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

Thank you for standing by, and welcome to the Data#3 Limited FY '22 Interim Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Laurence Baynham, CEO and MD. Please go ahead.

Okay. Thank you very much, Amar, and good morning, ladies and gentlemen. Thank you very much for joining us. I'm also being joined by Brem Hill, our Chief Financial Officer and Company Secretary. The agenda for this morning is a relatively simple one. I'll be providing an overview on the company and the operational performance in the first half FY '22. Brem will then take over and provide a summary of our financial performance, and then I'll round out with strategy and outlook, so relatively simple agenda. We move on to Slide 3. You can see that all the arrows are going in a positive direction. We're certainly very pleased with the strong result that we've been able to achieve in the first half of this financial year. In particular, earnings growth is nearly double that of the revenue, and it certainly reflects an operating leverage advantage that we've been able to achieve. The 30% plus growth has flowed through to the dividends and at a high payout ratio. So overall, we're certainly very pleased with the FY '22 first half results. Let's drill down a little bit more into some of the details on Slide 4. And the results across our lines of business, so the business units in which we operate, and also all the geographies in which we operate were all ahead of plan. So it's somewhat unusual that we have all our business units and all our geographies firing on all cylinders. So from that perspective, it's a great strength of result right across the board. From -- if you recall back into the start of this financial year, we also had a backlog from FY '21 coming into this financial year and -- of $3 million. And we've seen a similar backlog carry through into the second half. So the -- it really underlines the strength -- the underlying strength of the first half in that we've had an advantage at the beginning, and we're also flowing through an advantage, a similar advantage going through to the second half. Of course, our strategy is very much a deliberate strategy around software and services growth, in particular, driving recurring revenues. So we've seen some excellent increase in terms of the recurring revenue increases and also margin accretion as well. So from a public cloud perspective, we continue the public cloud growth of over 30%, and we see this as not only significant in its own right but also significant strategic value in growing our services business and right across our services business. And I'll spend a little bit more time on that in the coming slides. The other highlight that I'll point out on this particular slide, awards. And it's always great to win awards of any nature, particularly with some of our vendors and also international ones and global awards. For an Australian company to win global awards is always a significant thing. However, it doesn't -- winning the award doesn't necessarily come with direct profit increases. But what it does do is assist us in winning new customers. We've demonstrably been able to achieve that, and we set ourselves apart from many others in the market. And also, it's helped us in terms of attracting talent in the market. New people who want to join the business are already always attracted to organizations that are deemed to be at the top of their game. So from -- in addition, we've also made some progress, I'm really pleased to say, on the ESG component and the way that we run our business. And we've highlighted it here on this particular slide. So overall, we're exceptionally pleased from a financial perspective in terms of the good financial performance that we've been able to achieve in the first half. But we also made progress in parallel with strategy and on ESG. So overall, as I said, very pleased with the overall performance in the first half. So what's driving the performance? So we go into Slide 5. We've got digital transformation. And those who have known us for a little while would have heard us talking around digital transformation for quite some time. And this has got a long runway, digital transformation. Every organization that we're aware of, large or small, but in our market segment, public sector segment and large corporates, every organization has a digital transformation or a digital strategy. And behind that, our role in digital transformation is providing the foundation layer to our customers. And by the foundation layer, if you look at the diagram, what we mean by that is the cloud environments that they're operating in. And these could be multi-cloud environments, including public cloud. They'll be operating in a modern workplace. What that means in English is collaboration technology such as video conferencing, Microsoft Teams and WebEx and the like. Obviously, in recent years and as we've seen during the pandemic, there's been a huge shift to working that way for all businesses. And wrapped around a range of this foundation layer is enterprise-wide security. No great surprises there. Data and analytics, in particular, is taking shape in terms of collecting the information that we're able to achieve in a digital environment, in particular, cloud-based environments and using that to the advantage to helping our customers achieve their business goals. And then wrapping all of that around, connectivity solutions really enable everything to work. So with this foundation layer in place, customers are then able to achieve their digital transformation goals. And a lot of those are seen in probably some of the more cooler technologies and the headline-making technologies such as robotics and artificial intelligence and 3D printing. So from Data#3's perspective, we provide the foundation layer. We will partner with some specialist organizations to provide overall solutions for our customers. So building down a little bit further, and that's in -- is Slide 6. And in Slide 6, we've got -- and I won't spend time talking about the level of services in each one of these solution areas which I've just covered. But what we do provide is a full life cycle approach. And the full life cycle, what I mean by that is we start with consulting and advisory services in an ideal scenario with each one of these solutions. We can then move on to the project services, which is the design and implementation of these solutions. And then when we successfully implement the project, then we move into a support and annuity-based and recurring revenue-based contract service for our customers. We call this a full life cycle. It makes Data#3 stickier, and it certainly aligns very much with our long-term strategy of growing our services business and recurring revenues. So very few providers in the market, by the way, can offer this breadth of services, and it's a major differentiator in the market. Let's move to the next slide in terms of Slide 7 and talking of differentiators in the market. Our relationship with vendors, and we've listed the top 4 vendors that we work with, it is a significant differentiator for us in the market, and I'll just explain that a little bit more. These major vendors are global leaders. They drive markets globally. And we estimate that they account for, in our customer segment, enterprise customers and public sector customers, we estimate that they are associated with 70-plus percent of the customer spend. So our relationship with these vendors, we are the leading supplier of each one of these organizations in the Australian market. And we've got a substantial base with them in terms of working together. And of