Data#3 Limited (DTL) Earnings Call Transcript & Summary

Okay. Thank you very much, and good morning, everyone, and thank you for joining us this morning with the FY '20 results briefing. Also joined here with Brem Hill, our CFO, who will be joining me as part of the presentation. Moving on to the content for this meeting. I'll kick off with a summary or an overview of FY '20. Then I'll talk a little bit about what our business does and put in context how we were able to achieve the results that we did in FY '20 around our business, talk around digital transformation and what it means from a Data#3 perspective. I'll hand over to Brem, who will provide some detail in terms of the financial and some of the numbers. And also, I'll then cover the trends, what's happening in the market and what our outlook is. So -- and then we'll -- as we said earlier, we'll hand over for Q&A. So maybe if we move on and then move on to Slide #4. I'll read this out. We're very pleased with the full year performance and delivered another record result despite a particularly challenging second half. The result clearly demonstrates the inherent strength and relevance of our solution offerings in an evolving market. We're also delighted to achieve further extensive growth in our cloud-based business. Revenues increased 14.9%. Earnings per share increased just over 30%. And the Board declared a total dividend of $0.139 per share, which is 29.9% up on PCP, representing just over a 90% payout ratio for the full year. So all in all, we probably summarize all of that as a particularly good year despite many challenges that we're all facing. In terms of our business, we'd probably just start with Slide 6. And a reminder for those of you who are familiar with us as a business, one of the things that provides us a forward looking in terms of where we are as a business and what we do, it is to harness the power of people and technology for a better future. We use that in terms of what we do and how we position ourselves in the market. In particular, the combination of people and technology is something which we are very passionate about. Moving on to Slide 7. We have 1,200 of those people working across our organization and across the country. And from a historical perspective, you can see we've also been around for quite a few years, somewhat unusual as an IT organization on the ASX, having been listed one of the first IT organizations, listed way back in '97. Also a couple of other facts that we pointed out here. Around 60% of our revenues are under contract. Our target market remains the higher-end corporates or the enterprise market and public sector or government. We also have a very strong software business, which you'll see as part of the presentation. That continues to be the case. And in fact, we would be the largest enterprise software provider in the Asia Pacific region, over 2,000, which really is supplemented by a range of professional services projects that we provide during the year. Maybe talk a little bit more, moving on to Slide 8, around what we actually do and provide to our customers. It is based around the solution sets of: cloud; modern workplace -- modern workplace contains a range of different things, including how we work as a business, how we collaborate as a business, which is pretty pertinent sort of the -- and end-user computing and devices; security is a topic which we'll talk a little bit more about, and cybersecurity and how we're positioned with that; data and analytics; and connectivity. Our aim across these solutions is to provide as full a service offering as possible, and we start from a consulting or advisory perspective across each one of these solutions. We look to build out a full-service life cycle, moving into design and implementation around project services. And then our aim would be to provide a support service or a contract-based service to manage or support our customers' technology environment around -- based around these solutions. So that's, in essence, what we do as a business. One of the things that continues to drive the business in which we operate and in fact, probably the business overall, is digital transformation. And I don't believe, and we'll talk -- I'll talk a little bit more about it, but I don't believe this has diminished in a -- during the pandemic. And I believe that digital transformation will play a major role in the economic recovery of many businesses and in fact, this country and probably globally. So digital transformation certainly hasn't gone away. What it means, it means a lot of different things to many different companies. So I fully accept that. From a Data#3 perspective, I simply tried to simplify it in a slide, which is Slide 10, which, first of all, if we just have a look at the foundational of -- to enable digital transformation to take place for our customers really needs to have a foundational layer to enable, as I said, digital transformation. That foundational layer is usually made up of cloud of various natures, could be public, could be private