Endava plc (DAVA) Earnings Call Transcript & Summary

Thank you for joining us this afternoon. Before we really kick off, I have a quick disclosure I need to make sure I read. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley website at morganstanley.com/researchdisclosures or at the registration desk here on site. So I'm James Faucette, the IT services analyst here at Morgan Stanley. Very pleased to have senior management from Endava joining me for a conversation this afternoon. We have John Cotterell, the CEO; and Mark Thurston, the CFO. And I guess that before I get started, you should recognize that 2020 is the 20th anniversary of Endava. So congratulations. I think a lot of us would aspire to make it to 20 years of anything. So that's very good work. Maybe to start, though, you've had the opportunity to meet with a lot of investors today. I'm sure you're very well rehearsed in the response to impact from coronavirus, et cetera. So why don't we kick off and just kind of give us your -- what has become your boilerplate statement today on that.

Sure. So I mean obviously, the big question is, are we seeing any impact in the business from the coronavirus. The -- we're not seeing any impact in terms of revenue flows from clients, discussions with clients about business opportunities. And -- so no impact coming through from the top line at all. And obviously, we've been putting a lot of work into testing and making sure all our business continuity plans in this place -- in this area are working well. And for us, that is mainly around the ability of our staff to work from home. And so the one area where we have seen some activity is where some members of staff, who traveled, have decided that they want to self-quarantine. So we've seen some members of staff, not that many, but some members of staff moving to the self-quarantine, working from home environment. Now that actually has 0 impact on us from a revenue or profitability point of view because they then essentially continue doing the work that they were doing anyway, but they do it in a home context for a couple of weeks.

Right. And as you go through that or as you kind of envision or potentially envision changes in near-term and temporary changes in travel policy, et cetera, Mark, is there any impact on OpEx at all? Or should we -- can there be a wall and then a catch-up? Or how are you thinking about that, if at all right now?

In relation to the coronavirus?

Yes. Coronavirus, just like people saying, oh, we're going to travel less this quarter, but try to make it up later kind of thing.

Yes. Okay. Okay. I mean we operate a national delivery model. So basically around sort of 95% of our people are operating out of Central Europe and Lat Am. So we don't actually do a lot of travel to client locations, et cetera. So for us, the travel sort of angle, the OpEx angle will be pretty sort of insignificant.

Good. Good. Well, all right. So hopefully, we...

And in terms of our business model, we only have about 1% or 2% of our people who actually work on customer site. So the impact of customers needing to climb down on people in their offices, et cetera, is also very low.

Very minimal. Good. Well, good. Hopefully, we can leave that to the side and make use of our time in a much more beneficial and profitable way. So I'll start at a high level with you, John. For those that maybe are unfamiliar with Endava, can you just give a brief introduction of your company? I mentioned that this is the 20th anniversary, but kind of where does Endava fit? And what is your real focus and specialty?

Yes. Sure. So I mean I founded the business with the whole vision of reinventing the relationship between people and technology. And that is what we do. We're all about next-gen technologies and how those can be used and applied to transform business models, whether that's driving top line growth through new product or driving efficiencies or speed to market for clients through the use of technology, product utilizing these technologies. We do it through a nearshore delivery model. So part of the key to making that work is what we call distributed agile, which is why 95% of the people work within our offices because we can operate in a distributed way. But it's really, really important for distributed agile that there's a good time zone overlap with the clients. So it facilitates that communication that happens between the client team members and the Endava team members. All of that, when you put it together, has enabled 20% plus organic growth over the last -- over the period since we started actually with good margins coming out of the business.

So when we talk about Endava and we have conversations with investors, et cetera, in particular, you typically hear that the company being compared to the likes of EPAM or Globant, but you've recently mentioned it, you typically don't see them in RFPs. Like, why is that? Like what do you think the investment community is missing in terms of that landscape?

