Hello, everyone, and welcome to Thoughtworks' Earnings Call for the Third Quarter of 2022. 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, if you want to review or download a copy.

Some of the matters we'll discuss on this call, including our expected business outlook are forward-looking and as such, are subject to known and unknown risks and uncertainties, including, but not limited to, those factors described in today's press release and discussed in the Risk Factors section of our annual report on Form 10-K, our quarterly reports on Form 10-Q and other reports we may file with the SEC from time to time.

These risks and uncertainties could cause actual results to differ materially from those expressed on the call. We caution you not to place undue reliance on these forward-looking statements because they are made only as of the date when they were made.

During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. We also provide growth rates in constant currency as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations.

We include reconciliations of non-GAAP financial measures to our GAAP financial measures in our press release furnished as an exhibit to our Form 8-K, which is available on the Investor Relations section of our website at thoughtworks.com.

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..

Thank you, Sean. Welcome, everyone, to our third quarter earnings call. I'd like to start by sharing an overall update of the business, and then Erin will take you through our third quarter financial results in more detail. I will then share some of our business highlights before Erin provides guidance and we open for Q&A.

Let me start with a recap about Thoughtworks. We're a global technology consultancy that integrates strategy, design and engineering to drive digital innovation. We enable enterprises and technology disruptors to thrive as modern digital businesses. Now let me turn to the financials.

I'm pleased to report strong results in our third quarter, driven by the continued demand for our digital transformation services. We delivered revenue of $332 million in the third quarter of 2022, reflecting year-on-year growth of 16.6% and 23.9% in constant currency.

In the quarter, we achieved adjusted EBITDA of $67.2 million, reflecting adjusted EBITDA margin of 20.2%. Thoughtworks has established a reputation for thought leadership and fostering a unique and cultivating culture. Our diverse and global culture continues to track and retain what we believe to be the best talent in the industry.

I would like to thank every Thoughtworker around the world for the extraordinary impact they create through our technology excellence and culture. Today, the world faces a higher level of economic uncertainty.

Throughout this period, we continue to stay close to our clients, helping them to be adaptive to change and resilient in the face of unpredictability. And we're driving our business with rigor and discipline, managing supply and demand and being proactive with our clients to help them achieve a better return from their technology budgets.

The Thoughtworks business is diversified across industries and geographies, and we see this as a key differentiator. According to the KPMG global technology report published in September 2022, 67% of businesses are set to embrace emerging technologies by 2024.

The report, which surveyed 2,200 technology executives across the globe, found that 44% responded and cited the lack of talent in areas like data science engineering as one of the biggest challenges for the business. We believe that Thoughtworks has the best talent in the industry and that clients continue to value our people and our services.

We have seen better-than-expected demand in third quarter, and our clients are looking to digital innovation to help them navigate uncertainty. Strong themes are prevailing. Let me share some examples. We're seeing strong interest from clients in our data services and how data can transform and scale their businesses.

Clients are looking for us to develop new digital products and services, enhancing customer experiences, removing friction and bringing in customer-facing services together. We're seeing solid demand from clients for Thoughtworks' expertise in enterprise monetization and platforms.

We also continue to see client interest in developer experience platforms as a key enabler for improving the return on investment of technology budgets by boosting the productivity and retention of critical engineering talents. For these reasons, we believe that Thoughtworks is well positioned in the market.

Now let me share the details of our growth strategies. At the core, our revenue growth is from deepening relationships with existing clients and winning new logos. We then supplement this with focused strategies around M&A partners and geographic expansion. Turning first to our client portfolio.

The depths of our expertise and breadth of our capabilities means that we can help clients address all their challenges from strategy right through to business outcomes. Our clients appreciate the value we create with them and remain confident in our ability to sustain our premium position and pricing.

For example, at Atlassian, one of Australia's most successful technology companies, Thoughtworks has worked on a mammoth challenge to migrate one of Atlassian's flagship products, Bitbucket, to the public cloud. Bitbucket enables Atlassian's customers to build software at scale and processes on average one billion transactions per day.

Atlassian was managing this data through its own data center, which posed a challenge in terms of scale and security. Thoughtworks enabled the migration of 50 million customer co-repositories to Atlassian's platform-as-a-service, which is built on AWS. What would previously have taken years was completed by Thoughtworks in just three months.

Atlassian saw a 93% reduction in support requests due to outage and a 55% improvement in Bitbucket's web response time performance. At our long-term client, the United States Department of Veteran Affairs, VA, we have been working together to transform their organization through Data Mesh and data platforms.

VA is a federal cabinet level agency, providing health care services to eligible military veterans in order to improve health outcomes. For example, VA uses the medication possession ratio calculation, MPR, to provide clinicians with a view on how well a patient is adhering to a medication regimen.

MPR is critical for veterans who are taking control medication. Thoughtworks introduced data as a product, a core principle of Data Mesh which enables data to be managed by VA's domain teams.

We're paired with the Office of Mental Health and Suicide Prevention to enhance MPR to fully manage data platform and delivered an 88% reduction in processing time. Additionally, Thoughtworks implemented a data catalog for the Health Data and Analytics Platform, HDAP.

The new MPR data product became the first data product insight the HDAP Microsoft Azure platform, providing a scalable inventory of enterprise data assets. Now turning to new clients. We have a focused approach to new clients, helping the organizations we work with to deliver rapid business value from digital transformation.

