NCC Group plc (NCC) Earnings Call Transcript & Summary

Lovely. Thank you, and good morning, everybody. Thanks for joining us. Most of you, I'm sure, have had the opportunity to have a look at the recording that Tim and I have done, the presentation setting out our results for the year ending 31st of May 2021. But for anybody who hasn't had an opportunity, I'll just take 2 minutes, if I may, to give you a few highlights. So we're really pleased with this set of results. In a year when most people took a step backwards because of the disruption caused by the pandemic with which we are all familiar, NCC Group was able to take a step forward. This year in which revenue went up 2%, 3%. Our adjusted EBIT was up significantly more over 20% as we saw less, for example, travel costs and other costs coming in. Our cash flow, up to GBP 35 million almost, which as you know is a metric which is very dear to our heart. But I think beyond the financial results, which unquestionably experienced a bit of perturbation from COVID, I'm particularly pleased with the way that we use the time that we have very wisely. And the 2 things I'm going to point out are: number one, our most significant acquisition to get the $220 million acquisition of IPM, bringing in on a trading basis just shy of $22 million of EBITDA or so. It's strategically important, financially important, it's a joy to say that, that acquisition, that entity is trading on plan. In fact, it's trading a smidge ahead of plan, which is excellent, and we're looking forward to what we can do with that in the future. And secondly was organic investment, the thoughtful, deliberate investment in propositions, which will position the firm for the future, whether it's embracing Microsoft's Sentinel technology into our MDR offering; whether it is developing our remediation proposition, which helps clients to develop their resilience and protect themselves from cyber harm; and of course, our cloud proposition and software resilience, Escrow as a Service, all things which are going to see and bear fruit in the years to come. So a very interesting, very exciting year, one that we're very, very pleased with. And of course, off to FY '22 with a bang. But look, with that, I will hand over, if I may, Adam, to the floor for any questions.

[Operator Instructions] Our first question today comes from Steve Robertson of Canaccord.

Hopefully, you can hear me okay.

Yes, we got you, Steve.

Yes, well done getting through the year in a much better shape than everyone probably saw 12 months ago given what was going on and on the acquisition. I've got a couple of questions. I think one for you, Adam. And probably one for you, Tim. First one, on the half 2 revenue in the Resilience business, I think it was down about 4% year-on-year. What gives you the confidence that -- and I think you said it in the outlook that you should have sustainable growth for Resilience in the current year. And is that growth based on the pro forma combined numbers of the IPM acquisition plus the existing business? That's the first question. And if I could ask that, and then I'll ask the second one, which I think is more straightforward, later.

Yes. No, that's absolutely fine. Thank you. You're absolutely right. We did see a decline in H2 in Software Resilience division, and we pointed a couple of things here. Yes, first of all, we can see some attrition in our sales environment. The Software Resilience business has historically been a very office-centric, desk-bound sales force, which we've been very effective in that form. Frankly, we were quite pleased, almost amazed in our ability to continue running that sales force effectively through the first half of our financial year as the pandemic hit. We were able to cycle people and give them an experience of remote working before it became absolutely mandatory and essential in late March of 2020. So we were pleased with that, but we did experience some attrition. I think a loss of the sort of community spirit that you get on the sales floor definitely impacted a little. And I feel also there was a little bit of distraction from senior management as we worked our way through the acquisition. Clearly, a lot of effort went into preparing a good integration plan because that's what it's all about. Doing the acquisition is relatively easy. Getting ready to bring our colleagues on board, integrate our systems and everything was something we put a huge amount of focus in. So we found ourselves, in the second half of the year, with fewer salespeople than we would wish to have. That situation has now been remedied. And what we're expecting to see is there's a couple of points of decline in the first half of this year. We finished first quarter on an [ ordinary ] basis, flat on a constant currency basis over there. So we're pleased with the start. We expect to finish the half a couple of points down, but we expect to be getting growth in H2, and that's going to be coming from a number of routes. First of all, is the regeneration of our core business. It's going to come from the continued growth of our cloud offering, but also, it's going to start to come at the end of the year from revenue synergies kicking in with our new IPM colleagues.

Okay. Adam, that's clear. My second question, if you can just fit it in, and I'm almost afraid to ask this. But what do you think the impact of the new R&D amortization rules will be in the current year, if you could possibly quantify that? I think it was about GBP 3 million in the year just gone. Any ideas on that really?

