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

Good morning. My name is Richard Anderson. As Chairman of your Board, I would like to extend a warm welcome to all shareholders and guests joining us online today at the 2020 Annual General Meeting of Data#3 Limited. Like most ASX organizations and in accordance with asset guidelines, this is a virtual AGM with live streaming from the Data#3 head office in Brisbane. We hope that holding a virtual meeting will assist in minimizing the spread of COVID-19 virus and also encourage greater participation and engagement amongst our shareholders. Before we begin, I would like to introduce your Board of Directors who are with me at the corporate head office in Brisbane. First of all, Leanne Muller, Non-Executive Director, who joined the Board in 2016; Mark Gray, Non-Executive Director, who became a Board member in 2017; and our most recent Board member, who has just passed his first year anniversary, Mark Esler, Non-Executive Director. Finally, our Managing Director and CEO, Laurence Baynham. Also in the office are Brem Hill, Chief Financial Officer; and Terence Bonner, the company's Secretary and General Counsel. I would also like to welcome the representative from our independent auditors, Pitcher Partners, Dan Colwell, who joins us virtually. Now for the formalities of the meeting. I note that there is a quorum present, and I declare the meeting open. The Notice of Meeting was dispatched to all shareholders on 12th of October 2020, and the meeting has been properly convened. We will turn to resolutions later in the meeting. Please note that our only shareholders, proxyholders or shareholder company representatives may vote on the resolutions. I'll start today's proceedings with a summary address and then invite Laurence Baynham, our CEO and Managing Director, to address the meeting before we move on to the formal business of the day. Again, ladies and gentlemen, good morning, and welcome to the 2020 virtual annual general meeting of Data#3 Limited. The fact that we are meeting virtually today shows just how much and how quickly things can change. It also demonstrates how collectively we can adapt and find solutions, together with our many customers, Data#3 has been at the pinnacle of these changes right across the country. The last 4 months of the 2020 financial year represented unprecedented challenges for every business and individual. I am pleased to say that the people of Data#3 rose to the challenges and helped their customers continue their business operations. In doing so, many parts of our business accelerated with the use of collaboration technology, cloud, end user computing and enhanced security solutions. As a result, both Board and management were delighted to report a record performance for the 2020 financial year. Total revenue increased by 14.9% to $1.6 billion. We are particularly pleased with the growth in the cloud-based business with public cloud revenues increasing by 60.4% to $581 million. With this strong revenue growth, we were able to gain extra leverage. Laurence Baynham will discuss this further when he addresses you shortly. The consolidated after-tax profit and earnings per share increased by 30.5% and the directors declared a fully franked dividend of $0.088 per share, bringing the total dividend for the 2020 financial year to $0.139 per share fully franked. This represents a 90.6% payout ratio for the full year. The financial position of the company remains strong. We continue to be debt-free and very effective management continues to optimize the group's use of working capital. It is particularly pleasing that at the same time as delivering strong financial performance during the ongoing global pandemic, we are also making steady progress with our long-term strategic plan. The nonfinancial measures indicate that the underlying health of the business has continued to strengthen. Again, Laurence will provide more detail in his address. The Board and management particularly acknowledge the contribution of the company's staff, who this year performed exceptionally well, whilst coping with extraordinary circumstances. Likewise, we acknowledge and greatly appreciate the continued support of you, our shareholders. Many of you have been long-term investors in Data#3. There are 4 resolutions to be formally considered at today's annual general meeting. The remuneration report, which is included in the annual report, will be put to the meeting for adoption. Within Data#3, as in previous years, targets to produce earnings growth have been established and the management team's remuneration is structured in line with these targets, with a significant proportion comprised of short-term and long-term incentives. These are awarded based on the achievement of appropriately matching KPIs. We measure remuneration every year against industry benchmarks to ensure it is set competitively, and the Board believes that both the levels and structure of remuneration are in line with the market and appropriate to produce the results we are targeting. A key focus of the Board has been succession planning, both for the management team and the Board itself. The Board is focused on having succession plans for both senior management and directors to ensure that we always maintain a relevant mix of skills and experience. In progressing our Board succession plan, we were pleased to have had Mark Esler join the Board last year after Terry Powell retired at the 2019 AGM. In accordance with the constitution, one item for consideration today is the reelection of Mark Gray to the Board. Mark joined the Board in 2017, and he chairs the remuneration and nomination committee and brings valuable nonexecutive director insight. I recommend that shareholders vote in favor of that resolution. To ensure continuity and minimal risk to the company, I'm also standing for reelection. If reelected, we will continue with our established succession plan over this next term. For both of these items, I will ask Leanne Muller to chair the meeting. The final item for consideration is a request to approve the issue of performance rights to the Chief Executive Officer and Managing Director under the long-term incentive plan. Again, I recommend this item for your confirmation. In summing up, ladies and gentlemen, our key objective for the current year is to deliver sustainable earnings growth. With 4 months of the financial year behind us, we have made a good start to FY '21. and we remain very confident in our long-term strategy. I will now ask Laurence to address operational aspects of the company's FY '20 performance and the outlook for the current period in more detail. Thank you for your continuing interest in the company and your attendance at this 2020 annual general meeting.

