Endava plc (DAVA) Earnings Call Transcript & Summary

Good afternoon, everybody. Thanks for joining us this afternoon. I'm James Faucette, Senior Research Analyst who lead the IT services research effort at Morgan Stanley. And before we get started with Endava senior executive team. I've got a quick disclosure to read, but I'll say hi to him first. Thanks for joining us. So for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley rep. And with that, I'm very pleased to have from Endava, John Cotterell, CEO, Founder. It's been a good run. Thanks for being here with us today and Mark Thurston, CFO.

So maybe we'll just start with kind of the big question that everybody is being asked this week, in particular, and that's around Eastern Europe. As we think about kind of the ongoing conflict there, we appear to be facing a talent shortage supply or a talent supply shortage is getting worse, particularly as the Ukrainian delivery remains in flux, and it's already a tight labor market. You alluded to in the past for some clients who have exposure to delivery in the region, having discussions with you about potentially doing more with you given your lack of exposure to the Ukraine directly. Are you seeing any pickup there? Or what's your ability to capture the demand given the talent limitations? Like how are you helping potential clients and clients navigate the current environment?

Yes. So I mean, obviously, it's a terrible thing, this conflict that's emerged in Ukraine and our hearts do go out to other people out there. But yes, in terms of the business impact, I will reemphasize, we have no clients in Russia, Belarus or Ukraine, and we have no people in Russia, Ukraine and Belarus. So -- the -- in terms of the dynamics of what's hitting us, yes, we are starting to see some clients coming to us who have teams based in those countries, actually more in Russia than anywhere else. I think the sanctions issue is becoming a big concern for clients. And so they're starting to look as to how they source their teams in different jurisdictions. We are, however, more supply constrained and demand constrained as a business. So the priority for us is to select which of those pieces of business are actually long term and healthy for us to take on board in the context of all the other demand that we have. And so we run it through our prioritization process that we have in order to pick which clients we're going to run within that space.

So as you're talking about that, like what's -- you guys have been constrained for a while, and you've talked about kind of picking your clients accordingly, et cetera, the prioritization process that you just mentioned. Are you feeling additional pressure to kind of speed that up, widen the funnel, like how do you -- like where are you feeling the pressure? And what's your response right now?

So for us, we've always maintained that there is a healthy growth rate in terms of headcount, above which we have concerns that the culture and the ways of operating would start to be diluted by bringing so many new people in. And we are -- we have very low attrition as a business where in the last quarter, we were at the 12.5% level. That low attrition helps us to scale because a, we were not replacing as many people who've left and b, the ones who are staying have retained the knowledge of how we operate, that enables us to pass it on to newcomers. As a result of that, we are comfortable growing our head count in the sort of 25% to 30% range. We did more than that last year. Accelerate a lot more -- accelerating out of the pandemic, where during the pandemic, we've become more senior because we didn't let any people go, and we flattened off a little bit and people continue to grow their experience. So that gave us an acceleration point for the last year. So we do see that coming back a little bit into that 25% to 30% headcount growth. We'll see rate rises with clients probably in the 4% to 5% range that would then add on top of that in terms of revenue growth. So it is one of those things we could just go recruit loads more people and deliver against the clients. But our belief is that you start to burn the organization out and in the long term, it would be less healthy than managing the growth through this demand period.

Got it. Got it. So I want to come back to that and all the implications of it, pricing and margins and these things. But one of the questions that we've gotten, so you don't have any customers nor delivery out of Ukraine, Belarus or Russia. What are your operations in the region? And I guess, maybe more importantly, do you have business continuity plans in place in the event that the conflict were to widen outside of the country?

Yes. So we have a Ukraine situation task force as we call it. It's run by my COO, Rob Machin. And they meeting twice daily just to look at what's happening in the region, whether there's any potential impacts, plan for some of the scenarios, worst-case scenarios that might come along, but we all hope won't. The countries that we're in, we're in Romania and Poland, who are in NATO that border with Ukraine and then we're in Moldova that sits between Romania and Ukraine. So obviously, from a worst-case scenario planning, Moldova has the greatest vulnerability. It doesn't have that security umbrella of NATO sitting over it. We have about 8% to 9% of our revenue comes from the teams who sit in Moldova, so it's not a huge exposure.