Yes, that's fine. Thank you. It's Tim here. So yes, as you know, the change in accounting rules was a change in April from the IFRIC's guidance and is a clarification of the standard. And obviously, it's the main reason why we delayed our accounts because when we checked in with the auditors, we thought we could do an advanced disclosure notice, which other companies have done. But they informed us that we have to actually change our numbers. And it meant that we had to change both the current year and obviously going backwards 3 years of prior year adjustments, hence the delay. You're right, the impact this year is roughly about GBP 3 million in the current year, and we are setting the RNS that it's obviously broadly profit neutral for the year. So we're going to have expense roughly the same amount as we would write back this depreciation. So really, you don't have to adjust your numbers for it.

Next in the queue, we have Robin Speakman from Shore Capital.

I'm well done on our good sort of figures in a difficult year. A couple of questions from me. Sort of, first of all, given your statements on costs across the group, how do you see the pricing environment versus volumes across the business? Some more color on that, please, will be useful. And secondly, color on how you see margin development and mix going forward through full year 2022? Should we expect any sort of significant changes in any particular areas?

Lovely. Thank you, Robin. So I'm just trying to work out where to start the story really. FY '21, the one that we just reported on, very much an environment of low revenue growth. Although we're very pleased to step forward and of course, better margin growth as some of the costs fell away. This coming year, what we're expecting is better revenue growth as spending patterns normalize. But we're expecting higher costs, whether it's from travel and office costs coming back in that we didn't have last year, and also, we're all keeping an eye on inflation. How much of that is going to stick, how much is going to flow through to our cost base, and of course, how much can we pass on. So the pricing environment is fairly mixed. I would say we're not seeing the perturbation of COVID wash out yet. And so in some areas, we're still seeing tight scope. We're seeing people really very aggressive on costs. We've seen 1 or 2 clients over on the continent use reverse auctions, which is interesting. So they're just focused on getting the lowest cost, and they're not really concerned about the kind of quality. I don't really worry too much about that because we see those cycles, okay? And people put an emphasis on cost, they realize they don't get what they need and then they come back and they pay for value. Meanwhile, over in the U.S. in particular, it's all about whether you can get quality work done. And if you've got the capacity, you've got the people, then frankly, you can price for it because there is a massive imbalance in supply and demand over there. From a margin perspective, I mean, though, Tim, I'll hand over to you in just a second, if I will. I mean, Robin, you were asking specifically about this year. I'm going to answer a slightly different one. Over the coming years, we expect the perturbation of COVID to wash out, so we would expect the margin improvement track that we were on to kick back in over the medium term. This year, however, we do expect margins to be more challenged than they were last year because of some of the costs coming back in. But Tim, is there anything you want to add to that?

Yes, sure. So yes, so on the margin side, as you know, we had the gross margin of about 40.9% in the current year, up from 39.6%, which is a 1.3-point increase. With the costs coming back in, especially around the -- there's going to be inflation around wages, around the cost of cyber talent, and then obviously, the travel, offices coming back in this hybrid form of working. If I was doing your model, I would keep margin -- percentage margin as relatively flat because of those headwinds. And then who knows what's going to happen with FX? That's the other one to think about. And just on that FX, we've said that we're going to report in constant currency going forward. So I can also -- rather, we will start closing growth rates in constant stroke local currencies to give a true indicator before you get to the FX change, especially as you know with the dollar this year. So keep your margin. I would say margin is flat with last year.

Okay. Any particular sort of mix influences this year?

Between Assurance and Software Resilience?

Yes. I mean clearly, we've got the impact thing.

Yes, yes. I mean if you're looking at the EBIT margin, as you know, within Software Resilience, we've invested a lot of money in the management teams, in the new propositions and taking ports. So you can see that EBIT margin coming down in Software Resilience. We're expecting the returns to start coming through so that should go up slightly. In Assurance, I would say, in the short term, for this year, you'd hold them flat. And then as Adam said, in the future when we get more [ positions ] coming in, it will increase.

[Operator Instructions] We have a follow-up from Steve Robertson.

Thanks for that on the margin. That's clear, and that was actually one of my questions. I've only got one left, and that has to do with the contract provision. Sorry, I'm not quite sure of what that relates to. And I wondered if it was -- if the GBP 36.2 million is after the contract provision or before? And is that provision ongoing to the current year?

