Endava plc (DAVA) Earnings Call Transcript & Summary

Great. I think we're live. Thank you for joining us, everyone. For those who don't know me, my name is Charlie Brennan. I head up the software and services coverage in Europe for Credit Suisse. I'm delighted to have the CFO of Endava with us today, Mark Thurston. Thank you very much for joining us.

No, at all. Great to be here. All we have that remotely, as they say now.

Yes exactly. Just in terms of the format of today, we're going to host a fireside chat. I've got some prepared questions here. But if investors want to e-mail me any of their questions, I'll try and weave them into the conversation as well.

And with that, Mark, I think we should go straight in. And in particular, I'd like to start by picking up from 2 of the key messages that I took away from your last set of results. And firstly, it sounds like business conditions have normalized quite quickly for you. Given the ongoing uncertainty with COVID, it feels like you're coming out of this period quicker than others. What sort of metrics are you watching that's giving you comfort on that normalization? And why do you think you're seeing a recovery quicker than others?

Well, I think we're normalizing might be a better work rather than we've got back to normal. But yes, demand visibility is very much improved from where it was, certainly sort of 6 months ago. And the basis for saying that is we forecast the business every month. We look at the revenue that we can see. We split it into contracted and committed. And we look at that as a percentage of the revenue that underpins our guide. And we've seemed to have gone back to our historic norms as far as that's concerned. And then in tandem with that, the pipeline is strong. I mean we don't give order book because the level of order intake is currently ahead of historic norms. And that follows on the back of we had a very strong Q4, which was the quarter to June, which you referenced with the order book intake being about 2x sort of revenue. And then looking at the supply side, we're responding to that demand. So we're accelerating recruitment at the moment as we enter that demand curve, and we can see that we've had low levels of onboarding whilst we're in the pandemic. So we're having to really sort of rev that up as we speak at the moment, and bench has been high. It has been coming down to particularly sort of low levels, which we have seen, which is a testament to the recruitment that we're doing. And additionally, sort of attrition is very low. We should expect in a period like, this is probably lowest we've actually ever seen at Endava. So we're getting back to normal, but not quite there yet. So I think it's going to take a quarter or so for it to work its way through before we can sort of say that we're back where we should be. And obviously, it's dependent on what happens with the pandemic, which it looks like, touch wood, that we're starting to turn a corner as well.

And you said that contracted revenue as a percentage of budget is back to normal levels. That implies your new business needs to be normal as well for you to hit your budgets. You said the pipeline was looking strong. But can you say anything about the conversion of that pipe? Is -- are you having to assume a lower conversion factor than normal given the uncertainties of COVID?

No, not really. We always have a sort of waiting around the pipeline. So how opportunities are progressing through it. And they are sort of progressing at the same velocity in time. You get obviously eventual hiccups. Whether we can say some of that delay is due to COVID, it is difficult to pinpoint. You get some friction in terms of the interactions because of the virtual nature of it. You sometimes get a little bit of pause from week to week. But it feels like sort of the velocity of the opportunity is going down the pipeline the same as they were sort of pre-COVID. There's nothing really that is standing on that sort of pipe and slowing the progression.

And if we think about the capabilities within Endava, are there any particular skill sets that you're seeing accelerate harder? Are there any skills that are sort of lagging behind in demand at the moment?

I wouldn't say so. I mean it's been a relatively short-term phenomenon. If you think about it in terms of what we saw -- in terms of the demand stopping or slowing very precipitously. It was about sort of 3 months or so really. And we've had the sort of competencies that we require, or we believe to meet the demand. And we've slowed that slightly down in response to the slowing demand. But the actual bandwidth and breadth of capability is still there. I think in terms of the opportunities that are coming through in the COVID environment, there's probably a little bit more focus on data and automation. But actually, I think we're pretty well equipped to be able to deal with that. So I wouldn't say that we're suffering from any sort of gaps in our capability in meeting that demand.

And if I think about the other theme from the last set of results, it was all around more focus on the mobility sector. Do you think there's a conscious decision within Endava to try and diversify away from financial services? And can you just give us a sense of how important you think the mobility sector could be on, say, a 5-year time horizon?