course, the slide before, some of those solutions involve the combination, for instance, of a Microsoft and Cisco to provide an overall solution for our customers. And what we would also say is that there's many other vendors that we work with. And we've stated here 400 other organizations as well as vendors that provide differences in technologies. Over the years, we've adapted very much to the customer demand. So the vendors that we've got here may change over time. But one thing is constant, and that's our relationship with the customers. They will determine the relationships with the vendors. So if we move on to the next slide, and the next slide is a holding slide where we've got an operational overview, and then on Slide 9. We go into the Australian market. Again, I'm really pleased to say, the latest information coming from Gartner, who are considered to be the global gurus of the IT market, and Gartner have estimated and predicted that for the Australian IT market, it will grow 6.5%. Now we've never seen that before. We said that last year. Last year, they estimated between 3% and 4% during the year, which certainly came to fruition this year. The estimation is that the market is more buoyant than last calendar year. And the largest spend and the largest increases is in the software and services segments. And we estimate that well over 80% of Data#3's current business and future business is in the software and services market. So needless to say, we believe that we're in a very good position and a leadership position in a market that is absolutely growing and more buoyant than we've seen it in previous years. Now moving on to the chip shortage and its global shortage with integrated circuits and chips. And it seems to have been with us for a number of years. In fact, it has been with us pre-pandemic. However, it has been exacerbated by COVID, there is no doubt. And what we have been doing increasingly and certainly last year and this first half and continue to do so is working really closely with our customers and vendors to overcome these constraints. By working closely, we bring forward orders. We plan together in terms of how do we overcome supply chain shortages, and the first half result is a great testament to the way that we've been able to achieve that with our vendors and our customers. And what we're also seeing is that the backlog will be continuing. This is not a short-term shortage. This is going to go well into next financial year. So we're seeing this, in some respects, the -- it's normalizing in the way that we are currently working. Now of course, as far as COVID-19 disruption, now aside from the health and safety aspects of COVID, which we take very, very seriously, aside from that, the working-from-home environment has -- and working remotely has not impacted our business. In some respects, it's actually benefited that business. We've seen productivity gains. In being able to work remotely, we've been able to achieve more from a productivity perspective. Of course, what we would like is for many things to go back to normal, and we've got to at least have a choice to be able to work from home and work from an office environment. But many of our customers have also been able to achieve the same productivity benefits that Data#3 has been able to achieve. Now if we go into the next slide, which is Slide 10, and then work out that -- if I take multi-cloud, and some of you may not be familiar with this terminology, it includes public cloud and it includes private cloud where customers build their own cloud environments, utilizing public cloud-like technologies from the likes of Microsoft and AWS and Cisco and Dell. And if you combine the 2, it's a multi-cloud environment that almost all of our customers operate within. And we've published the cloud -- the public cloud growth. We haven't published the private cloud growth probably because it's private. But the -- what -- suffice to say that we're enjoying significant growth in both public and private. Moving on to security. Security, we highlighted at the beginning of the year, is one of our strategic goals to grow. And I'm pleased to say that we've been able to continue to achieve that security growth rate. It is one of the fastest-growing solutions within our portfolio. And what we are doing is seeing a combination of our Consulting business, Business Aspect, and the Data#3 business getting better outcomes for our customers. Also, our security solutions absolutely complement each one of our solutions as well. When we put in a WiFi solution or a collaboration-type solution, of course, it's going to need an enterprise security to be wrapped around those solutions. Now in addition, from our services, one of the key highlights is our Consulting revenues, which increased over 68%, and our Support Services revenues increasing 48% for the year. So again, I'm very pleased with our services business achieving not only the financial goals but achieving our strategic goals as well going forward. On customer service -- or customer experience, from a customer experience perspective, many of our highlights have been driven by our investments in new systems and processes that we've put in place with our customers. And what we're seeing is that as the customers adopt more and more cloud-based technologies, we're able to provide more informative data and analytics to help our customers get the most from their IT investments and, in particular, achieve their business goals as a result of their IT investments. And it's very much a long-term goal for us. And it complements the life cycle view of the services, so working with our customers over a long term. And it's a long-term commitment. The last point on this slide in terms of the operational highlights is the new ERP system, which we are in the throes of putting and finalizing in the second half. The first half, a lot of the hard work was put in by the team, and we've got a go-live coming up in a few weeks' time. And certainly, it's been a multiyear investment. We expect to see some long-term benefits, and certainly not immediate benefits but certainly long-term benefits, when we put in a system, which is cloud-based, Microsoft-based and is scalable and more robust than our current system. So if we move along maybe to the next slide to Slide 11 and talk about our customers. And we've got an example here, which is delivering the digital future in South Australia. This is one of our newer customers with the South Australian government with the Department of Education. And we've been able -- we've been successful with a multiyear contract to provide managed services environment to the Department of Education. And I mentioned this previously at the AGM, if you recall, that the trend in managed services seems to be the breaking down of the very large outsourced contracts, which have typically been maybe hundreds of millions of dollars, where some of the larger customers, for instance, the South Australian government, may not have seen the benefits that they hope they would see from a single supplier. We're now seeing that breaking that down into more manageable chunks, we see great opportunity in winning new contracts, new smaller contracts. And we're able to provide probably more flexible and adaptable services to our customers. The other point here in -- of course, as far as the education market is concerned, this contract and several others have extended our leadership position in the education sector. The education sector is our leading sector going to market. So on that note, going to Slide 12. I'll now hand over to my colleague, Brem Hill, who will take us through the financial performance. Thank you.

