventory in our ESG report. Since then, we have diligently strive to comprehend and minimize emissions, infusing environmental and sustainability responsibility across our organization. Leveraging initiatives, such as our ESG powerhouse and collaborative projects with our business units, we actively integrate sustainability into every aspect of our operations. Our commitment involves consistently refining our approach to environmental matters and in alignment with industry best practices.
Now I invite Stanley to give you more details about our financial performance.

Stanley Rodrigues

Thank you, Bruno, and good morning, everyone. I'm glad to be here once more sharing our financial results with all of you. In the third quarter '23, our net revenue was BRL 529.1 million, and it compares to BRL 559 million in the third quarter 2022. The variation in net revenue was mainly due to the unexpected budget preplanning of our top 1 client and part of our acquired portfolio.
For the 9 months '23, our net revenue increased to BRL 1.7 billion, up 9.9% at constant currency compared to the same period of last year. When analyzing our revenue distribution by geography, North America is our largest market accounting 44% of our total revenue in the 9 months of 2023. This is a testament to the strong presence and success we have achieved in this region. Latin America is another significant market for us, representing a substantial share of 41% in our total revenue. Europe follows with a revenue share of 10% while Asia Pacific holds a 5% share.
In terms of verticals, the Financial Services segment continues to be our primary source of revenue, contributing 29% to our total revenue in the 9 months of 2023. Additionally, the consumer goods sector is a significant contributor accounting for 20% of our total revenue, exemplifying our ability to deliver transformative solutions in this industry. The technology and telecommunications vertical contributes 18% to our revenue, showcasing our proficiency in meeting the unique needs in this rapidly evolving sector.
Finally, our revenue share from our top 1 client improved to 10% today from 16% in the 9 months of 2022 and the top 10 clients' revenue share improved to 42% from 52% in the same period. This is due to a variety of factors, including the cautious approach in the enterprise's spending environment as well as the successful onboarding of new robots.
Most importantly, as we look forward, it represents the diversification of our revenue streams as we expand our client base and enter into new geographic regions and industries. Talking about diversifying our client base throughout the last 12 months, we have successfully onboarded 40 new clients that are generating revenue exceeding BRL 1 million. We are excited to share that these new clients will serve as a catalyst for our growth as these engagements expand and gain traction over time.
The consistent net revenue retention rate of approximately 123% over the past 5 years is a strong indicator of the value we provide to our clients. This rate exemplifies our ability to not only retain new clients, but also expand our engagement with them over time. This aspect plays a pivotal role in ensuring our sustainable growth trajectory.
Moving forward, we will continue to prioritize both the acquisition of new clients and the nurturing of existing relationships. Now let me detail our financial performance for the third quarter '23 and the 9 months '23. Our adjusted EBITDA was BRL 98 million in the third quarter '23 compared to BRL 105 million in the third quarter '22. The EBITDA margin was 18.5%. Analyzing the results year-to-date, the EBITDA increased to BRL 328 million versus BRL 290 million in the 9 months 2022, up 13.2%. The EBITDA margin rose to 19.2% in the 9 months '23 from 18.4% in the 9 months 2022.
These results demonstrate our strategic focus on optimizing our SG&A expenses. Through a systematic and disciplined approach, we have actively identified operational optimization opportunities resulting in a reduction of these expenses. This has helped to offset the impact of our gross margin, reflecting our commitment to maintaining financial resilience and efficiency. It is important to note that we have adopted a cautious approach throughout this year, recognizing the need to navigate the current market dynamics with prudence while preparing our resumption of more aggressive growth in the coming years. As we continue to adapt and refine our strategies, we are confident in our ability to position ourselves for sustained growth and long-term success.
Our adjusted net profit was BRL 45 million in the quarter versus BRL 67 million in the third quarter 2022, mainly due to higher net financial expenses which I will explain in more details. In the third quarter '23, net financial expenses were BRL 20 million, BRL 13 million higher than third quarter '22 as a result of 3 factors: lower foreign exchange gains in the comparable period which is a noncash effect, a derivative gain from an interest rate swap that benefited our results in the third quarter '22 and higher debt position as part of our M&A strategy. The foreign exchange variation and derivative results tend to balance out throughout the year.
Our adjusted net profit in the 9 months '23 increased by 10.5% to BRL 176 million from BRL 159 million in the same period of 2022.
Finally, our cash generated from operating activities rose to BRL 254 million in the 9 months '23 from BRL 29 million in the same period in 2022 and our free cash flow, excluding the CapEx of our net operating cash flow increased to BRL 163 million substantially above our cash consumption of BRL 81 million in the 9 months 2022. The consistent generation of strong cash flow empowers us to continue investing in strategic initiatives that will further drive our growth and enhance our competitive advantage, while simultaneously maintaining flexibility in our capital allocation priorities.
Now I invite Cesar back to comment on our business outlook.

