Shearwater Group plc ($SWG)

Good afternoon, and welcome to the Shearwater Group plc Investor Presentation. [Operator Instructions] The company may not be in a position to answer every question it received during the meeting itself. However, the company can review all questions submitted today and publish responses where it's appropriate to do so. Before we begin, I'd like to submit the following poll. I'd now like to hand you to Phil Higgins, CEO. Good afternoon, sir.

Good afternoon, and welcome, everybody, and welcome to this new presentation of our interim results. Today, I'm joined with Jonathan Hall, CFO, who will be able to give you a deeper dive into the financials later on. But before all that, let me give you a brief overview as to who we are and what we're about. So for those unfamiliar with the group, let me give you a little bit of background. Underneath the Shearwater banner, there are 2 divisions. We have 3 companies, and we have 4 brands that operate inside there. With inside our Services division, we have Brookcourt Solutions and Pentest. And we also got a consulting company, which is now fully immersed inside the Brookcourt division. In our Services division, we sell through to corporate clients. We're very strong in the telco and the financial sector, but we also do quite a significant amount of business now with inside the government divisions. On our Software side, we have SecurEnvoy. We own our IP. We develop both on-premise and in-cloud multifactor authentication and data discovery solutions. We sell our software through a network of global distributors, and we touch circa 50 countries with that distribution. The sort of market space we're in, we sell cybersecurity solutions, security solutions, advisory and consulting through to those corporate clients. And we do that with the brand names, you can see there on the screen. They've all got in excess of 20 years independent proven experience. They're multi-award-winning companies, and they're known for their quality of service. Take you straight into some of the highlights. Obviously, we're very pleased with the start of H1. As you know, last year, we moved our fiscal year-end. So we just come up to the end of our H1, and we're very pleased with the start. It gives us a lot of confidence moving forward. Revenues are up 31% in comparison to the same time last year. You'll notice there that the adjusted EBITDA is on breakeven. And when you consider where we were at the same period last year with a GBP 400,000 loss, obviously, there's a vast improvement that we've had so far. On the net cash, Jon will give you a little bit more detail and coloring around our cash position. But needless to say, when Jon came into the company, he helped us actually use that cash more effectively. Obviously, there's some compliance and regulatory rule sets, which determine and dictate how we do our reporting on our numbers. But that cash now, needless to say, is actually being used more effectively to actually help us grow and develop the business. As I said, we started obviously -- we finished our H1 very positively, and we started our H2 with some good wins. Since the start of the year, we've managed to secure in excess of GBP 13 million worth of new contract wins, and that's across telcos and the banking sector. So just taking into some of the market opportunity. You've seen it in the press, obviously, cybercrime is increasing. We see this increase further with war and upset and some of the issues that are taking place globally. We are seeing -- depending on who you talk to, the market space is worth anywhere between [ 200 billion and 500 billion ] a year. We don't cover all the market. We cover certain sectors. Obviously, with the authentication, we're in that space. But in the solutions side, we do focus around the cyber, the deep web, the monitoring and those types of sectors. What we don't do is the firewalls and the basic commodity-based items. So the technologies we're involved with are -- they put us in a very unique position. It allows us to talk to large corporate global organizations. It gives us the opportunity for lots of multiyear, multimillion dollar deals. It also gives us the opportunity for repeat business. So we got a high percentage of what we do is repeated. And you'll see that in some of the RNSs that we've announced. Obviously, we see the landscape itself is evolving. We see not just the threats are evolving with things like AI. The bad people are using that against us as well as obviously the regulators tightening up the control of your data. So all of these things contribute to additional spend that we see coming out of our corporate market. With our software development, we continue to develop into that space, and we're making sure that our software keeps pace with all the latest regulatory requirements and security needs and standards. If you look at the U.K. market and the