Yes. I suppose there is -- I mean Payments has been very good for Endava. I mean Payments and Financial Services is roughly about 50% of the revenue. And we've done a really good job of riding that fintech wave, and it continues to be a very productive sector for us, and a position of strength as a flywheel that just keeps on going. But we need to sort of broaden out into other sectors. We only have the sector what we actually call out TMT. And then within Other, which is where mobility sits, that's where we actually see quite a lot of traction. So we are consciously looking at the industry verticals within Other, which mobility is the one that we are pretty sort of excited about. And it's quite broad, and it's -- I don't think it's a well-known sort of term, but we tend to think of it as covering the movement of things, people, objects. So it will cover traditional sort of sectors such as logistics, travel, automotive, et cetera. And I think there's also a linkage with payments, because as these sectors blur and change and evolve, then there will be a different way of monetizing them, which is, I think, where our sort of payments pedigree comes into it. So I think it's a long-term trend. I think as John, our CEO, pointed out in the earnings call that we can see overcoming over a number of years. And I think we've got the skill set to take full advantage of that. I don't think we're going to significantly need to sort of upscale or scale up in different areas to meet that need. So I think we will see Other grow. And I can see potentially mobility being a sector that we would pull out separately from investors to get a sense of the progress that we're making there.

If I think about some of the specific customers that you referenced, you talked about customers like Royal Mail and Aer Lingus. I think about these customers as being financially challenged over the medium term. Just how do you think about allocating resource to these sort of customers versus someone like Worldpay that's in a structurally growing market? I'm just wondering whether it makes sense for you to be allocating time to companies like Royal Mail?

Yes. Well, maybe that's true at the moment, and as they're dealing certainly with the impact of the pandemic. But once we're through this, they're exactly the kind of businesses that need to look strongly or closely at their business model and figure out how they adapt post-COVID. And we have a relatively sort of minor exposure to those businesses at the moment. But you have to plan for the future. So our decision around resourcing are always a balance for us between building strategic relationships which, for us, as we sort of -- we were just talking about industry verticals. So it's expanding our industry vertical footprint and meeting the demand in established sectors, so like Payments. But we typically don't really face those decisions or decision points where we have to turn work away, because we continue to sort of building that capability and relationships and continue recruiting the talent into the demand curve that we see. So we carry, what we call, a strategic bench, which is particularly large when we were at a high point of, sort of, COVID. But we carry it there, so we can flex and respond to the demand. So it's not a case of we've got 2 opportunities, and we sort of pursue one. We're in a position where we can pursue most of them and not put the business at a disadvantage by doing that.

Talking about opportunities, maybe we can go on and talk about M&A. I guess it's quite hard to do M&A in a virtual environment. Has this period led to a hiatus in the funnel of opportunities for you? Or have you managed to keep those rumbling along? And when we think about the future M&A pipeline, what sort of skills and capabilities are you looking for? Is that geographic expansion? Is that vertical market? Is that technical skills?

Yes, yes. So for us, our focus is geographic growth coming out of our sort of U.K. strike routes, both from the demand revenue perspective and, let's call it, supply, which is where the talent pools are. So we have a steady intention to grow in North America and Continental Europe as distinct from the U.K., certainly in the medium term. And over time, we wish to expand the rest of world geography, which is about 3%, which covers both equally at the moment, Asia-Pac and Middle East. So we have these geographic ambitions in terms of where the work is delivered, but that puts demand on the near-shore delivery capability. So we need that near-shore time difference to be small, to be effective and creative when we're delivering solutions for clients. So what it means for delivering work to Continental Europe is we need locations in Central Europe. So we did the acquisition of CDS Comtrade in August, so that added additional geographies for us in Slovenia and Bosnia. And similarly, for North America, it will mean us looking at LATAM and increasing our footprint there and looking at other countries in which we can tap into that talent that we need to deliver. Now for Asia-Pacific, where we have a particular sort of interest, that delivery capability in that region, we actually don't have something that is in that same time zone proximity. So we're going to have to sort of focus how we actually achieve that. We're not going to do it through greenfield site. We're going to have to do it through M&A. So the geography vectors are really the ones that are driving things at the moment. And if as part of that search, we pick up on particular companies that have a focus on an industry vertical, like mobility or health tech, for instance, then that is an added attraction. So in terms of the pipeline, we're still getting lots of opportunities that are coming through. We're looking very seriously at them. But being part of a people business, we want to make sure that we get some sort of face time with the management team that we would want to join in on, because the cultural fit has got to be strong. And that is the most difficult piece to do in a COVID environment. We can do it -- say, in North America, as we have a good team there, who we can take their sort of judgments when they meet a potential target. And we have managed to do it with the CDS acquisition in Europe. But if it's going to be further afield out of our established geographies, like Asia-Pacific, it's going to be a little bit more challenging, and we're going to have to, I think, probably wait until travel restrictions, this is transcontinental get relaxed somewhat. But in terms of the opportunities that are coming through, we're seeing a lot. So it's being selective and then thinking can you actually execute on it.