Thank you. Yes, so the contract -- so again, Tim can correct me if I get any of this wrong, but I think the GBP 36.2 million is after the provision has been taken. The provision, which we first highlighted, I think, at the half year, is to do with one-off the 2 very long-term contracts that we inherited when we bought Fox-IT, which has to do with the integration of some pretty niche kit. Those 2 contracts has certainly given a lot to us over the past few years. They are now nearing completion. We do feel they are under better control than ever before. We first flagged up that we were taking a provision at the half year. I have, I think, Tim, in my mind, that we topped it up to the GBP 2 million position that you will have read about in the full year. But we don't expect there to be any further additions in this current year. Is that about right, Tim?

That's correct. So we think we're now at the end of the provisioning. We've fully loaded all the cost to completion as far as we're aware at this current stage, and so it should not repeat going forward.

We have a question from Caspar Erskine from Singer Capital Markets.

Congratulations on a great set of results. Just a couple of very quick ones from me. The first is you mentioned some buying pattern disruption in H1 and I was just -- sorry, in Q1 FY '22. And I was just wondering, I mean, if I'm imagining if it's anything like us in the city as people taking holidays, and that should come back pretty quickly. But do we therefore anticipate a weaker H1 and then a stronger H2? Or has that largely came back into Q2 already? And then my second question was just on Escrow as a Service. I mean there's been some pretty sort of high-value notable customer wins displayed in your presentation. And I was just wondering, is that GBP 2.2 million, is that representative of all of the upsell opportunity within that? Or do you think there's still a lot more to go for within wins such as Sky and Deutsche Bank?

Yes. Lovely. Caspar, thanks for being with us this morning. So let's start with the first question. The -- so you're exactly right. In fact, I'll just hand over to you to give the answer, if that's all right. So it is an unusual concentration of holidays is the way I think we phrased it, was what we observed over the course of the summer. And there was a missing piece of the puzzle, which is probably worth me mentioning just to sort of fit in everybody's minds. We've seen orders increase in Q1 versus Q1 last year, which is exactly what we expected as spending patterns normalized. But we do need some customer involvement in most of our work, whether it's getting us access to systems or whether they just want to be around to supervise even remotely what we're doing. Of course, in many cases, we are hacking into their systems to find out their vulnerabilities. And of course, they don't want to let us do that completely unaided and unsupervised sometimes. So it is that coordination between other parties who are often away to get the work scheduled, which has been a bit frustrating in Q1. So Q2 is off. It's off to a stronger start. We've got the robust orders pipeline. We're expecting acceleration through Q2. So we're expecting a better Q2 than Q1, for sure. We do have anywhere in our expectations for this year a better H2 versus H1 because we do think we're going to get a continued acceleration as there's further normalization out of COVID. But what we've seen in Q1 doesn't really change our expectations at all at this point. So Escrow as a Service, we're really pleased with, a, some of the continued growth rates that we're getting there; and secondly, some of the client names that we've been able to land. I'll just answer a very slightly different question here, Caspar. We have 0% of the opportunity here. So there is so much for us to go after with Escrow as a Service as we refine that offering, as we refine the way we take it to market. And I just can't believe we've got everything that there is to get or rather than to keep it around. I can't believe we're delivering all the value that we can deliver, right, to the likes of Deutsche Bank and to Sky. So if we think about the banks in particular, they're always under regulatory scrutiny. That's only going to increase the need to protect their software supply chain irrespective of whether it's on-prem or in the cloud, just drives them into the arms of the kind of offering that we've got. So hopefully, more to come.

Great. That makes perfect sense. And then just one last question, if I might, and just for Tim on his favorite subject, the working capital. Have -- do you believe that we've hit the end of that sort of process of shoring up systems to unlock what was a significant working capital balance back in the day but seems to have come down a long way? Have you -- do you feel that's fully optimized? Or is there still a bit more to go for there?

Thank you, Caspar. As you know, I've always thought the medium-term target was about 85% cash conversion. And even after the GBP 3 million adjustment as a result of the cloud computing, we're at 88%. Before we had that adjustment, we're at 98%. So we -- I still think there are some opportunities for us to squeeze cash conversion further. So -- but I do believe that the 85% will be the medium-term area that we land on when all the opportunities have gone. So yes, I think there's still a bit more to go.