U.K. government, they're suggesting that the growth rate, 10% to 12% CAGR. And obviously, we're thinking that we could be able to exceed all of that moving forward. If we just look at some of the things which highlight are in the press at the moment, we're seeing this constantly. We've all heard about market spends, the January ones, but there's others which are taking place on a constant basis. And a lot of -- what we are seeing now is there's a lot of reinvestment, a lot of new cash coming in into the budgets. There's -- organizations have been holding back for some time now, and we're starting to see that release of that cash. And historically, we used to see this period to be quite a fruitful period for us, the last minute spend during March. And we do see those opportunities increasing. We do see the conversations increasing. The meeting frequency is increasing, and it's all because of these headlines, all because of the threat landscape that we're seeing at the moment. So just to give you a little bit of those highlights. As I mentioned, we service -- on our services, we can go straight to the corporate end user. You know all the brand names. We deal with the key leading telcos in the U.K. We deal with a number of leading banks. We've got international customers, both European and U.S. based. Typical size of our deals, they're multimillion dollar deals on the high end. They're multiple years, and they've got of repeat business. We've got a large percentage of our revenues do come from relationships which are in excess of 10 to 15 years. And when you look at on the right-hand side there, some of those highlights that we're talking about, revenue up 37%, GBP 12.9 million. And this is a result of obviously some very large deals that we've been working on for some time. There's an expansion, and there's some renewal in that GBP 7.3 million. That GBP 1 million contract was obviously a result of our inclusion into the G-Cloud 14, where at the time we actually service or we presented around about 30 solutions and services to the government as part of the G-Cloud platform. Now we've resubmitted for G-Cloud 15 north of 50. So we do expect to see more growth coming out of the government departments. And then post period end, we've managed to secure, as I mentioned, we're around about GBP 13 million at the moment, but there's a major win with a major bank, which once again was an expansion and a renewal. It's a multiple year, and it's sort of a program which we'd like to think there's opportunity for us to expand even further. Just looking at some of those opportunities for growth. What we are seeing is obviously AI growing, and we are using it ourselves. It's helping us to be more efficient. It's helping us to create faster throughput, more throughput in effort from the resources we have without growing the headcount too much. It's also making us very sticky where we -- the types of deals that we deal with. As I mentioned, we have some long-standing customers. We do see a lot of repeat business. We are seeing a lot of growth inside that as well. We're seeing new features becoming available and our customer base expanding into that. We're also seeing obviously that G-Cloud opportunities. We are dealing with some very large departments inside the government as well as a number of the smaller divisions. The case study on site there, the 3-year contract, GBP 7.3 million. That's -- as I say, that's a renewal and expansion. The bank was a renewal and an expansion. And obviously, the government, that initially was a 1-year contract. And once we were able to prove ourselves, it then extended into a 3-year program. Moving on. On our Software division, we -- typically, we see our contracts there are 1 to 5 years, and we do service both the on-premise and in the cloud. So when you look at some of our competition, they're just servicing the cloud space. And we do see a number of clients now pulling it back into on-premise. We are seeing not everyone wants to leave their data in the cloud anymore. And in key departments where it makes sense, that is being pulled back. So we're still developing into that area. We're still making sure our software stays compliant. We are constantly releasing new version controls to make sure that we keep pace with industry change. And we deliver that to circa 750 clients around the world through that 50 or so countries through a number of global research. We're also moving the agenda where we dealt with a lot of smaller customers and many of them, we are obviously trying to push that up further to get them more of that medium-sized organization. And we've had some success at that. We still got a lot to do. We're still investing. We're still confident, but we do have more to do in this space. And with that, I'm going to pass over to Jon, who's going to be able to give you a little bit more detail around our financials and where we sit today. Jon?