cloud that we help our customers build connectivity, the modern workplace and also based on security, which is, if you recall, back to the 2 previous slides, it is very much -- the foundational layer is very much what our core business actually is. So our core business is built around providing a foundational layer to enable customers to transform their businesses. Then once you've got the foundational layer, many of our customers embark upon some really core projects, such as blockchain and artificial intelligence and a whole raft of different things, which they can build on top of the foundational layer. And we play a role in that, either directly or indirectly, where we're partnering with specialist organizations. In terms of also partnering with other organizations, Slide 11, is across the solutions that we provide. And indeed, within digital transformation, we were working very closely, in particular, with 4 major vendors who we believe are driving the IT market globally and locally as well. We believe that in the market in which we operate, the large corporates and the public sector market, that these 4 players and 4 vendors represent around 75% to 80% of the total customer spend. So we think this is a pretty good bet to put our investments and our time and effort in and build out our solutions, working with these organizations: Microsoft, Cisco, HP and Dell. Moving on to Slide 12, and many -- we can't go past the fact that we are still within a pandemic and the impacts of COVID. Chronologically, if we look back at FY '20, first half was a very good half as far as we were concerned. We secured a record first half performance, financial performance. We started the second half in January and February very strongly, and the outlook was extremely positive. Then, of course, we hit March. And like many organizations and individuals, everything was turned upside down in many, many different respects. We, as a business, our paramount priority was around the safety of our people and also providing the continuity of service to our customers. I'm really pleased to say that we not only transformed, but we transitioned our business almost overnight to provide for our teams, to provide our services remotely to our customers. The majority -- the vast majority of our staff are still working from home currently. And we have a slow gradual return to work, in particular, in Perth and Adelaide today, and it will be followed with the other locations as we speak. The other things that we did in -- back in March was to adapt to the market conditions very quickly, not only in terms of the work-from-home environment and provide -- and help our customers transition very quickly, we also prepackaged and adapted our solutions to meet their COVID-related requirements. So what -- a lot of the solutions were based around working from home and collaboration and then providing robust secure solutions for our customers. One of the pleasing things about that, and the results speak for themselves in terms of the impact and the financial impact, has been that we've continued our business and continued that strong outlook and managed to secure the financial result, which Brem will talk about in a little while. But we also did a recent survey in terms of how we performed over the last 4 months, in particular, during the March, April, May time frame. Our customers have provided us some excellent feedback in terms of the assistance that we're able to provide their organizations. So moving on to Slide 13. We thought that we'd provide some context as well in terms of -- the work that we provided in March in terms of the adaption and the move to work from home for our customers, we don't see as just being a one-off. We see it as being a phased approach. And the phases we've categorized as being -- we've reacted -- and we and our customers reacted to an event, which was a pandemic. We've then moved into an adapt and then a recover phase and then, ultimately, to a growth phase and to -- back into the digital transformation phase. Quite clearly, the March, April and May time frame was based around the solutions that we've put in this chart around the red boxes. I believe that we are largely speaking, although we're still providing a lot of the react solutions to our customers today, but the majority of our time and effort is now working with our customers to provide, be it in the adapt phase and also in the recover phase as well. So a lot of the reviews in the network modernization and also the security is becoming a higher priority once we've got past the react-and-adapt phase. What I'm also pleased to say is that a number of -- we're also seeing that our customers are embarking upon some of the growth phases as well and really getting back on to the digital transformation track that they were on in the early part of this calendar year. So hopefully, that provides you a little bit of more context in terms of how we position ourselves in the COVID-19 times as well. Brem, I'm now going to pass over to you for some financial performance.

