Endava plc (DAVA) Earnings Call Transcript & Summary

Good morning. I'm James Faucette, the U.S. IT services analyst for Morgan Stanley. Thank you very much for joining us today at this year's virtual Morgan Stanley TMT conference. Before we get started with John Cotterell, CEO of Endava, I have a quick disclosure to read. For important disclosures, please see morganstanley.com/researchdisclosures. And with that, we will kick off with John, CEO of Endava.

Look, Endava had an incredibly productive year to wrap up 2020. The outlook is obviously fantastic, John, for 2021. I guess for me just thinking about demand and starting off, we continue to hear about the demand environment outside of pandemic-impacted industries. How are you thinking about that demand in context of your outlook for 2021? And I guess maybe you built in, in a little bit more nuance there is -- what is currently contemplated from a recovery perspective particularly around the pandemic-impacted industries and adjacent verticals? And so just how have you formulated your outlook? And what's your feeling for '21 right now?

Sure. So hi, everyone. Good to be back on, even if it's in an online format. So as we all know that the pandemic crisis has triggered a massive change in consumer and business behavior as lockdowns and caution has moved people online, et cetera. Now for Endava, that acceleration has more than offset our exposures to industries that have been negatively impacted by the pandemic. So -- but I think what it's done is it's underlined the importance of a digital agile approach to business because the organizations who have that approach have been able to respond much more quickly and actually even benefit from the massive disruption that's been going on for the last 12 months. So going forward and what we've built into our expectations from guidance is that those changing behavior patterns amongst consumers, including that massive surge to online, the reduction in usage of cash, the higher working from home where possible is going to further accelerate that need for digital and agile capability in our client base. So we continue to see new opportunities, areas with clients arising from that, areas where we can ideate and drive change with our clients. Our guidance for fiscal '21, which is to the end of June, is for constant currency growth of between 22% to 22.5%, which reflects a continued recovery in the second half of our fiscal year. Now this growth is really driven by that subset of positively impacted industries. And whilst we're not expecting the negatively impacted sectors to contribute meaningful growth over this period, so it's the positively impacted industries that are still driving that growth rate. Once those negatively impacted sectors start to come back, we'd expect that to be incremental as activity revives there.

And John, can you talk a little bit about the negatively impacted industries? What the conversations, if any, you're having with them in anticipation of those coming back? And I guess how are you thinking about what the budget and engagements are going to be like as those impacted industries start to come back?

Yes, okay. So I mean one of the things that is worth calling out is that our exposure to sectors, the specific sectors that were hit such as travel, hospitality, some areas of retail is actually minimal. So it was about 3% of revenue. But we do have areas in the less impacted -- the -- related to the impacted industries, things like travel insurance, consumer FX-related activities, cross-border payments and so on. So the investment restraint is not just within those specific industries. It's cascaded into some of the others that we're strongly into. Now the conversations with clients are actually getting more encouraging. They're starting to look over the hill to business coming back. They're starting to look at what the impact of -- the shape in which business will come back has on the way in which they're going to operate and realize that they need to start doing something about that now. So we're getting those early conversations in some of those industries and those related areas starting to happen, probably over the next 2 to 3 months moving into those initial ideation phases and things starting to happen. But only a small amount of that right now.

Interesting, interesting. And so I guess with that limited amount that's happening in conjunction with the rest of your business, how do you think about the potential paths to upside or -- and getting your growth aspirations and targets for this year? It seems a little bit crass to even be thinking about upside, let alone just serving that 22%-type growth that you're looking for. But how are you looking at that opportunity for upside versus really just having to find the resources to deliver on the 22% growth?

So you have to do both. You have to keep them both in balance because obviously, if you turn up a lot of opportunities but you haven't gotten the staff to do the work, you don't get any benefit from it. So we have to keep that in balance. The -- and there is a strong ramp up. Let's not forget that in that growth that we're talking about, there were a couple of quarters that were fairly flat in terms of the client demand plateaued through the summer. So actually, to achieve that step up, we've had to accelerate beyond historic levels acceleration, which is what we're in at the moment. And that is putting urgency. Clients are wanting teams ramped up perhaps faster than they historically used to because the urgency that's hit in that business is higher. And that then cascades through into the -- the recruitment exercise around onboarding ahead of demand and all of the rest of it that we're doing. So it's not a business as usual. It's a business with the full-on accelerated dimension. I think that's probably what you're alluding to there.

