Luxoft Holding, Inc. First Quarter Fiscal 2019 Conference Call August Confirmation # Page 1

Transcription

1 Page 1 Operator: Greetings and welcome to the Luxoft Holdings First Quarter Fiscal 2019 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star-zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tracy Krumme, Vice President of Investor Relations at Luxoft. Thank you. You may begin. Tracy Krumme: Good morning everyone. Thank you for joining us on Luxoft's first quarter fiscal 2019 conference call. On the call with me today are Dmitry Loschinin, Chief Executive Officer and President, and Evgeny Fetisov, Chief Financial Officer.

2 Page 2 Before we begin, I would like to note that we have provided a slide presentation to help guide our discussion. This presentation can be accessed on the webcast and on our website, Luxoft.com. I would like to also caution investors regarding forward-looking statements. Any statements made in today's presentation that are not based on historical facts are forward-looking statements. Such statements are based on certain estimates and expectations, and are subject to a number of risks and uncertainties. Actual future results may vary materially from those expressed or implied by the forward-looking statements. We encourage you to read the risks described in our 20-F filing for the fiscal year ended March 31st, Except to the extent required by applicable securities laws, we undertake no obligation to update or publicly revise any of the forward-looking statements that we make here today, whether a result of new information, future events, or otherwise. Today's presentation will also include references to certain non-gaap financial measures. We have reconciled the comparable GAAP and non-gaap numbers in today's press release as well as in the supplemental tables in the slide deck. With that, I will turn the call over to Dmitry. Dmitry, please go ahead.

3 Page 3 Dmitry Loschinin: Thank you, Tracy, and thanks, everyone, for joining us today for our first quarter fiscal 2019 conference call. I will begin on slide number four with key highlights from the quarter. We are off to a good start to the year, with Q1 results ahead of our expectations on all fronts. This is despite ForEx headwinds that we--that had a negative impact of 5.3 million, or 2.5%, of revenue. As we stated on the Q4 call and at Investor Day, we believe Q1 is the slowest quarter of the year and that we will see incremental improvement as we move through fiscal '19. This quarter we continued to diversify revenues and deliver top line growth. Financial services' revenue increased 4% year-over-year and grew 25% excluding our top two accounts. DB concentration dropped to 14% of revenue versus 17% over the past year, and UBS is now our largest client. We continue to rebalance our solutions portfolio and grow our teams to meet evolving client needs. Our auto business continues to generate strong growth, with revenue up 25% from Q1 of last year. We continue to strengthen our market positions through leading innovation and expanding number of partnerships with major OEMs and tier one suppliers. We expect revenues in this line of business to grow over 40% in fiscal '19.

4 Page 4 We continue to invest in disruptive technologies that will enhance our market position and allow us to provide greater value to our clients. To that end, we recently made two small tuckin acquisitions, Smashing Ideas and Objective Software. I will speak to this acquisition in greater detail in a few minutes. We are pleased with the strategic progress made during the quarter. As we have stated on previous calls and at Investor Day, we are transforming our digital enterprise business and allocating resources to higher margin digital opportunities. We have made a number of additions to our senior team, strengthening our leadership in sales and management of digital enterprise. We've taken initial steps to address our cost structure and increase efficiency by reducing SG&A expenses and eliminating back office redundancies. Q1 SG&A as a percentage of revenue declined 100 basis points year-over-year. Lastly, we remain committed to returning capital directly to shareholders. We announced a 60 million share repurchase program in April, and have repurchased 20 million of our stock to date.