Perfect. Brilliant, and congratulations again.

[Operator Instructions] We have a question from Damindu Jayaweera from Peel Hunt.

And well done on getting through what was a difficult here. I just have a couple of questions, if I may. First one I wanted to ask was on the MDR offer, which is obviously growing fast, and there's impressive order growth there. But on the slide deck on that pie chart, which shows the completion of the offer, it's clear that it's not quite there for you in terms of it's -- what you are offering within that. In fact, probably that's why you are adding the Sentinel capability or adding the machine learning capabilities to that. Do you think you can organically expand the MDR offer, including going to new geographies? Or do you ultimately think it needs to be scaled faster than is possible organically?

Yes. Lovely. Thanks, Damindu. So really interesting question. I mean I'm going to start at the beginning there. You're right in terms of the trivial pursuit punch-off, if you like. We are measuring ourselves as just over half here. I mean the reality is we just see such opportunity in MDR. And remember, Managed Detection Response is about, yes, the amount of services, but it's also about the response. It's also about the instant response, the protection of our clients and all the rest of it. And if I look at the distance that we have to travel or the opportunity that's there for us in the market to scale up our CIRT teams, our computer incident response teams, it's just enormous, right? So I compare where we are on the security testing world with where we are on an instant response and a managed services world, I just see a big disparity, right? It's clear to me that there is much market opportunity for us to go for. And therefore, the other question is, how are we going to do it? Are we going to do it organically, or do we need to do it by acquisition? Well, first of all, let's start off with some really obvious comments, shall we? If the price has been paid for private assets in the cyber market, at the moment are absolutely eye-watering. So if we're going to buy something in that arena, we need to make very sure that we can extract value out of it. I'm confident we would be able to do that if we bought something with a good geographic footprint, a nice piece of technology that would add to what we have and then we were able to deliver it at much larger scale. So inorganic acquisition is absolutely on the table. We've reviewed a few assets, but we haven't found the one. In lieu of that, we're just going to crack on organically. We do think there's a huge return on investment that we can get by applying our smarts and our investment on an organic basis. Your specific question about whether we'll need to buy something to crack a new geography, I think it's a live debate. We are very keen this year to grow into our North American market. We're going to start there in a fairly low key way where we're offering service-led bounty offerings, where we're offering some of the more scanning-oriented offerings. We are looking to deliver the more complete MDR offerings. And we're going to find out just how much traction we can get without, for example, a fully-stuffed sock in North America or having acquired something. And as we learn, Damindu, we'll make our decisions.

Adam, very clear. The other one I wanted to ask you, if we take U.K. Assurance and you take the -- I know MDR is larger in Europe. But if we take the MDR in U.K. away and you take the Remediation services revenue away from the U.K. Assurance, U.K. is actually probably not growing as fast as U.S. and probably explained by the fact that U.S. got these tech giants that are spending much faster. And also, I guess, in U.K., you have long established clients with probably much better penetration than you do in the U.S. But one of the things that kind of caught my eye is in one of the slides, you have this growth rate that you attribute to your top 10 clients. And if we look at other very fast-growing consultancy businesses, not just in cybersecurity, one of the things you note is that they tend to grow with their largest customers who, either through luck or targeting, end up being the higher spenders with the faster budget growth. In the U.K., are there any underpenetrated verticals for your U.K. Assurance business that might, let's say, lift up the growth prospects in the U.K.? Or do you think the U.K. market is just slowly getting back on its feet and therefore I shouldn't conclude that the U.K. is always going to be much slower than U.S.?

Again, let me start my answer again this time without the phone on mute. So I don't think it would necessarily be wrong to assume that the U.K. would grow slower than the U.S. I mean the opportunity in the U.S. is remarkable. And as you know, we have a strong presence in the tech sector. We've seen the phenomenal success of the tech sector over the course of the disruption. And we don't find ourselves demand-constrained over in North America. The challenge is actually finding the right capacity, the right skill set, the right time and try to get it. So that's great. And we do feel, by the way, that it's protected our North American experience from the more broad disruption of the wider economy. If we were heavily invested in other sectors in North America, we might have had a different experience. Over in the U.K., right, it's absolutely too early, Damindu, to write off the U.K., I would say. In the second half of last year, which is for us December through to May, we saw the U.K. grow at I think it was about 9% or something across the half. So that's great as we saw the U.K. economy start to lift and come out of the restrictions that we all enjoyed, if that's the right word. Over the summer, we talked a bit earlier about this concentration of holidays that has made getting the stuff that we've sold into people's schedule a bit more difficult. But I would expect us to see some much more pleasing growth from the U.K. over the course of the remaining 3 quarters. Whether we can match the demand that we see in North America, I'm not sure, but I just think of it -- I think of them both as assets, I suppose.