Thank you, Laurence, and good morning, everyone. As Laurence mentioned at the start of this briefing, we are very pleased to report another record result in what really has been an extraordinary year. So Slide 15 gives a summary of the financials and show strong growth against all metrics compared to FY '19. Total revenue increased by 14.9% to $1.6 billion, and that was fueled by continued strong growth in public cloud revenues, which increased by 60.4% to $581 million. The overall gross profit margin percentage decreased slightly due to a change in sales mix, and I'll expand on that shortly. And the total gross profit increased by 8.1% to $188 million. This solid increase in gross profit, combined with improvements in operating leverage, delivered a very substantial earnings growth, with basic earnings per share increasing by 30.5%. I'll review these results in a bit more detail as well as the historical trends in the next few slides. Firstly, the total revenue slide on Slide 16 show sustained revenue growth over the past 5 years. If I looked at the longer-term trends over the past 20 years, there have only been 2 years in that period where our revenue didn't increase, and they were the 2004 and the 2013 financial year. We're particularly pleased with the very significant growth in our cloud-based business over the past 5 years, and the chart on the right-hand side of the slide illustrates that trend. It's also very reassuring that approximately 60% of our total revenue is recurring, and that's derived from contracts with government and large corporate customers and fulfilling essential IT requirements. Identity comprises our portfolio of businesses, and Slide 17 shows the revenue generated by the different parts of the group. And just a bit of a recap of what Laurence said earlier, that market conditions in both the public and private sectors generally remained stable in the first half, with digital transformation projects driving growth in our core infrastructure software and services businesses. The second half saw significant shifts in our customers' project and investment priorities and obviously, in response to the pandemic. And broadly speaking, these changes help boost demand for Infrastructure and Software, and they have mixed impacts on Services, Business Aspect and Discovery Technology. The pie chart on the left side of this slide splits the total revenue into broad functional areas, which is Infrastructure Solutions, Software Solutions, Services, Business Aspect (consulting) and Discovery Technology. And then the table on the right gives a more detailed breakdown of revenues by individual business unit and the changes compared to FY '19. And there's further information on these different revenue components contained in our annual financial report. This table shows the change in sales mix that I mentioned earlier, with very strong growth in Software Solutions and decreases in Support Services and Business Aspect (consulting) revenues. To run through a quick summary of each of these business units. Software Solutions had an exceptional year, increasing revenue by 25%. And this includes the majority of our public cloud revenue, which is predominantly based around Microsoft's offerings: so that's Office 365, Dynamics 365 and Microsoft Azure. Infrastructure Solutions delivered a solid 8.7% increase, and Project Services achieved similar growth, up 8.8%. Services. Support Services revenues decreased by 19.6%, and this is a combination of Managed Services and Maintenance Services. And what we saw in FY '20 was a decrease in the Maintenance Services revenues, which was of steady growth in our Managed Services revenues, so there's a shift within that functional area. Recruitment and Contracting revenues increased by 10.2%, which is a great result given the tough market that they've been in. Business Aspect (consulting) revenue decreased by 38.6%, down to $16.2 million, and this reflects our decision to narrow its focus and to avoid higher-risk fixed price application projects. And finally, Discovery Technology increased revenue by 12%, and this is the WiFi analytics business, in which Data#3 has a 77.4% shareholding. So while revenue is obviously important, our managers place even greater emphasis on gross profit. And the left-hand chart on Slide 18 shows the gross profit trend. Total gross profit increased by 8.1%. And as mentioned previously, the overall gross profit margin decreased slightly from 12.3% to 11.6% due to the changes in sales mix. We've always managed our internal staff and operating costs very closely. And the chart on the right of the slide shows the trends for these costs and how they compare to the total gross profit. Our internal staff costs increased by 6.9% to $133.8 million, with total staff numbers remaining relatively stable throughout the year and only minor rebalancing of resources to meet changing business demands. The average salaries increased in line with the broader industry trend, and staff incentives generally increased as a result of strong profit improvement in most areas of the business. Other operating expenses decreased by 5.1% to $22.2 million, with savings following the decommissioning of the Data#3 cloud platform in FY '19, and also from a reduction in travel costs as a result of the pandemic. Our internal cost ratio, which is staff and operating expenses expressed as a percentage of gross profit, decreased to 83%, which is a very pleasing result. This ratio is one of our key internal measures. It's a very simple yet effective tool that we use for business planning purposes. And over the past 5 years, the ratio has decreased from 89% to 83%, demonstrating steady improvement in operating leverage across the group. So now if you look at the earnings and dividend trends on Slide '19, the core Data#3 functional areas all delivered profit growth. And Business Aspects' contribution improved in the second half, following a loss in the first half, and they ended the year with a small profit, albeit slightly lower than the PCP result. Discovery Technology, which is 77% owned by Data#3, delivered a pretax profit of $584,000, which was a very significant improvement on the PCP, which had a $990,000 loss pretax. The combined result was obviously a very strong profit increase, consistent with the earlier guidance, and maintaining our longer-term growth trend. And as highlighted previously, basic earnings per share increased by 30.5%, and total dividends increased by 29.9%, which represented a payout ratio of 90.6%. The fully franked final dividend of $0.088 will be paid on the 30th of September, with a record date of 16th of September. The return on equity increased from 38.5% to 45.2% in FY '20, which is another outstanding result. Lastly, Slide 20 gives a brief overview of our balance sheet and cash flow. And we have continued to enhance the financial position through careful management and obviously, with a heightened focus on working capital and cash flow in the current economic environment. The new accounting standard for leases, which is AASB 16, has not had a material impact on the balance sheet, and we have no borrowings. Our only debt relates to lease commitments under the new accounting standard. The net cash flow from operating activities was an inflow of $160 million in FY '20. As usual, the operating cash flow and the year-end cash balance were inflated due to the timing of receipts and payments around 30th of June. The typical May-June sales peak produces higher-than-normal collections prior to 30th of June, generating temporary cash surpluses, which subsequently reverse after 30th of June when the associated supply payments occur. The 30th of June cash balance increased from $121 million last year to $255 million this year, reflecting a higher-than-normal temporary cash surplus due to some sizable early customer receipts prior to year-end. The underlying free cash position has remained strong and increased from the previous year. We've also increased the allowance for impairment of receivables, or otherwise known as provision for doubtful debts, in recognition of the increased credit risk, which customers in industry sectors more adversely affected by the pandemic are exposed to. Our key trade receivables indicator of average days sales outstanding increased by just 1 day to 29.7 days and remained ahead of target throughout the year. We believe this is an excellent result and demonstrates the effectiveness of our ongoing focus on collections and credit management. On that note, I'll hand you back to Laurence to complete the presentation. So thank you very much for your interest in Data#3 and for listening to this results briefing.