Thank you. Thank you, Laurence, and good morning, everyone. It's my pleasure to review the first half financial performance in a bit more detail with you. I'll start with Slide 13, which shows the revenue trend. And we've clearly delivered sustained revenue growth with a compound annual growth rate of 13.9% over the past 6 first halves. And once again, we're very pleased with the strong growth in public cloud-based business, as shown on the chart on the right-hand side. And as Laurence mentioned earlier, that increased by 34.8% to $466.7 million, and that represents 47% of our total first half revenue. Also, as mentioned by Laurence earlier, approximately 65% of our total revenue is recurring, up from 62% in the pcp. And that's revenue derived from contracts with government and large corporate customers and reflects our deliberate focus on growing our software and services businesses. The mix of revenue has changed significantly over time, and my next slide expands on this change in mix. And just a quick recap, Data#3 comprises a wide portfolio of IT businesses. So the chart on the left of Slide 14 splits the total revenue into 3 broad functional areas, which is infrastructure, software and services. And this chart shows the change in revenue mix over time and shows the strongest growth in software, and that's where most of our public cloud revenue is recognized. So I'm showing the public cloud revenue trend in the orange line on the chart. Then the table on the right shows the breakdown of revenues by individual business unit within the 3 broad functional areas and shows the changes compared to the pcp. So obviously, we've got a range of services and businesses. But if I put all of those together, collectively, they generated $146 million of revenue in the first half, and that's a total increase of 26.7% on the pcp. So definitely, we're seeing the accelerated revenue growth. And each business unit, with the exception of Discovery Technology, grew revenue. And Consulting, Support Services and Software delivered the strongest growths. As I mentioned in previous briefings, it's important to remember that there are significant interdependencies between these different business units, and our solutions typically comprise a combination of these elements. While revenue growth is obviously important, we actually place even greater emphasis on gross profit. And Slide 15 expands on the revenue mix summary that I had and adds the relative gross margins generated by the various business units. And they're simply rated low, medium or high in terms of the typical gross margin spectrum. So the change in revenue mix in recent years had been caused by the very strong growth in software and public cloud, and those are both relatively low gross margin areas. And that has reduced the overall blended gross margin. And just to repeat, this is purely a mix issue. So the gross margins have remained relatively stable within each individual business unit. So we're actually seeing gross margins strengthening in some business units. And our deliberate strategy to accelerate the growth of services has shown to be successful. And the very strong growth in the higher-margin areas of Consulting and Support Services has helped stabilize and improve the overall blended gross margin in the first half of FY '22. And another point I've emphasized in previous briefings is that our objective is to achieve sustained growth in total gross profit dollars. And we think that's far more important than looking at the blended gross margin percentage. So we expect to continue to deliver strong growth in services, and that will definitely boost the overall gross profit. But it should also increase the blended gross margin percentage. Next is a brief review of our earnings and dividend trends. And obviously, just to recap, our goal has been to deliver sustainable earnings growth, and we're definitely very pleased to report such strong growth in the first half, delivering another record profit. As Laurence mentioned before, the basic earnings per share increased by 31.5%. And total dividends increased by 31.8%, representing a full payout ratio for the half of 90.5%. And as the chart shows, this really is a standout result. The fully franked dividend of $0.072 will be paid on the 31st of March, and the record date is the 17th of March. The next slide I have is a quick summary of the P&L statement, and I'll summarize the key points on the side of the slide. So as highlighted previously, total revenue increased by 16.6% to $999 million in the half. So I just want to expand a bit more on the expenses section of the P&L. So the first 4 lines, which is probably a bit difficult to read, but the first 4 lines represent cost of sales. So if you deduct those lines from the revenue from contracts with customers line, that gives you the total gross profit. And that increased by 17.5% to $105.4 million. And the gross margin increased slightly from 10.5% to 10.6% with the change in revenue mix that I discussed earlier. The next line of expenses, the fifth line, is labeled other employee and contractor costs, and that comprises all of our internal staff costs. And that increased by 13.3% to $75.5 million in the half. That reflects a 10% growth in head count compared to the pcp, and that head count growth was predominantly in services. And it also reflects general remuneration increases in line with the broader market. The remaining expense lines, the total of that gives what I'll term other operating expenses, and that total increased from $9.7 million to $11.6 million. And that was largely due to the planned expenditure on our Dynamics -- Microsoft Dynamics 365 ERP system. And as Laurence mentioned, that's going to go live in the second half. As mentioned before, we place considerable emphasis on gross profits. So I've got a slide here which shows the total gross profit trend on the left. And obviously, we're very pleased with the first half performance that delivered the 17.5% increase in total gross profit. We also manage our internal staff costs and operating expenses very closely, and the chart on the right of the slide shows the trends for these costs and how they compared to the total gross profit. We have an internal measure of operating leverage, which we call our internal cost ratio. And that's measured by taking staff and operating expenses as a percentage of total gross profit. So that ratio has decreased from 85% in the pcp to 83% in this half, and that is actually a better-than-expected result. The improvement in leverage is largely achieved in the business -- was largely achieved in the services business units, and that has more than offset the increased operating cost due to the new ERP implementation project. Longer term, we should be able to continue to drive further operating leverage across our business and especially in the services areas. The balance sheet on Slide 19 also may be a bit difficult to read, so I'll just run through the key points. In summary, we have a very strong balance sheet with no borrowings. The traditional fourth quarter revenue spike, which I've spoken about many times before, but just to emphasize that again, that inflates the current trade receivables and current trade payables at 30th of June and typically generates large temporary cash surpluses at year-end. So that's why the balance sheet is comparing 30 June with the 31 December. So they are quite different views there. The -- if I look at the trade receivables measure of average days sales outstanding, that was 26.8 days for the first half, down from 27.3 days in the pcp. So that's another excellent result and shows that we're effectively managing our credit and collections. Our inventory holdings are typically relatively low, and inventory is comprised of allocated stock. So that's product that we're holding in our warehousing and configuration centers pending delivery to customers. However, we have experienced a general increase in inventory caused by the supply chain delays, and that saw $16.6 million of inventory held at the end of December. The fourth quarter revenue spike also skews the working capital. So I've included a working capital analysis on Slide 20 that helps explain the seasonal impact. So this chart shows the changes in the working capital components as reported at 30th of June and 31st of December over the past 5 years. So you maybe -- the chart, you may want to look at a bit more in detail later. But the real point I want to highlight is that the underlying working capital position, which is shown as that black line, it remains stable and positive despite the significant seasonal fluctuations between the different reporting period ends. So to try and summarize that, we have a very efficient working capital model, and our working capital cycle is typically very short or even negative. So our business is effectively self-funding. And obviously, this is due to our relatively low inventory levels; our short collection cycle, which is -- averages around 27 days; and also the favorable trade terms offered by our suppliers, which typically range from 30 to 60 days. Last slide I want to cover is Slide 21, which shows the cash flow statement and summarizes the key points. So the seasonality has a significant impact on the operating cash flows due to the timing differences in collections from customers and payments to suppliers around 30th of June each year. So as I mentioned before, the 30th of June cash balance is usually significantly inflated by the sizable early collections, and then the associated supply payments occur after 30th of June. So this causes the typical operating cash outflow in the first half of the financial year. The cash flow remains healthy and continues to strengthen. And your one point of comparison of these in the past is looking at the average daily cash balance. So that figure was $190 million in the first half of FY '22 compared to $158 million in the pcp. However, once again, I have to stress that those cash balances always include sizable temporary surpluses simply due to our working capital cycle. So if -- to provide a rough estimate of the underlying free cash position, it's typically in the sort of $15 million to $20 million range. The other point I wanted to note are the relatively low levels of capital expenditure and the high dividend payout ratio, which is -- tends to be around 90%. So I hope this information has helped you get a better understanding of the key drivers of our financial results. And I'll now hand back to Laurence to complete the presentation and many thanks for joining this briefing.