Cesar Nivaldo Gon

Thank you, Stanley. While enterprise spending sentiments remain cautious we are glad to be supporting a growing number of clients with their core digital initiatives as they design and prepare their AI investments for the years ahead.
For the fourth quarter of 2023, we expect our net revenue to be in the range of BRL 519 million to BRL 540 million on a reported basis. The midpoint of this guidance range indicates stable sequential revenue.
For the full year of 2023, we are narrowing the range within the previous guidance. Now we expect our 2023 FX-neutral net revenue growth to be in the range of 4% to 5% compared to last year. Finally, we are maintaining our expectations for the adjusted EBITDA margin of at least 19%.
In such a volatile year, we have focused on maintaining our solid profitability, generating a significant amount of cash and evolving the AI capabilities of our team as we resume our solid growth trajectory.
Thank you for attending our call today. We now conclude our presentation, and we will begin the Q&A session.

Question and Answer Session

Eduardo Galvao

All right. We'll now begin the question-and-answer session. (Operator Instructions) The first question comes from Ashwin Shirvaikar from Citi.

Ashwin Vassant Shirvaikar

Thank you, Eduardo, and good morning, everyone. I appreciate the comments. Let me start with maybe asking about the step down the top client. Is that more in nature of furloughs, temporary steps, things like that? Or is there something greater with regards to something else going on, with regards to the client? And are there any indications of when spending at the client might come back to a more normalized level?

Cesar Nivaldo Gon

Good day, Ashwin, and thank you for your questions. Great to see you. Well, I think as (inaudible) , it was an unexpected budget replanning for our top 1 client. And as now we believe that we have a very stable situation, that's what we are foreseeing. This top 1 client has been with us for more than 10 years now. So I think we are still, I think, the most strategic partner for digital. And I think it's just a result of a very volatile leader and they decide to adjust budget, and that's why we saw this decline. So now we foresee a stable situation.

Ashwin Vassant Shirvaikar

And as we think more broadly passed the one client, any early thoughts that you can give us as to how you're planning for 2024? What we've heard from others is a slow start to the year with the hope that higher backlogs should convert in later parts of the year. Are you consistent and are there things that you can say that provide higher visibility into forward comments?

Cesar Nivaldo Gon

Sure. I think, Ashwin, (inaudible) way to see the current demand environment for our services, I think there is an equipment (inaudible) acting in different directions. The first one is macroeconomic and to (inaudible) I think pointing to (inaudible) cautious spending of our clients. But there is a second force that is the new tech revolution driven by, I think this is pushing our clients and every single company to increase their investments around digital to capture efficiency first and then prepare the company for inexorable customer behavior disruption that is going to happen because of the competitive environment in our (inaudible) AI.
So macro constraining, AI pushing demand and our recommendation is simple, capture efficiency with CI&T/FLOW, of course, opening budget and space for playing the new customer experience game. If we -- how we translate that to our -- this demand equation to our environment, I think if we exclude the variations that Stanley mentioned, we are observing new demand, indicating growth across the board. So we are confident on delivery of very stable and strong Q4, marking what I believe is the start of our standard sequential growth through 2024 and accelerating as we progress in the year. That's our current visibility under the current market conditions.

Eduardo Galvao

Our next question comes from Ernesto Gonzalez with Morgan Stanley.

Ernesto Gonzalez

It's an international expansion, just to see how it's doing relative to your expectations? And anything you can comment going into year end and into 2024, would be great.

Cesar Nivaldo Gon

Bruno, you want to handle this one?

Bruno Guicardi

Not sure if I got the question. Can you repeat like your are asking we are seeing how the revenues outside Latin America are going?

Ernesto Gonzalez

Yes, how they're doing relative to your expectations for the year? Have you seen any improvement in demand and trends or anything you can comment going into year-end and 2025.

Bruno Guicardi

We don't see a lot of differences in demand across regions Ernesto, it looks like very similar across the board, so some sectors are a little softer than others, like mainly the tech sector itself, which was a relevant one for us, softer than others, but still too strong in the CPG, Financial Services, so it's more like by the cohort of clients like traditional big fortune 1000 clients still going stable, right, on a smaller tech companies -- softer, but that's across the board, it doesn't have any difference across regions. So that's what I've seen everywhere.

Eduardo Galvao

Our next question comes from Puneet Jain with JPMorgan.