We continued momentum from the first half of the year, and we have contracted with 32 new clients in the third quarter. Now let me provide example of a new client that we have been working with recently. We have signed a multiyear agreement with PCI Pharma Services, a leading global contract development and manufacturing organization.

Thoughtworks will help PCI in its journey to digitize its supply chain, with the goal of accelerating the time it takes to bring life-changing therapies to market for patients.

The agreement includes expanding and adapting PCI Bridge, an industry first of its kind data platform that provides real-time status of projects, automatically identifies risks, spots trends and provides business analytics.

With this modern application programming interface, clients have the ability to seamlessly integrate their systems with PCI's, creating greater transparency and a more simplified process for decision-making. We're also pleased to share that last month, Thoughtworks Federal LLC, a wholly owned subsidiary of Thoughtworks, Inc.

was awarded a Multiple Award Schedule prime contract by the U.S. General Services Administration. This is a government-wide indefinite delivery, indefinite quantity contract that grants Thoughtworks Federal an awarded base period of five years and additional 15 years of optional periods.

This is a big step forward and will allow us to sell to federal agencies directly. Now let me share an update on partners as a growth strategy. Our primary focus is to develop go-to-market partnerships with hyperscale cloud providers, including AWS, GCP and Azure.

For example, as Amazon AWS's Premier services partner, we have the highest tier of partnership with less than 3% of AWS partners achieve. In the third quarter, we also achieved a new AWS Financial Services competency.

Thoughtworks has deep technical expertise with AWS cloud technologies, and we're successfully working with a large number of clients at scale. We're also working on a new data platform together with AWS and the Natural History Museum.

The Natural History Museum is a world-leading science research center and was the most visited indoor attraction in the UK in 2021.

The new data platform, which is called the Data Ecosystem, is designed to help the museum scientists to bring together a huge breadth of UK biodiversity and environmental data types in one place to help build scientific understanding of the UK's biodiversity and environment.

You can find details of some of these customer successes on a new section of our website, thoughtworks.com. I'm now going to hand over to Erin so that she can take you through the numbers in greater detail..

Thank you, Xiao, and thanks to all of you for joining us today. We were very pleased with our results in the third quarter, which demonstrate continued solid demand across our business. Let me begin by summarizing a few of the highlights for the quarter. In the third quarter, we saw revenue growth of 16.6% compared to the prior year period.

Constant currency revenue growth was 23.9%. Our revenue growth in constant currency is 2.1 percentage points higher compared to the midpoint of the range I guided to in August. This is primarily due to strong execution and better-than-expected demand.

Adjusted EBITDA for the quarter was $67.2 million and our adjusted EBITDA margin of 20.2% was 270 basis points higher compared to the midpoint of the range I guided to in August. Adjusted EBITDA margin decreased when compared to the prior year period due to the impact from lower utilization. Now let me share some details. Turning to revenue.

For the third quarter, revenue growth year-on-year was 16.6% and 23.9% on a constant currency basis. Our clients remain committed to large digital transformation programs. However, we are starting to see a change in client behavior.

Some clients are contracting in smaller phases to allow themselves flexibility, and sales cycles are normalizing from the accelerated post-pandemic levels. Our demand environment, however, remains healthy and clients value working with Thoughtworks.

This is evidenced by our average revenue per employee of $112,000 annualized for the first nine months of 2022, which remains higher than the industry average. In the third quarter of 2022, we continue to see clients select Thoughtworks for their digital transformations.

Over a trailing 12-month period, we had 41 clients with bookings greater than $10 million compared to 33 clients over the same period last year, an increase of 24.2%. Our overall bookings in the trailing 12 months increased by 19.1% year-on-year to 1.5 billion. We have a diversified business across industry verticals and geographies.

North America grew by 24.7%; Europe by 15%; LATAM by 13.3%; and APAC grew by 9.7%. Our growth in APAC continues to be impacted by the COVID situation in China. Given the continued strengthening of the U.S. dollar in recent months, we want to provide a deeper view into its effect on our reported results.

Our primary revenue-generating currencies alongside the U.S. dollar are the euro, Great British pound and Australian dollar. I’m pleased with the underlying strength of our business this quarter.

For example, on a local currency basis, our revenue contracted in euros grew by 26.1%, Great British pounds by 20% and Australian dollars by 15.9% compared to the prior year period. Due to the diverse nature of our business on a geographic basis, 62.6% of our year-to-date revenues as of September 30 were contracted in non-USD currencies.

We also continue to see good growth across our industry verticals during the quarter.

The strongest growth was in technology and business services growing at 25.5%; automotive, travel and transport grew at 23.5%, financial services grew at 17.7%, energy, public and health services grew at 16.5% and our retail and consumer vertical was in line with last year.

As we shared with you in May, energy, public and health services is a strategic focus and this industry vertical has returned to double digit growth as expected in the third quarter. In the retail and consumer vertical, we are seeing normalizing spend after the post-pandemic boom.

At the end of the quarter on a TTM basis, 88.6% of our business came from existing clients. We have a balanced customer portfolio with relatively low client concentration. In the third quarter, our top five, top 10 and top 50 clients generated 16.1%, 25.4% and 65.4% respectively as a percentage of total revenues.