Thank you. So before I dive into the detailed numbers on the slide, just to, I guess, take a step back and provide some context to where we're heading into the year. So a lot of people will remember, last year, we did a relatively strong performance; good growth; 29% annualized growth in revenue; and adjusted EBITDA up 91% year-on-year. So we came into this year off the back of a strong year and the market expectations with good growth in both revenue and adjusted EBITDA again. So the targets that are in the market for revenue growth of 12% and adjusted EBITDA of 32%. And I think, again, as a lot of people will be aware, we are typically quite an H2-weighted business. So there's always an extent when we get to our interim results that we're looking at the start, but the main course is always to come in the second half of the year. And you may remember that we actually took the decision last year to move the year-end away from March because that March, April kind of period is a big period for us in terms of number of deals that can close and sort of timing of some of those deals could become an issue in terms of providing expectations. I think where we are as we go into this, with this set of numbers, we see this as a really positive first half of the year, but also that we're going into H2 with a strong pipeline. We already had some good wins, and we're feeling confident around delivery of those market expectations, which, as I say, is for a second year of good growth in both revenue and EBITDA. In terms of the numbers themselves, top line growth of 31%, that's driven by continued good momentum in the services business. We do benefit a little bit there from the, I guess, the tail of revenues coming from projects we sold and delivered last year. Some of you will also remember, we changed our accounting policy last year, specifically as regards to provision of cloud-hosted software contracts and also third-party support as part of solutions that we deliver. The policy that we have historically applied was to recognize things upfront. And that's reflected when the bulk of our work was done because really the value add that clients are paying us for is to understand their needs to go out and find the right solutions, be that software, hardware, engineering services, to go out and procure and deploy that solution for them. And then there's a sort of project management layer that sort of sits over the top of that. The bulk of that work is done upfront. However, IFRS 16 is reasonably clear that when we are providing a cloud-hosted solution to a customer, that needs to be spread over a period of time. What we agreed as an accounting policy is that we would spread the cost of sale, we apply a small markup to that, but there is still a chunk of margin that's recognized on delivery. What we saw in the first half of last year is we deployed 2 big cloud hosting solutions contracts that led to a spike in margin last year. So you'll see the full year growth of the first half margin last year is higher than the full year margin. What we've seen this year is we have that sort of longer tail of hosting revenues that continued to sort of inflate our top line, but not actually contribute so much towards the gross profit. So we got that sort of dilutive effect, and I'll mention that in a little bit more detail when we look at the segment-by-segment reporting because it's a little bit more clear there. From an admin expenses perspective, we did some restructuring in the latter part of last year. The sort of the flow on the fast into our H1 numbers means admin expense is down 6% to GBP 2.9 million. That gives us an adjusted EBITDA very much flat with the restated numbers for the same 6-month period in the past year. I think Phil mentioned earlier. Actually, when we report our interims last year, we were talking about an April to September period, and that was a GBP 0.4 million loss. So we've made a solid start. We made a good start towards delivery of our full year numbers. We're pretty confident with where we're heading. Obviously, we've still got to go and do it and sort of close out the remaining deals in the second half of the year. Probably the only other number worth picking out in the lower half of the P&L, you'll see the amortization of acquired intangibles. Obviously, a noncash item that's come down year-on-year. And that comes back to the fact that at the end of last year, we took an impairment charge against some of the intangibles and some of the goodwill we were carrying on our balance sheet. So we're now amortizing a slightly smaller number. So that's all that's happening there. If we look at the split by services and software, as you'll see, services revenue up, but that's benefiting from that tail of revenues from projects we carried forward into this year. I think the first question we get asked in meetings is, well, does that mean your gross margin is now -- is 17% the new norm? Or what should we see as a gross margin? Actually, that's diluted, as I say. The real margin, if we look at last year's full year, we delivered gross margin of just under 22%. If I look at the lifetime value of contracts we deployed over the first half of this year, we deployed about GBP 10 million of new contracts in the services business at an average gross margin of about 21.5%. So fairly consistent with what we've sort of seen as an average for the whole of last year. We do get a little bit of variance project by project, so it can move a little bit of up or down, but I wouldn't want investors to think 17% is the new norm. That's more of just the impact of particularly when you look over a 6-month period, we will get some spikes where we deliver new cloud hosted solutions. And there when we don't, we'll sort of have our actual margin diluted by the sort of the carryforward element of that. We'd expect that as we head into the second half of the year, which is our peak in terms of our new contract delivery, we would expect that margin to normalize slightly over the second half of the year. On the software side of the business, revenue was down GBP 0.2 million. It looks if the gross margin -- well, the gross margin is down slightly, but what we're really seeing there is cost of sales that are relatively fixed. So our cost of sales in the software side is salespeople, it's sales promotion expenditure. It stays relatively constant in the short run. So you're seeing a GBP 0.2 million drop off in revenue translate to a GBP 0.2 million drop in gross profit. Again, we managed our admin expenses through the tail end of last year so we've got a slight reduction in our admin expenses. So we're able to sort of reduce the impact of that on our adjusted EBITDA. So it's still contributing GBP 0.4 million to our adjusted EBITDA from the software business. If you look at our cash flow, GBP 2.2 million of cash at period end. That's slightly artificially low. Our cash does always reduce over the course of the year. We have a typically U-shaped profile, which just reflects the fact that being quite an H2-weighted business, we do a lot of our cash collection and billing in the second half of the year. So we typically would expect to see a drop. What we also saw this year was just in terms of trying to put our cash to best use or best use for us, we had an opportunity to do a piece of business where we had a vendor who had a software vendor who had a price increase coming from the start of January. But we had a customer who wanted a piece of software or wanted a product solution but wanted to pay for it out of their FY '26 budget. So there was a solution that we deployed, paid for and delivered to the customer in December, but we weren't getting paid for that until 20th of January. So it's GBP 1.5 million that really relates to all of H1, which, as I say, we paid the cost of sale, but didn't come into our books until the second half of the year. So adjusting for that would have been at GBP 3.7 million, which is sort of a good guide to our normalized cash balance at that point. That would have been very slightly up on where we were at the same point in the prior year. And as I say, we typically do most of our billing cash collection in the second half of the year. So we'd expect that balance to increase quite significantly over the second half of the year.

