Alfa Financial Software Holdings PLC (ALFA) Earnings Call Transcript & Summary

Hello, everyone, and welcome to Alpha Financial Software's Half Year Results Presentation. I'm Andrew Denton, the CEO of Alfa, and I'm joined as usual by Duncan Magrath and Matthew White, Alfa's CFO and COO. We'll follow our normal agenda with some highlights from me before Duncan takes us through the financials. Matthew will then step through our delivery performance leaving me with the business and sales update ahead of Q&A. So in overview, we've had an excellent first half with trading in line with our expectations as we made room to invest in our product and as major new projects began to ramp up strongly. Major wins in U.S. also and multi-country European equipment finance have driven strong TCV growth, up 40% from this time last year. This month saw another marquee win in U.S. Auto. This win included our first sale of the new Total Originations product line, a key first step in the significant expansion of our addressable market. And we've continued our industry-leading delivery record with 13 deliveries overall in the half and one customer go-live. This brings the number of customers on Alpha systems V5 to 28, a number that has seen a material acceleration in recent years, and we expect that acceleration to continue. Acceleration will be a theme for this presentation. We've also seen significant strategic progress during the half. SaaS is now business as usual at Alfa. We no longer sell Alfa systems any other way and SaaS continues to be a key engine for revenue growth. Subscription is up 18% with subscription TCV up 26%. We've also continued the launch of Alfa System 6, the fifth installment dropped in July and Matthew will expand on how intelligent automation delivers embedded AI in the real world. And looking forward, Alpha System 6 delivers 10 new modules which showed great promise in accelerating incremental sales in 2025 and the demand for our services driven by our sales success means we are also accelerating recruitment. Finally, as well as the wins I just mentioned, our late-stage pipeline remains very strong. We are a preferred supplier with 9 of the 11 prospects, and we are working under contractual cover with 8 of them. New opportunities have entered the pipeline, and we're seeing demand across all of our markets. All of this gives us great confidence in our prospects, and we've therefore increased our full year expectations by GBP 1 million and the Board has declared a 4.2p a special dividend. Moving on to key highlights then. Duncan will explore the numbers in more detail. But we have turned over GBP 52.3 million, in line with our expectations for H1. GBP 22 million of cash at 95% conversion, again, in line with our expectations after unusually strong billing at the end of 2023. 18% growth in subscription revenues, laying down the foundations of future growth and resiliency. GBP 16.2 million operating profit, which gives an EBITDA margin of 33%. Our closing and average head count were in line at 5% up and retention was up from this time last year at 96%. Finally, TCV was up to GBP 193 million, an increase of 18% from this time last year, in line with our strategy and our focus, subscription TCV was up 26%, which provides the underpin for continued strong subscription growth. Over to Duncan.

