Datatec Limited (DTC) Earnings Call Transcript & Summary

Good morning. We are presenting today our first half fiscal year '25 results. The format remains unchanged. I will provide a summary, and then hand over to Ivan to go through the detailed consolidated financial results. I will then cover the operational review of the main divisions and conclude with a wrap up. Starting with the summary, Slide 4. Gross profit grew, while reported revenues fell. Gross profit is the real measure of the dollars we bring in the door as revenue reporting under IFRS is affected by the shift from traditional hardware to recurring software and services, which are increasingly net accounted. Under net accounting, the reported revenue is the gross profit. The increased gross profit and margins, along with tightly controlled operating costs, meant adjusted EBITDA grew considerably by 19%. All the earnings measures grew in tandem and underlying earnings per share jumped 56%. The consolidated EBITDA margin of 4% would have been higher, if not for the drag from a still weak Latin America region. Both Logic Westcon and Logicalis had excellent profit growth and margin expansion. Aside from the P&L performance, the main highlight in this period of reporting was the very strong operating cash generation. Logicalis LATAM has experienced 3 challenging years. The market environment seems to now be improving, supported by an end to the economic turmoil in Argentina. We are declaring an interim dividend of ZAR 0.75 or approximately USD 0.04. Current trading. For most of this year, there has been a slowing of network infrastructure purchases, driven in part by the surge in orders and backlog built up during the years of challenging supply chains. Demand for cloud infrastructure, and especially cybersecurity solutions, remains robust. Across the world, there is a mixed economic picture. North America and Asia remain strong. Some markets in Europe, especially Germany, are weak, while Latin America remains a laggard. Interest rates are now falling in many countries, and we expect our overall finance expense to begin to drop. All divisions are expected to deliver a stronger full year performance. I'll hand over now to Ivan to take us through the detailed financial results.

Thank you, Jens, and good morning, everyone. We are pleased to present a very strong set of interim results. Moving to Slide 8, the P&L. Gross profit grew by 3.5%, despite revenues declining by over 5%. The decline in revenue is as a result of a change in mix, with more revenue being reported on a net basis where we act as agent as opposed to principal in a transaction. We had a very good quality of earnings, with EBITDA growing over 27%. Adjusted EBITDA margin was 4.1% compared to 3.2% in the prior year. Net finance costs increased as a result of higher interest rates as well as higher average utilization of facilities, primarily in Westcon. The effective tax rate of 33% is approaching a more normalized rate for the group. As announced with our trading statement earlier this month, we have changed the definition of underlying earnings per share to now also include unrealized foreign exchange losses. This aligns our reporting with peers and also creates further alignment between our adjusted EBITDA and our underlying earnings per share metrics. Slide 9. This slide shows the segmental P&L. Both Westcon and Logicalis International had a significantly improved operating performance. Latin America also had an improved performance compared to last year, with conditions in Argentina starting to improve. Slide 10. The geographic mix of revenues was relatively stable year-on-year, with an increased contribution from Asia Pacific and Europe. Slide 11. The mix of revenues is gradually changing to more services and software. It is important to note that there has been an increase in net revenue-accounted software. Slide 12, the balance sheet. The balance sheet remains healthy. We had a good working capital performance during the half, resulting in a reduction in net debt. Liquidity remains strong. The increase in goodwill from H1 FY '24 is due to acquisitions in that period, including Mason Advisory becoming a subsidiary. Over the page, Slide 13. This slide represents our segmental balance sheet. Slide 14, cash flow statement. Operating cash flows improved significantly from the prior comparative period. The Westcon EAP scheme was settled in the prior financial year. We paid a cash dividend of $9 million during the first half. I will now hand over to Jens to cover the remainder of the presentation.