Yes, for sure, for sure. So you mentioned in your -- about your -- with your conversations with those that are starting to kind of look over the hill and this process of ideation. And given the ideation, the production nature of your engagements has really helped to add a meaningful number of 1 million count plus customers. For that type of engagement, what is the typical time line around ramping those engagements to get to that hurdle? And do you see that number of those types or the number of those types of engagements increasing meaningfully in the near term or even in the near to medium term?

Yes. So I think what you're picking up on is that we've seen the growth in the number of clients who now pay us more than 1 million in the rolling 12 months, has stepped up to 75 from 65 a year ago. And that is coming from those new clients who start with an ideation phase or a proof-of-concept phase. What that is, is a small assignment where we can show how technology can impact our clients' business model. And then as that's brought to life through that assignment and the client can start to really visualize and see the impacts it's going to have on their business, then they scale it up into production systems, significantly expanding the activity and the client footprint as we're doing that. Now in terms of how long that takes, it's actually, as you can imagine with the process lines, it's a huge range. Some will move very, very fast and it will take 2 or 3 months to get to significant levels, even the 1 million type run rate levels per annum. But for others, it might take a year or even 1.5 years. So there's a very, very wide span. The one thing that I would say is that there is evidence at the moment, as I touched on a moment ago, of acceleration because clients are responding to a higher level of urgency in the pressures that are coming from the marketplace, so...

Yes, for sure. And then to your point, it's like being able to add 10 million plus customers last year. What -- any sense of -- or can you give us a sense of like what that retention or longevity is? What -- how many of those 1 million plus customers have you intended to lose over a period of time? Is there a natural life cycle? Or are you basically being able to retain everybody and find incremental services you can deliver for them?

So the retention levels are very high. I mean the number that we tend to cite is that in each year, between 88% and 90% of our business has come from people who are clients the previous year. And that's sort of the revenue that we're earning, it's not just numbers of clients. So obviously, with 20%-plus type growth, you can see a huge proportion of the growth is just coming out of the client base that we have and then adding incremental clients on top. Some clients do go -- some clients just grow and grow and grow. Some clients go through a life cycle where they've got a new program area or a new product area that we're pushing out. And it might get very busy for a couple of years, and then plateau will come down slightly and then you'll get the next wave a year or 2 later. So it's not always inexorable growth. You do have some growth and slowdown with mainly the medium-sized customers. The big ones, there's much more opportunity to just keep growing and growing.

Got it. Got it. [Operator Instructions] So let's go back to something we touched on a moment ago in terms of the high level of demand overall and how you're managing utilization and supply dynamics. And in particular, what are you doing about recruiting? How much bench do you want to be building right now versus keeping it fully utilized? And I guess that balancing act of not getting too far ahead of yourself but also staying enough ahead of the curve that you can deliver as customers need, particularly -- as I can imagine, especially for a lot of these customers, they have very much like, "We need it now" or "We need it yesterday" type of attitude when they're engaging you.

Yes. So I mean obviously, bringing the people into the organization is as fundamental to the growth. It's actually opening up customer opportunities, doing a good job for them. One of the things that we did over the last year was that we made a decision to continue recruiting, albeit at a slightly lower level during the height of the pandemic through our summer. And we didn't lay off any of our people during that period either. So actually, given that we had a bit of a plateau, we -- in terms of the revenue side, we built a bench during the crisis with the view that we'd be better prepared to meet demand when it returned. And it was the right decision. So our utilization rate now is back in that high 60s, the way we measure it, which is what we target. And we continue to recruit based on the demand that we forecast. I mean we are a business who reforecasts every single month. So at a project level, our people will reforecast the expectations that the client has set around how long the project is going to run, whether we're adding new team -- new people to the project or new teams to the project, when those are expected to start up and so on. So every month, we get a refreshed view of the demand within the business. And we're able to use that to then very intelligently drive what we're doing with our recruitment teams. And then in terms of actually being able to execute on that, we're a very strong brand in our markets. We've always set out to be the employer of choice in the cities that we operate in. As a result of how we operated and responded to the pandemic, we're seen as a safe haven in these times where people still feel little bit of uncertainty. So as a result, we've got very, very low attrition. For the last 12 months, we were around the 8% level, which is currently stabilized at that level. It dropped from low double figures pre-pandemic. And that helps as well because obviously people are not leaving the business. We don't have to recruit to replace. And then the recruitment is actually running well. It's -- I think there's some sensitivity in the market whether it's harder to recruit people in these pandemic times because no one's changing jobs. Whilst we have very low attrition, we're not finding it harder to recruit people than we did pre-pandemic.