5 Page 5 Slide number five provides an update on our success diversifying our revenues and reducing our client concentration metrics; a few things I want to point out. The automotive business has been an area of strategic emphasis over the last several years. The business represents 21% of our revenues now compared to just 10% three years ago. We have been able to grow that business rapidly given our strong offerings and established OEM partnerships. From a client concentration perspective, our top 10 has fallen 5 percentage points since Q1 last year, and our top two concentration has fallen 3 percentage points. Our expanded global delivery presence in APAC and Europe drove higher revenue contribution this quarter. Revenue from APAC and Europe increased 89% and 12% year-over-year respectively. De-risking our business remains a key strategic priority in fiscal 2019 and in the years ahead. Turning to slide number six for an update on our financial services business, this business continues to grow despite the challenges at Deutsche Bank. Revenue was up 4% year-over-year and up 25% excluding our top two accounts. Growth in this market is driven by our success across tier one and tier two institutions as well as ongoing demand for solutions in simplification, cloud, and AI adoption.

6 Page 6 We are also seeing new business in response to the evolving regulatory agenda in the UK, particularly with Brexit and the Open Banking regulations, PSD2. These changes are driving consistent demand for data related technologies, including big data. For example, we created a key solution to address the requirements within risk and finance under Brexit for one of the world's largest financials group. We continue to build new relationships in fast-growing markets, demonstrated by our double digit growth in North America and APAC. We also have a strong position in the Australian market, and continue to build our team to address increasing client demand. We continue to grow our Murex business and recently played an integral role in a leading European multinational bank's migration to Murex. In addition, we secured two new strategic contracts for large scale Avaloq implementations. We believe further demand will be driven by ongoing pressure to improve profitability, continued regulatory reforms, and adoption of new technologies. We are well positioned with a strong team to meet these trends and have a strong pipeline for the remaining of this fiscal year. Now turning to UBS on slide seven, UBS is now our largest client. Revenue in the quarter was up 3% year-over-year and down 6% sequentially. This account is performing largely in line with

7 Page 7 our plan, and we expect this business to remain relatively stable throughout fiscal We continue to believe that this account offers attractive opportunities for our services, and we remain a critical solution provider to UBS. Now moving to slide number eight and an update on Deutsche Bank, our second largest client, our outlook remains the same. We continue to face headwinds at Deutsche Bank as stated in our Q4 call and at Investor Day. Visibility into DB's long term strategy is challenging given the new executive team and shifting geographical focus. This account was down 18% year-overyear and down 24% sequentially. We are looking for ways to leverage our longstanding relationship with DB outside of investment banking, into business areas such as transactional banking, wealth management, and information security. We continue to diversify revenue away from DB. However, the account will have a material impact on revenue this year. We expect continued decline in Q2 and throughout the year. Moving on to automotive, where revenue grew 25% year-over-year, this continues to be our fastest growing line of business as we secure new engagements while also growing existing partnerships. We expect this business to grow 40% this year. We have expanded our client base as we see growing interest in autonomous drive, digital cockpit, and connected mobility.

8 Page 8 Our progress demonstrates not only the strength of our offerings, but also the benefit of our early entrance into this market. We have been able to establish multi collaborative agreements with many tier one suppliers and leading global OEMs due to our strong reputation and offerings. In fact, today we have established multiyear partnerships with all the major European OEMs. Let me highlight a couple of achievements during this quarter. We partnered with Daimler subsidiary MBition to open a research and development center in Berlin. We began a strategic collaboration around software platform development with a large Korean tier one and a leading German OEM. We had double digit growth in APAC and won a multiyear contract with a leading tier one supplier in Asia. We are uniquely positioned to capitalize on the autonomous automotive megatrend and will continue to evaluate opportunities to round out our solutions and expertise in this rapidly growing business. Turning to slide 10, we recently made an exciting tech-focused addition to our auto business. We acquired Objective, a technology solution provider with a focus on connected cars and autonomous drive services for leading OEMs and tier ones. This acquisition is very similar to those of Pelagicore and Symtavision, where we can combine objectives, deep subject matter