So I mean there's 2 reasons for that. So one is the -- we don't do a lot of RFPs. So the engagement that we have with clients is all around how do you ideate new product. So you get in a conversation at a senior level with the business people around a business opportunity or a business challenge that they have. And we get into an early ideation process, prototyping process with them that brings to life what technology could do for them in that space and then move through prototyping and through MVPs and so on to actually get these products to market, and then we're able to scale them. So we're most likely to meet an RFP process when we've actually been working in the client for 12 to 24 months, and they want to put us through the process, do all the regulatory ticks and all the rest of it. So it's not particularly competitive. It's more of a business discussion around how we structure the relationship for scale that benefits both the client and ourselves. So the other reason, of course, is that the market is actually very large. And so even, although we're the biggest niche-focused players in the market, we don't actually run into each other as often as people might imagine.

Right. So back to your initial point, how does that preliminary contact with customers take place? And how you brought into the organization? And where is that relationship level taking place, just to start?

So we've got a lead generation team, and they're out in the market building relationships with clients through all the different channels that you can do that. They will then set meetings up that gets our business development salespeople in front of clients. And we'll be looking for business owners, who've got a product area that they're looking to develop. They're seeing a business opportunity and they're wondering how technology could help transform them.

So are those conversations typically with the most senior heads or CEOs of your eventual clients? Or is this more at the business development and product management-type levels?

It would be a mixture of C-suite people, and it's not as focused as you might imagine. You see CDOs, you see CMOs, you see CIOs, you see CEOs, who are driving these initiatives. And one of the benefits that they get out of our approach is that that early prototyping phase can produce a working product that they can actually show to the rest of the C-suite to get support for developing that product and taking it further.

Interesting. So you talked about not running into EPAM and Globant very often, but you have highlighted Accenture as being one of your top competitors. Can you compare the Endava value prop versus Accenture? And what do you -- like what are the strengths you're typically trying to sell to when you're dealing with them as a competitor?

Sure. So I mean Accenture has a very large footprint out there. So they're...

Yes. Absolutely. They're going to be at a lot of places, yes...

And an incumbent in many of the clients that we want to talk to. And they've also invested heavily in some of the strengths that you need to be able to portray in our space. But the difference with Accenture is they have a consulting strategy business. They've built, over the last few years, a digital creative business, an agency-type business and, of course, they've got the engineering capability, but they haven't integrated them. They keep them as separate business capabilities for cultural reasons and all sorts of other reasons that have concerned them. The Endava approach is all about integration of multidisciplinary teams. So actually making sure that within scrum teams and multiple scrum teams, we have the product and technology strategy people, we have the creative and design people, and we have the engineers who can work with technology. So that together, they ideate this product in a way that not just looks like a clever idea, but actually, if you're successful in the market, it can scale into large scale production. So that's how we differentiate against Accenture. The client can see much faster speed of product creation and acceleration than the more disparate extension capability can deliver.

So that sounds compelling, at least to me. What -- for deals that you don't win against Accenture, why do you think that's typically not the case? Like what -- is there a common thread you see?

So it doesn't actually happen very often. So we -- I was actually comparing notes with Julian, my Commercial Director over there, and we don't think we've lost the deal to Accenture in the last 3 years. And -- but a lot of that is that same, we don't have a lot head-to-head in the way in which we go and win business. I would say, if you got like further than that, the reason where we would have lost, it would have been because of the longevity of relationship and establishment that they have an account.

So just as you're -- go beyond 20 years, et cetera, like that relationship, and I would imagine reputation, et cetera, will continue to help you, I guess, avoid those losses that you think is a very...

And probably already is and actually helps us in expanding because you get clients who move to a new company, and they bring us in very frequently.

Right. So at the outset this afternoon, you described Endava and your approach to leveraging agile development, and it's clear that you've embedded your near-term -- nearshore teams with customers in a way that -- or at least have access to them in a way that makes for a very compelling case, for sure. What do you make of some of the larger competitors that are trying to succeed in distributed agile? Like where is your persistent advantage likely to be even as they try to onshore themselves?