Thank you, Brem. I'll then take over from -- and discuss some of the trends that are happening within the market. On Slide 22, we'll move on to market trends. What I've described here in the headline here is the market trends with or without COVID-19. What that means is that a lot of the market trends have either accelerated, but they certainly haven't gone away as far as the pandemic is concerned. And the overall trend, as I discussed previously, is around digital transformation, which is still driving technology spend. And we also will see, and we are already seeing, that digital transformation will be the key driver in economic recovery in the market in which we operate, so the larger corporates and government. Of course, with that, in terms of digital transformation, we're also seeing increase and probably increased maturity rather than the adoption phases of artificial intelligence and a range of, as I said, the cooler technologies in artificial intelligence, 3D printing, blockchain and the like. Data analytics remains and continues to remain mainstream for our customers. And of course, the -- one of the key differentiators in the market and probably expectations with customers is that the customers are expecting more in terms of the value in operating with technology suppliers. And it's not just a Data#3 thing, it is very much a market trend, and expecting more is being able to measure the value and measure the customer experience that we are providing. Likewise, the vendors that we are working with, the likes of Microsoft, Cisco, HP and Dell, are increasingly moving to models and rewarding organizations that are making improvements in the adoption of the technologies that they're providing, and also the overall customer experience and utilizing some of the solutions. So you'll see more and more of that working within the IT market as a whole. So from our perspective, and moving on to Slide 23 and some of the key priorities at the highest level, they're really across the solutions that we provide, the people that we have within our business, our customers and how we operate as a business. Now the solutions we're going to -- our plan is to continue to adapt those to the market environment. So the way that we did that with the outbreak of COVID was a really prime example of how we adapt to market demand. We will continue to do that with the solutions in which we're providing to the market. Likewise, the attraction and retention of the best people in the market remains and continues to remain a high priority. It is one of the key differentiators that we have in the market. From a customer perspective, as I mentioned before, customer experience, the measurement, the data and analytics that we are now able to provide in terms of how we work with our customers and how they are gaining improvements in their business, and the measurement of how we do that is going to be one of the priorities going forward for this year and beyond. And of course, we, as a business and a large $1.6 billion business, we've got some scope to improve the operational performance and our own system enhancements that we'll be focusing on within FY '21 as well. So moving on to Slide 25, and moving on to the outlook. I'll just read this out. Our expectation is that technology will play a major role in Australia's economic recovery from the pandemic, and we remained well positioned to capitalize on those opportunities. The timing of the recovery is less certain. And consequently, we are unable to provide meaningful commentary on our FY '21 outlook at this stage. Our long-term financial goal remains to deliver sustainable earnings growth. And now I can open up for question and answers. Thank you for remaining with us.