Thanks, Andy. Financial performance was very much as expected in the first half of the year. Revenue was in line with last year on a constant currency basis or down 1% at actual exchange rates, mainly due to the reduction in chargeable software development work. However, the quality of the revenue continues to improve, which I will cover later. Costs were broadly in line with last year, and so operating profit fell by GBP 0.7 million principally due to the revenue drop. The effective tax rate of 26% was higher than last year on the back of the increase in the corporation tax rate and the change to the R&D tax credit resulting in diluted EPS being down 10% at [ 4.0p ] per share. We are pleased with the performance in the first half. And given our confidence in the outturn for the year, the Board has declared a special dividend of 4.2p per share. Turning now to TCV. The 2 wins in Q1 gave a very big boost to our TCV, which is up 40% on a year ago. I also wish to highlight that the next 12 months TCV is up 20% and it is this growth, which supports our expectation of a strong growth in H2. I've also noted on the slide that there were 2 prospects in the late-stage pipeline where we are conducting paid work that we expected to sign shortly. One signed in August, which has an initial TCV value of GBP 19 million. We still expect the second to sign shortly. Enterprise sales can be uneven, and we had a relatively quiet patch in H1 '23, but you can see from the graph that we've made very significant progress since then. As you know, the TCV is calculated using an arbitrary 3 years for subscription revenues, while our customer relationships are a lot longer than this. And so arguably, this understates the position. We are often asked what our customer churn looks like, and so the next slide demonstrates how sticky our customer base is. This slide shows all the customers that are either on V5 or in the process or discussions to move on to V5. The key takeaways are stickiness and acceleration. Firstly, stickiness. There have only been 2 customers who did not continue with Alfa V5, one due to the customer selling their portfolio, and this was, in fact, to another Alfa customer, so the contracts stayed on Alfa. The other loss was due to the OEM making strategic change and withdrawing from the financing market shortly after having gone live. There have been no other losses, so we have never lost a V5 client through a tender process. Secondly, acceleration. It took 7 years from 2010 to 2017 to start the first 10 V5 customers. The last 10 have started in just the last 18 months. As discussed in previous presentations, we've made great progress in diversifying our customer base over the last 5 years, and we are now at the point where we are much less reliant on any one customer in any one market. More details of this are in the appendix on Page 33. Turning to subscription revenues. Firstly, looking at subscription TCV, where you can see we've had 26% growth over the last 12 months as we've added the new customers we saw on the last slide. This has made subscription our fastest-growing revenue stream. And of course, it adds important visibility to our revenue projections. This visibility allied to our great customer longevity that you saw on the last slide, highlights how important the revenue stream this is for us now. Subscription revenues grew 18% in the first half and now account for 35% of our revenues. 66% of these revenues come from live V5 customers with 19% from customers upgrading from V4 with a balance of 15% from new customers. The new customer figure, however, does not tell the whole story. So I think it's worth having a look at an illustrative subscription life cycle, which I've shown on the next slide. Before starting, a quick reminder that our pricing is based on contract volumes and not user account. The more contracts on Alfa, the greater our revenues, also the more modules customer uses, the greater our revenues. So the 3 key areas of growth for subscription revenues are: firstly, growth with existing customers either increased contract volumes, new modules or pricing. Secondly, customers upgrading from V4 onto the SaaS model. And thirdly, new customers implementing Alfa. Regarding new customers, it's worth understanding how the revenues grow over time. A typical subscription customer will pay for some services during implementation, but our revenues will only start to ramp up once they go-live and start putting significant contract volumes on to Alfa. So it is only once past go-live that revenues from new customers really start to reach a steady-state run rate. As mentioned earlier, the way we calculate subscription TCV is to take an arbitrary 3-year period and include the estimated revenues for that period, which are highlighted inside the purple box on the left. As you know, each customer contract often has some different or unique characteristics, but we've tried to show an illustrative contract on this slide. You can see from this that the subscription TCV at the start of the initial 3-year period will be relatively low, but increases significantly up to go-live. This growth will, of course, vary from contract to contract, depending on the length of time between signing the contract and go-live. And therefore, how much of the post-go-live subscription fees are captured in initial TCV. This is not something we've highlighted before, but the key thing to take away is that subscription TCV will grow quite strongly over the first few years. The growth in our subscription revenues is very much driven by the successful move to SaaS, but this has had an impact on our software revenues that you can see on the next slide. Software revenues decreased by 33% in the period by continuing successful transition to SaaS, along with the reduction in chargeable software development, and this was against a very strong period last year. I've illustrated this with the bridge diagram, which reconciles the GBP 8.9 million of revenue from the first half last year on the left to the GBP 6.0 million of revenue for the first half revenue this year on the right. The 2 significant movements are the GBP 1.3 million reduction from the customized perpetual license recognition, along with a GBP 2.4 million reduction in revenue from chargeable development work. The reduction in the customized perpetual license income is the headwind that we've been running into as we transition to a SaaS model and increase the quality of our revenue. As previously discussed, the reduction in chargeable development work is a function of 2 things. Firstly, our development teams have been focused on internally funded development into Alfa System 6. Secondly, there has been a gap in chargeable development between existing projects having gone live, but not yet being replaced by new projects where development is later in the project. Looking forward, though, you can see that the next 12 months TCV has increased from GBP 6 million last year to GBP 10 million this year as we start to see the planned development work become agreed with new clients. We are, therefore, expecting a stronger H2 from this. One final point with the transition to SaaS, our software license revenue is increasingly shown in subscription. There is, therefore, only software license from historic contracts shown in software, and it is at a relatively low level. With the majority of the revenue in software now from chargeable development, I'm wondering whether this revenue stream would be better described using the name Product Development instead of Software, [indiscernible]. Turning to our final revenue stream, services. Total services revenue reduced by 1% versus a very strong H1 '23. As previously discussed, we had a number of projects going live in H2 '23 with the new projects not yet at a full run rate in H1 '24. You can see from the very significant growth in TCV that the new projects are starting to be contracted driving the more than doubling of TCV since this time last year. This was boosted by one customer signing a statement of work for the whole of the implementation project through to 2027, which is quite unusual, but obviously good news for us. I've had a number of questions about what activities sit within services. It is essentially activities carried out by our delivery teams and comprises delivering implementations, upgrades, migrations and other deliveries to clients. Perhaps this too could be doing with renamed to say Delivery. Turning now to expenses. Overall costs were very similar to last year, up only GBP 0.1 million, so I won't dwell long on this slide. The biggest movement here is the increased salary costs from additional employees and pay rises, largely offset by more people being involved in internal development work with a consequent increase in capitalized development. Turning to cash flow. Cash conversion of 95% was as expected, with the accelerated collections at the end of 2023 impacting 2024 cash conversion along with the higher capital expenditure for the intangible asset and capitalization I referred to on the previous slide. We noted at the time that the 140% cash conversion for H1 2023 was unusually high. As previously flagged, we expect to operate around 100% cash conversion going forward. But this can vary between years. And given the very strong finish to 2023, we would expect overall 2024 cash conversion to be 90% to 100%. We had GBP 0.8 million of share purchases in the period, solely for purchase of shares for the employee benefit trust to satisfy share options. We also paid GBP 9.7 million of dividends in the period. So now on to the balance sheet. Taking out some key items and firstly, trade receivables. As just noted, we had an unusually strong cash collection at the end of 2023, and so receivables were unusually low. At June '24, these have returned to a more normal level. Prepayments and accrued income has increased by GBP 1.5 million, largely as a result of awaiting a PO with one customer before we could invoice them, which has now happened. Maintenance contract liabilities increased due to the annual billing in May, although this is reducing in importance as more of our business is on monthly SaaS payments. Now some words on capital allocation. There is no change to our policy, which is to ensure that we have sufficient funds to run the business, but to retain some optionality for further investment into our product or possibly bolt-on M&A. We create the optionality through our progressive ordinary dividend being set at a sustainable level and supplementing this using a special dividend to return any excess capital. There are no immediate investment requirements, so we have declared a special dividend of 4.2p per share. Now to modeling guidance. We very much expect our growth in 2024 to be second half weighted, returning to a more typical pattern. We will continue to see sequential subscription growth, and this will be boosted by services and software growing in H2 as the new projects ramp up. For the full year, we expect cash conversion to be below the long-term trend of 100% as a result of the very strong conversion in 2023. We expect the full year effective tax rate to be 26% due to the full year impact of the 25% U.K. corporation tax rate, along with no longer receiving any benefit from R&D on the tax line, but instead receiving benefit through the RDEC Scheme, which is shown in operating income. Currency sensitivity has been updated slightly, with an increase in our underlying sensitivity to the U.S. dollar due to the change in the balance of our business, although this is more of a 2025 issue as we are largely hedged against the U.S. dollar for 2024. I will now hand over to Matt.