Okay. Thanks very much, Brem. If we move on to the strategy and outlook, and I'll pick up on Slide 23 and reiterate what our focus is. And I've already described what progress that we've made in the first half, but it will continue on certainly into the second half. And certainly, it's something which is not an overnight strategy, the -- particularly with customer experience. As I said, it's a long-term view. It's not a transactional view. It is around life cycle. It's a life cycle approach to working with our customers. We've got joint investments with the like -- with some of our global vendors. That also see the benefit of working in life cycle, taking a life cycle approach as opposed to an individual transactional approach. And we're seeing that. This will continue to offer value and make Data#3 stickier and stay with our customers. We have a view in terms of working with our customers that we keep our customers forever. So that's quite a goal. From a security perspective, again, to reiterate, fastest-growing business unit within our business. There continues to be market opportunity. We have combined an executive leadership position to get a better outcome in terms of our go-to-market with security solutions, and we continue to grow. We've seen growth in the first half. We'll continue that path well into the second half. Likewise, in terms of accelerating services, it's very much a catchall. Our services business, we're very pleased with the performance to date. And we're certainly very excited with the pending second half projects and contracts that we are currently working on. And we're going to continue to see growth, in particular, around the Consulting and Managed Services part of our business. The other thing is that our services business very much complements the software and infrastructure components of our business. So let's move on to Slide 24 and talk around the outlook. And in terms of the market outlook, as I described before, it is very strong, and it's strong, in particular, around software and services. What we're seeing -- which is the largest part of our business. So we're continuing to see that strength coming through, and we'll continue to focus on growing our fair share of the market or maybe a little bit more than our fair share of the market. In the growth of the cloud services, again, that's growing faster than the overall market. And what we've also seen is the data and insights that the cloud environment provides us gives us the opportunity to enhance our overall life cycle services. So there's a good deal of integration with the points that I've just covered in terms of our investments and focus on growing the life cycle component of our services business. On the supply chain constraints, they're going to be with us and will continue into next financial year. However, we are very well placed in providing our customers with solutions in a period of constraint. We are the largest provider within the country of many of these solutions, and we have the -- probably the most significant relationships with our vendors. And we have escalation not only within the country but to global leaders in the vendor community as well. And we've got urgent orders to deliver. So we'll continue to work in that, and that works in our favor and provides us a differentiator. What we've also seen is we do have a strong pipeline of integration projects. And the integration projects, just as a reminder, are projects similar to the Sydney Football Stadium, which we're in the -- looking to work through to completion. We're in the implementation phase there. It's certainly taking shape. We've also got many other significant transformation projects which we are working on and we have in the pipeline. These will benefit not only the community in which we operate but will also benefit the overall Australian economy. So some great exciting projects to look forward to there. Now just on the outlook. I'll just read out the outlook, and then we'll move on to Q&A. So while the strong trading performance has continued at the start of the second half, given the pandemic-related uncertainties remain, at this stage, it would not be prudent to provide specific guidance for FY '22. In line with previous years, we continue to expect the sales peak in the months of May and June and higher profit skew in the second half and to deliver sustainable earnings growth. Okay. On that note, I'll now open it up for question and answers. Thank you.