We now have 36 clients with trailing 12 month revenues greater than $10 million, seven more than the third quarter of 2021, representing a 24% increase. Moving down the income statement.

For the quarter adjusted gross margin was 40.7% compared to 45.7% during the prior year period, impacted by utilization as previously discussed with respect to adjusted EBITDA.

In the third quarter, our adjusted SG&A as a percentage of revenue was 21.2%, which is better than the third quarter 2021 by 100 basis points, due to efficiencies from scaling and strong execution.

Adjusted EBITDA was $67.2 million for the third quarter and adjusted EBITDA margin was 20.2%, a decrease of 310 basis points compared with the third quarter last year due to lower utilization. GAAP diluted loss per share was $0.10 impacted by non-cash stock compensation charges.

On an adjusted basis, our adjusted diluted earnings per share was $0.08 compared to $0.14 in the third quarter of 2021, primarily due to effects from income taxes. Free cash flow for the quarter was $27.7 million compared to $27.5 million in the prior year quarter, and we continue to have good liquidity.

Our cash balance at September 30, 2022 was $185 million compared to $453 million at September 30, 2021. Our cash balance reflects debt repayments of $100 million in October 2021 and $100 million in July 2022. Our debt is continuing to go down and is $404 million as of September 30, 2022.

Now, I would like to hand back to Xiao to share additional updates on our business from the third quarter..

Creating Business Value with Data Mesh. This whitepaper from Harvard Business Review Analytics Services in association with Thoughtworks is based on research with academics, industry experts and three of Thoughtworks data mesh clients, Roche, ITV and Saxo Bank.

We’re also pleased to share the ITV and Thoughtworks were the winners of the DataIQ Awards 2022. Thoughtworks partnered with ITV to implement a data mesh approach in reimagining of data use for content production, promotion, distribution and monetization in a way that is scalable and shareable.

The result has been that ITV’s marketing team can identify addressable audiences in minutes rather than the prior three months timeline. Our shared culture and data mesh sales service data exchange impressed the judges. Now let me hand back to Erin..

Thanks, Xiao. I would like to update you on some areas of focus within our ESG priorities. Our transformational social impact work is a core part of Thoughtworks culture. For example, Bahmni, our long-term global priority in healthcare is now the first open source hospital information system to be accepted to India’s National Digital Health Mission.

In the third quarter, Thoughtworks set up the core architecture to support the Bahmni vision to create a national digital health ecosystem that supports universal health coverage, which over 1 billion people are expected to benefit from. Another focus of our approach to ESG is in the practices around responsible technology.

As technology becomes ever more pervasive in our lives, the field of responsible tech is growing in importance to help mitigate negative inadvertent consequences of technology. We are a leader in the field of responsible tech. For example, Dr.

Rebecca Parsons, our Chief Technology Officer, opened the world’s first Responsible Tech Congress held in Ecuador in September. Thoughtworks is also a contributor to a new report by Forrester, a leading global research and advisor firm.

The Forrester report responsible and ethical technology strategy spotlights that every company, not just big tech is accountable for having a responsible and ethical technology strategy that earns trust and drives sustainable differentiation. Now, let me turn to our business outlook.

While there is uncertainty in the macro environment, our customers are continuing to come to Thoughtworks to transform their businesses. For the fourth quarter of 2022, we expect revenues to be in the range of $303 million to $309 million, reflecting year-over-year growth of 5.6% to 7.7% or 14.2% to 16.3% in constant currency.

We expect acquisitions completed during the year will contribute approximately 3% to fourth quarter reported revenue growth. We expect adjusted EBITDA margin for the fourth quarter to be in the range of 17% to 18%.

For the fourth quarter, we expect adjusted diluted earnings per share to be in the range of $0.08 to $0.09, assuming a weighted average share count of approximately 330 million diluted shares outstanding. As we did in the third quarter, let me provide some context that is informing our guidance for the fourth quarter.

We expect the demand environment for digital transformation programs to remain solid as we help our clients drive growth and efficiencies. Within that framing, let me share a few factors.

First, as we mentioned last quarter, we expect some clients contracting behavior to be at more normalized decision cycles compared to the post-pandemic compressed cycles, additionally, some clients breaking larger digital transformation programs into smaller statements of work to allow themselves flexibility.

Second, we expect the caution we are seeing in our business in APAC, primarily China to continue into fourth quarter. And third, in a few clients in the Retail and Consumer segment, we are seeing signs of moderation in demand due to additional scrutiny on budgets.

Certain retail clients are being more cautious in response to overall consumer sentiment and economic uncertainty. For these reasons, our fourth quarter guidance is prudent. We have taken a realistic view.

We expect that managing the impact of the challenges we have just shared would most likely negate any overperformance on our fourth quarter guidance. Now turning to full year guidance. For the full year 2022, we expect revenue growth year-on-year on a reported basis in the range of 20.4% to 21%, or 26.7% to 27.3% in constant currency.

Reported revenue growth includes a negative foreign currency impact of approximately 6.3%. We expect acquisitions completed in the year to contribute approximately 2% to full year 2022 reported revenue growth. Since I last provided our full year 2022 outlook in August, the U.S. dollar has continued to strengthen.

As such, I am providing a deeper view into the impact of foreign exchange on our guidance. The full year 2022 expected revenue includes a negative impact of $69 million compared to the $57 million due to foreign exchange that I shared in August.