No, not.

Set against that, between 60% and 70% of our Moldovan staff are EU nationals. They are Romanian or Bulgarian passport holders. And so they have the right come and work in the EU -- anywhere in the EU. But the most natural place for them to go is just across the border into Romania. So part of our BCP planning is that if needed, in a worst-case scenario, those people can relocate across to Romania and work. And that would also probably be true in a worst-case scenario for the others who are not EU nationals. It's one of the things that we're encouraged with our staff because it actually enables them to travel around Europe and the world much more easily than you can with a Moldovan passport.

Interesting. Good, good. So back on kind of jumping around, but it all ties together. So if we go back to the demand environment, it's crazy, robust right now. It's like -- and we actually -- that's been really encouraging. And given the outlook that you gave earlier for this year, it's clear that you're seeing the same kind of demand trends. The biggest question we get from investors generally, though, is -- how much of this current environment is the result in benefiting from a pull forward in demand? So my question really is, well, how are you thinking about the durability of growth particularly in the segment of digital services that you deliver? And what are the indicators that you're looking at to try to forecast or anticipate that durability?

Sure. So within the industry sectors that we focus on, we're always looking for those spaces where technology is driving significant opportunity for business change. I'm thinking of things like frictionless payments or autonomous vehicles or the whole transformation of media convergence of different forms of media into streamed environments, health tech with diagnostics and so on. So there's substantial change, technology-enabled change going on, on a long-term curve in many of the sectors. We focus in that space. We don't just do generically everything in media. We're just focusing on the space where technology is driving that change. So it's been a long-term sustainable demand environment. The thing that's happened with the pandemic is it's caused a lot of boards to become much more aware of how technology is impacting their business and to realize that actually they can't allow the innovators in the space to run ahead of them because their business is not going to be sustainable. So we believe that actually this is a sustainable change that's been triggered by the pandemic pushing these technology revolutions up to board level, getting their attention, getting their support for investment. We can actually see it. If you look at Endava's numbers, we have a much higher number of new customers. People who are doing those ideation pieces of work with us to understand what technology impact they can have. And that's been pulling up into the growth of the numbers of clients spending substantial amounts of money with us. So we can see that pipeline of work that's going to be coming through in the next 12 to 18 months, and it's not slowing down.

So when you look at that pipeline, and I think that, as you said, is this ideation and particularly for incumbents trying to keep up with the innovators, especially in the verticals where you're working at, how easy then or what are you having to do to match that with skills and in your hiring? Like you said you hired a substantial number of people last year. You kind of want to try to limit it to 25, 30 whatever percent headcount growth for all the reasons culturally and business-wise that you described. But what do you -- Like, how do you go and find people that can do the work that you need to be done, particularly if you're going to continue to grow at that clip in these targeted verticals?

Yes. So actually, if you look at our intake of staff, each year between 30% and 40% of the people who join us come on the recommendation of an existing Endava. Another...

Okay. Do you give bounties to them for that?

We do. We do give bounties, yes, not a huge bounties, but certainly we're making those. We also get about 20% to 25% that we're recruiting through internships from university. So through the internship, we can pick the best graduates and then give them permanent jobs coming out of it. And then the remainder of the 30%, 35% balance is what we're having to headhunt in the market. So that seriously shrinks the unknown challenge of where we're going to find people. Through the recommendation side, you're also building part of that cultural induction because people who are arriving already know someone in the business, and that helps to -- for them to settle in and become part of the culture and the business and the way that we operate. And that, amongst other things, leads to the lower attrition that we have. So we're -- last 12 months, we were at 12.5% attrition, which is significantly lower than most players in our industry.

So one of the problems that we find on attrition is just like how that's calculated can vary from company to company. How do you guys sort of -- does the employee count as an employee? Or are they counted within your attrition calculation from day 1? Or do they have to be staffed on a project initially or?

So we talk about attrition in terms of an employee has chosen to leave. And they survive their probation period.

Okay. And how long is probation period?

3 months.

3 months. Got it.

So generally -- and they're very small numbers actually, that fall into the category of -- we chose for them to leave or probation phase that would be added to the number I just gave.

