Endava plc (DAVA) Earnings Call Transcript & Summary

All right. We'll go ahead and get started here. Thanks to everybody for joining us this afternoon for this conversation with Endava. We have Mark Thurston, CFO, joining us. I appreciate it. I'm James Faucette, senior research analyst here at Morgan Stanley. And before I get, I'd just quickly have to read this important disclosure. Please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. So Mark, thanks for joining us. We're on the clock. So let's get started.

I guess -- let's start with kind of comments and following up from comments from your most recent earnings call. And during that call, you noted seeing some changes in customer behavior during December, where clients were at the very least adding some extra levels of due diligence that resulted in some projects maybe not proceeding and others getting delayed. However, it seemed like that started to improve a little bit in January and February. Can you kind of walk us through what you were seeing in December and then how that started to change in January and February and kind of what's happening?

Yes. So we saw latter part of December, the pipeline not converting into revenue basically sort of projects not starting. And as we went through January, like weeks 1, 2, 3, we're seeing that same sort of dynamic. So there was basically a customer hold back is our sort of sense. We tend to see this a little bit around December transition into January, tied basically to the budget process from a fiscal perspective, but it was certainly very much more amplified with us. So basically had the impact on the quarter to March, basically, where we're missing about 5, 6 weeks' worth of revenue. But those pipeline items are now proceeding. The projects are starting, and that was basically the sort of basis of the guide that we've given. It's still sort of a sort of subdued market, I would say. We're seeing different behaviors. We've seen some PE-backed businesses sort of delay further in terms of our holding off to get increased sort of visibility. But on the other hand, we're also seeing some clients sort of accelerate in certain areas. So it's a bit of a mixed picture at the moment.

So I guess it's understandable like the PE type backed firms might be delaying and kind of figuring out what their funding state is going to look like, et cetera, and calibrating their trajectory accordingly. But what about the other customers that you're talking about that are looking to accelerate or move forward like, a, what kinds of companies or verticals are those in? And what are the types of projects that they're trying to take on?

Well, it's interesting because we've certainly called out some weakness in payments we've seen. But we're actually seeing some clients accelerate in that fast space.

Oh, really. Okay.

Yes. I think that's basically a sort of orientation into, we'll call it, the sort of newer technology. So sort of open banking real-time sort of payments areas. In TMT space, we're seeing clients in the sort of media space, we're building product for them. They are not holding back on that product development because it's impactful their top line. So again, it's a bit of a mixed picture. We see some sort of slow decision-making, a bit of caution in [indiscernible]. So people will have budgets. We told they've got budgets, but they don't want to start spending it yet. And while they read the rooms ahead and other areas where they are doubling down.

Interesting. And then back on, I think, the -- this point of due diligence and kind of extra due diligence maybe that some of your customers are engaging in, like how does that change your go-to-market and your sales cycle strategy? Like what do you have to provide for those customers?

There's no real shift in that, our go-to-market sort of strategy. So we're all about providing solutions to clients. We have an industry-vertical focus. None of that has changed. It's just an added layer of caution from clients in terms of sort of committing is what we have experienced. And it is just getting clients comfortable from the perspective of what the technology is going to deliver for them. They obviously have to go through their own decision-making sort of process. But wherever we could be helpful with that, that's what we do. But it hasn't had a tremendously different impact in terms of how we approach the situation.

And you kind of ran through just a moment ago some of the different verticals, like you're seeing some payments weakness, but others come through, et cetera. Can you kind of go through and help us parse a little bit, not only by vertical, but also geography? Are you seeing much difference in geographic behavior?

Yes, yes. I mean, we anticipate, funnily enough, North America will be quite weak for us in the near term. The sort of drivers for that is West Coast tech, but TMT more generally, weakness in Financial Services, mainly for payments. But then some recovery, we think, in Q4. U.K. is going to be flat for us sequentially going into Q3, largely sort of payments driven again there, but we then see some recovery. But funnily enough, Europe continues to be relatively robust at the moment, and it's across all sectors, and that's quite different to what people or many commentators were thinking about, I don't know, November last year.

Yes, for sure. For sure. No, that makes sense. And it is different. And then back on the PE-backed firms you called out, like, hey, they're kind of evaluating, you feel like -- like how quickly are their plans getting set? How does that impact like what you're expecting from them? Is this just like an assessment period and then they move forward? Or if there is like a sustained period of less new capital coming in, does that change the type of projects they'd be looking to do with you?