This negative FX impact comprises $23 million to the midyear, $21 million FX impact in the third quarter, an expectation of $25 million negative FX for the fourth quarter. For adjusted EBITDA margin, we expect full year 2022 to be 19.4% to 19.6%.

We expect full year adjusted diluted earnings per share for 2022 to be in the range of $0.40 to $0.41, assuming a weighted average share count of approximately 331 million diluted shares outstanding. Our full year EPS guidance is negatively impacted by foreign exchange and a lower than previously assumed tax benefit from stock-based compensation.

For 2022, we remain highly vigilant of any potential impact of external factors or emerging global developments with our focus on strong execution and scaling our operations efficiently. Our value proposition and services are highly relevant, and we continue to stay close to our clients. We have solid bookings and good visibility into our business.

We believe that we have the best talent in the industry and low attrition levels. We expect to continue hiring in fourth quarter around specific skill sets at more moderated levels.

We remain focused on calibrating supply and demand so that we can balance solid utilization with an ability to respond to growth hotspots in the market, for example, like the high demand we are seeing for our data platforms and data mesh services and our developer effectiveness propositions and our partner-led opportunities.

Now let me hand back to Sean..

Thanks, Erin. You can find our investor presentation on the Thoughtworks Investor Relations website. We now move on to Q&A. I would ask that each of you keep to one question and a follow-up to allow as many participants as possible to ask a question.

Operator, would you please provide instructions for those on the call?.

[Operator Instructions] Our first question comes from the line of Tien-Tsin Huang with JPMorgan. Please proceed..

Thank you. Nice to speak to you all. I understand the prudent comment around the outlook and the conservatism. I wanted to ask on what you can control, which is really on the margin side, if you don’t mind. The third quarter margin was quite good. SG&A was down quite a bit. Fourth quarter, it looks like you’re expecting that to come down a bit.

So maybe, can you talk about the headwinds that will impact margins in that – in the fourth quarter relative to the past and what you’re proactively doing to get there?.

Thanks, Tien-Tsin. Sure. So definitely happy to talk about Q3 to Q4 margin and what we’re doing. First, it’s important to be mindful of the seasonality factor with respect to Q4. And certainly, that is informing the guidance in Q4.

So there’s a lot of public holiday time and vacation time, and so that does have a pull-down impact on utilization from Q3 to Q4, and that is what is largely driving the margin shift from actual in Q3 to be guide in Q4. In addition to that, what we focus on to improve that, there’s a few things.

So there is some discretionary spend that we are tightening up on. We did that in Q3, and we continue to do that in Q4. We also have the benefit of some variable pay impact, so that was higher in Q1 and Q2 than it was in Q3 and Q4. So that helps to offset in part that utilization impact.

But on the whole, with respect to Q4, we will continue to execute well as we did in Q3, making sure that we are reducing revenue leakage, reducing discretionary spend where we think that makes sense. However, we continue to invest in our demand and our marketing efforts and continue to invest in the business strategically..

Great. Great. Thanks for going through that Erin. So maybe just my quick follow-up, Erin or Xiao, maybe for you. Just thinking about your management team, there’s quite a bit of tenure, you’ve been through different cycles before.

How does it feel different at this stage as you’re seeing some of your clients change their priorities? I know you referenced the KPMG report, and we agree around digital transformation.

Did you see a little bit of a pause here and then it comes back with more intensity? I’m just trying to think how you are evaluating this given what you’ve seen in past cycles. Thank you..

Hi, Tien-Tsin. Thank you for the question. I’ll take that.

So we definitely think that in this current cycle, a lot of the hesitation is due to just macro induced uncertainty versus should we do this digital transformation or not? I think there’s no doubt that there’s a conviction of leveraging tech, digital tech to transform the business, to drive growth in the long run is the core strategy for most of the business we’re working with already.

But this macro-induced uncertainty is causing a lot of our clients to just to plan for the better for next year, thinking about what should we invest now, which area should we invest now, and that’s why we are seeing a lot of the additional approval layers required some of the sales cycles stretching out, becoming longer.

And then when we look at this particular timeframe, what’s different from the previous similar situation we’ve seen, I think, a couple of things that’s different. One is there’s a greater focus on leveraging digital technology to drive efficiency and cost saving programs.

For example, the developer effectiveness platforms Erin mentioned earlier, we’re seeing a big uptick in terms of interest in building that out in many organizations. We’re also seeing clients, especially in the verticals that in public energy, automobile are doing better than, as Erin mentioned earlier, retail, for example.

So the performance of different verticals are different. And third one, I think is different, is that the geographic variance is different than some of the previous areas we’ve seen. North America is doing very well. Europe is actually doing decent. Southeast Asia is doing very well. But then we have this softness in APAC.

And besides the China zero-COVID situation, we’ve seen Australian market, just the traditional conservatism is driving more caution facing just the macro headwinds. So overall, we feel that this uncertainty is mostly short-term, meaning that is in the next three to six months windows.

We strongly believe that once this uncertainty is gone, whether that the recession materialize or not or to what extent, I think spending will pick up and continue. And then as we’ve seen before, we also believe that the spending on tech will be one of the first to pick up once this uncertainty is gone. Hope that makes sense, Tien-Tsin..