Good morning, ladies and gentlemen, and thank you, Richard. Thank you for making the time to join us this morning. Like Richard, my preference would be to join you in person. However, we're living in unusual times. Although this virtual meeting is a good demonstration of how we are helping our customers conduct business and how Data#3 works with all of our stakeholders. I would like to take the next 15 minutes or so to provide you with some more information on our operations and strategy. In doing so, I'd like to break this down into 3 elements: An overview of our FY '20 financial and operational performance; a summary of the Australian IT market and the drivers; and lastly, I'll provide our outlook for the first half. Starting with a review of an extraordinary year, FY '20, we all know that calendar year 2020 has been and is still is a year that we will all remember in so many ways. I thought we'd seen change in disruption in our 40-year history, but nothing compares to this. As Richard said, we have had a good FY '20 with strong growth in revenues, profit and share price. But they -- but the numbers belie the extraordinary events that have taken place from late Q3 and Q4. Let me start with the first half of FY '20. Off the back of a strong FY '19, we continue to grow our business across our portfolio and geographies. The highlights of FY '20 for the first half included an increased integration project activity, that's the combination of infrastructure, software and services. We also had all our business units and regions on or ahead of plan, except for the business aspect consulting business. And in addition to that, we experienced record growth in the Australian IT market. These were extraordinary indeed. We ended with a substantial 41.5% increase in earnings compared to the PCP. It was somewhat unusual that everything across the group's portfolio was going according to plan. The second half in calendar year 2020 started with good results in January and February. We then started to read about a virus in China and highlighted possible supply chain issues. Like many organizations, our risk register started to expand. In early March, we made what we thought at the time was a very difficult decision to cancel our major customer event, JuiceIT. The impacts of COVID-19 pandemic was significant. Our highest priority has been to safeguard the well being of our staff and our customers as well as ensuring the continuity of service to our customers. We invoked company-wide business continuity plans in response to the pandemic, aimed at protecting our people and providing our customers with the best possible outcome as far as customer service. As part of the business continuity plan, we put in place a pandemic response plan and implemented remote working models across our business, with approximately 97% of our staff working and supporting customers remotely from March 2020 onwards. As the leading Australian IT solution provider, we were in a prime position to help our public sector and our large corporate customers to through their massive and immediate changes. Our core business includes connectivity, collaboration, modern workplace, end user computing, cloud, enterprise security, and these solutions have been and continue to be a high priority for our customers. We accelerated the delivery of remote working solutions and pre-packaged other relevant cloud and security solutions to respond rapidly to our customers' changing requirements as they adapted to new ways of working. Now let's cover the financial performance. We delivered sustained revenue growth, and we continue to gain market share. The Data#3 business is structured around 3 functional areas: Software Solutions, Infrastructure Solutions and Services, operating across 8 regions in Australia and the South Pacific Islands. Each of these geographic regions saw growth in FY '20, and the standout regions for FY '20 were the ACT and Western Australia. As Richard stated earlier, our total revenues have increased to $1.6 billion. The Software business was the most significant FY '20 business unit, which was largely boosted by the $581 million of public cloud revenue. The Infrastructure business also experienced solid growth in FY '20 with private cloud, end user computing, networking and general growth in software-defined hyper-converged infrastructure. Our Services business unit largely supports the growth of our software and infrastructure teams. Project services in FY '20 grew, and we had a decline in support services, where we're continuing to transform our managed services business. An example of this transformation is the recent attainment of our Microsoft Azure Managed Services Provider certification. This status provides Data#3 amongst the elite ranks of Microsoft Azure Managed Services providers globally. People Solutions had another solid year, increasing revenues in a highly competitive recruitment and contracting market. Business Aspect, our consulting business, started with a poor first half, but followed with a much improved second half. I'm pleased to say that for FY '20, we reported approximately 60% of our revenues are under contract, which is important in times of economic volatility. Richard also mentioned that we gained some leverage from our growth in revenues. Total gross profit increased by 8.1% from $173.9 million to $188 million, and total gross margin decreased from 12.3% 11.6%. The gross margin reduction reflected change in sales mix, with very strong growth in software licensing and public cloud revenues and decreases in consulting and support services. Internal staff costs were -- increased by 6.9% from $125.2 million to $133.8 million. Total staff numbers remained stable, and average salaries increased in line with industry trends. Staff incentives increased as a result of strong profit improvement in most areas of the business. Our operating expenses decreased by 5.1% to $22.2 million, with savings from the decommissioning of the Data#3 Cloud platform and also a reduction in travel costs as a result of the pandemic. This improvement in operating leverage contributed to the group's 30.5% increase in net profit after tax to $23.6 million, and more importantly, continued our profit growth trend. Discovery Technology concluded a long-running