Sure. So that you've touched on there, sure. Most of them have an offshore rather than nearshore delivery model, which means they don't have the time zone overlap with clients for that really close, iterative dialogue, that communication that makes agile work. Second one is the cultural area. The culture that you need in order to do agile well and particularly in a distributed way is not ubiquitous by any means. So the ability of people to really push back and challenge and wrestle with clients around what's the best way of doing things, what technology can do, what the client's business issues or concerns are, needs very, very close dialogue over a video link by every single member of the team. And many of our competitors don't have the people who are able to have the culture in the way of operating in that way. And then the third is the one that I already touched on when we were talking about Accenture, which is the ability to field multidisciplinary teams who can genuinely work together and you can get the creators and the engineers and the more strategy product guys actually interacting in a really positive dialogue. That's also very unusual. And these are difficult things to create. So we don't see most of the big players being able to do it.

So I want to talk about expansion. You recently opened offices in Texas and California, and maybe I'll direct this question to you, Mark, to begin with, but investors typically understand that there's a shortage of strong talent or at least it can be deer and expensive, particularly in the higher-value services. Can you talk a little bit about the hiring strategy you have in onshore locations? And how you're trying to economize and find the best deals, if you will, as you're hiring people and expanding? What are the things that you're thinking about, Mark, as you go through the expansion phases?

So the sort of close to clients or the onshore locations. So it's where we can get exposure to clients and have those sort of discussions with them. But again, it comes back to that sort of nearshore model that we have. So as I said sort of in the earlier sort of question, about 95% of our people are in our nearshore locations, Romania, et cetera. So it's how do we scale up to meet the demand that we get from the jurisdictions in which we operate. And typically, what we do is we're in cities where we have close linkages with universities. So when we're actually recruiting sort of talent, that's -- 1/3 of those people will come from that relationship with those universities. And we also get a further 1/3 from referrals from existing Endavan. So we know that there's a cultural sort of fit with the individuals that we're onboarding. So when we're actually going out to the market to bring on board the talent, that's the last sort of 1/3, it is not such a big ask in terms of meeting the demand that we get in the front end of the business.

Got it. Got it. And is that something that you see, as you continue to scale, as something that you can continue? Like, I guess, one of the things as an investor, you might worry is, like, well, are you starting to -- do you get to such a scale that you exhaust your pipelines into academia, et cetera, faster than it can be replenished, et cetera?

So we plan quite far ahead. So we have -- we currently sort of every sort of 5 or 6 years, we plan to size the organization to more than double. And giving various people within the organization the challenge in terms of what that will mean. So in terms of actually onboarding people, we will look at the individual sort of countries that we're in and determine which cities we want to go to. And it can be other countries as well. So we're always thinking what that potential demand curve is going to be like and how we're going to sort of satisfy it.

Right. So you -- Endava recently announced a couple of acquisitions: Intuitus, based in Scotland; and Exozet, based in Germany. I guess, John, can you explain how those transactions fit within your expansion strategy generally? Or kind of what was the drivers behind those deals?

Sure. So they're slightly different. Intuitus is a business that was focused on doing due diligence -- IT due diligence and digital due diligence work for private equity companies. Now the reason we went for it is, as you looked at the Endava business, we could see that between 20% and 25% of our business and growing slightly year-on-year has come from PE portfolio companies. And that's been something that's been very central to what we've seen over the years. And so as part of that, it was visible to us that more and more of the PEs are beginning to look at the platform dimension of their investment thesis. As in, in order to get the best value from this investment that we're making, we shouldn't just try and drive revenue growth and squeeze cost to improve profitability. We should actually look to see if there's a platform opportunity where the -- in exit terms, if we can go, we're driving the revenue, we've improved profitability and we have an amazing platform that you could utilize and scale, they're then getting much, much larger returns. And we would have been helping them to deliver those transformative platforms. So Intuitus was all about opening that market up and giving us much, much bigger access to the PE conversations around those investment thesis and what you can do with it. Exozet in Berlin more of a digital agency engineering capability, but was really going to accelerate what we're doing in Continental Europe, particularly in the DACH region, Germany, Austria, Switzerland, and -- but also had some real capabilities in the broadcasting space, they had a small gaming capability, which is an area that we haven't been in before, but which is growing strongly and actually starting to feed into some of the business model stuff that we're doing with clients. And then they had a strong capability in the automotive space, which is a big area in Germany to get into. So you put all of those together and it just was a real step forward as well as being a great team that we wanted to pull on board.