[Operator Instructions] Your first question comes from Ed Woodgate from CCZ.

Great results. Very pleased to see you win so much services work in the half. So maybe we should start there. It would help if you could give some [ examples ] who you're competing against and why you won. And also, what was the growth of Managed Services versus Maintenance Services?

Maybe if I break that -- thanks for joining us, and thank you for the question. If I can break that question down, maybe if I can answer the first part and then maybe, Brem, answer the second part?

Yes. Sounds great. Thanks, Ed.

So in terms of who do we compete with, we compete with a lot of organizations, predominantly large multinationals that we compete with, such as NTT, who are obviously part of the Japanese conglomerate. We also compete with the likes of DXC and other large multinational organizations. That's at one end of the spectrum. At the other end of the spectrum, we also compete with small boutique organizations who are highly specialists in their environment, and they may only be 10- or 20-person organizations. So in the security space, there are many of those specialist organizations who we are the partner with or compete with. And hopefully, that answers your question in terms of who we compete with. In terms of what we're also seeing on the Managed Services segment of our business, as we described with the South Australian example that we -- that I illustrated earlier, is that the trend is to break down some of the larger outsourced contracts that the larger multinationals had held. Our strategy was not to go after their large contracts. Our preference would be instead of having a single $100 million contract, our preference would be to have maybe $25 million contracts. That's -- and that strategy is very much along the lines of being able to manage risk but also improved profit performance as well. So -- and we're starting to see the benefits of that. We're starting to see the benefits in the first half, and we're seeing that in the outlook for the second half as well. Brem?

Yes. I'll see if I can respond to your second part. Look, the -- so Support Services, just to recap for others on the line, it's a combination of Managed Services and Maintenance Services. We don't disclose the low-level breakdown just for competitive reasons, but what I can say is that Managed Services is still the lesser component of the 2. However, in terms of growth, the growth we've seen in Managed Services in the first half is far greater than the growth we've seen in Maintenance Services. However, Maintenance Services also had solid growth. So both have performed well, but Managed Services growth is a standout, albeit on a relatively small base as we're growing the new Managed Services offerings on the new platform following the decision to effectively reshape that business over the past 3 years.