Thanks, Duncan, and good morning. A brief update from me today with some highlights on our progress in strengthening our product, our team and our delivery track record in scaling our organization and in simplifying our delivery to enable that ongoing subscription revenue growth that Duncan has just described. . We're strengthening our product differentiation with the launch of Alfa Systems 6, which includes 10 new modules released in 6 installments. Alfa 6 will be sold as a SaaS-only product, providing the clearest possible strategic direction. We're continuing to invest in our product with an enhanced new business originations product line and commercial finance support as the key items expanding our target addressable market. And following the movement of Alpha IQ in-house, AI innovation is now fully embedded into our product and our organization. Our product includes intelligent workflow process automation and predictive analytics for credit. Our delivery tooling includes [indiscernible], which uses large language model technology to provide chat-based interaction with system documentation. And AI innovation sponsors within our teams enable AI use to improve our operational efficiency while ensuring that everyone is clear on the guardrails keeping us all safe. As you can see here and as Duncan has already described, we're building our customer base and our journey towards having all customers on the modern technology stack of Alfa V5 and Alfa System 6 is progressing well with nearly all the 4 customers now actively working on an upgrade. We're investing further in simplifying our delivery methodology and tooling to enable faster and more efficient delivery. And we're also investing in preparation for partner-led delivery to enable us to reach more customers. I mentioned [indiscernible] earlier, and that will be a very important tool for partners as well as for customers and our own team. We're growing our head count with increased targets for recruitment in H2 to support the exciting pipeline that Andrew will describe in more detail next. And we're rolling out an improved induction program to enable us to onboard those new people more quickly. The team remains very engaged and people are sticking around. Retention remains very high at 96%. We have very few levers, but we stay in touch with those who do leave and we see many people return down. As a different lens on our engagement, we've quoted our employee net promoter or eNPS score here in the slides. eNPS scores between 10 and 30 are considered good. While those between 50 and 70 are considered excellent. Our score, which exceeds even that excellent level reflects commitment to shared goals within the team as together, we build our company for the future. And as always, we're really grateful to everyone in the team for enabling the excellent progress that we're reporting to you today. That's all for me, and I'll hand back to Andrew.