It does, Xiao. Thank you for going through that. Thank you..

Thank you. And one moment for our next question, and it comes from the line of Maggie Nolan with William Blair. Please go ahead..

Hi. This is Jesse on for Maggie. Thank you for taking our questions. So previously, you talked about expectations for flat revenue in the third quarter as a result of ramp-ups being pushed to the fourth quarter.

Do you still expect those projects to ramp up this quarter? Or have you seen them pushed further?.

Thank you, Jesse, for the question. We – the ones we referred to, the ramp-ups that was delayed from Q3 now are ramping up in Q4 as we planned. So there’s no change in that. That said, we were not seeing that kind of behavior change three quarters ago, as Erin mentioned, in some of the major markets.

I think it’s more that in the last three months, we see some of the concerns about macro headwinds that are translating to different behaviors on some of the other programs that have ramped up.

But less about the ramp-up, it’s more about just the funding become more incremental and then the deal side is being compressed with smaller teams to start with. Our clients are still planning and funding long-term programs. We signed up 32 new logos in Q3, which is higher than Q2 and then similar to what we’ve seen before.

But the deal size is getting smaller to start with, and then I think a lot of our clients are expecting the work of Phase I, Phase II to complete before they reevaluate and further ramp up the team. A lot of this is due to this uncertainty. I think it makes sense.

Our clients want to keep optionality and then the flexibility to ramp up further if the business condition remains stable or doesn’t deteriorate further worse than what they’re expecting. And if it doesn’t, then do we expect these long-term programs to continue to ramp up..

Got it. Thank you.

And then as you’re thinking about more normalized sales cycles in those smaller types of projects you’re seeing, do you think that impacts Thoughtworks visibility at all? How does your visibility now compare to where you’ve been previously?.

The visibility is actually very similar to what we have been previously. Internally we do our own calculation. We could say that we have around about 80% of revenue visibility for Q1, which is similar to what we have said around this time of the year in previous years.

Because our visibility is not just the signed contract, it’s not just SW itself, it’s the program itself, the willingness and then the scheduled ramp-up as we can see in the coming future. So not everything will be signed when we think about the visibility. Take that 32 new logos, for example.

Some of them are starting with smaller teams, but others are also still starting with bigger teams as we – big teams as we’ve seen before. About four of those 32 new logos from a bookings perspective, even from SW perspective, adds up to more than $100 million.

And then five or six of them have the potential to grow to a much larger footprint in the next 12 to 24 months, potentially to top 20 clients. So we do feel similarly about the visibility at this time of the year, both for Q1 and then full year 2023..

Thank you, Xiao. That’s very helpful..

Thank you..

Thank you. One moment for our next question, please and the question comes from the line of Bryan Bergin with Cowen. Please proceed..

Hi. Thanks for taking my questions. Just the first one, I wanted to dig in a little bit more on the details of the client conversations and behavior.

So are you seeing cancellations of work that had been previously signed or if that was in late-stage pipeline? Or is it just more so this more measured pace and right down into smaller deal size?.

Thank you, Bryan. There was a bit of a cracking, but I think I got the message. So I have to say, from a cancellation perspective, the only vertical we’ve noticed that in the non-usual way is the retail vertical. We’re definitely seeing more caution from retail clients due to the overall consumer sentiment and economic uncertainty.

We have seen almost complete pullback on spending from all vendors and a few clients in the retail vertical. And this is already showing in Q3 results, and we believe it’s probably going to remain a similar pattern in Q4 impacting the growth in the retail sector.

That said, in other sectors, for example, public, energy, healthcare, automobile, financial services we continue to see this strong growth. There’s a bit of a caution here and there, small delay pullbacks here and there, nothing major prepared with the retail sector.

And then that’s why I think in Q3 and also in Q4, we expect all the other verticals to grow in a very healthy pace, just I think retail sector is the one that’s having seen the biggest impact..

Okay. I appreciate that. Makes sense. And then just on China, can you just talk about that performance of the China business? We know this was something you had called out as a headwind going into 3Q.

How did that perform relative to what you’re forecasting? And how are you thinking about the headwinds in that 4Q outlook specific to the China business?.

North America, about 39% of revenue; Europe, about 24%; APAC is 33%, is quite significant compared with any other companies, I think, in this area. That 33%, about 14% is – 19% is in Australia; and about 7% is in Southeast Asia; and 7% is in China local market.

So while there is a significant impact to that 7% of revenue from a growth perspective, it’s also relatively contained in the broader revenue diversification context. From – and then just from a local market perspective, the – all the fundamentals are still looking very positive from pipeline, win rate.

We’re still gaining wallet share in most of our major clients. It’s just that the economy is going slow and then the zero-COVID policy is putting a lot of constraints in place. So it’s probably going to take a little while longer than three months for it to get back to similar growth rate compared with the other regions..

Okay. Thank you..

Thank you. And one moment for our next question please. And our next question comes from the line of Jason Kupferberg with Bank of America. Please go ahead..

Good morning, guys. I just wanted to pick up on some of the comments around visibility. I know the Q4 guide calls for mid-teens constant currency revenue growth. And then you’ve got some pretty tough compares in the following couple of quarters. So it seems like maybe mid-teens is a reasonable proxy to think about for the first half of 2023.