9 Page 9 expertise, and IP-based solutions with our global scale to win large strategic deals. We are excited to work with the Objective team, and see great synergies ahead. Lastly, turning to slide 11 and our digital enterprise business, the 16% revenue shortfall was primarily due to the trimming of low margin noncore business. We expect this pruning to be completed at the end of Q2. Also, this causes a short term top line impact. We are taking the strategic action to enhance our margin profile in the long term. Digital transformation remains a global investment priority for many of our clients, and we expect to see sequential growth throughout the rest of fiscal A few achievements to highlight in the quarter; we collaborated with our newly acquired Smashing Ideas' team and a major travel client to build a comprehensive loyalty program. We started to work with two new energy clients as we grow this practice. We continue to work with our clients on cloud migration and AI, and recently won a cloud migration project for a German OEM. We were identified as a representative vendor in the first blockchain consulting market guide by Gartner. We partnered with a leading e-enterprise blockchain software firm to integrate identity management applications on their open source blockchain platform. Lastly, we've

10 Page 10 partnered with the city of Zug and Lucerne University of Applied Sciences to create the first customizable blockchain-based e-voting system. We remain an important player in this growing industry and continue to take part in complex projects, delivering end-to-end value to clients. We are taking the right steps to strengthen our digital enterprise business, and reiterate our medium term goal of 20% revenue growth. Our transformation, once completed, will place us on track to deliver strong additional growth in fiscal 2020 and beyond. Turning to slide 12, here we'll look at our acquisition of Smashing Ideas, the Seattle-based digital innovation design agency. The strong capability of Smashing Ideas will serve us as a disruptive digital catalyst, driving transformation for our clients. The company spans across multiple industries, including automotive, aviation, entertainment and media, health and wellness, and consumer products. Combining Smashing Ideas' strong expertise in product development and digital transformation with our deep technology and industry expertise will enhance our positioning as a leading technology strategy and innovation partner.

11 Page 11 Before I turn the line over to Evgeny, I would like to conclude by reiterating that we are on track to deliver on our strategic initiatives laid out at Investor Day. I am very confident in our strategy and look forward to executing on our plan. With that, I will turn it over to Evgeny. Evgeny Fetisov: Thank you, Dmitry. Hello everyone, and thank you for being on the call with us. I will go over some key numbers, provide additional color on Q1 results, and introduce our second quarter fiscal '19 guidance. If you turn to slide 14, despite certain client centric challenges, we delivered Q1 revenue of million, up 1.7% year-over-year. This was in the midpoint of our guidance range. Q1 FY '19 FX impact on revenue was a negative 5.3 million, or a negative 2.5%. Our gross margin was 35.4%, up 20 basis points from one year ago. SG&A as a percentage of revenue was 26.7%, down 100 basis points from Q1 of last year. SOP expense as a percent of revenue was 2.9%, down 90 basis points from Q1 last year. This is in line with our expectation of annual SOP expense less than $30 million and below 4% of revenue. Our adjusted EBITDA margin of 11.2% was down 140 basis points year-over-year and was ahead of our Q1 guidance. We expect to see EBITDA rise throughout fiscal '19.

12 Page 12 GAAP EPS amounted to $0.14 per share compared with $0.18 per share in Q1 last year. This was above our Q1 guidance. On a non-gaap basis, diluted EPS was $0.43 per share compared with $0.50 in Q1 last year. The quarterly weighted average diluted share count was 34 million shares. Turning to slide 15, where I will provide a bit more detail on our currency mix. Looking at the numbers, you will see 43% of our revenue is non dollar, out of which 29% is euro and euro dependent currencies, so these revenues were impacted by the stronger dollar in Q1. Looking ahead, our top line performance will continue to depend on the strength of these currencies, and we anticipate further FX headwinds in Q2. Slide 16; for the second quarter of fiscal 2019, we expect revenue and adjusted EBITDA margin to be in the range of 225 to 230 million and 13.5% to 14.5% respectively. We expect GAAP EPS to be in the range of $0.28 to $0.36. Our Q2 revenue guidance is impacted by the trimming of low margin business in digital enterprise. As we have stated, we expect growth to accelerate as we move through the fiscal '19 and continue to focus on corporate consolidation and higher margin work. We reiterate our full year guidance of 20% of revenue growth outside of top two accounts.