Puneet Jain

I have a question for Stanley, like on margins. Like obviously, you are doing like a lot of cost-cutting this year, including cuts in SG&A. Is that margin upside sustainable? And what are you seeing on pricing or expect for gross margin as we move into next year? .

Stanley Rodrigues

What we've seen in this quarter, I would say that this is the lowest -- it's a transition phase, a quarter of the transition, it's the bottom of a moment that is changing, coming from this depressed market in overall and heading to transitioning through a stabilization and adding to a growth period again as we calculate. And in terms of the margins, of course, we see margins regaining to our track record in the next quarters. And with regard to sustainability, we see everything fairly sustainable and what -- everything that we've been managing in terms of cash, in terms of margins, in terms of cost is -- everything has been fairly sustainable.
And mainly we've been preparing ourselves to regain growth. And for example, taking the opportunities, especially towards AI, I think we did a great move really at speed and with a strong strategy towards optimization and later down the road to capture all the consumer experience that is -- it will really drive further growth, and we've been focusing on that. And cost and cash management, all combined, everything fairly sustainable, and we will continue in that path.

Puneet Jain

Got it. And then are you seeing any differences across regions or across verticals as it relates to clients' willingness to start initiate new projects, specifically in AI area?

Cesar Nivaldo Gon

Go ahead, Stanley. I'll complement you.

Stanley Rodrigues

Yes. I would say that we have [20] of the biggest clients already into flow platform, doing all the experimentation, initiating the trajectory on top of optimization, but some clients already willing to jump to the next phase, which is towards consumer experience. Cesar, you may add (inaudible)

Cesar Nivaldo Gon

I think CI&T/FLOW helps (inaudible) go-to-market strategy in 2 ways. Puneet, I think in 2 different time frames. The first is efficient productivity. So it's already happening, and we are replacing competitors based on concrete gains around tech efficiencies leveraged by CI&T/FLOW. This is the main opportunity for now in 2024. And I see a big opportunity for many years ahead because it's not a sprint. It's a 10-year marathon around the evolution software development and software engineering boosted by AI.
The second opportunity is the demand associated with the advent of new business use cases by industry, by vertical, it's already happening, but it is still in the early days, and I believe it will be relevant -- really relevant in terms of revenue in 2025 or so as the technology gains some maturity and stability and the competition environment reshape, it's natural that customer will have to increase their investment in hyper-personalization and new customer experience, natural language experience, all based on AI. So this is -- this is a big shift, but probably from 2025 on.

Eduardo Galvao

Our next question comes from Carlos de Legarreta Diaz with Itaú Corretora de Valores.

Carlos Antonio de Legarreta Diaz

I have 2 on my end, very quick ones. The first one, if you can talk about the utilization rate and its evolution, how do you see that going forward? And secondly, if you can comment on how is the, let's say, the digesting of the acquisitions that you made in 2022? I mean it was at least 4 of them. So if you can talk about that, give us some color at the qualitative level, that will be very helpful.

Bruno Guicardi

Carlos, thanks for the question. Utilization rate has been high as we've been adjusting the workforce, right, according to demand. So it kept high, and we are forecasting that as we kind of resume growth, we will continue high and we already have a couple of hundred positions open. So we see substantial growth in the near future, right? So that's a metric that we track very closely. And so even in the previous quarters when the low demand was hitting, the utilization rate is still very high. Right? To your second question what was that again, sorry, Carlos. Second question was around?

Carlos Antonio de Legarreta Diaz

Adjusting the acquired..

Bruno Guicardi

So we're very happy with the speed of that integration. And so how we already kind of really seamlessly integrate the business teams and the delivery teams across the board with all the acquired companies. Low lights in that process is actually some of the acquired companies had a bigger exposure in tech, as I mentioned before, that's a segment that has a soft demand right now.
But the highlights, we've already seen the theses of those acquisitions working, right? So we have many clients that were coming from those smaller companies that had under $1 million type of engagements scaling rapidly to $5 million, $10 million engagements, kind of really tapping to the scale of CI&T, in the complementary capabilities of CI&T and reaching a completely different level of engagement and relevance for those clients. So that -- we're very happy to see that happening already.
We see that in U.S., in EMEA, so we have many cases. So we feel like that's going forward, we'll still continue to -- it's a long-term game for us. M&A continue to look for more opportunities to do this in 2024 and maybe the second wave of M&A is coming as soon as we see kind of market conditions and prices coming to -- as long as they make sense, we resume that activity.

Carlos Antonio de Legarreta Diaz

And as a follow-up to that, I guess, the last comment you just made, like what would be the conditions or the metrics that you will be looking at to assess that the outlook for M&A is getting better?