Thanks, Ivan. I'm now moving on to the operational review of the divisions, starting with Westcon International, Slide 17. Another very solid performance from Westcon. The main underpin over this period has been the continual and steady rise of the cybersecurity industry, which is now the largest component of Westcon's business, at close to half the total. Coupled with this profitable growth has been a steady improvement in working capital and debt management. Innovative methods to improve margins and returns are being utilized, and one of those is a small, but now profitable contribution from flexible financial services, supporting both customers and vendors. Revenue. There has generally been slower demand for networking products in this period. The growth of cybersecurity has changed the mix to more software and services, which is largely recurring and also where revenues are often net accounted for. These factors have led to a slight reduction in reported revenues. However, the growth in recurring revenues was very strong at 16%. Revenue by geography. Revenues declined slightly in Europe and Middle East and Africa, but grew strongly in Asia Pacific. Increased net accounting affected reported revenues everywhere. Revenue analysis. The slowdown in networking mainly impacted the Comstor Cisco unit. Other Westcon technology categories posted good growth year-over-year. Sales to large system integrators and global IT companies grew. Revenue by technology category and segment. Cybersecurity continued its multiyear growth trajectory and is approaching half of the total revenue mix. Networking remains a significant sector as it provides the foundation upon which the Internet and cloud infrastructure operates. Software and services has, for the first time, exceeded 50% of the segmental revenues, accelerated in part by the reduction in hardware. This trend, with the increase in annuity and recurring software license sales, is set to continue. Gross profit. Gross profit advanced steadily in the period by $12 million. With distortions in comparative revenue analysis, due to additional net revenue reporting, it is better to focus on gross profit contribution as the key indicator or the total value of what is generated. Adjusted EBITDA. 1/3 or [ 33% ] of the gross profit contribution converted into adjusted EBITDA. Margins are now at a high of 4%. In the past 5 years, adjusted EBITDA over this period has risen more than threefold from $23 million to $71 million. EBITDA. Reported EBITDA closely tracked adjusted EBITDA with growth of 16%. 80% of the incremental $12 million of gross profit generated turned into EBITDA. Working capital. Another period of excellent working capital management, with further contraction in the net working capital. Smarter inventory management and payables control generated a high proportion of EBITDA conversion into free cash flow. Net debt at the close of the first half was $42 million lower than at this time last year. Outlook. There are mixed economic signals, albeit overall growth is still vectored in most markets. Europe, in particular, is facing challenges with low growth, whereas the U.K. economy is finally feeling more energized. The multiyear investments in digital systems with customer and supply integration on the company's common ERP platform is really paying off. Productivity is on a continuing improvement trend. Moving on to the Logicalis Group, and starting with Logicalis International, Slide 29. A period of strong gross profit and EBITDA growth with lower revenues, but a much improved business mix. The multiyear strategy to move from a largely transactional product sales business to more software and services is paying off. The investments in modern technology are helping, with more automation still to come. Hybrid cloud solutions are ever increasing, and technology supply chains have become more normalized. Financial performance ratios and quality of the P&L are much better. Revenues. Both total revenues and recurring revenues were impacted by a greater element of net revenue accounting with more software and services. To illustrate this point, on a gross revenue basis, the rise in recurring revenues would have been 11% year-over-year from $502 million to $558 million on flattish total revenues of $932 million. We report IFRS revenues, which is on a net basis. Revenues by geography. All regions showed a slight decline in reported revenues despite the gross profit contribution rising. Again, this was a function of the business mix as software license sales and services grew, while hardware sales reduced. The U.S. and Asia had the strongest underlying growth, while Germany was the weakest market with low profitability over this period. Revenue by segment and cloud revenue. In proportion, all services grew, while hardware fell. Software sales also increased in total gross revenue value, but not after the net accounting required for IFRS revenue reporting. The biggest increase came in cloud revenues, which includes any product or service run as a cloud solution. Gross profit. The real indicator of growth is the gross profit contribution. As revenues fell and gross profit increased, so did the margins. Gross margins for this period rose to 28%, a new high, driven by the change in business mix. Adjusted EBITDA. The $10 million increase in adjusted EBITDA exceeded the growth in gross profit as real operating expense reductions took effect in this period. The operating expense reductions were largely as a result of workforce reductions in Europe and the U.S. made during the latter part of last year. EBITDA. Reported EBITDA mirrored the increase in adjusted EBITDA. The U.S., in particular, had a very profitable contribution. Germany was the weakest market and South Africa narrowed previous losses. All other markets performed in line with expectation. Working capital. The value of receivables outstanding fell slightly, as did inventory. The year-over-year changes were modest, reflecting the disciplined working capital management. There is more improvement to be gained. Outlook. Going forward, the focus will remain driving efficiencies, controlling CapEx and improving operating cash generation. The environment is stable and well supported by the growing adoption of hybrid cloud solutions. Enterprise users continue to depend on technology service companies to augment their internal IT resources. The company is well placed to take advantage of the advisory, managed service and infrastructure requirements that will be needed to support the AI implementations of its customers. Logicalis Latin America, highlights, Slide 39. There is potential for a better backdrop to emerge across most of Latin America. A much more positive, albeit cautious evolution is underway in Argentina. Within this period, we had an elimination of ForEx losses. There has been a pickup in order intake across the region. Brazil has been very dependent on the telecommunications sector for many years, but is now transitioning to a more enterprise and public sector-focused business. The shape of the P&L has improved considerably, with net debt and interest costs continuing to fall. Revenue. The Latin America region started the year with a much reduced backlog position. In addition, a few multiyear cloud-delivered managed services contracts did not renew. This rebased situation, driven largely by events in Brazil and Argentina, is expected to improve in the second half. Revenue by geography. Brazil has the biggest weighting and also had the biggest decline. Unaided by the previous year's backlog, revenues were lower. NOLA, Northern Latin America, which includes Mexico and Colombia; and SOLA, Southern Latin America, which includes Argentina and Chile, fared much better. As mentioned, the Brazil business has been refocused and is developing well new opportunities in the commercial and enterprise sectors. Revenue by segment and cloud revenue. The majority of the revenue contraction was from hardware. Annuity and recurring revenues gained in proportion was still reduced overall. Revenues derived from cloud-delivered solutions fell. This was tied to the reduction of a few managed service contracts. Gross profit. Gross profit declined by less than revenue as hardware was the main component. As a result, gross profit margins edged up to 22.4%. Adjusted EBITDA. Despite the fall of over $9 million in gross profit contribution, adjusted EBITDA was flat year-over-year. This was helped by the resizing of the cost base and reduced operating expenses, mainly as a result of workforce reductions in Brazil. EBITDA. Reported EBITDA had the benefit of a tax credit item related to cost of sales. This helped the shape of the P&L and drove a much improved profit before tax. Working capital. The big driver of improved working capital came from Argentina and the ability to turn inventory into revenue, collect the cash and remit the money internationally. This shows up in the reduction in accounts payable as aged creditors got paid and trade flowed more normally. Inventory fell by almost half year-over-year. Outlook. A more positive outlook is apparent and a much more diversified pipeline is developing in Brazil. The areas of focus for growth are around core networking and cloud infrastructure, information security and in developing Mexico. Mexico has roughly the same-sized IT market as Brazil, but our operations there are less than 1/3 in size. Mexico presents lots of opportunity to grow. If Argentina can continue to stabilize, the whole region could benefit and at some point, risk pricing and interest rates should improve. In closing remarks, prospects and outlook. We are entering an era of technology regeneration, where artificial intelligence will lead to much enhanced business automation and will require a new balance between skilled workforces for continued economic progress. It's going to be an exciting time for many industries, but it's also clear that the dark side of AI will create a more sophisticated threat landscape in cyberspace and will add more pressure on suppliers of security. We are confident in the focus and execution of all our businesses and with a long-term value creation objectives that we have established. I will hand over now to questions from the webcast.