legal matter and recorded a profit for FY '20. In addition, we have just increased our shareholding to 100% from the previous 77% majority holding. We see improved opportunity for Discovery Technology working even closer with the Data#3 business. To illustrate our growth in FY '20. We have dozens of fantastic customer references, and we have extremely high level of customer satisfaction and retention. One recent customer example is with Hearing Australia, who operate across Australia with 160 centers. Faced with increasing competition, Hearing Australia undertook a major digital transformation project, with Business Aspect taking a lead in digital strategy and the implementation. The outcome was a shift from multiple legacy systems into a modern cloud-based Microsoft solution. The initial great work from business aspect has paved the way for more work for Data#3's software and services teams. Another example of our great work is in the education sector, where we have just signed an exclusive relationship with a U.S. application provider called Gaggle. They specialize in software that supports the mental health needs of 6 million students across 1,700 districts in the U.S. Using a combination of artificial intelligence and trained safety experts, the solution proactively assists schools in the prevention of student suicide, bullying, inappropriate behaviors, school violence and other harmful situations. We do not expect this solutions to provide any material difference to our financial performance. However, we believe it aligns with our vision to harness the power of people and technology for a better future. Our Corporate Social Responsibility program continues to increase as we grow our business and enter stock market indexes that require greater scrutiny of CSR and ethical behavior. Awards also form an important of external validation for our company, and our people are motivated to gain national and international recognition. One of the most recent awards was from Cisco, which was presented virtually at an annual global conference. The award was for the global Commercial Partner of the Year, which is Cisco's largest business segment, and Data#3 was selected ahead of 60,000 other Cisco partners. It referenced our great work in customer experience and helping customers maximize their investment with Cisco solutions. In addition, for the fifth consecutive year, we have won Employer of Choice for organizations above 500 employees, awarded by HRD. This is across all sectors, not just IT, and provides independent external confirmation that Data#3 is considered a desirable place to work. Another visible example of our support for our wider communities is the appearance of hair on the top lip of many of our team members, including myself, although with the video, it might not be so obvious. We're supporting men's health with Movember this month. We are still of the belief that if we can do good in the community and improve our business, it's a definite win-win. Now FY '20 certainly contain many incredible achievements and challenges and ultimately produced record financial performance for the Data#3 group. Looking forward, I'll start looking at the market in which we operate. For the IT sector, Gartner is the world's leading market research and advisory company. And pre COVID, they predicted that the Australian IT market would increase by 3.7% in the 2020 calendar year. More recently, they have modified their prediction to a 6% decline in the $94 billion market. I think this is an illustration of the uncertainty in the market and the difficulty of making predictions. As we have said on previous occasions, one of our greatest strengths is our ability to adapt and keep evolving with customer demands. One thing I believe in certain: technology and more specifically, digital transformation, will play a major role in Australia's economic recovery. Data#3's role in digital transformation is to provide the foundation layer, which includes the various forms of cloud, scalable networks and mobility solutions, all embedded with robust cyber security. Our ongoing strategy is to lead the foundation layer of digital transformation and continue to work with global leading vendors. Now let's look at FY '21. Our planning assumed that the external environment in FY '21, would see the continuation of the pandemic and the associated economic downturn, which would put pressure on our first half. In contrast to this expectation, we have navigated our way through the extreme market volatility and made a solid start to FY '21. Activity levels are high and the pipeline of business continues to grow. December is traditionally of one of our largest months, and we are focused on closing out the first half strongly. However, the timing of realizing these opportunities can be hard to predict. At this stage, we do not envisage the first half result to be materially different to our substantial first half FY '20 performance. We still have a skew to the second half and our fourth quarter. And in particular, June is again expected to contribute significantly to our annual profit. The FY '21 first half results and interim dividend will be announced on the 18th of February 2021. It is our -- also our intention to maintain our usual dividend practice. I want to personally acknowledge and thank the entire Data#3 team for their skilled work, dedication over this challenging -- over these challenging times. I'm confident that our great team will continue to outperform the Australian IT market. I'm proud of our past achievements, but there's no room for complacency in a fast-changing market. We have plenty of opportunity ahead, and I look forward to updating you with our progress during the year. Going forward, we are confident about delivery of our company's longer-term strategy. We have a robust business, no material debt, solid long-term customer relationships, committed supplier partnerships and a highly experienced and productive team. We see ongoing growth in the Australian IT market and believe we remain well positioned to capitalize on those opportunities. We will continue to build on our strengths and enhance shareholder value. Our overall financial goal remains to deliver sustainable earnings growth. Thank you. I'll now hand back to Richard.