Thanks, Matt. Now a couple of words about the pipeline. As I noted in my opening remarks, our new business pipeline remains strong, continues to provide the fuel for our growth. We've also had a good half of converting prospects into fully contracted wins, particularly if we add August win, a massive milestone and real reinforcement of our leadership position in U.S. Auto Finance. We started the year with 11 prospects in our late-stage pipeline. The 2 wins exit the pipeline, but new additions have kept the pipeline at 11 at the half year point. By fast forwarding to today, another prospect and another win keep the score board ticking and show the health of our sales channel, particularly when we overlay the position of these prospects, preferred supplier with 9 of the 11 and we are working under contractual cover with 8 of them. The late-stage pipeline right now is very much alive across all geographies and sectors and with a good mix of customer size. A new analysis for subscription revenue rather than just project revenue shows the power of our strategy. A point in time view shows that the projects are weighted towards lower effort levels but future subscription revenues are weighted towards much higher revenue levels. In a nutshell, we're switching on higher subscription levels with much lower implementation friction. We are delivering our strategy, and we are accelerating our future growth. So the business is in fantastic shape, a strong pipeline with high levels of conversion bringing internationally recognizable logos onto our customer roster. This reflects the continuing high demand across the industry that we serve. We have executed on our investment plans for 2024. We mend the roof and extend our house while the sun shines to ensure continued success and provide the foundation for a strong future. New sales coming on stream in H2 and planned low investment levels will see financial performance weighted towards the second half of this year. And you will continue to see sequential growth in subscription revenues, a key part of our strategy for accelerated growth in the future. So in summary, we've had an excellent first half with trading in line with our expectations as we made room to invest in our product and as major new projects began to ramp up strongly. Major wins in U.S. auto and multi-country European equipment finance have driven strong TCV growth. And this month saw another marquee win in U.S. Auto. We continued our industry-leading delivery record, as Matthew has outlined, with 13 deliveries overall in the half and 1 customer go-live. And SaaS is now business as usual at Alfa. We no longer sell Alfa systems any other way. And SaaS continues to be a key engine for revenue growth. Subscription is up 18% and subscription TCV up 26%. And we've continued the launch of Alfa System 6. Alfa System 6 delivers 10 new modules, which show great promise in accelerating incremental sales in 2025. Our late-stage pipeline remains very strong. We are a preferred supplier with 9 of the 11 prospects we're working under contractual cover with 8 of them. And new opportunities have entered the pipeline. We're seeing demand across all of our markets. So all of this gives us great confidence in our prospects. And as we set out, we therefore, increased our full year expectations by GBP 1 million and declared 4.2p special dividend. Thank you for listening.