And then just, Brem, you called out the -- that you should be able to drive further operation leverage in the Services business. Could you give us a sense of what utilization levels are now and how this looks against the various different service verticals?

Look, speaking generally, utilization levels are really solid at the moment. We've seen -- and that's pretty much across the business. In Consulting, we've seen really solid pickup there and high utilization. In Managed Services, likewise, we've been very successful in winning new contracts. So we've -- actually, the challenge is getting staff on board to sort of transition these new contracts onto our platform because it does need some additional head count. And then in the Project Services space, because of all of the big integration projects that we've got, that's also pushing up the utilization in that part of the Services business as well. So all of that helps contribute to leverage. And moving forward, I think the biggest opportunities are still around Managed Services. So we've invested in the platform and the systems and the tools that we need for that environment. So as we add more contracts, yes, we do need to add some additional head count. But there's definitely leveraging opportunity.

Okay. Great. Okay. So further upside in regard -- in relation to leverage. Just on the product gross margins, they improved in the half, at least on my calcs. And I'm just wondering if you could talk to that because you've had very strong growth in software, and that's tended to, I guess, dilute the product -- gross profit margin in products. So what trends are you seeing there? Are you sourcing more product directly? What do you put it down to?

Well, it's actually -- it depends. If you do the very simple measure of gross profit from the P&L, and I'll say it is a bit rough, but that -- our gross margin overall for product actually came off slightly. But yes, I'm talking down from 7.1% to sort of 7%, so effectively flat. But yes, you're right, we've seen -- given the stronger growth in software, that is at a lower gross margin. So that has been offset by improving margins in more of the infrastructure space. So I think that -- example of that would be in the pcp, a lot of the infrastructure spend was on end-user computing-type devices given this shift in the pandemic. Now we're seeing more of the big integration project spend, which is typically higher-margin infrastructure associated with that. So the two have offset each other.

Just to clarify. When I was saying the gross margin has come down, I was talking about the first half of '22 to the implied second half of '21.

All right. Okay. Sorry, I was thinking here first half to first half. Look, that is a bit of a tricky one, Ed, because the mix does shift between first half and second half. So typically, our software business has -- is not as heavily skewed to the second half. In fact, it's pretty evenly first half-second half or even skewed to the first half, whereas the infrastructure business is skewed to the second half. So it's not really an apples-with-apples comparison looking at the second half to first half.

Okay. Got it. And then just one more question before I jump back in the queue. Just with the Microsoft ERP system, I understand this is due to go live in the second half. I just wanted to check if there's any more costs related to this in the second half and whether we should be thinking about any other one-off projects or costs in the medium term.

Look, I'll stay with that. Yes, there will be additional costs in the second half. I'd say, it's -- we've had a heightened period of spend in the first half, but we expect a slight reduction in that spend in the second half. But we're still going to be spending probably $800,000-odd in the second half on that project. And there will be ongoing expenditure because we will continue to refine and enhance that system, but it will be at a much lower level. And it should be offset then by some of the benefits of shutting down our old ERP system, which has licensing costs associated with it.

And sorry, actually, do you mind if I just ask one more quick question and then...

Yes.

So just on the infrastructure growth side of things, I mean, that was, I guess, a little bit more modest compared to recent historical levels. Is that just largely explained by supply constraints? Or are you cycling particularly strong comps in certain hardware verticals like monitors, for example? Just say -- just in the context like Cisco a couple of hours ago just said that their backlog is at all-time high levels, and it's more than double what it was a year ago. So...

Yes. So while the total -- the dollar value of the revenue only grew by about 1.8%, the makeup of that revenue is quite different. So the same -- the pcp was a lot of end-user devices with predominantly end-user device-type spend. Now it's shifting more into the -- like the Cisco-type business, networking, bigger end systems, the stuff that's behind these big integration projects. So it's higher -- generally higher-margin product that's being sold in this first half. And yes, Cisco is a very significant part of that spend.

The next question comes from Nick Harris from Morgans.

Can you hear me?

Yes.

Yes.

Excellent. A great result. So first question for me was just around staff and inflation, obviously, sort of subject of the moment -- at the moment. But just wondering, could you make some comments on, firstly, your ability to pass on higher prices for products as they're coming through? And then secondly, what you're seeing kind of with inflation generally? And maybe more specifically, it seems like pockets of wage inflation are still largely intact. So do you -- how are you handling that? And with international borders likely to open, do you think that's going to help?