Thank you, Jon. Just to take you through some -- obviously, the -- what we're looking at for H2. The marketplace is growing. Depending on who you talk to, is that 40% per annum growth, is that realistic? Or should it be bigger than that? What we are actually seeing is we're seeing more opportunities come through in more conversations, more face-to-face meetings, more team meetings, more proposals, more bids, and we're seeing increased expenditure coming from our key corporate clients. We're also seeing -- we're waiting on, obviously, the government at the moment to see how budgets will get spent in the new budgetary period. But so far, the conversation once again have increased. So there's plenty more opportunity out there for us. We are well capitalized. We returned to growth last year. And so far, in H1, we've been doing very well. We're very pleased with that performance. So we're using our cash very effectively. We're using our resources very effectively. We're fine-tuning wherever we can. And we believe that we're actually presenting a very good commercial position to the competition, and we're being successful with that as well. Our -- when you look at our pipeline itself moving forward, as Jon mentioned, post period end, we're in excess of GBP 13 million already. This is the busy period for us. Historically, Q4, as it would have been, would have been a period where we see some very large contracts come through. We've already experienced some contracts coming in. There's more to do. We're not finished with the year, obviously. But we are looking forward, obviously, to the March to the April period. That's when there's -- historically, when you look back at our numbers, you'll actually see a lot of large opportunities coming through to the system. Because of that, it actually fills us with confidence. We're probably more confident now than we have been in recent times that we're -- despite the headwinds that we see in the marketplace, and we are confident about achieving our year-end forecast targets. Couple that with the opportunities going through the business at the moment, keep watching, we'd like to be able to announce those in the coming months and before fiscal year-end. And with that, I'm going to pass back to Lilly and answer any questions that you may have. Lilly, back to you.