That's an interesting comment. And I want to pick up on a couple of things that you said there. First, how much visibility do you have into the supply and demand, both in terms of like what you see coming down the pike as well as what the recruiting cycles are like? You said just now that your attrition levels are very low. You're being able to recruit well. But is that following a pretty forecastable trajectory so that you can match it up to the demand that you anticipated? And how much visibility do you have right now on that balance?

So yes. Because the business is constantly reforecasting, we -- it also gives us the benefit of where we want to do rotations and so on, and we can see where the opportunities are emerging. And that helps us manage having teams with a good mix of seniority and Endava experience as you're pulling in new recruits into the business. So worth calling out as a key to enabling that scalability. In terms of the forecasting, that gives us a very clear outline of what's expected to come in over the next month, 2 months, 3 months and so on. I think one thing that I touched on earlier in our conversation was that there's a higher degree of urgency right now than has traditionally been the case, meaning customers are coming and going, "We'd like a team in place in 4 weeks' time or 2 weeks' time," sometimes instead of the normal sort of 6-week type conversation that we would have. So that is a tougher from a forecasting and getting it right point of view. And to be honest, there probably is a little bit of that demand that we're not getting to as quickly as we would like because we're delivering on 4 weeks rather than 2 weeks. But then we deliver. One of the things that we do is deliver fast. So we catch up for the client on a delayed start.

And what are you finding in terms of costs and pricing, both in terms of hiring talent? Like what's happening with that pricing environment and then your ability to pass through it? I guess I've got to imagine, if you've got customers who are like, "We'd like a team to assembled in 2 weeks," is that the price sensitivity maybe isn't very high. But that's my supposition. I don't know if that's true or not.

Well, it depends on the client. If you've got a framework agreement, it's at the price you've agreed. But as I've mentioned, there's a lot of new activity with clients and obviously that the time pressures in the urgency does -- for those smaller pieces of work that kick things off enable us to have sensible but good price discussions with our clients. It is an area where we have, over the years, as you all have seen from our previous sets of results and so on, been able to do well at getting sensible price step-ups each year. There was a little bit of a lull in that over the summer, maybe as much down to us as our clients were seeing what was going on in the world. We probably pulled back a little bit on price pressure. But we are definitely back to normal in terms of pricing discussions and being able to adjust for the inflationary pressures that we have in our business and pass those through to clients in a sensible way.

And so if you're saying that the pricing discussions are back to normal, does that -- should we also infer from that, that the inflationary pressures on hiring and talent and recruitment are also relatively normal right now?

Yes. So I would characterize it as we are -- the step-ups in -- while we pay our people as they progress as they get more experience, et cetera, is normal. We're not making savings on what we pay our people just because we're in a pandemic.

That's right. That's right. So I want to turn now to kind of forward vision and where you're headed. And central to our thesis on IT services here at Morgan Stanley has really been the importance of M&A. And that's something that you at Endava have been very good at executing on. In the past, you've talked about the desire to expand in the U.S. and in APAC via acquisition. How are you thinking about timing? And beyond cultural fit, what are you looking for from a technology capability perspective?