So I think there's definitely been a slowdown in new projects. We do work around the due diligence before investment. So that has definitely sort of slowed. We're not making comments about PE. And It's about 1% of our revenue...

Okay. 1%, so small.

But the -- when I'm making comments about PE, we work with portfolio companies, something like 23% of our revenue is portfolio companies. It's where they are making decisions to the portfolio company about slow the burn rate on cash. Now I think it is delays rather than curtailment. We are building typically product for these companies, and it is basically a delay on bringing on stream revenue stream for them. So I think it's a question of delay. I think it's them assessing sort of the macro sort of position before they move ahead with it. And I think that is what is the nature of it.

Got it. Got it. I've got my own list of questions here, but if anybody has -- in the audience has questions, please raise your hand, and we'll get you a microphone. We have a question up here in the corner. Maybe we'll just jump over there.

I'm just curious on the European piece, what do you think explains that outperforming kind of everyone's expectations?

I don't know really. To be honest, I mean, inflation is high in Europe. We've certainly been thinking it more from a sort of a labor perspective for ourselves. So we've been going through our main payment route for -- which is January, where we have not been giving inflationary matching pay increases basically because we're cognizant of the market. But the demand is relatively solid, basically, and that's across all of our industry verticals, where it's payments in Financial Services, TMT, other, as we call it, which covers things like mobility and health tech, et cetera. We have seen weakness in retail, but retail isn't a big deal for us. It's about 5%. We've seen that across the sort of piece. Retail is the only place where we've seen a bit of a slowdown actually but other areas continue to be good.

Anybody else this -- like I said, as we go along, if you want to ask a follow-up, just raise your hand.

My question is, as you sort of talk to customers, do you see -- I think it sounds like you saw some customer behavior change. Have they signaled like are there, call it, like checkpoints throughout the year, whether they'll reassess given the like sort of weirdness of the year or anything like that?

No. No, they haven't said. I see what things are like Easter, they're a little bit -- let's see how things unfold, whether it's week-to-week or month-to-month basically.

So what do you think kind of explains the improvement you saw?

Well, there was -- I think it was just a delay. I mean people have to get on with things. Think about what we do is we're building product, which is around sort of acceleration. So it's top line rather than bottom line efficiency. So if they're going to proceed, they need to see, and it's basically the rate at which they do it.

Got it. So back on -- you mentioned and you called out the softness in West Coast tech, et cetera. But -- and I think that's understandable, especially when we read the headlines about like this company, that company, et cetera, and what they're doing with headcount, et cetera. But is it -- is that all there is? Because another question that we get is like, is there something that's happening competitively for Endava? Are you seeing newer players or at least other players that you hadn't been running into as frequently before expanding into the space or anything like that?

Competitively no, I think the -- let's say, activity levels have come down, basically. So you expect it to get more competitive. But it isn't, we're not seeing more of the peer group. We're not seeing new players come into the space. It's mainly sort of client-driven in so many respects. And we -- when we see sort of these sort of situations, we tend to get more -- it's more of a volume thing. It's the rate at which they proceed with things rather than push back on rates because I think if people -- competitive sort of situation is rates about who would they go to, to sort of displace, so to speak. So we haven't seen any of that activity.

And then back on the payment space. You mentioned like there had been some weakness but others coming back. How much are new initiatives driving the conversation and the engagement right now? And I'm thinking of things like, whether it be the concepts around open banking and APIs or FedNow is also supposed to start to roll out, at least for some member banks and starting in June and July. How much -- what are the kind of the buzzwords, if you will, that are driving engagement and interest right now?

There's definitely -- there's a backdrop and given the sort of macro in the payment space, there seems to be a rotation out of, let's call it, older technologies like [ less ] acquiring platforms where clients are increasingly talking to us about real-time banking, those new technologies, which is where Endava tends to focus, we tend to focus on acceleration and change. So we're in the right sort of space for that. So we've seen a rotation of -- and when people are rotating from older into new technologies, they don't tend to invest in the older technology -- it's a maintained sort of level. So it's a natural thing that happens with us anyway. We're a change to top line growth enabler company. And so as that sort of change in demand happens, it's natural. And what happens with those, they're not legacy, but they're older technologies. There's no investment. The client can either decide to maintain them themselves or somebody else sort of does that. We sort of move on to the new.

Got it. Got it. And then what other types of projects are you seeing clients prioritize right now? I mean we hear a lot about cloud optimization initiatives in our conversations. But how are you at Endava equipped to capture some of this demand? And are you -- what -- are you seeing those kinds of requests like cloud optimization? Or what are the things people are asking for?