Bruno Guicardi

No, we've been looking at pricing, right? So if the private market is kind of already reflecting the reality of public markets. And of course, we're looking at for companies, for assets that are doing well, right? So we want to see that resilience on the target companies as well as companies that we navigate in the soft demand environment. So those are the -- I think, with the main 2 things we want to see there before moving forward with M&A processes.

Eduardo Galvao

We have 2 questions here that we've got by e-mail. The first one is regarding CI&T/FLOW. How do we expect it to contribute to winning new clients or expanding the relationship with existing ones?

Cesar Nivaldo Gon

Again, we are very excited with the early results. As I mentioned before, more than 20 of our largest clients of the team, more than 2,000 people from CI&T and clients onboarded the new platform. And we are now reaching a large number of use cases for efficiency in the platform. We have now around of 30 AI agents. So this is basically fulfilling our (inaudible) we started with our foundation that we're going to handle privacy, security, going to be make (inaudible) AI enterprise ready. On top of that, we boast the teams with AI agents towards tech efficiency, and this is powered by AI team which can tackle traditional digital demand with hyper productivity or even work on new AI business use case.
So this is the [3] layers of the (inaudible) enterprise (inaudible), efficiency and experience. And in terms of the way we are seeing the demand being generated by that has basically tackled productivity. So replacing poor performance competitors based on concrete, the most tradable gains around tech efficiency and open space, budget space and creating the AI teams that can tackle the opportunities around that experience.
So basically, a huge push around our current portfolio, and we -- it's the main focus in this initial beta and launch of FLOW. And from next year on, we will onboard new clients in the platform. Right now, it's available only for CI&T current clients, and we are preparing everything in terms of capabilities and the technology to scale from next year on.

Eduardo Galvao

The second question is considering the strong cash generation this year, what are the priorities for capital to be deployed?

Stanley Rodrigues

I can take that one. Thank you for the question. Well, on top of that, cash generation, we may bear in mind that usually traditional or we have the seasonality of generating a stronger cash flow in the second half of the year and we are deploying that cash. We're allocating that cash mainly in 3 areas.
First, we have our debt service. So we are paying down debt in order to prepare our balance sheet for this more -- the next strategic inorganic moves that we are -- we will make in the near future. Second one towards R&D, and we have this great opportunity towards AI. And we, as I mentioned, we are investing timely -- with proper timing and in a proper scope in that area as well. And the third would be, we are -- we've been promoting a share repurchase, for example. We see that we have a great opportunity with the price out there and it's a way to return value to our shareholders as we have no dividend policy here. And as well, we have some M&A obligations that we may use those repurchase shares to comply with that with those obligations. So mainly those 3 areas for capital allocations.

Eduardo Galvao

There's just another question that came up by e-mail on how do you foresee the evolution of our organizational structure in response to client demands and artificial intelligence?

Bruno Guicardi

So the thing that, as Cesar has pointed before, right? So the next 10 years, I think, will completely reshape our industry. So we're very happy with the pace we're learning. So we're not thinking of, there is no amount of hiring that can be done to actually get people that know what it's going to happen like it's for the scale that the new demand will bring. We have to retrain our whole staff and the game will be who kind of learns faster, right? And that's where we're dedicating our efforts to really move fast.
Today, we have more than 2,000 people -- almost like 1/3 of the company already exposed to either our AI (inaudible) houses, one of those 22 clients that we mentioned that already using FLOW. So we have 1/3 of the company, learning exposed and contributing to what we need to do and what we need to reformulate the software development, what needs to be done. So we're very happy with the speed and kind of upgrade in conditions and investments to kind of support (inaudible) CI&T/FLOW is now open to 100% of the staff.
So we get even more and more people joining it and kind of helping clients figure out how to kind of really reformulate their whole software development processes and this is going to happen in next year, the next 2, next 3, next 10, we'll be always changing there with an immense potential for gains in speed, in productivity. And of course, just applying those tools to the external world, we're going to capture a lot of potential for hyper-personalization and hyper-experimentation, kind of creating completely different user experiences for our clients -- our clients' customers.

Eduardo Galvao

All right. That concludes today's Q&A session. I'll now invite Cesar to proceed with his closing remarks. Cesar, please?

Cesar Nivaldo Gon

Thank you all for participating in our call. Thanks, Eduardo, Stanley and Bruno. Once again, I want to thank you all CI&Ters around the world for the hard work and achievements in the quarter and a special thanks for our clients that are selecting CI&T to (inaudible) this amazing new chapter of innovation powered by Artificial Intelligence. Stay well. See you in the next quarter.

Eduardo Galvao

Thank you. Thank you all for attending today.