Yes. Maybe I'll go with that, Nick. The answer to the first question, the international borders opening up, absolutely, it will help because it will provide a greater pool of resources for us. It's never been a huge contributor to our hiring process, but it has been particularly for specialist technical skills. So that will certainly help. In terms of wage inflation, yes, we're seeing it the same as everyone else. What we're seeing is almost that we're -- it's become -- we've become planned in that we know what we're working with. Our customers know what we're working with. So it's -- we're still seeing it as we grow our customer base. We -- obviously, we build in the cost base. And if that's growing a couple of points, then that's the way things are in the market today. The -- probably the bigger challenge for us isn't so much on the cost side of things. It's actually getting the right people. And I think it's the same for every organization in the sector right now. And getting the right people, we've got -- because of our services growth, we've got -- we're hiring more than we have done previously in specialist technical areas. And we've got a few ways to -- that differentiate ourselves across that. And one is we're a great place to work, but I think everyone says that. But we've got a few employer of choice awards that we can point to, some proof points. And also, the tenure of our people seems to be a lot more than most. Also, we've got a recruitment business within our business. So we've got a people solutions business that helps us recruit talent into our business. And the other one which we've got -- which we've mentioned previously, which is also increasing, is for some components of our business, we're offshoring. And not the customer-facing work, but we do also have a lot of our businesses is related behind the scenes in terms of noncustomer-facing. And we're seeing some improvements in our offshoring component. So with those 3 elements, that's the way that we're combating it. But there's no doubt that it's taking place in the industry.

Thanks, Laurence. That's really, really helpful. And I guess my second question was just following Ed's lead there, just to dive into that services side of the business a little bit more. Obviously, that was a fantastic result. Appreciate growing services is clearly the long-term plan, but that was a pretty big win in this half. So I was just trying to get a bit of a feel. Is there some kind of short-term kind of lumpy gains there on some of the project work? Or is there a bit of a structural change happening now with digital transformation really starting to lift and you should see that healthy growth in services continue because it's a medium-term, not a short-term, trend? And then I guess finishing that, is it sort of -- should services lead or lag product now? I'm just trying to understand that.

Sorry, what was the last, services what?

Should services lead or lag versus product?

The answer to the first component of your question, the answer is yes to all of the above, meaning we're seeing more larger-scale projects and recurring contracts taking place in the market. So our pipeline is strong. As I mentioned before, we're seeing -- it may be too early to talk. But as we're progressing to the next stage of the pandemic, we're seeing more confidence in the market in terms of more larger-scale infrastructure-type projects, which involve -- go right across the portfolio of our business. So the answer is yes, we're seeing that. We see it continuing as far as we can see forward. The -- and what else was it? The last component was should services lead -- in many cases, services does lead the product side of things. So in reality, we don't necessarily talk to our customers and services or product. We're actually talking in the form of solutions and outcomes, what our customers actually need to achieve. And usually, it's a combination of the two. And it's probably -- we don't view it so much as one leading the other.

Can I slip in 2 last questions for Brem at this time?

Yes. Go ahead, Nick.

Yes.

Yes. Just the ERP. Can you just remind us, Brem, under the CapEx and the D&A next year, as it goes live, I think the D&A will kick up and the CapEx will come down. But can you just remind me what I should be thinking there? And then the second bit was just the kind of recurring revenue. Obviously, that's ticking up to, I think I said, 65% now. Can you just remind me what your definition of recurring revenue is? Like does that mean you know what -- much more clearly what's going to happen in the next months? Have you got pretty good visibility?

Yes. Okay.

Or can recurring revenue slip into the next financial year?

Yes. Thanks, Nick. So look, the ERP first, that is -- look, the estimate we've disclosed previously is we expect to have about $6 million capitalized by the time we complete the implementation. So -- and then that cost is going to be amortized over a 5-year term is typically the approach we take. So -- what else? I think -- but the costs when that project come in, there's various different forms. So there's the direct costs, which we've highlighted that we spent $1.3 million in the first half. So that's clearly direct costs associated with that. So it's the implementation partner costs. It's project management resources brought on specifically to work on the project. There are -- I should say, there are other costs that are spread across the business that we don't quantify because this had a significant impact right across the business in terms of designing and testing the system. So those impacts will all lessen once the system goes live, but we do still expect to have an internal development team that will do some fine-tuning and enhancements to get better functionality out of the system over time. But those costs will not be capitalized. So I don't think you'll see any more capitalizing once the project goes live. Does that kind of cover what you're questioning, Nick? Or was there another?

Yes. That does. That's good. And then just on the recurring.