13 Page 13 With this, we are opening the lines. We look forward to your questions. Operator: Thank you. If you'd like to ask a question, please press star-one on your telephone keypad and a confirmation tone will indicate your line is in the question queue. You may press star-two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question is from the line of Joseph Foresi with Cantor Fitzgerald. Please proceed with your question. Joseph Foresi: Hi. My first question here is just on guidance. I guess we're moving our way through the year and you certainly gave the quarterly guidance again, but why not at this point give full year guidance? And how's the visibility on the numbers for the full year? Dmitry Loschinin: Hi, Joe. This is Dmitry. Joseph Foresi: Hi. Dmitry Loschinin: So, as we explained during our Q4 call, the major factor that does not give us a possibility to provide the annual guidance is uncertainty with Deutsche Bank, and it remains

14 Page 14 the case. So, hopefully towards the end of the year, we will see a better picture and will understand DB plans. So, for now, we just--the range where DB can end up is quite significant, so we believe that we better--we are better off with quarterly guidance. Joseph Foresi: Got it. And so, can you perhaps give us that range, your expectations for DB next quarter this year and headed into next, and any color you can provide on UBS as well? Dmitry Loschinin: So, for DB, the outlook looks that Q2 and going forward we're going to see about a 30% plus drop year-over-year. However, we don't believe that DB will go below 80 millions for the full year. So, you can see that 80 is sort of a bottom, and then you probably can compute what is the top. But that's the number. Joseph Foresi: Okay. And then margins did better than expected. You know, maybe you could talk about--it looks like you cut some SG&A. Maybe you can talk about the margin improvement, the expectations, you know, throughout the year on the margin side, and maybe update us on some of the metrics associated with, like, utilization. Did margins hang in there because of some extra work from DB? I'm just trying to get more sense of what the margins are going to look like.

15 Page 15 Dmitry Loschinin: Yeah, we were quite conservative on our margin guidance. And we did a little better on utilization, which, as you correctly said, DB is a major factor decreasing utilization. And also, we started seeing some improvement on SG&A side. Joseph Foresi: Got it. Thank you. Dmitry Loschinin: Thank you, Joe. Operator: Our next question comes from the line of Avishai Kantor with Cowen & Company. Please proceed with your question. Avishai Kantor: Hi. Thank you. Good morning and thank you for taking my question. I believe you recently beefed up your sales capabilities in North America, your automotive side. Can you maybe talk a little bit more about your efforts specifically in North America and the traction that you are gaining there? Dmitry Loschinin: Hi, Avishai. All right, some decline in North America. As a matter of fact, we see the revenue in the business growing there. There was some re-class--it's not re-class, but the change of the billing address for one of the large clients. Whereas we used to charge and

16 Page 16 kind of the originated bills or invoices were sent to the US subsidiary, now we send it to the European subsidiary. So, therefore there is some shift in the revenue recognition. Rather than that, we are on track. And for instance, we see pretty steady growth and good growth for North America in financial services. As well, automotive has started picking up in the U.S. Avishai Kantor: Thank you for clarifying that. And going back to the guidance, you have a pretty tight range for revenues but a pretty wide range for EPS. What needs to happen in order to you to hit the upper end of the EPS range? Dmitry Loschinin: Again, there are a few factors that impact the EPS. One of the major is the DB ramp down and how well can we absorb the bench. And it really depends, you know, what are the growth plans for other parts of the business, how well we can sync up. And another thing is ForEx, obviously. Avishai Kantor: Great. Thank you and good luck the rest of the year. Dmitry Loschinin: Thank you.