Thank you, Laurence. Before we consider each item of business, I would like to outline the procedural matters for this meeting. At the bottom of the web page, under the webcast and presentation, there are 3 boxes, which allow you to get a voting card, ask a question and download the AGM documents, being the Notice of Meeting, the annual report and the virtual meeting online guide. The ask a question and get a voting card buttons are replicated at the top of the web page. If you would like to ask a question and you did not submit your question prior the meeting, you can ask during the meeting via the online platform by clicking the ask a question button. You can then select the item of business that your question relates to, write your question and click submit. I confirm you can submit questions via the online platform now. You do not need to wait until we get to the relevant item of business. Please note that not all questions are guaranteed to be answered during the meeting. But we will do our best to address as many as reasonably possible. We ask you to please keep your questions or comments as concise as possible. After each item of business, we will address shareholder questions received in advance as well as those posted through this platform during the meeting. If you're having any difficulties submitting a question, please refer to the virtual meeting online guide or call the help number you see at the top of your screen. I would now like to briefly summarize the voting procedures we'll apply for this meeting. As shareholders are participating virtually in this meeting, voting on each resolution will be conducted by a poll. To register vote, click on the get a voting card box at the top of the web page or below the presentation slides. The share registry will have sent the relevant proxy numbers to proxy holders validly appointed by shareholders prior to the proxy cutoff. To obtain a voting card, please click on the get a voting card box and then key in your proxy number under proxy details in the pop-up box on your screen. If you have misplaced your proxy number or have not received your proxy number, please ring the help up line displayed at the top of your screen for assistance. You may submit your votes via the online platform at any time during the meeting. Following discussion of all items, shareholders will be given a further 5 minutes after the meeting has closed to submit their votes via the online portal. After this time, the polls for each relevant item of business will close. Where undirected proxies have been given in favor of the Chairman, the Chairman will vote in favor of the resolution to the extent permitted. The number of proxy votes received on each resolution will be displayed in the slide viewing section of your web browser as we move through the resolutions. Your vote will be counted by personnel from our share registry, Link Market Services, after the meeting closes. The results of each poll will be announced via the ASX as soon as possible after this meeting and will also be displayed on our website. If you experience any difficulties using the online platform, the helpline number is displayed at the top of the page. You can also refer to the virtual meeting online guide, which is accessible via the online platform. We will now move to the formal items of business for this meeting. The first item of business for discussion today is to receive the financial report, directors' report and independent auditor's report for Data#3 and its controlled entities for the year ended 30th of June 2020. The reports are placed on the agenda for comment or questions only. There is no voting on this item of business. Dan Colwell, the audit partner with Pitcher Partners, is available to answer the questions relevant to the conduct of the audit and the preparation and content of the independent auditor's report. We will now address questions received for this item of business. Moderator, are there any questions received for this item of business?