[Operator Instructions] Your first question today comes from the line of Louis Bannon from CCZ.

Could you please provide some tangible examples of the hurdles you faced in the Services division? And further, which of these continues to be out of your control?

Hurdles in the Services division. Well, as Brem broke down some of the services that we've had, we can clearly see that in our Consulting business and Business Aspect has been a -- we've got room for improvement there. It has been a particularly good year for Business Aspect. The first half was particularly poor. We had a big improvement in the second half. We scaled back the business, so the revenues reduced quite significantly. And we've really concentrated on smaller projects, less risky projects. And we've been able to deliver on those in a -- probably a lower-risk environment and a steady build. The -- in terms of the current environment, one of the -- and within the pandemic, in particular, and where our customers are looking at, I think the consulting or advisory services are the ones that are under more pressure than some of the other parts of our Services business. And some of the shift of the spend has been more on the implementation and the design of projects than it has been on the -- providing the advice. As I've said in one of the slides, in terms of the different phases that we see, we believe that once the new systems have been put in and the collaboration systems have been put in, for instance, Webex or Microsoft Teams, Office 365, where we've had significant uptake in the last few months, for obvious reasons. We believe that the consulting requirements will actually come back again in terms of how we've implemented them and what impacts it's actually working within the organization. So in some respects, it's a retrofit of consulting rather than the usual way of doing consulting and then the design and implementation. Does that go some way to answering your question? The second part, which is under pressure, as we've described, is our Managed Services business, in particular, where the -- again, our focus has been to narrow the contracts that we are going after in the market to smaller, more bite-sized, if you like, and lower-risk contracts as opposed to the larger Managed Services, our enterprise managed services contracts. And as a result, our revenues have also declined.

Right. No, that makes sense. Just one more question, if that's okay. So what portion of the public cloud revenues is clients' first experience with Azure? That is, what portion of revenues was first time implementation versus the purchase of additional offerings?

That's a good question, and we don't have the exact answer right now. I would -- we'd be guessing. So we could certainly get that information, but probably not on this call.

Yes. And a proper color -- my comment there would be also, obviously, with that public cloud revenue, it's a combination of, like, substitute revenues. So clearly, we've shifted from traditional licensing models to public cloud-based models as well as net new business that's a combination of the 2. But you get the split between Azure, Office 365 and Dynamics, I -- we really don't have that readily available. And we're kind of probably reluctant to disclose that level of detail, to be honest.

Yes. We don't. One thing that we can say, in particular, around -- with Microsoft is that we've seen an uptick and this has happened globally with no great surprises, from the -- with Office 365 with the E3 to E5 product set. And the E5 is the enhanced one, with increased security products, so cybersecurity, that there's been a larger -- much larger uptake than we've seen in previous years.

Your next question comes from the line of Adam Dellaverde from Taylor Collison.

Congratulations on another great result. I've got a few questions. I just want to start, though, with maybe if you could expand on that Q3 to Q4 period, just how much changed. I just list off a few things that I have picked up on, if you could maybe talk through the commercials of them from your perspective. So the first one is some of the free offers on things like Teams and Webex and what the customer take-up is and sort of what that has meant for revenue or future revenue? Second one is that E3 to E5 and other similar sort of ARPU upgrades. When do we see them flow through into revenue? I'm assuming if they're sort of monthly recurring-style upgrades and most of that flows next year. Third, just the hardware spend. When do you start lapping sort of tough comps on that? And how is that carried on through to this year? And then fourth, you talked about the infrastructure work picked up Q3, Q4. So maybe if you could expand on them as a start, please?