No. Again, cleared. And the last one I wanted to ask is, I think it has been touched a few times before in prior questions. But your utilization is up, I think, 5 points, but I suppose there is still quite some headroom before you need to worry about utilization being hot. Your attrition is also up. I guess that's the nature of the market. You see that everywhere as kind of we come out the pandemic. But the pricing is stable. So if assume wage inflation is definitely coming, which lots of people are seeing, and I'm sure you are also seeing as well, how helpful is this global sourcing going to be? And do you think global sourcing, which impressively doubled for you guys in terms of mandates, will it -- can it continue? Is there more global sourcing penetration within your offer to come that will potentially help you manage that wage inflation in an environment where pricing seems to be stable?

Yes. I mean it's been an essential tool for us to deliver the results that we delivered last year. I mean we were expecting, as we went into the main crunch of the pandemic back in April, May of 2020. We were battening down the hatches. We were saying to our colleagues, we're not going to further anybody. We're going to hold on to our capacity. We're going to look after each other, right? We're going to get through this, and we're going to be stronger for it. What we didn't reckon on was over in the U.S. in particular, that strength of demand in the tech sector, coupled with suddenly remote working, meaning that you didn't have to move physically to the Bay Area and endure the horrific housing cost to get a job with some of the brand names. What we saw was a remarkable mobility of labor, not just in our firm, but in the U.S. market in total, which frankly took us by surprise. So that left us then working hard to recruit more people, to bring more juniors, to train them up, and it is the global resourcing engine that allowed us to meet the demand that we saw. And we have installed now a global professional services horizontal right across NCC Group, which has the ambition of knitting together all of our pools of talent into one flexible workforce that we can deploy. Now real life dictates that time zones are a thing. You can't service every piece of work in the Netherlands via somebody in North America or vice versa. Okay. So we recognize that there is limitation. But a couple of things, Damindu. Number one, global resourcing has further to go. No doubt about it. And obviously, it's going to be driven by demand, but we would expect that number to increase in the future. And secondly, it just allows us to hire more thoughtfully. And I'll point to the success of our Spanish office, for example, where historically, it was perhaps a little bit more cost effective to hire in Spain, not a lot. But there were more available people in the market that we could hire, and as a result, we've managed to build this fantastic, powerful Spanish office, which is deployed on work all over the year. So the globalization of NCC Group is, as I said, a hugely important tool in our armory.

And one last question, and I'll stop hogging the queue. Just on Software Resilience, IPM acquisition from memory, had some impressive sales leadership. Obviously, they are coming over. To the extent you can, could you kind of elaborate on what they will take over? Because one of the things that most people are interested is -- it was the fact that IPM actually had better revenue per sales head. So could we expect some of that magic to spread across more of the U.S. footprint and perhaps even elsewhere? So if you could comment on leadership, what the IPM guys will kind of take over or have taken over?

No, absolutely. I mean we've brought our colleagues across from IPM. You're absolutely right. Some of the stats we ran showed their sales effectiveness was higher than we were getting out of North America. And you'll appreciate, Damindu, I don't necessarily want to announce stuff on an analyst call. But we -- what we're looking to do is harness the skills and the leadership of the IPM team overall in our North American market. So they will be -- over time, we'll be creating one North American sales organization and taking the very best of IPM and giving them a lot of responsibility. In that regard, we don't see it as a takeover kind of acquisition. If that makes sense, Damindu. We see it as them joining our team and then giving them the space to show off.

[Operator Instructions] As we have no further questions, I'll hand back to the management team for any closing remarks.

Well that's lovely. Thank you, Adam. I think this falls to me to say thank you to everybody for taking a bit of time to join us this morning. Thank you for the questions. Of course, if you need anything else, don't hesitate to contact us. We look forward to updating you again in a few months' time. All the best. Thank you.