[Operator Instructions] First question today is coming from Sven Merkt calling from Barclays.

It's very encouraging to see that you already signed a customer for total originations. Can you perhaps give us a bit more color on why you won the deal, how competitive it was and if you replace with total originations and in-house or competitor solutions? And then secondly, as we can clearly see subscription revenues continued to increase in the mix. Given the strong subscription TCV development and subscription-heavy deals in your pipeline, can you comment what share of revenues you expect to come from subscription over the coming years?

Thanks for your question. I'll take the first one and ask Duncan to comment on the second one, if that's okay. In terms of originations, we've always, of course, had end-to-end capability. And to a degree, we would have been competitive within originations in all of our target markets. When we talk about originations and indeed this first sale of total originations that we've made, we're really focusing on U.S. auto originations, which is an enormous opportunity. And without going into huge detail on this call, there's a fair bit of difference between the way that it operates at originations in all the other markets that we serve. The reason that we've won it is because, of course, of those strength of relationships. But as much as anything else in the same way that a wholesale finance function -- functionality on Alpha benefits hugely from having more of the operation on the same core system, originations is in exactly the same position. There are huge benefits from having the end-to-end operations for our customers on a single system and on that single system being alpha sitting at the heart of their ecosystem integratable with all of their other channels and systems. In terms of the competitive landscape, the competition out there is as always within the world of enterprise software, a combination of in-house homegrown systems and existing competitors. But we're enormously excited about this first step in a key expansion of our addressable market, given that there are whole companies out there who do nothing but U.S. auto originations feels like a great expansion of our footprint and a super opportunity.

Yes, Sven, you're right to point out that the very strong growth we've had in subscription revenues. Projecting forward is always a little bit tricky. We expect that strong growth to continue, but we sort of also expect the whole of the company to be growing as well. So increasing it as a proportion of the total revenues is more -- will take some time. I think going into the 40% is entirely possible within the next few years. I think getting above 50% will take quite a while based on the current plans that we have in place. So I think you should think of it as high 30s, mid-40s over the next few years, but with the potential to go beyond that in the longer term.

[Operator Instructions] We'll now move to Harvey Robinson of Panmure Liberum.

A couple of questions -- well, a few questions from me. Just following up from the question on subscriptions. Clearly, that has a upward pressure on gross margins. I mean, obviously, we should be rethinking about higher gross margins in the medium term? The second question I have really is on total originations falling up there. As you talk about the size of this opportunity, is it possible to quantify what the dollar value of this market might be in total? And then I've got a couple of technical questions more from that, I suppose, on other functionality within the System 6, I should say. I mean I know you've made quite a few comments about the entity-level close capability, but that sounds quite material to your customer base. Could you talk to that from the customer side and what it means and how much productivity improvement that can give to them? And the final question, sorry, so many today. You've mentioned commercial loans in the past, and I know you've been busy with a lot of work on System 6. But when do you think we'll start to see a more material revenue profile from commercial loans. Sorry for so many questions.