Just trying to be realistic about quarter-over-quarter growth assumptions as well in our model over the next couple of quarters beyond Q4 of this year.

So I just wanted to bounce that off you and see if that seems reasonable or if there’s some other considerations we should start to try and factor into our models, just as the demand environment is shifting a little bit. Thanks..

Thanks, Jason. I’ll comment on that, Erin. So I think your estimate is not far off from what we’re thinking. There’s just going to be a lot more uncertainty in the next three to six months due to the macro concerns.

And then as we – as I mentioned earlier, while our business is highly diversified across geographies and verticals, we do see growth potential in the ones that are performing better in this potential downturn like public sector, energy, automobile, hopefully, financial services.

We also will be doubling down in better-off markets like North America, Southeast Asia, to some extent, Europe. We believe that the Australian market should bounce back given the healthy economic fundamentals.

It’s just, as we know, the Australian business community is very conservative and then – which has kind of helped them to fare better at the – during the 2008 global financial crisis, but they tend to slow down earlier than others and bounce back earlier than others as well.

So with all that said, we are confident about the value proposition and pipeline strengths, win ratio, wallet share, the long-term programs I mentioned.

But given this, the drag of the macro headwind, we think that probably early 2003 in H1 because of the – that and the tough comps, as you mentioned, Jason, we’re probably looking at sub-20% growth rate in H1 on a CCY basis. And then certainly, once the caution is gone, getting back to the 20% growth rate in H2 is highly possible..

Okay. Yes. No, that all makes sense. And I guess just thinking about what kind of visibility you might have, let’s say, at the turn of the year versus a typical year.

I mean it just seems like we’re hearing this from other companies, too, just client budgets are going to take a little longer to get finalized and decisions around kicking off new engagements may be pushed out a little bit.

So are you guys preparing for an environment where you’ve just got a bit less visibility on the full year? Maybe that doesn’t emerge until, I don’t know, March-April, instead of January-February? I don’t know if I’m framing that accurately, but I just wanted to get your perspective on that..

I can jump in there, Jason. So firstly, I would say, which I think indicated by your question, we are in the middle of our planning process right now. As Xiao has already talked about, we do have good visibility into next year. It is at similar levels as we’ve had previously. That said, we are not providing guidance at this time.

I know you wouldn’t expect that. Because we’re in the middle of the planning process, and we do go through a rigorous process, we’re running our process around the same time, but maybe about two or three weeks later than we do previously. And that is just because of the recent caution that we’ve seen in the market.

We want to be thoughtful, and we want to make sure that we are agile and we’re able to move as needed in the business. So Xiao’s comments stand certainly, but again, we are in the middle of our process.

As you were highlighting, there is similar amounts of visibility, but certainly, the market dynamics are showing a little bit more caution associated with the macro headwind. So for that reason, we will be waiting to give final guidance when we are in the market in February..

Understood. Thanks Erin, thanks Xiao..

Thank you. One moment for our next question, please. And it comes from the line of David Koning with RW Baird. Please proceed..

Yes. Hey, guys. Thanks for taking the question. And I guess, first of all, you talked a little bit about the retail vertical.

I just wanted to ask a little more about the financial services vertical, I know that was down maybe close to 10% sequentially and just if there's any subparts of financial services that are maybe stronger or weaker, I guess – yes, just that..

Thanks, Dave. Financial services vertical, I think it's down sequentially, not out of the line with the other verticals. I think it's just – it's coming back to a more normalized growth pace from this hyper growth phase just post COVID.

And then within that vertical in our own portfolio, we generally do very well in the digital banking area, wealth management, payment. I think the main difference compared with a couple of quarters ago would be the cryptocurrency space. There's just a lot less activity in that area.

But other areas, we haven't seen a pattern that calls out – calls to our attention where in particular pocket, it's – it's pretty similar to what we've seen before. So that's why we're still, knowing that there's macro headwinds ahead, very confident about the ability to continue to grow the financial services sector.

And then part of the reason is that if we look at our global footprint from a revenue perspective, our biggest share of revenue is in the tech business services sector.

Financial services, given how dominant from a tech spending and digital spending perspective in the whole – among all of the whole sectors, we still have a relatively small percentage of revenue in this sector compared with what we could get.

So we're feeling strongly that this higher growth than pre-pandemic growth in the finical services will continue, but it's just not as hyper as two quarters ago..

Yes. Got you. And then maybe just a follow-up. I know it's really, really hard to guide the tax rate when between GAAP and non-GAAP earnings gap is kind of close to breakeven. And it's just difficult. But this quarter was, as you mentioned, very high kind of adjusted tax rate.

Is there anything as we go forward that's either changed or just for us to think about like 25%, 30% tax rate kind of adjusted as normal going forward?.

Yes. Dave, that range that you just mentioned is reasonable going forward. Just a couple of points to help you understand what's happening with respect to both third quarter and then included in guidance for fourth quarter. You will recall, of course, that we've got outsized, stock-based compensation and much of that relates to the IPO.

There are significant amounts of nonrecurring expense that runs through income in 2022. There will be a little more of that in 2023, but the vast majority of it, we will be through at the close of 2022. We also had a vesting event in the third quarter and the dynamics of the share price at the time of vesting led to a higher-than-expected tax impact.