We've always sort of operated in cloud as part of the solutions we provide. We don't -- we haven't really done a lift and shift, for want of a better word. So when we're working on a solution with the client, it will always include cloud because it's part of the experience for clients and customers. So it's not new. So I mean there's -- there's definitely talk about, it's probably not the right word, but overcapacity in cloud, it's like the engineering sort of platform and surplus capacity. But I think it's now moved on to how do clients and customers get the best out of the cloud, which is what Endava does.

And when you start to look at those solutions and does it make much difference when they're trying to optimize on cloud, like are they trying to optimize on cloud from a single cloud, public cloud vendor or maximize across? And does that make much difference to Endava in terms of the types of solutions that you can help develop for customers?

No, not really. I mean we have relationships with all the big cloud providers. And we're an adviser first and foremost. So we're agnostic basically about -- the solutions that we recommend even though we do have these relationships. So there hasn't been any real change in that.

Right, right. So let me ask about where now the -- if you will, the rubber starts to meet the road in terms of pricing. And you mentioned that you've seen some price increases coming through. I mean I can't imagine that clients are always receptive to that. But I think there also has to be an acknowledgment like, look, this is the world that we were in, where we're in now, what you have to do. What are clients leaning into and -- versus pushing back? And how, I guess, more importantly, is that contemplated in your outlook?

So it's not as positive a pricing environment as it was last year, but we think we will get price improvement. I mean, in terms of the guide, we factored in no price increase in the current quarters of Q3, but we will get pricing as we go out. It just won't be at the level that we've seen historically. Historically, we've seen sort of quarter-on-quarter increase in rate per mandate. But what's important for us is to get the cost base right, basically. And we make that decision when we do the main pay rise every sort of January. So we're no longer in a hot labor market. So we -- as I was saying earlier, -- we've just done the main pay [ rise ]. We have not paid the level that we did last year despite levels of inflation being high in the countries that we operate in because it's based on what we think we can recover through rate through the rest of the year. But we think we can get rate increases, although they are going to be modest. And when we get pushback from clients, and you do because they they're facing headwinds in the sort of macro, what we tend to lean on is can we get more commitment from you, which is multi-period, and then we can have that conversation about rates.

And what about your customers? Like I can imagine -- and I don't know this, which is why I asked the question. But I can imagine a scenario where like if I'm a customer, traditional customer of Endava, and I'm looking at, a, I was consistently being outbid for engineers by Google and Facebook, et cetera, maybe there are projects or types of projects that I might want to consider, think about in-sourcing versus turning to somebody like Endava. Are you seeing that much in terms of your conversations with them? And how does that impact the type of work that maybe customers are looking to Endava to do?

I think it depends on the situation, depends on that cost model, whether they want fixed cost or variable costs. And we have variable costs, so I tend to think of Endava as providing innovation at scale at reasonable price. So when we're building product for clients, we could be -- I don't know the exact figures, but we could be like 30% of their cost base or we could be 90% or 80%. And it will depend on the philosophy that, that client has basically. And clients can change their mind. They can have a change in the team. They may decide that they want to take it in-house and manage it, and we will have to flex down, and then we will have to redeploy to other sort of clients. So it's a philosophy for clients to do. I think the thing that when they do, do that is they sometimes struggle because we may be -- and the quote is sometimes being expensive. But what we're able to do is provide this innovation at scale, and we provide very good value. So the managing of the in-house people is difficult to do because you have to manage attrition, you have to keep balanced teams, and you have to keep the workforce sort of motivated, and it's surprising how difficult clients find that.

Got it. So you mentioned on the last call that FIS remains a top 10 client. Any incremental color there on conversations with FIS, at least as it pertains to future opportunities? I mean I think you called out there may be some long-term opportunities for additional work due to them spinning off Worldpay, which I think that would make sense. But can you help us think about like that and potential magnitude. And at the same time, how should we think about potential for at least near-term delayed decision-making as we kind of -- I would think we're in a little bit more of a waiting pattern as it relates to what they do corporately and structurally.