17 Page 17 Operator: The next question is from the line of Maggie Nolan with William Blair. Please proceed with your question. Maggie Nolan: Hello. You mentioned that you're focusing on 20% revenue growth outside of the top two accounts. I'm wondering how much of that you expect will be from acquisitions. Dmitry Loschinin: Hi, Maggie. So, both acquisitions are very small in terms of the revenue contribution. Actually, I would say it's not material. The Objective acquisition is more the technology acquisition, when they come onboard with certain skill set and some IP that enables us to be in a certain business. We already see several opportunities where we bid together using the--you know, using their solutions. And the same would go for Smashing Ideas. It's a relatively small shop, but a very good fit to our digital offering. So, the impact is very small in terms of the top line. Maggie Nolan: Okay, great. And then I was curious about what's driving your expectations for the sequential increase in adjusted EBITDA margin.

18 Page 18 Dmitry Loschinin: There are a few things that--and I think we are very consistent here to what we said in our Investor Day. So, we have DB, Deutsche Bank, this year as one of the major factors that hurt the margins because of the bench, predominantly. We also are going to scale our automotive business, and we are scaling down low margin business. So, all in all, we want--we believe we will be able to improve utilization. We are also working on our SG&A spend and we are bringing this down. Our plan is to do 1% every year and at the same time grow in the high margin business. Maggie Nolan: Thank you very much. Dmitry Loschinin: Thank you. Operator: The next question is from the line of Georgios Kertsos with Berenberg. Please proceed with your question. Georgios Kertsos: Yes. Hi, guys. Can you please confirm when you expect to complete the remaining part of the share buyback program by? Is it within the current fiscal year, or do you expect that to sort of fall into the next fiscal year? And then I have a quick follow up question.

19 Page 19 Evgeny Fetisov: Yeah. Hi, this is Evgeny. So, the share buyback program was approved for two years, and we just--. Georgios Kertsos: --Okay--. Evgeny Fetisov: --Started it last quarter. So, we expect it to happen within that timeframe. Georgios Kertsos: Okay. Thank you. And then a follow up on the--can you confirm the organic growth rate for the quarter? Evgeny Fetisov: We don't disclose the quarterly organic growth rate. We usually focus on the yearly number 'cause that's more relevant given the seasonal fluctuations. Georgios Kertsos: Okay, clear. Thank you very much. Operator: The next question is from the line of Vladimir Bespalov with VTB Capital. Please proceed with your questions.

20 Page 20 Vladimir Bespalov: Hello and thank you for taking my question. My first question is on the automotive segment. You had a 25% growth this year--this quarter year-on-year, but you are guiding 40% for the full year. Could you maybe provide some color on what slowed down your growth in this quarter and what's going to happen in the coming quarters to accelerate it again? Then my second question is on digital enterprise. We see that the decline is accelerating. It was minus 10 in the previous--year-on-year in the previous quarter. Now it's minus 16. So, you expect a turnaround here as well. But maybe you also could give us some color on what to expect next quarter, when you're going to finish the cleanup of these low margin accounts and we finally see some growth, moving you closer to your midterm target of a 20% growth. And the last question is on working capital. I see an increase in working capital in the reported period, both in DCO--in DSO and DSO full. So, could you maybe provide some color on that and what you expect in the coming quarters? Dmitry Loschinin: Yeah. Hi, Vladimir. I will answer first two questions and Evgeny will answer about the working capital.

21 Page 21 So, on automotive, you correctly point out the 25% this quarter, but we are still confident we can do 40 plus percent of the year. There is a seasonality. You can see it every second quarter. You have a higher revenue growth and then another one is less aggressive. So, the same is going to happen this year, so next quarter finds us--in automotive should be, you know, pretty good. But all in all, the growth remains as strong as we saw last year. And it's actually, you know, extremely impressive development on all fronts. So, confident 40%; seasonality is the factor. You're going to see high growth in the next quarter. For digital enterprise, yes, it's down 16%. However, we expect the cleanup to be completed in our Q2. You're also going to see some sequential growth in Q2. And as we move forward in the year, then towards the second half of the year you're going to see the growth, both sequentially and, at the end of the year, we're also going to see year-on-year growth. And Evgeny will answer on working capital. Evgeny Fetisov: Hi, Vladimir. So, on DSO being higher this quarter, the largest impact comes from the lower revenue versus the last quarter. If you look at the numbers, the accounts