And so we've had excess tax deficiencies on stock-based compensation that was recognized in the third quarter, and that is why there is the higher tax for the quarter. And so again, we're expecting that to continue somewhat in Q4. And that is included in guidance, but that really is the big difference for the quarter..

Got you. Now thank you for that. Appreciate it..

David, thanks for your question..

All right. One moment for our next question, please. It comes from the line of Moshe Katri with Wedbush. Please proceed..

Hey, I'll take maybe two quick questions here, guys. So first, so your non-GAAP EBIT margins were down. Maybe talk a bit about the factors. I think you mentioned lower utilization rates.

Maybe some color on that, Erin?.

Yes. It was really down to lower utilization. We talked about that with the third quarter guidance in the Q2 release. I'm sure Moshe, you'll remember the three factors that we mentioned, and Xiao talked a bit about them on the call. And so that lower utilization was a – it was an impact in the third quarter, which you can see with gross margin.

Our gross margin was down significantly compared to last year, about 4 to 5 points. And so that was largely utilization. I do just want to highlight that if we look at the pricing dynamics, our pricing dynamics remain strong. And so we did continue to see price increases in the third quarter, the same as we had in the second and the first quarter.

And so the underlying fundamentals are very strong, but our utilization is running lower than we targeted. And certainly, that is the impact that we saw in Q3 and also is impacting the Q4 guide as well..

All right. That's great color. Actually, my follow-up was on pricing. So pricing looks good.

Are there any major renewals coming up? Or anything in terms of – anything on the pipeline in terms of client renewals that we have to be kind of aware of?.

We have renewals throughout the year. There is a larger concentration towards the end of the year, and certainly, that would be in line with our clients' planning cycles. So as we are going through our planning process, we do plan on a bottoms-up level with respect to client accounts, account by account.

And so we will have a reasonable amount of renewals in the fourth quarter. Nothing that I would note particularly as – it's all in the normal course. It's part of the – really the annual process. And so Q4 is heavier, but it is throughout the year. And so far, things are trending reasonably well with that..

And then just a quick follow-up on that, Erin, I think we have been getting – looking at Q3, a mid-single-digit increase from a pricing perspective. That is obviously offset to some extent by the geo mix and then the utilization.

But we feel confident that these higher value-add service offerings we are focusing on will continue to get the pricing power we have as before..

Thanks guys, thank you..

Thank you. One moment for our next question, please. And it comes from the line of Arvind Ramnani with Piper Sandler. Your question, please..

Hi, thanks for taking my questions.

I wanted to ask, when clients are looking to streamline or kind of reduce budgets, are you seeing any behavior of vendor consolidation? And in particular, are you seeing them consolidate by increasing spend with some of the larger vendors and reducing spend with the smaller vendors? Just wanted to ask about what kind of behavior you're seeing on vendor consolidation..

Thanks for the question, Arvind. We have – so in terms of the client behavior, the priority change from a vendor consolidation perspective, we've seen some of them in some cases. The common pattern we've seen is that there's a desire to consolidate more on the commodity service providers, to create more space for strategic providers.

And then in many situations, we are actually seeing an increase of wallet share because of the strong delivery track record and also the strategic positioning we have. So we are actually taking the opportunity to – even though as the macro headwinds is coming, we're taking the opportunities to win more share during this vendor consolidation.

It's – but just more of a step back just from an overall context of vendor consolidation, not too many. It's more of an isolated case than across-the-board pattern, if that makes sense..

Yes, yes, it does. And then just a quick follow-up. Just given the potential like demand headwinds, how are vendors thinking about pricing? I know you said that you're still seeing sort of price increases.

But typically, when folks are trying to reduce budgets, for those particular clients that are looking to reduce budgets, are there any discussions on pricing as well, saying that, hey, we need to reduce by 10%, but if you can get better pricing, then we can maybe reduce our spend a little bit by a more modest amount?.

We – from that kind of a pricing discussion perspective, where that's never a surprise and then it happens all the time, historically even, I think we're definitely facing a tougher pricing environment at this moment. And then our teams on the ground are doing all the right things for our clients.

One is to support them to help them through a difficult time, if they're facing difficult time. And also to protect our win rate. So we are definitely not putting our win rate at risk, just making pricing the only priority. It's a multifactor decision we're making that.

But overall, I think at an aggregate level, we do see this tougher pricing environment. We will end up with perhaps less price increase that we're going to see in the next quarter or two. But overall, we feel confident in that – the pricing power we have.

And also the higher margin, gross margin we have in general give us more flexibility to deal with these issues than otherwise..

Terrific. And then just kind of last question. When I look at your Q4 to Q3 kind of revenue compression, it's roughly about $26.5 million in the midpoint.

Are you able to dimension how much of that is from currency versus volume compression?.

Yes. I can help answer that question, Arvind. Thanks for that. You did mention currency, that is part of it. I think it's really important to understand in looking at Q3 revenues to Q4 revenues, there's a number of structural factors that really is driving the majority of the decline in revenues from Q3 to Q4.

So exchange rates are going to account for approximately 1% of that. In addition, there's one less week day in this Q4 versus Q3. And so that is another about 1.5%. And we've talked about seasonality at various times. We talked about it last year in Q4.

I mentioned earlier on the call, but seasonality is a big factor for revenue growth in the fourth quarter for Thoughtworks. Public holidays and vacation leave are significantly more in the fourth quarter than any other quarter in the year. And so that has a big impact, and it's really easy to underestimate that.