Our first question is from [ Nick Krishna ] from [ Signal Arm ]. A few years ago, Datatec hired Lazard to examine strategic alternatives. Can you give us an update on this matter? And what Datatec intend to achieve?

Thank you, Sharne. Yes, indeed. That was almost 3 years ago. Our strategy remains to maximize performance improvement, along with maximizing value. And I think we're demonstrating a good -- a pretty good job of that in terms of the execution of the businesses. Of course, there are other dynamics in the world in the last few years in terms of rising interest rates and reduction in M&A activity and so on. But in the meantime, we've been applying ourselves to developing the business, each -- all of our main business divisions as best as we can, and the results are excellent. In the last 2 years, we've also drawn in or brought in a senior executive management into the equity of the respective divisions through various management buy-in schemes. So they are now completely aligned with Datatec in terms of strategic outcomes and strategic possibilities in terms of how we can maximize value in the future.

The next one from Katherine Thompson, Edison. Westcon, did you see changes in customer demand for cybersecurity after the CrowdStrike issue?

I don't think there's a direct correlation to organizations, budgets and behaviors in real time to such an incident. But the CrowdStrike incident certainly raised the profile in many places and most probably put -- from what we have seen has put enhanced cybersecurity and threat protection in general. It's, yet again, elevated this space to the forefront or further to the forefront of many enterprise and corporate decision-makers.