22 Page 22 receivable are actually down $8 million, and the unbilled revenue is slightly up. I mean, it's up 9, so it's more or less flat combined. So, unbilled; we set the unbilled range, which we target in--say between $30 and $40 million. So, we're slightly above what--where we wanted to be, but otherwise we--i believe we're on track on improving our DSO. We set the target for ourselves at 75 days on a quarterly basis by Q4, so that's where we want to be by the end of the year. Vladimir Bespalov: Thank you very much. Operator: Thank you. As a reminder, to ask a question today, you may press star-one. The next question is coming from the line of Alexander Vengranovich with Silva Capital. Please proceed with your question. Alexander Vengranovich: Yes. Hi; a couple of questions from my side. So, first on Deutsche Bank, so obviously it was particularly weak this quarter. So, I was just wondering what sort of a foreign currency fluctuations impact you've had particularly on the Deutsche Bank revenues. So, it looks like it's mostly like euro denominated, so as far as understanding, that should be also quite strong and that's one of the reasons why you are providing a bearish outlook for the upcoming quarters. So, could you first confirm that?

23 Page 23 Dmitry Loschinin: Yes, DB is all euro, so obviously we have the ForEx headwind here. And also, as we guided, for the full year we still see the DB to go down, both, you know, with some of the ForEx headwind but also in terms of the business itself, so the ramp downs will continue. And again, as we can see now, the floor for DB is somewhat--about 80 million. So, we will be above that number for sure, but still the range is pretty wide, yeah. Alexander Vengranovich: Okay, got it. Dmitry Loschinin: And this is the major--it remains the major factor for us, you know, that we don't guide for the full year. Alexander Vengranovich: Of course. Dmitry Loschinin: Once we see more clarity there, we will come back to the full year guidance. Alexander Vengranovich: Okay. And then the second question on how do you see your headcount to evolve this year, both in terms of engineers and G&A personnel, if you have any comments on that.

24 Page 24 Dmitry Loschinin: So, G&A or SG&A personnel will remain flat as we grow our sales and marketing team, and at the same time we're trimming our G&A, so back office operation. Again, we are committed to reduce the percentage of SG&A by roughly 1% every year, so that's the target. And as for the engineering personnel, usually it is linked to the growth of the business. So, obviously, for instance, engineering personnel for automotive line of business will grow 40%, maybe a little slower than the growth of the top line as the revenue per engineer is also growing. So, as we--again, we don't provide a full guidance for the year, so--but the correlation is very simple. Alexander Vengranovich: So, basically you expect your annual utilization to be broadly flat year-over-year, right, if I understand you correctly. Dmitry Loschinin: Yeah, utilization is typically the same. DB ramp downs impact utilization, you know, from 3 to 5%. And again, this is really, you know, depending how well we can absorb, you know, the ramp downs and redeploy people. But on average, it's 3 to 5% impact for the whole year. And as--.

25 Page 25 Alexander Vengranovich: --Okay--. Dmitry Loschinin: --We will see a ramp down to continue throughout the year, that utilization will stay more or less the same. Alexander Vengranovich: Okay. And the last probably one, how would your--describe your M&A strategy for this year. Do you have any other acquisitions in mind and--or do you feel that you are pretty full in terms of the capacities you require right now for your product mix and for your domain expertise? Dmitry Loschinin: I--yeah, so no immediate plans. You know, I think on the short term horizon, we would continue looking for a small tuck-in acquisition, as they provide very clear purpose and also relatively easy integration and much lower risk, you know, for the company, also for the shareholders. Alexander Vengranovich: Okay. Thank you. Operator: Thank you. Dmitry, I'll turn the floor back over to you for any final comments.

26 Page 26 Dmitry Loschinin: Thank you, operator. And thanks, everyone, for being on our--today's call. We are proud of our progress, and look forward to updating you on our transformation in subsequent calls. Have a good day. Bye. Operator: Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.