So I want to go back to something that you mentioned related to the Intuitus acquisition and kind of the aspiration of the private equity customers that they have and you're attempting to address and with their portfolio of companies, like everybody has, and maybe rightfully so the aspirations of being able to be a platform, et cetera. But what about, for you, specifically at Endava, I mean I think one of the things that we find interesting is like we listen to the VC panel earlier today or we talk to investors, et cetera, and you see this like ongoing massive private investment in new software solutions, et cetera. And a lot of times, they don't come in through the front door. They come in through a team that needs them or feels like they can improve their output. How do you -- is there an opportunity for you to, I guess, platform or standardize some of your frameworks and delivery mechanisms, so that you can help deliver things even faster and maybe incorporate some of the new tools that are out there? Is that something that it makes sense for Endava to help companies with and that you need to focus on yourself? Or is it always going to be kind of a lot of manual labor and lifting by the company?

So we do what you're describing as a matter of course for all of our clients. It's not just about start with nothing in code. There's huge utilization of tools that are in the market. And that's part of the next-gen technology that we're talking about that we utilize. It's why you can do prototypes in 2 to 6 weeks.

And are those tools rarely available in the market? Or what's specific to you? I'm just trying to understand like what maybe is your own expertise versus what is specific to reusability from Endava?

So we create some tools which are around being able to do analytics, being able to understand problems of existing systems because you have to plug into them and so on, but we -- and driving productivity and performance of our teams. But we don't build tools that we're going to license to clients as products. And the reason we don't do that is that it undermines the relationship we have with our existing clients. If they feel that we're harvesting the nail out of it to create that product we're then going to use to compete with them, it makes them uncomfortable as a services business working with us. So with the work we do for them, they get the IP. We get the know-how, and we can go and talk to other people in the industry with that.

Interesting. So let's talk about expansion in Europe. You talked a little bit. Are there head count challenges there? Like Adam Wood sitting over there very, very aware, like a lot of the IT services companies trying to expand in Europe and the challenges. What are you seeing in terms of being able to expand in Europe?

Are you talking close to client or in...

Just in -- yes, to be close to client, but just in terms of finding head count and resources that you need to address...

Yes. So I mean Mark, touched on this a little bit. So our whole focus is around in the cities that we operate in, establishing ourselves as the premier employer brand to work for. And we are able to do that because of the interesting project work, the nature of the projects that we're working on, make it a particularly exciting group of projects for the creators and the engineers who'd want to join us. Secondly, making it a great place to work in terms of the culture. That message gets around in the cities that we operate in. And then thirdly, Endava is a strongly growing organization. And so people get career opportunities, where the opportunity for promotion and taking on greater responsibilities is very high. And that message gets into the city. We clearly help to get that message there, and that helps to attract people into the business.

So I should have asked this from a high-level question maybe at the outset. But historically, investors have looked at the linearity between head count growth and revenue growth in the IT services industry, but it's clear that your revenue growth outpaces your head count growth pretty substantially. What are kind of the key things that you've done to break that linearity?

So I think it is all about the added value of being able to deliver a product that is helping transform client businesses. And so that helps with our pricing. When you deliver real value to clients, they get in much less of a wrestle with you around unit costs and all the rest of it because they're seeing the value come through in their wider business. So that's a big part of the nonlinearity. But also some of those tools around being able to investigate where issues is lying in the existing systems, drive productivity and so on also from a client point of view takes the pressure off that. So most of the nonlinearity is coming through in pricing benefit.