I guess deal sizes have been edging higher over time. I guess that's consistent with you being a bigger company. But have you got anything that's transformational in the pipeline that could add 50% to the critical mass of the group?

So we wouldn't do that. For us, it's always bolt-on, mainly because of the 2 reasons. It's the culture. So if you bring in 50% headcount, that is a big cultural sort of challenge, and we would probably spend a long time trying to integrate. The other thing is we have one way of doing things. The Endava distributed agile scale, as we would call it. So people coming or firms coming on to, let's call it, our platform, have to adopt to our platform. So a life-changing acquisition for scale would be extremely disruptive. And I don't think it would work for us. It's always going to be bolt-on, and bolt-on is probably 10%-ish, it could stretch 12% around those sort of limits. And so we wouldn't be doing something that would be, for us, over 1,000 people or something like that. That would be probably a bit of a stretch. Certainly, to 10%, 7,000, you're looking at 700 that -- but if you're looking at 1,500, 2,000, that is just too big, fivefold.

Yes, yes, yes. Makes sense. And can we just think about a different dimension of M&A, which is M&A in your customer base. You've obviously got some customers who are involved in large M&A. Are there any combinations at the moment that are giving you any cause for worry? And just as an example, can you walk us through what happened when Worldapy was acquired by Vantiv, that was acquired by FIS. Just what happened to your wallet share as we went through that merger process?

Yes. So M&A tends to be good for us. As some of the drivers for those transactions is the underlying tech, which we have usually been a key part in building in the target in those transactions, certainly in the case of Worldpay, that was the case, because we all work with Worldpay. It's basically about speeding up their time to market by their merchant acquiring platforms. And then we built out from that. We brought into other technologies such as e-commerce. So Vantiv and then subsequently, the acquisition of FIS, hasn't really changed that basic need, and that sort of direction of travel that those technologies are taking, because they need our help to continue to sort of evolve and deploy those products, which is essentially what we're doing. We're essentially building products for most of our sort of larger clients. So it's usually a continuation of that process. So where we've currently got in terms of FIS, Worldpay, et cetera, we've currently got the highest level of engagement we've ever had with them. We signed a 3-year MSA extension with them, and we're on FIS' preferred supplier list. And we're working on new opportunities with them and exploring how we can help them in areas outside the payment space. So it's -- I tend to not be too worried about consolidation in the -- in our key customer base, because we're usually at the heart of what they do. And when they are acquiring these businesses, they're looking at the underlying technology that has driven success for that target. And we're usually a key part of that.

So we know that Worldpay was a top 10 customer. There are other European payments companies at the moment involved in M&A. I know you haven't given us a detailed top 10 customer list, but how many of your top 10 customers are involved in material M&A transactions at the moment?

Probably about a couple, as you say, one in Europe and one initially U.S. But again, we are seeing that as an opportunity basically for us. We've done work with -- from both sides of the coin, so to speak. So we can see the opportunities that will come from that.

Maybe we should go on and talk about the medium term and some of the financials. Certainly, before COVID, it felt like you were tracking ahead of your medium-term margin expectations. Where do you think we'll settle on the other side of COVID? And where do you think the right margin structure should be for Endava?

So there are 2 components of the adjusted gross margin for us. We've consistently sort of delivered over 40%. And I think when we were coming into the IPO, we thought we'd be around the high sort of 30s, but we've consistently been above that 40%. In our most recent quarter, we got to 43%. There are a couple of reasons for that, which were COVID-related as why it was so high. But I can see us delivering consistent gross margin between 41%, 42%. And the real sort of driver for that, I think, is -- I think the pricing environment is going to remain positive as it has. Despite COVID, we saw a slight stepping back, I think, on our revenue ahead during the real impact of COVID in Q4. Rates have been relatively sort of stable since. So I think we're still and we will be for quite a period of time in that positive pricing environment. As long as we manage our bench attrition and utilization, I can't see our margins weakening below that. And then where we will get, I think the margin accretion at the adjusted PBT level is focusing on our SG&A. So if we get back to the plus 20% growth, we enjoyed pre-COVID, then I can see us leveraging our SG&A, which last quarter was about 19%. And I could see us reducing that by a couple of hundred basis points over the coming years to get us to an adjusted EBT margin that will certainly be in the sort of 19% to potentially a 20% level. And I think that is generally sort of achievable even as we grow internationally at scale.