Got it. Okay. So that's useful. And so -- all right. So that's how you're handling from hiring. And so when you look at the verticals that you're operating in and you called out a few of them in examples, but which verticals are you seeing accelerating or decelerating growth over the next 12 to 18 months?

Do you want to pick up the headlines on that?

Yes, yes. So definitely, we're seeing acceleration of frictionless payments. We're seeing it in what we call the mobility space, which is the overlap between logistics sort of negative and airlines, et cetera. That's the digital platforms that underpin them. We're seeing leakage from payments into things like retail basically as well. So with clients with paying up by later, where the client wants to retain that technology. So it's across a number of fronts that we're seeing it.

So in -- here's a little bit of a gut question what you know right now. How close are we to seeing a new segment called out?

Interesting, John, because I mean, we have -- it's not a very sexy name for it, but Other, but that's our emerging industry verticals, which is about 25% of revenue. And some of the examples I just gave, specifically so mobility, are a sizable proportion of that 25%. So we want to see them -- mature is not the right word, it become self-sustaining, deliver performance quarter-on-quarter, but before we fully sort of disclosed that -- so it will become apparent in due course, if I can say that.

Is that really close due course or?

We review it at the new financial year, which is in the beginning of July. So we will review it then.

Yes, yes. Okay. Got it, got it.

No promises.

All right. So talking about revenue, so headcount is obviously a primary driver. But pricing is also a point of leverage there or at least it increases the revenue and revenue growth if you're increasing pricing. How are you thinking about pricing power right now and combining that with wage inflation. I think one of the things that I've noticed is as companies have talked through their earnings and then started to engage with investors post earnings, the later the companies have reported, it seems like the more wage pressure they've talked about. And I don't know if that's coincidental or if it's continuing to ramp up. But what are you seeing from a wage pressure perspective? And then how is your ability to pass on pricing right now?

So well, our main pay rise for us goes through first of January. So that is done basically. We did see elevated levels of cost compared to the previous order periods, but not prohibitive. So where we may see on average cost pressures of around 2% to 3%, we see 3% to 4%. The evidence is that we pitched that -- those packages, pay rises about right. We're not seeing any increase in the attrition levels above the 12.5% that we reported in Q2. And if you're talking about a cost pressure of between 3% and 4% and then recovering that in the market, we have been able to recover 4%, 5% and sometimes 6% historically. And given this is a supply-constrained market at the moment and people are raising demand for our sort of services, we don't see an issue in recovering over the near term.

Is there any lag or frictions? A lot of times I think about it is like restaurant menu repricing is like, yes, like they can reprice the menus, but there is some friction or lag as you have to reprint them, decide what the right numbers are, et cetera.

That's right. I mean we -- it's always been rough, and we get some margin compression on the gross margin in the quarter that we're in. So we're expecting to see that and that's in the guide. And then over the balance of the year, 12 months, we recover that as we have those renewal conversations with clients. And it's always been that pattern.

Got it...

Sorry, just one thing to -- a bit of color on that. It's worth noting that people hear about 10%, 12% type inflation happening in the markets that we're operating in. For an individual developer, they may well be seeing remuneration increases at that level, right? But they're also -- they've got a year's more experience, right? So if you normalize across the seniority, that gives the rates and the cost inflations that Mark's talking.

So you're already like -- already anticipating like, okay, I've got this developer or this person that's a year later on, they're going to get a natural increase as it is like whatever that now is 3% to 8%, now I'm adding another. So that's already kind of built into the way you think about the engagement, et cetera. So the gap that you're trying to close isn't actually as big as it seems like on a nominal basis, yes.

Yes. Correct.

Good. Let's talk about -- oh, before I go on, I want to make sure that we open up to any questions from the audience. I mean I have -- we've got about 8.5 minutes left, and I got about 30 minutes of questions. But yes, 1 here.

Relatively new to story. So obviously, I apologize for the ignorance of the question. You have no -- there's no -- you have no employees or anybody in Ukraine, Russia. Obviously, a lot of your competitors do. When you think about the opportunity and you've laid out the calculus to your guidance and revenue. When you think about the opportunity for to either accelerate that given the increase in demand to build strategic opportunities, given the situation you're in and everybody is in. Can you just talk about that? Like if we're sitting at 3, 6 months from now, is there an opportunity to push on the lever of growing faster, 35%, 40% on headcount, just knowing that this is an opportunity where you can really entrench our position to help potential customers?