Good. Good. We've got a few minutes here. Any questions from the audience? Yes?

Just a quick question on go to market. If you're not doing a lot of RFPs right now at about $400 million run rate, are you worried about being able to find enough revenue at a bigger run rate?

So -- a good question. I mean so for us, the revenue growth comes from scaling our existing clients. We see 18% to 19% growth on average of our existing clients spending more with us in following year. And then finding some of those new clients that's going to top-up that 18% or 19% into the mid-20s. So the volume that we're hunting for in the new client space is relatively low. And it is all around the ideating product and so on. Now the focus for us in order to address that how we scale problem is around finding and growing relationships with larger and larger clients. So the focus we have, if you look over the next 7 years, is how do we need to scale the clients that we engaged with and scale what we do with them, I suppose, rather than scale the clients, so that that actually enables us to continue scaling the business. Now that doesn't necessarily force you through a new relationship RFP process because the RFP comes later in the process when you struck a relationship with them. You still do an RFP, but it ends up being much more single source. It does mean we steer away from these huge RFPs that you've seen organizations do in the past. But my belief is that it's healthy. What they end up with is large, they have pieces of business with a margin issue. And you can see that in the performance of those businesses, frankly.

Any other question?

Just a few short questions, if I might. Just I tried to look at your P&L, I couldn't tell what your gross margins are. If you could provide that. You have long-term margin goals of 17% as you're running above that. What would make it go down? And just, again, if you could provide organic growth numbers because I couldn't tell just from the P&L kind of what are your organic growth rates?

Yes. So our organic growth is typically over 20% constant currency. The last quarter, where we had headline constant currency growth of 24.5%, did get a contribution from M&A, but say that's about 1 percentage point. So that gives you a sense of the range of the organic constant currency growth that we have. Gross margin...

[indiscernible] maximum growth rate?

Yes. Broadly, yes. It can vary from quarter-to-quarter. But since IPO -- before IPO, we've been growing at that plus 20%. The other question was about gross margin, I think, that you had. So last quarter, we were at 45%. There was a number of -- there was a one-off in there due to an Argentinian fiscal credit. But our adjusted gross margin has been pretty strong. Pre-IPO, we're around 38%, et cetera. And we were up last year around 40%, 41%, and it has been at that level for the first 2 quarters of this fiscal year. That should come off a little bit because we have our major pay round 1st of January. So we will lose probably about 2.5 percentage points on there. But our adjusted gross margin, certainly for this year, is around sort of 40% to 41%. Now coming back to the adjusted PBT margin. When we came into the IPO, we said that we had an aspirant target of 17%, but we were operating at 15.5%. So we've already sort of achieved that in fiscal year '19. Part of that was due to elevated levels of utilization, just around the low 70s for us. That is -- this current year, it has been at our long-term sort of average, which is high sort of 60s. But what we've also had is investment in SG&A as being part of a sort of public company. So we have more investment in SG&A for the balance of this year to put in place. And then we will take a view about what our long-term adjusted PBT margin will be basically for fiscal year '21. I imagine that we will have a better view on that when we get towards our third quarter results, because we'll see the balance of this year out, and we'll also have insights into next year when we're almost concluding our budget process.

So John and Mark, just to finish up, we're out of time here, but if I look at the things that you've said, et cetera, I mean is it still the aspiration to essentially double head count every roughly 6, 7 years going forward and then get revenue leverage on top of that and continue to grow faster than head count?

So we would expect to double head count more quickly than 6 or 7 years. It would be pedestrian by our...

Right. But that's still...

Standards and expectations. But yes, continue to see good growth and continue to see revenue per head moving up.

Right. So I'm going to guess, if you're -- yes. So if you're doubling faster than every 6 years and then you've got revenue per head going up even -- continuing to grow, then I think that's kind of a long-term target of 20-ish pretty easily, it seems like.

Yes. Absolutely.

Okay. Good. Well, thank you very much. John, Mark, thank you for joining us today.

Thank you.