That actually accounts for an additional approximately 4.5%. So a lot of it is really what we would call structural factors. And just to help remind of the dynamic that we saw last year, last year, we had year-over-year growth in the fourth quarter of 39%, which is clearly a very strong level of growth.

And even with that, our revenues were flat from Q3 to Q4. And so there definitely is a seasonality impact at play here, and that is going to cover most of it there. We have already talked about some of the areas where we're seeing just a little bit of softening and some caution.

But on the whole, we are expecting solid growth, 15% CCY, but it is a step down from the 24% that we saw in Q3..

Yes. Yes, terrific. But I guess, just if I have to go back to kind of last earnings, things have gotten like kind of a bit worse than what you were anticipating last earnings. And is that – I'm trying to dimension what's changed from last earnings.

Like some of these things like – some of the structural things were already in play, right? But if there was any additional headwinds from FX that's driving guide versus what you were anticipating three months ago?.

Yes. So FX is definitely part of it. So there was around $11 million in reduction in USD revenues related to FX factors compared to guidance, and a lot of that is in Q4. And so that is clearly playing a part. But I would also say we didn't see – lots of clients were talking – and talking about potential macro factors.

It's been in the news for a long time. That's no surprise to any of us. But I think what has shifted a bit in the last month or two is we have seen that play more into the contracting cycle. And there's just a general more cautious tone as people manage budgets towards the end of the year, and that largely is what we're seeing as a difference.

Xiao mentioned, we continue to have very strong win rates. It's just that we are seeing clients start engagement with smaller teams initially, a big focus on ROI. And in some cases, clients have said, okay, well, it's just going to make more sense to start this in Q1 rather than Q4.

So we're just seeing a little bit more of that dynamic, particularly in the last months than we did in the third quarter. And that is the other part of the difference beyond the FX..

Terrific. Really appreciate that color. Thank you so much..

Thank you. And one moment for our next question, and it comes from the line of Dan Perlin with RBC Capital Markets. Please proceed..

Thanks. Hey, Erin, I just wanted to follow up a bit on this cadence as we think about what you have outlined a little bit for 1Q. I know you're not giving specific guidance, but you've got 80% visibility. I think to an earlier question, you kind of alluded to sub-20, call it, maybe mid-teens.

And you just outlined a lot of things as to structurally why there's a downdraft in the 4Q. But the absolute number for 1Q, based on what you've said, has a pretty significant absolute dollar ramp sequentially. So can you just help us with why that would be the case? Maybe there's some structural things we need to be mindful of.

Obviously, we'll get back maybe the holidays and things of that nature, but FX will continue to be tough. So anything there would be very helpful. Thanks..

Sure. So if we think about the first quarter, so the structural things, as we saw in Q1 of this year, they do provide a benefit into in – from fourth quarter into first quarter, so that's a typical pattern for Thoughtworks. We would expect to see that pattern continue next year.

What we should be aware of is that we've seen strong growth across the year. And the – we had very, very strong growth in Q1 and Q2 of this year, and then it's been a bit more moderated in Q3 and Q4. So as we consider growth into the next year, we've got to take into account the FX headwinds.

As you mentioned, Dan, that's a big factor for us, but then we also just need to take into account also that macro uncertainty. So that said, we're not going to give specific on growth rates right now. We'll wait until February to do that. But what Xiao said holds true, we are expecting solid growth for next year.

But just given the current run rate and given the market dynamics, that will be more moderated, we believe in Q1, then it will be potentially in the second half of the year. So I would say, hopefully, that's helpful and then more on that in a few months' time..

Yes, that's great. I just have one real quick follow-up in terms of utilization. Is there a level of growth that we think about in order to maintain a margin expansion opportunity as we go into next year.

Again, I'm not looking for specifics for the guide, but just directionally, is it likely that first half probably is compressed but second half, as you just described, is going to have better likely outcomes for growth, and therefore, we could see some expansion in margins?.

Thanks, Dan. Yes, that's very reasonable. We do believe there are margin expansion opportunities. Again, of course, we're too early to talk about the specifics. We have opportunities to drive efficiency from an operational perspective. We've seen that this year, and we expect to continue to see that next year.

That typically is relatively balanced across the quarters, and so there's nothing specific to call out. With respect to next year, again, from the seasonality impact, we talked about this in Q2, but our Q2 margin tends to be lower than the average for the year because of the impact of the annual pay cycle.

So that dynamic was in place this year, and we expect it to be in place for next year. So I would suggest keeping that in mind. We are at lower levels of utilization. We're working on a program to drive increases there, and some of that will happen through revenue growth, we expect.

So that will play – we expect that will benefit a bit in Q1, but the larger margin expansion opportunities are more isolated likely into the second half, as you noted..

Excellent. Thank you..

Thank you. And we’ve no further questions in the queue. I will turn the call to Guo Xiao for his final remarks..

Thank you. And so thank you, everyone, for joining us today for our Q3 earnings call. I'd like to acknowledge the continued support of our Board and shareholders. And then in closing, I want to thank all Thoughtworkers, clients and partners for the extraordinary impact we're delivering together every day.

Stay well, and we look forward to catching up with you next quarter..

And with that, we thank everyone for participating in today's conference. You may now disconnect. Have a great day..