Yes. So I agree with you. I think M&A has an important role to play in our business model. I mean important to say that strong organic growth is the fundamental. And we always want to make sure we're keeping that organic growth at the 20%-plus level. But then, augmented by the right tuck-in M&A actually helps us to build out our business mix, extend the business in directions that would be tough to do on a pure organic model basis. And you did touch on the cultural fit. That is always the first question when we're looking at an M&A discussion. Does the business culturally align with Endava? Culture is not some ethereal thing. It's how we do things as a business. Are we -- are they agile? Do they have that ideation DNA? Do they work with next-gen technologies? If they don't have that, they're not a cultural fit. They're a different sort of business to us. So it's not some ethereal behavioral thing, although that is also part of it, for instance, the agile dimension. If that isn't right, then I know these businesses are going to be difficult to integrate, and so we just don't go there. So that is the first thing that we look at. But then beyond that, what we're looking for in acquisitions are firstly, geography. Is it going to help extend our footprint, whether that's in client geographies or in delivery geographies, delivery being the number of cities where we recruit and expand? If it's going to help us push our footprint in the places that we're looking to extend, then that's number one. Secondly is around the verticals, strengthening our emerging verticals. And it is worth saying that emerging vertical is not just about trying to move into every vertical out there. We very much have a thesis around what are the verticals that are being transformed by the technology waves that are coming through and then focusing in on those and how Endava can help drive that technology change. Long-wave changes, things like how autonomous vehicles are going to transform the mobility space. It's a long-wave change, but there are so many steps, technology-enabled steps that the world and business is going to go through to get there. Endava is all about helping our clients ideate those and drive that change. And then the final area that we look at is around -- and this is to a much lesser extent, is around the technology space. Is there a technology where we feel we've been left behind? And you all have observed, we actually end up doing relatively few of those because we tend to build the technology capabilities that we need ourselves. But occasionally, there's a deal that comes along that augments that. We did one in the Salesforce space with a little business called Seers nearly 2 years ago, and that's been good. That's nearly doubled in size as a Salesforce practice for us since we did it. But the business needs to be growing. They need to be agile. They need to be demonstrating strong value through revenue per head and margins before we'll look at them.

So can I ask you, John, is -- when you look at a -- 2 things. Are there top 3 or 4 verticals that fit the description that you described that are being transformed in a way that Endava can play a critical role? And then secondly, I get the acquisition for customer footprint and that kind of thing. But what's the motion around delivery changing or expanding delivery footprint? Is that just to be match with the customer sets? Or maybe you can expand on those 2 things, the key verticals and then the importance of delivery location, et cetera, for Endava?

Yes. So the key verticals, the waves that I've mentioned on some of these, on the earnings calls over the last few quarters. So last quarter, I was talking about the health tech space and the technologies that are coming through that starting to transform the way in which clinicians can work with patients, either remotely or data based and analytics that they can do that can actually enable much better outcomes. In the personal health space, the sort of apps and data and inputs you can have in terms of people's lifestyle, et cetera, these are all areas within the health space that are being driven and actually accelerating. Mobility is another one. I just touched on that, so I won't go through that one again. Payments, one that we're already in. The long wave is a move from very explicit payments to a sort of frictionless payment world where the system is able to work out that you walked into a shop and picked up a good and left and charges you appropriately. As we start getting into those sorts of spaces, the payments world starts integrating deeply with other industries. You can see how it starts impacting the change in business models in retail through that example I just gave. But also going back to the mobility one, the way in which you pay to move around or move goods around will become much more micropayment oriented, the way in which therefore the payments rails as an enabler as much as technology is fundamental. And so we were able to use those 2 planks of strength in that. You've also got the whole convergence wave around media and broadcasting and telco. And actually, the position that we've taken in that is strong and accelerating as well. And there's a payments dimension to that one as well. So does that give that bit of color on the verticals?

Yes, it does. That's great. That's great.

And then on the delivery footprint, we essentially run to a model that says when we go into a city, there is a certain level at which we can recruit people in that city without massively overloading it and causing inflation spikes and so on in that environment. So as our business grows, in order to not exceed those limits in individual cities, we need to expand into the number of cities that we're operating in. We don't have an India model that says we've got Bangalore and it's just enormous. So that's the reason why we need to expand our delivery footprint.

Got it. And then last question to wrap up here, John, on M&A. Is there a specific algorithm that you kind of are working with or towards as it relates to M&A, whether it be a percentage of free cash flow or how much inorganic growth you'd like to contribute per year as a good measuring stick to make sure that you're staying up at the leading edge? How do you think about that? Or is it almost purely ad hoc?

No. So we do have a model. It's not one that we publish because we don't want expectations to rise ahead of the organic growth that we know we can deliver because obviously, M&A comes and goes a little bit. We'll have seasons where we probably get lots of good opportunities and have other seasons that might be a little dry. But evened out, we would expect to expend most of our cash that we generate. And we're pretty cash-generative to push that into M&A and add incremental growth through that.

Well, that's great. John, that's all the time we have today. Thank you very much. We really appreciate you spending time at the Morgan Stanley virtual TMT conference. Really looking forward to how you can continue to drive the business. It's been impressive obviously thus far, and I'm looking forward to the things that you're doing. So thank you very much for joining us today.

Thanks, James. I appreciate the time.

Thanks to everybody, and have a good day.

Cheers.