And how do you think about the trade-off between growth and margin? Because presumably, if you sacrificed a couple of points of margin, you could drive even faster growth. Why do you think 19% to 20% margins is the right balance? And why don't you go for faster top line growth?

I think it's about remaining sustainable. I think, we've always been like we have questions about the sort of utilization. So it's pretty sort of static-ish. It fluctuates between the high 60s to low 70s, and it impacts gross margin, and it does it from quarter-to-quarter. But the model is sort of predicated on recruiting at a steady rate and sustainable rate that keeps attrition in the right place, make sure that the average cost per head is in the right place. So it's a sort of built-to-last model. So if we crank up, say, the demand, then we start to create a potential operational sort of issues for us, because we're known for the quality of the delivery. So we could invest a little bit more in sales, et cetera. It's probably going to be around the fringes. We typically invest about sort of 5% of revenue in sales. We could push it a little bit, but these are all things a little bit at the edges as far as I'm concerned. Because if we push sales a little bit, I think we will get savings on property, talking about when we return to the office. Once we're past all of this work-from-home phenomenon, I think we will get better utilization out of our property, and that potentially creates the space to invest a little bit more in our sales activity to drive for the top line. But I think overall, these are sort of minor puts and takes in the grand scheme of things.

If I think about some of the financials on a more short-term basis, certainly, when I looked at your guidance for Q2, and I tried to back out acquisitions, it feels like your guidance assumes a slight deceleration in underlying growth from around 12% in Q1 to 10% in Q2. And I stress that's my forecast rather than your explicit guidance. But given your comments around the normalization of market conditions, are you just being overly conservative and factoring in some unforeseen disruptions in that guidance? And I guess, given that Q2 momentum, what gives you the optimism that the second half is going to accelerate? Because, again, I think your full year guidance implies an exit rate closer to the 20% run rates that we've seen in the past?

Yes. So we aim to deliver on our guidance. And I don't comment on us being conservative. I think us reinstigating the full year guide that gave us -- well, I hope to convey the sense of confidence that we have in the underlying momentum. And it goes back to earlier comments about improved revenue visibility, the number of opportunities in the pipeline that we're working on. And I think, generally -- sort of stepping back a little bit from it. I think COVID has, to a certain extent, accelerated some of the underlying changes that were already underway under the banner of digital, and we're seeing new and existing customers engage with us on that agenda. So yes.

Good, good, good. I'm conscious of time. So I just want to end up talking about the competitive backdrop. You talked about optimism around firm pricing continuing. Not many of your competitors are talking about upward pressure and positive pricing trends. Who are you seeing as your core competition in the majority of your bids at the moment? And what sort of circumstances do you tend to do well? And what sort of scenarios do you tend to lose out to the competition?

I mean we tend not to be in a competitive bid situation, basically because of the nature of the sort of work that we do. We tend to get small level engagements. We talk about going through this ideation to production process where we're coming up with a solution for a particular problem that a client has. So it usually starts pretty small around a couple of hundred thousand dollars or a little bit larger, and then it increases as we get traction and build out that solution. And then in those situations, we don't tend to come up against other players. Or if we do, it is where they are testing our creative tops, so to speak, where they will give us a problem and they are checking that we can come up with something that's in additive, but also we have the engineering capability to build out on it. So it isn't a typical RFP thing, run this at a lower cost. So those conversations continue to take place. And we haven't really seen any change in terms of the competitive sort of landscape in the COVID environment. We see -- obviously, we see other suppliers and clients. And obviously, people like Accenture, but we tend to be focused on different area of spend within that client.

And some of your competitors, certainly the larger ones, are talking about supplier consolidation. Is that something that impacts you either positively or negatively?

Well, as I said, we sort of work alongside these guys, and we tend to be focused in a different area of spend. So we're not focused on legacy. We're usually involved in projects that are either product in nature or helping accelerate growth or evolve the business model at pace. So we typically don't seem to see this sort of trend. It may be happening in their world, but it's certainly not impacting on us at the moment. So we don't tend to get tied up in those discussions.

Perfect. Great. I think we're pretty much up with time. Thank you so much for joining us today, and good luck with the rest of the quarter. And hopefully, next year, we'll be doing this in sunny Phoenix.

Let's hope so, right, Charles.

Perfect. Thanks, Mark.

Okay. See you. Bye-bye.

Cheers. Bye-bye.