Yes. We'll do our best on that one, Adam. And maybe if I can kick off with the first one, in terms of the free offers that have been out, and these are particularly around Webex and Teams as well. There's certainly been some of our customers that have taken those up, and we expect -- and have taken them up quite successfully and have taken advantage of a range of different offers. The other offers that are coming from probably all vendors have been financial related as well. So there's been financial assistance in leasing interest-free a whole range of different things, which our vendors are looking to -- look to provide end-user customers. Specifically, the free offers, we would see that -- we don't see it as being a material spike. But it will only improve our business down the track when those offers run out and they'd buy it -- effectively have to buy the license, pay up and buy the licenses to all the subscriptions. We don't see it as being something that material, but it will certainly be positive. The E3, E5, I've mentioned before, we haven't disclosed what that specifically is. We haven't broken that down. Again, that is a positive, and we see that as being a positive trend going forward as well. We see that it's a customer spending more on the -- probably the higher-value bundles.

And actually, just jumping in on that, Adam, we've had specific marketing campaigns to help push that migration. And there's this better security, obviously, improves the collaboration tools as well. So it's been well -- the take-up has been strong.

Yes. I think, on the hardware spend, we've -- we're not experiencing anything just in terms of -- we saw a spike in March and April, particularly for our end-user computing and devices. That spike continued through to the end of June. And in fact, we're still seeing it today. So it's not something which is -- seems to be going away anytime soon. And I think customers continue to have refresh cycles and also continue to have more devices than they ever have before as well. So there's a number of combinations in terms of end-user computing. What we've also seen is an increase in the connectivity side. So with the -- in particular, with the work from home, the upgrading and the -- making networks more robust and probably more secure is something which is high on all our customers' agendas. So that we categorize as still on the infrastructure spend. So those have certainly -- have increased, and we see continuing to increase.

That's great. And I guess the comment on maintenance services being down in the context of all of this hardware activity, is that just a timing thing as we see a new maintenance based on the larger hardware installed base?

Right. Yes, Adam, it's largely a timing issue around a limited number of sizable contracts, which certainly reduced revenue but had a much lesser impact on contribution. So we're expecting to see that business unit can grow moving forward in terms of revenue.

And just on Managed Services. Microsoft, in particular, talks about leaning on that partner channel for providing the service layer in the Azure environment. And imagine, if you guys ever touch on AWS, it would be something similar in terms of needing that last mile to help customers. Is that -- are you already seeing that in terms of the engagements? Or is that more like the next level of digital transformation that you're talking about in the slides?

Yes. We're already seeing it. And the expert MSP, managed service provider, certification we announced, we didn't announce it to the ASX but we announced it to the media. Was it about 4 weeks ago? I think, which we've been working on for quite some time, well over 12 to 18 months. We've secured 1 of 4 such certifications that Microsoft provide within Australia. I think 70 globally. So we've joined the elite, as far as Microsoft is concerned, to be able to provide the Managed Services to their cloud-based solutions. And it's a pretty stringent audit and certification process that they put us through. We see that as fundamental in terms of going forward and we get pretty obvious in terms of the size of our Microsoft business. So we see that as a good thing. We've yet to capitalize and get the return on that investment. So that's on FY '21 and beyond.

So I guess in the context of all of that, which all sounds really, really positive, I just found your outlook statement to be really cautionary. Is there something kind of missing in terms of how you're seeing it and how one of these trends are working behind the scenes?

I think it's positive in the things that we can control. There's a number of things that we can't control, unlike most businesses. So it's the external factors that are really causing us to provide that cautionary outlook at this stage and in the year. So that's -- it's not a big internal or internal factors.

[Operator Instructions] There are no further questions at this time. I would like to hand the conference back to today's presenters. Please continue.

Okay. As we've said before, thank you very much for joining us. If you're still there with us, thank you for your participation in the meeting. Thank you for your questions, and we look forward to catching up with you during further briefings. So thanks very much, everyone.

Thank you. Take care.