Yes. So FIS, Worldpay, do we do most of our work for the Worldpay part of FIS. So we're a strategic supplier to them. So when they took the cost reduction exercise, we're a strategic partner, we have to help them with that. So we've reduced the run rates with them. So instead of being a sort of 7% revenue client, they're 5%. And I think that's what they will be for us under FIS ownership. Funnily enough, we have heard, they think they may have cut a little bit too deep in the area that we're in. We're doing work in the new product area. So it's open banking, et cetera. So the demand is there. And we are talking to them about multiyear sort of contracts. So the mood music is very positive. I think with the demerger, we know the guy who is the CEO of the business, we worked with him in the past. And I think they have a different investment philosophy than they did under FIS. So I think it all goes well for us, and we just have to wait to see what plays. But I think -- certainly, I think the run rate would be as it is at the moment until they are spun out, but I think it's positive for us thereafter.

Got it. And turning then to the supply side of your business. I mean, obviously, that's -- the real revenue generation is delivering the supply beyond -- to the demand at hand. But how are the demand dynamics impacting your hiring strategy, particularly given what seems to be -- have been a buildup in bench? How do you balance that goal with go-to-market and trying to acquire experienced talent right now?

So we always hire into a demand curve that we can see through our forecasted process. So it's this pipeline things. So if we see pipeline slow like it did before Christmas, you start to build a bench, which is what we've got at the moment. So it's higher than we would like it. It's sort of 10%, which has an impact on margins. So our gross margin will be impacted by that. So in terms of going forward, based on what we can see, implied by the guide, we see some sequential growth going on, but we won't grow the headcount into it. We'll have a bench that we aim to sort of burn down. We will still recruit because we will be recruiting for skills that we can see in that sort of shape, but we will not recruit the rate that we have done. And looking at that bench, you look to assess where you've got the right skills for the demand that you can see. And who is being deployed, we look at them as well. So it's always of looking into the pipeline, the future sort of forecast, have you got the right shape of teams on the bench to be deployed for that. And that is the key sort of driver. And if we don't see that pipeline, we slow recruitment.

So speaking of just continue to develop the supply side of things, expansion in Asia Pacific has been a priority for you. How has the Lexicon integration been? And how do you think about the opportunity incrementally there?

It's progressing well. It's a long way away from us and you. But we think it's an underexploited market certainly, Australia. We think -- there have been a number of mid-tier companies that have grown up in Australia. And I think it's because they weren't receiving -- these are clients in Australia, receiving the level of service they expect from the bigger players. Now the Lexicon is primarily onshore, which I think most of the businesses are in Australia because it is a long way from anywhere. But they have been looking to develop a nearshore capability, which is places like Malaysia or Vietnam. So they had started to explore Vietnam. Now we are, in a modest way, in Malaysia and Vietnam, and we would want to build that nearshore capability with what we do. So we think Australia is an end market, and Singapore are underexploited in terms of what a firm like Endava can have to offer. We can add to it through our distributed agile methodology through building out basically Vietnam and Malaysia. So we're excited by it. We want to grow Lexicon, and we're looking at other opportunities in the region as well.

So on that point, what are you seeing in the acquisition pipeline? And I guess how has the current macro environment impacted your acquisition strategy? But also, what is it doing, any movement on valuations or that kind of thing?

Well, doesn't seem to be much movement on valuation at the moment.

As much as there should be.

No, exactly. I mean, we had a very interesting opportunity just before Christmas, and the multiples were a lot higher than we were [ impaired ] -- pay for it. And it was a very nice sort of asset. [ We have the bench pat ]. But we have stuff in the pipeline that we are hoping to land that will, I think, be additive to Asia Pacific and also North American [indiscernible]. It Is one of the biggest markets that we need to establish our critical mass in. So the stuff in the pipeline is still slightly elevated. Probably you'd expect in terms of multiples but -- so these rare assets you sometimes have to pay what you need to.

So on some of those, particularly if it's like a good asset, but valuation's high, like you said -- you just said is that maybe you need to be prepared to pay for things that are particularly good. But what's happening with those where you just can't quite reach a meeting of the minds from a valuation perspective? Is it like, well, hey, let's see what happens over the next 12, 24 months and see if there's something that makes more sense or...

We'd only buy a business that makes sense for us and then is it sensible in terms of price. And the other thing sort of going through everybody's mind at the moment is the macro environment. So if businesses aren't going to meet what's in their projections, then are you going to cause a problem for yourself? And we don't buy businesses that are going to be dilutive. We want them to be additive. So you don't want to increase the sort of risk by overpaying. So I think there's an element of caution. I don't think private multiples have come down enough. I think the expectations are overdone. But we will pay for the right opportunity at the right price.

Right. Right. Good. Well, Mark, that's all the time we have. We really enjoyed you having been here at the TMT conference and look forward to chatting again soon.

Thanks very much. Thank you.

Thank you.