Yes, Chairman. We have a question from [ Nairi ], who has asked, can you please discuss the reasons we have moved from Coronation Drive during the past year?

I will ask our Chief Executive Officer, Laurence, to respond to that question.

Thank you, Richard. Maybe if I put into context the question as well because our head office is in a suburb in Brisbane called Toowong. We were previously in a high street, and we had a 10-year lease on our building there. It came to the end of the lease and we had a decision to make on whether we should stay put or move. So we made the decision for a number of reasons to move, not least of which that we moved into new offices into Coronation Drive, which gave us a single floor plate for our entire team, which was preferable to the 3 floors at the previous building. In addition to that, we also had a more competitive rate. So that always helps. And now we've also got the benefit of some wonderful Brisbane River views as well. So those are some of the reasons. In terms of why -- and also maybe moving a little bit more as well, why we've moved only a few hundred meters from our previous office. We also had considered minimal change to our staff requirements as well. So our people liked working in the current environment and we've moved a few hundred meters to what we believe will see us out for many, many years to come.

Thanks, Laurence. Moderator. Any other questions for this item of business?

Yes, Chairman. We have a question from [ Nairi ], who's asked, can you please comment on the notable increase in debt during the last financial year?

Again, Laurence, would you like to address this question?

I can address this question. But maybe more appropriate for our CFO, Brem Hill, to address this question.

Wonderful. Brem?

Good morning, ladies and gentlemen. Thank you, Richard. Just to clarify, the increase in debt is actually due to an increase in lease liabilities. So the company's borrowings are 0. But with the introduction of the new accounting standard for leases, AASB 16, we had to recognize a liability for any leases, and that was an $18 million liability that is really, I think, the increase that's being referred to. And that, in our case, is predominantly for office premises. There is more detail on that in Note 1 and also Note 20. But to confirm, the company has no borrowings in this sense of debt. Thank you.

Thanks, Brem. Thank you for that response. Moderator. Next question, please.

Thanks, Chairman. Our next question is from [ Peter Storer ]. [ Peter ] has asked, on the 28th of August, Data#3 notified the market about a cyber incident. Has this been fully investigated and resolved? What corrective action was taken?

Thank you. Laurence, would you like to respond to that question, please?

Yes, certainly. And as the question, thank you, [ Peter ], for that question. And on the 27th of -- 27th or 28th of August, we notified the market about a cyber incident. We also said that we would update the market if there was any material change to that. We don't have any material developments since the cyber incident. We have undergone forensic investigation and detailed forensic investigation. Again, no material developments and no material impact on Data#3's ongoing operations.

Thank you, Laurence. Next question, please, moderator.

Our next question is from [ Peter Storer ]. Peter has asked, I note we now have 100% ownership of Discovery Technology. Can you provide some detail of the business model, including how revenue is generated, length of contracts and proportion of recurring revenue? What precisely are the benefits to the parent company of full ownership of this subsidiary?

Again, Laurence, over to you.

Okay. Thank you, [ Peter ]. It's a fairly detailed question. And in fact, multiple questions all in one. And I'm not certain that I can probably satisfy exactly the detail in terms of exactly the number and the nature of those contracts. What we can say is that there are existing contracts and annuity-based contracts that we have with Discovery Technology. And we've, over the past 12 months, in particular, we've started a much tighter working relationship with our sales teams, taking to market joint solutions between Data#3 and Discovery Technology, and we're gaining more and more traction and more success. As a result of that, we've gained more confidence in the Discovery Technology business. And the -- it also made a lot more sense in working closer together to continue the increase in our shareholding. As you would appreciate, over the years, we started with a relatively small shareholding. We've consistently increased that, and we've made the final step of increasing it from 77% to 100%.

Thanks, Laurence. I trust that response covers the main issues related to Discovery Technology. Moderator, next question, please.

Our next question is from [ Ray Tollison ]. He asks, it appears from both Richard and Laurence's introductory comments that it's intended to return to in-person meetings when possible. Will the Board please confirm its intention to hold physical AGMs in future to enable as many shareholders as possible to participate? Is it intended to also run it as a virtual meeting?

Thank you very much for that question. Yes, it is difficult to run meetings virtually, particularly when our experience has traditionally been of a face-to-face format. And yes, it is certainly our intention to return to face-to-face meetings as soon as we possibly can. Obviously, there are another -- a number of factors out of our control that will govern that decision. Whether we will, in future years, be holding a face-to-face meeting, which is also a virtual meeting, again, it's a bit difficult to say here now, and we will certainly be keeping shareholders informed as things progress. And as it becomes clearer what possibilities are available to us. Thank you, moderator.