So we're -- for the reasons I touched on earlier, we're unlikely to go down that route. We achieved it this year because we had this backlog in terms of simply the most senior teams coming out of the pandemic that enabled us to push the -- I think, we did 38% headcount growth this last year. Looking forward, I'm comfortable keeping the top end at the 30% mark on headcount growth. We'll then see those rate rises of 4% to 6% on top of that, that Mark was talking about in terms of impact on revenue growth. If we push for too high growth, we will get short-term boost. We'll be able to deliver it, we'll deliver the revenue, but it will undermine the long-term sustainability of the business because we'll undermine the culture and the ways in which we operate will get diluted. And our industry is full of organizations who've done that in the past and have burned themselves out.

Sorry, just was asking in a different way, given the situation you're in or your -- as you look out in the world, is the 3-year or the longer -- the medium-term opportunity to keep revenue at a -- using that same calculus are you -- you have more confidence in that given the demand backdrop and the increased demand that you're seeing, I guess?

The answer to that is yes, we do right now. We as a business, we build a 7-year plan, and we renew it every 2 years. So it goes out 7 years, it drops back to 5, we push it out. That enables us to look at significant change in scale of the business that comes from that level of growth and enable the managers all across the business to actually get their heads around what does it mean for how many new locations we need to be in. How many big clients do we need to win? Where are we going to go find them, how do we scale the sales force, all of those things get built into that plan. And then we lay out some M&A on top of it to just accelerate top line growth that we can bring out.

I think we had a question over here.

A similar question. But if you look at the total addressable market, in higher-end design services, what percent of those are being performed out of Eastern Europe right now? And secondarily to that, then what do you think the odds are that this structurally changes clients' willingness to do business in Eastern Europe versus it being a temporary pause during the conflict?

So I'm going to take the classification of Eastern Europe as being Russia, Ukraine, Belarus. We see ourselves as being in Central Europe. And I think it's a fair distinction -- actually seeing some of you smile. So Dan has done a bit of work on this recently, and they came up with that there are 250,000 developers and creatives sitting in the Russia, Belarus, Ukraine space who are providing services outside of the country. I've never sat down and worked out how many -- what percentage of that is in global terms, but it's a significant number. And that is going to put pressure on the industry and additional demand on the industry as that settles out, assuming we don't have a quick resolution to what's going on.

So I'll come over here. She's coming over here. I'll ask questions. So you mentioned, speaking geographically, you recently made a decision to expand into Malaysia. How are you building brand recognition in the region? How does that impact your future expansion plans and at the same kind of high-end design work, et cetera, that we're talking about for Eastern Europe that you could deliver out of places like Malaysia?

Yes, absolutely. So I mean we have a playbook for going into a new geography, establishing our name and our brand and the perception and reality of us being an employer of choice, a place where people can really advance their careers by joining us. And we have great success. We win best employer brands in the established markets that we're in. And we're doing that in Malaysia right now. The -- actually, the demand for our services out of Malaysia is sold out for the next 18 months. We have committed work from clients that we will be ramping up in completely clear plans with them to deliver out of that geography. So that will help us scale. It will help us attract people in. There's real projects to talk to them about, et cetera.

That's great. I think we've got time for 1 last question.

Kind of new to the story as well. Just curious to know the need for your services are undeniable over the next few years, but all attention is being focused on the near term. And with that in mind, have you seen any priority shifting? You read about so many companies disentangling themselves from what's going on and all of a sudden, they had very high level priorities of digitizing their business or whatever. All of a sudden, they're more interested in undoing financial parts of their business for the next few months or how this takes...

So we -- it's a fair question. We've not seen any reduction from any clients in any of our geographies on the teams that we're operating with nor are there any hints of conversations about that coming down the pipe.

Great. Well, that's all the time we have. Thank you very much. John, Mark. I appreciate you making it out here today. Thank you very much.

Thanks, James.