That's great. Thank you very much for your presentation this afternoon. [Operator Instructions] I'd like to remind you that recording of this presentation along with a copy of the slides and the published Q&A can be accessed by our investor dashboard. As you can see, we have received a number of questions throughout today's presentation. And if I may just start off with the first question here, which reads as follows. Can you provide more color on why H2 is expected to be stronger than H1?

A lot of the deals that we get involved with, as budgets get released with our large corporate clients and our banking sectors, some of these programs are very big, and we're working with those over -- sometimes we've been working just quite a few months. And a lot of that expenditure will start happening now. So we're in that bit of phases. And obviously, we are optimistic. We know the sort of deals we're going to win. We know the type of conversations we are having. We know at what stage we're at with those conversations. When you bring all that together, it increases our confidence moving forward. So it's client opportunity, it's our position in the marketplace, and it's also -- we're seeing the need to spend as well. And that's all giving us that extra confidence to move forward.

That's great. The next question we have here reads, services revenue is growing strongly, but gross margin fell to 17%. Is this a structural issue?

That's one for me. Yes. I think I've touched on this probably already, so that might have come in ahead of what I was saying. So no, it's more an accounting issue, and it's more down to the profile of contracts. And as I say, where we don't deploy new cloud hosted or when we do deploy new cloud hosted solutions, we'll get a spike in our margin, similar amount of gross profit coming in, but a spike in our percentage margin, and it's followed by a longer tail of lower margin as the contract comes in. The margin that was in the full year number for the services business around 21.5% is probably a reasonable guide for where we trend over the long term. Occasionally, we'll do a larger contract where we might take a slightly smaller margin than that just because the scale of the contract justifies it. But no, it's not a structural issue. It's not a sort of a sign of a structural shift and margins being eaten away. It's more akin to a profile and mix issue.

That's great. Government is mentioned increasingly. How material is this opportunity?

Now it's quite significant for us. It's a good contributor. Historically, we stayed away from the government business simply because on a large scale, simply because of the bidding and was so aggressive in the price point. But we have some unique services and solutions, which we can take to the government now. And we won our position on G-Cloud 14, and we've now submitted our G-Cloud 15, and we've nearly doubled the solutions and services we're presenting through. And we've been winning some very large departments. Some of the biggest departments in the government are now clients of ours. So -- and with this -- when you look at our services and solutions, we do see a lot of repeat business, a lot of opportunity to renew. And we've seen it with one government department where they purchased 1 year from us, and they renewed in H1, and we saw that as being -- and that moved to a 3-year deal. So they're seeing value in the product set. They're seeing value in the solutions we're offering. And commercially, obviously, we're landing with the right number. And to us now, it's certainly worth the investment. We've also struggled historically with having the resources available to respond against government bids. They do produce a lot of paperwork, I hate to say. But of course, we developed over the last sort of year, 18 months, our own AI engine internally. And what that allows us to do is to chop through a lot of that paperwork extremely quickly. It takes seconds. It doesn't take days or weeks now. Historically, we used to have a team of people that would have to read an inch worth of paperwork, then it had to be reviewed in meetings. And that's even before if we decide to go after the bid. Now we can achieve all of that in 30 seconds, which means that we can increase our throughput. We can increase the amount of activity we get involved with and respond effectively against the government contracts.

Given the large cash balance, why don't you pay dividends or buy some shares back?

So we are constantly looking at how do we best deploy our cash for the benefit of our shareholders. As you'll see with the sort of the usage profile, we always get, it does drop a bit towards the middle of the year. But our judgment has always been, for the moment, up to a point of probably about GBP 5 million of underlying cash. We want to keep a certain amount of cash on the balance sheet for resilience. We don't want to drop below a certain level. We also want a certain amount of cash on the balance sheet for flexibility to do the kind of deals that we did in December because it gives us an opportunity to create some extra margin and drive extra value for shareholders. We think, at the moment, that drives better value than returning the money to shareholders via dividends or taking existing stock out of the market. So we are always looking at those opportunities. And as I say, if we continue to grow the cash balance as we hope to over the next 12 months, once we get north of a genuine underlying cash balance of around GBP 5 million, I think we can maintain the flexibility and resilience that we want while also starting to look at some of those options. But at the moment, we consider that using our cash in the way we are is in the best interest of shareholders. And I think that sort of the position we had around year-end is probably a good example of being able to do that kind of deal gives us that kind of flexibility. And so that's why we keep a little bit more cash on the balance sheet than sometimes, particularly when people look at year-end balance sheet, it might look almost a little bit too luxurious a position, but I think we're putting it to good use.

That's great. Just turning to a question here around AI. You mentioned that the accelerated integration of AI is fueling demand for secure systems. How specifically are you monetizing this trend? Is it through increased demand for existing services or the launch of new AI-specific security products?

All of the above, really. So we're seeing obviously that the bad people are using AI as well against us. We have been working with AI-based tools. In the early days, it's simply known as deep learning tools for a number of years. Pre-COVID, we were dealing with deep learning technologies. So we've been deploying that for some time. But we also -- as you know, we achieved our ISO 42001 solution business. And that put us right in the center of AI in terms of a knowledge set. So we use it to actually build out our own large language module inside the company. So we're using that to actually increase our efficiencies, get more work done with the same amount of resources. We're also selling our existing technology set, which is deep learning based. But also as the marketing moves forward and as AI becomes more popular, there's a lot of people obviously developing into AI. So a lot of our vendor partners have brought to the market additional technology solution set all based around AI. So we're using all of that to actually grow our position. Hopefully, that answers your question.