On the recurring, yes, so that -- and just for simplicity, the -- if you look at our revenue line, that recurring revenue is predominantly derived out of our Software and our Support Services areas. And that is where we have contracted revenue. So the spend is locked in. So it is genuinely committed. I use the term -- those contracts, typically, they're 3- to 5-year contracts that drive that revenue. It does not include other revenue where we are on a contract but the spend is not committed. So you've got a whole lot of panel contracts where we may be the only supplier, but because there's not a committed contract spend, we don't include that. So that 65% increase was, fair to say, it's probably better than I expected for the first half. But going back to my answer with Ed earlier, we tend to see a skew to software to the first half. So that sort of helps boost that recurring revenue trend. So yes, it might hold in the second half or even -- may even soften slightly, I'm not sure. But long term, we expect to see that recurring revenue steadily increase.

Your next question comes from Adam Dellaverde from Taylor Collison.

Well done on the result again.

Thanks, Adam.

I was hoping to really just drill into the numbers a little bit, so probably more focused on you, Brem. Just wondering, the line in your P&L, other costs of sales on services, can you just sort of unpack what's in that? Is there a lot of labor in that? Or is that other things when you talk about your platform?

Yes. Thanks, Adam. That is -- it's a mix there. So that is -- there's -- the label implies that, that's various cost of sale elements that relate to services. It's either labor, and the labor would be where we take on a contractor. An example would be in our recruitment business where they are -- take on a contract that's directly on charge to a customer. So they're effectively working on the customer side. So that's a direct cost of sale of the revenue. So there's that sort of resource cost in our People Solutions or recruitment business. There's some contractors that are either a consulting team or even our project services team may take on a short-term contractor to work on a specific activity with a customer. That forms part of that cost of sale as well. What's not in there is our just general resource of permanent staff, if that makes sense. And then the other element that feeds into that line is if we are in the maintenance services space, if we are reselling a vendor support contract from a vendor like Cisco or someone like that, the costs associated with that also goes into that line.

Okay. So if I'm thinking about the rate of growth in cost in that line versus the rate of growth in Managed Services, Support Services, are they relative? Or they -- it seems like they fall across the other service line -- revenue line categories more than the Managed Services line. Is that right?

Yes. There's very little Managed Services cost of sale there. It would be in the Maintenance Services space and then the People Solutions and Project Services and Consulting. So probably all 4 areas, except Managed Services, feed into that. And also, what I'd say is that I think there's been a bit of a trend. As Laurence mentioned earlier, in this environment, it's been quite difficult to find people with the appropriate skills. So while we've grown head count quite significantly in the services space, we have had to engage external contractors as a temporary solution effectively if we don't have the resource on board. So that sort of top-up cost with external contract resource feeds into that cost of sale line. So that's what's also seeing an increase in that cost of sale element compared to the pcp.

Yes. Got it. That makes sense. And so when you talk about adding head count to the business for Managed Services, we're really seeing that through the other employee and contractor cost line?

Correct.

And so just help me understand -- I mean, we are in an inflationary environment. The -- what kind of mechanisms do you have in place on these 3- to 5-year contracts to protect you against wage inflation?

Look, that's a pretty general one to try and answer. There are normally provisions in there that allow us to vary costs when necessary, but it really depends on the nature of the contract.

It will vary by contract. There's probably not a global answer to that, Adam, I don't think.

Yes. It really depends, Adam.

Okay. So just -- I'm just thinking about your optimism around margin expansion and just trying to reconcile to what I've seen first half. Is there any nuance in, say, the nature of contracts where like the scope of the services expands over that period as they bring on more capability or more hardware? Or is there anything in terms of natural inflators to the amount of revenue in the latter years versus the first years that's typical to these contracts?

Laurence, do you want to have a go at that one?

Yes. I don't think that there is -- again, maybe there's peculiarities on certain contracts. But at a consolidated level, I don't think that there is anything which is unusual from 1 year to the next.

So I guess what I'm trying to get, like, are you spending -- are you putting employees in ahead of the curve? And is that why we -- like the gross margins that I can calculate off those 4 cost to sales categories. And then a comment you made that the Consulting and the Managed Services parts kind of helped prop up margins in the group. But margins like-for-like look like -- they were definitely on second half in that sort of services category, at least on the consolidated stuff that I calculate. So I'm just trying to understand how there's so much movement between periods and when we really see that open up.

Yes. No, maybe it all comes back to a changing mix, I think, Adam. So what we'd have seen comparing second half of FY '21 to this first half, yes, we probably have stronger Maintenance Services component in the second half of FY '21, which would have sort of pulled that down. But it really depends on the mix and with the Project Services, the timing of that coming through. So it's not really a trend that I'd call out.

Okay. That's helpful. Maybe we'll take the rest off-line.

All right.

That's great.

Thanks, Adam.

There are no further questions at this time. I will now hand it back to Mr. Baynham for closing remarks.

Okay. Thank you very much. And for those of you who are still with us, thank you very much for your support. Thank you for joining us in this meeting, and enjoy the rest of your day. Thanks very much.

Thanks, everybody. Thank you.

Bye.

Thank you very much. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may now disconnect your lines.