Next question from Katherine Thompson. Would you ever report gross invoice sales in addition to IFRS revenue, so we can see how software and services is growing on an underlying basis?

Thanks, Sharne, I'll take that. Katherine, yes, that's something that we are considering to essentially also show pro forma numbers for gross sales as the trend towards more net accounted revenue reporting is certainly expected to continue. But at the end of the day, I'd say that your gross profit growth is the most relevant metric as this essentially represents the dollars that we bring in the door.

Next question from [ Nick Krishna ] again. Paraphrasing NVIDIA. NVIDIA had invented a new computer; two, Moore's Law has stopped working with old computers, and there was little innovation; three, $1 trillion of old computers need to be replaced by new computers. What is your opinion on the statement? And how is NVIDIA positioned for this upgrade cycle?

Thanks. Yes, I think in my commentary in the presentation I mentioned, on at least one occasion, that we expect that there's going to be a significant upgrade in PC and laptop refresh as a consequence of AI developments in the last few years. In fact, the fundamental AI development have been the exponential increase in processing power, which goes to your -- I think to the point about -- and NVIDIA, of course, has played -- NVIDIA, which was an old name in graphics computer processors for many years, has obviously been at the forefront of the processor surge now, which underpins AI. So we think that there is going to be a massive endpoint, if that's the right way to put it, surge in AI. AI at the moment is dominated by cloud-based infrastructure and cloud-delivered solutions and so on. But just the sheer amount of processing power that's required suggests that the activities will be repatriated away from the cloud, potentially back on to campuses and premises where these AI-intensive applications and processes need to take place. So we think there will be a massive rising tide for endpoint devices. And in turn, that will lead to another generation or regeneration of network refresh and so on. And of course, the other, almost dark side of AI, is the exponential threat landscape is going to change because you're going to have such a degree of automated invasion or attacks in cyberspace that previously were organized by more traditional human control or human intervention. So that's another area that could go exponential.

Next question from Katherine Thompson. Logicalis LATAM. The multiyear cloud services contracts that didn't renew, were these related to the weakness in telco demand?

Yes. Essentially, we have some very large contracts with some very large telcos and service providers, and there's been basically some shrinkage in the IT spend of that entire customer class.

Question from [ Sandilim Magogula ] from [ Former Wealth ]. What has been the common driver of slower hardware sales across the different geographies? And which segment of the market you serve had you been observing higher adoption rates in AI technologies? So two parts.

I don't -- on the AI adoption -- I'll start with the second one first. On AI adoption rates, I think it's hard to opine on that in terms of geographies at the moment. It's easier to pinpoint certain business segments as opposed to geographies that are better exploiting AI from an automation perspective. So for example, large online or B2C kind of businesses have been aggressive users of AI because it helps modernize and automate their processes more efficiently in dealing with areas of customer service, client interaction and so on. The first part of the question, sorry, Sharne was?

What has been the common driver of slower hardware sales across the different geographies?

Right. So that's a common -- that's a pretty common thread. So lower hardware sales has 2 components. There's, obviously, been the overinvestment or overbuilt period that happened during the 2 to 2.5 years of very poor supply chain dynamics, which was basically post-COVID. And there was an era, sorry, where organizations were -- not double counting, but we're ordering in advance. So there's still the -- I guess, the period coming out of that overbuilt or excess hardware purchases that were built up during the supply chain years. The other dynamic that's going on is a financial dynamic, not a device dynamic. And the value of hardware -- somebody asked before the Moore's Law question. I mean the Moore's Law has gone exponential, which is basically prices dropping and performance increasing. That's the axis of Moore's Law. So that has been accelerated in the last few years. And what we see is the absolute volume of hardware being shipped isn't changing. In fact, it could be going up. But the value of that hardware is decaying. So when you look at our numbers or manufacturers' numbers, our suppliers, organizations like Cisco and others, you see exactly the same trend. You see this increase in value that's been ascribed to software and then associated services, and the value that's being ascribed to the hardware is falling. And on top of that, you have this other dynamic where recurring revenues and annuity incomes are going up and transactional revenues are going down. And of course, we opine on that a lot in our reporting, the whole net accounting -- net revenue accounting that we're talking to and one of the earlier questions about what are we going to do about future disclosure. So that's a dynamic which is affecting our entire industry, and we are -- we'll be focusing on that quite a bit going forward.

There are no further questions.

Thank you very much.