Thank you. It was good to meet you in person at Mello last year. Will you be presenting at Mello Birmingham next month?

Not next month, no, unfortunately. And the reason is quite simple is, as we mentioned, this is one of our busy periods. And we find -- we want to prioritize the business in front of the roadshow. But we are participating in more roadshows. And so hopefully, there will be an opportunity, and we will publish that nearer the time as and when we get to those. But we will be -- we will not be attending Mello next month.

Perfect. Today's results said you're trading in line with expectations, but they require a big H2 weighting and the market seems to be doubting that you'll hit those numbers. Surely, you're doubting the numbers, too. Otherwise, you'd be buying back shares hand over [ first ] on a forward [ EV ] EBITDA less than 1.

I think this probably comes back to the point we take with the cash point around how best do we use our cash for the benefit of shareholders. Our judgment at the moment is because there are some deals around that occasionally we need cash flow and because we need to continue to show resilience to the type of blue chip customers that we sell to, we don't want our cash balance to get too low, and we want to retain a degree of flexibility to deliver better returns and better profits by being able to use that cash to grow the business. So no, please don't interpret that as a sign that we think the valuation market is a fair reflection of where we are. We believe in sort of where we're heading to. As Phil says, we can see it in the pipeline. We're still going to go out and win it. So the fact is in the pipeline doesn't mean we can sit here and say it's done. We know that the numbers are there. But we do feel positive about it. And the fact we're not doing a sort of share buyback shouldn't be interpreted as a lack of confidence on ourselves.

And the last question we've got here reads, noncurrent receivables have seen a big jump. Is it normal to book revenue for which you won't receive the cash for over a year?

Yes, it can be when we deliver the on-premise solution. So this comes back a little bit to the point I was talking about the accounting. We might deploy a solution, which might be a 2-, 3-year solution for a client. We might get paid over a period of time, but the significant portion of our work has been delivered. In an on-premise solution, almost all of our work has been delivered at the point our solution has been delivered. So we may book revenue where we won't actually see some of the billing happen for over a year. So we can't yet. And some of the revenue, even that we booked for last year, we will be collecting in the latter half of this year, which, again, gives us confidence around the visibility of some of our cash in H2 of this year.

That's great. Thank you for answering those questions you can from investors. And of course, the company can review all questions submitted today, and we'll publish those responses on the Investor Meet Company platform. Just before redirecting investors to provide with their feedback which is particularly important to the company, Phil, could I please just ask you for a few closing comments?

Certainly. Well, firstly, thank you very much, everyone, for tuning in today. Key message to take away. Obviously, we returned to growth and profitability last year. We had very aggressive targets on top of that this year. H1 started very well. We're very pleased with our progress so far. Post period end, we've had some great results come through already and gives us a lot of more confidence for driving through to the end of this fiscal period. We've got expansion in our services, expansion in our solutions. We've got more conversations taking place, more bids on the table. So you can see why we're more confident about our position at the moment. And when you look at the marketplace, we're living in a very hostile environment at the moment. And all the time that we're seeing this, we're seeing more of the more regulators, more threat landscape growing, and we're playing into that space. We're selling directly into that space with large corporate clients. And we've been doing that for a number of years now. We've got some big blue-chip companies, and that's some of our foundation revenues come from there, but we're also attracting new business. So we are growing our client base as well. So when you take it away, do take away those positive messages. And we look forward, obviously, to updating you as we go through the year and hopefully be able to present you with some additional RNSs with our corporate wins. Thank you very much.

That's great. Thank you for updating investors today. Can I please ask investors not to close this session as you'll now be automatically redirected to provide your feedback in order that the management team can better understand your views and expectations. This may take a few moments to complete, and I'm sure it'll be greatly valued by the company. On behalf of the management team, we'd like to thank you for attending today's presentation, and good afternoon to you all.

Thank you.

Thank you.