No problem at all. I assume it's Harvey, not [indiscernible] that we're talking to. So perhaps we'll play with the sequencing of your questions if that's okay, Harvey. And we'll move margins backwards and perhaps ask Duncan to comment after Matt and I had to go on the accretive value of the growth in SaaS and subscription. I'm afraid I'll take the fit in terms of the total dollar value of originations. But again, subjectively, I'll repeat the fact that there are whole organizations that do their business purely within the field of originations. The new customer that we have is -- will be a fantastic reference in that way. But we feel very confident in the pipeline of the existing customers and new wins who will also want to have that end-to-end capability. And as ever, we are confident in Alfa's competitiveness. And of course, everything that we've been announcing in Alfa Systems 6 is part of our proposition within originations. On a similar note, I'll talk to commercial loans. We have actually announced some small pieces of functionality in that area and our ability to support commercial loans. And as you know from conversations that we've had, commercial loans, the initial opportunity there is in terms of pivoting into that market through our existing customer base, similar to originations. Most asset finance, probably more on the equipment finance side, they do have commercial loan portfolio for a variety of reasons. So we're very much looking to make headway into those portfolios. And you would hope that we will see some top line from that pretty imminently, but your overarching point, absolutely, we want to remain agile in the way that we marshal our investment, our development and our entry to new markets. We saw a big opportunity within originations, and we put some focus into that. But our long-term strategic focus in terms of the underlying capabilities of the system and our target markets remain unchanged. I'll ask Matthew to talk about entity level close because it's, as you know, an exciting technical advance for software, but perhaps also take a liberty repurpose your question a touch and talk about how excited we are with Alfa components, which is where there is huge customer productivity gains in our eyes.

Thanks, Harvey for entity-level close, a really exciting thing for our customers is that it enables true 24/7 operation. So for entity-level close, you should read rolling closed on a contract-by-contract basis within our portfolio. And that enables uninterrupted round-the-clock operations for our customers, and there's nobody else in our market, who can do that. So you're right that it's a really exciting development for us.

Harvey, to your gross margin question, it's probably just a quick recap for those people who don't necessarily know what's in our gross margin. It's basically the salary cost of all of our external people. It's the costs of our partners, where we utilize them on projects and then it's the cost that we pay for cloud services. You're right that basically a growing percentage of subscription within our business mix should be driving up gross margins. The one caveat I would have is that we are in this sort of transition period where we've gone from perpetual license is recognized over a relatively short period of time to a subscription environment where the licenses are recognized as my slide hopefully demonstrated over a period of time and they grow post go-live. So we're in that transition phase where I'm not expecting to see the benefit of the subscription gross margin coming through in the next, certainly not in 2025, it will be beyond that. But longer term, you're right, that should be beneficial to us. The other caveat is also -- slightly depends on how our partner program as a proportion of the business changes because that could have an impact on margins and depending on how we're structured. But your thesis is right. I don't expect it in the next 12 months, but longer term, that's absolutely what we were expecting.

[Operator Instructions] We do not appear to have any further audio questions coming in. I like to turn the call back over to Mr. Andrew Denton for any additional or closing remarks. Thank you.

Thank you. Firstly, as always, we appreciate your interest in hearing our results presentation this morning. Wanted to note really just how excited we are about the prospects of the business. We've talked about stepping into our opportunity, hopefully, through our results presentation. What everybody is hearing is the fact that we're now accelerating into that opportunity, accelerating our pipeline, accelerating our software capability, and functionality, accelerating the number of customers who are using our software and of course, acceleration of our journey into subscription. Thanks to SaaS being business as usual and just a general sequential growth in subscription revenue, all of which gives us great confidence in as Duncan has set out financial acceleration in outlying years and continued great progress in the short and medium term. Again, appreciate everybody's attention, and we hope to see you all soon perhaps on the road show.