Endava plc
Q3 2021 Earnings Call Transcript

Published: 19 May 2021

[Operator:]

Good day and thank you for standing by and welcome to the Endava plc Earnings Release Third Quarter Fiscal Year 2021 conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. . Please be advised that today's conference is being recorded. . I would now like to hand the conference over to your speaker for today, Ms. Laurence Madsen. Please go ahead.

[Laurence Madsen:]

Thank you, operator. Good afternoon, everyone, and welcome to Endava's third quarter of fiscal year 2021 conference call. As a reminder, this conference call is being recorded. Joining me today are John Cotterell, Endava's Chief Executive Officer, and Mark Thurston, Endava's Chief Financial Officer.

[John Cotterell:]

Thanks, Laurence. And I'd like to thank you all for joining us today. I do hope that you're all staying safe and healthy in these unusual times. We're pleased to be here to provide an update on our business and financial performance for the three months ended March 31, 2021.

[Operator:]

. You have a question from the line of Bryan Bergin with Cowen.

[Bryan Bergin:]

I wanted to ask on the 4Q outlook and this material uptick in growth? First, can you just quantify the level of organic versus inorganic mix? And then, it would seem like the demand is rapidly normalized here, but can you talk about what you're seeing in the pace of client decision-making, sales cycles, really any changes in client buying behavior you're noting now versus pre-pandemic?

[Mark Thurston:]

There has been a material uptick in the guide. We have a full quarter for FIVE compared to a month in Q3 and then we have a full quarter contribution from Levvel. So, the inorganic component of the growth guidance that we're giving is circa around sort of 12%. But, actually, there's been a very big acceleration in the underlying business and that is around sort of 11% of the increase that we had on the previous guide, which is implied in our full-year guidance of around 30%. So, the two components is a 23% sort of uplift, slightly more from acquisitions at 12%, but the organic uplift is around 11%.

[John Cotterell:]

On the wider picture around client buying behavior and what's driving demand, we see demand remaining very strong. And that's the buying process with us is that clients engage with us, whether it's a new client or indeed those existing ones who are looking to build out new products in initial ideation phases where we're looking at what the new product would potentially do for their business, where we're producing proof of concepts and so on. And as those get selected, they scale up into larger production demand. So, what we're seeing at the moment is we've got many of these early stage engagements, more than we would have had pre-pandemic. And the expectation is that, over the next 12 to 18 months, we should see those flow up into production scale engagements that drive demand. So, we see quite a large pipeline coming through that is being driven by that early stage work that we're doing with the clients. And you actually see some of that in the numbers of smaller clients that are expanded fast over the last year. One of the drivers of that has been new clients engaging us in ideation phases that don't have huge cost tags attached to them, but as they get traction as a way to move their business forward, they flow into wider engagements.

[Bryan Bergin:]

You had a notable SG&A reduction that's down 11% in pounds quarter-over-quarter. Can you talk about the efficiencies that are driving that? I don't think you've been at this level since pre-IPO. So, how do you think about the sustainability at this rate as you do consider reopening later in 2021 and a likely uptick in S&M activity?

[Mark Thurston:]

There's a number of sort of positive facts behind that. We're in the range – and slightly above actually on the revenue, but the EPS was a big beat, primarily that was sort of gross margin. But the SG&A was a big contributor to that, is around on an adjusted basis, just under 16% of revenue as we were anticipating 18%. And there's a number of items there which range from bad debt release as we're coming out of the pandemic and then lower spending which is mainly to the timing around items such as sales and marketing. But, going forward, certainly for Q4, we'd see a more normalized level of SG&A around 18% – adjusted SG&A 18% of revenue. And that's sort of implicit in the EPS guide we're giving.

[Operator:]

You have a question from the line of Ashwin Shirvaikar with Citi.

[Ashwin Shirvaikar:]

My congratulations as well. This is quite a quite an exceptional uptick in expectations. Let me start with asking about supply of talent. You also have a very strong uptick in headcount. So, in the geographies that you are getting your talent from, are you beginning to see sort of supply concerns emerge? And if so, is it more range related, just the number of people related? Or if not, what are you doing something different that you're not facing this, similar to other people are facing in this way?

[John Cotterell:]

The recruitment of quality staff, as you know, is always a challenge. It requires a successful market presence and career proposition that's going to attract and retain the best. Currently, demand is running ahead of our ability to grow in terms of the ramping up of people, although, of course, we have taken that into account in the guidance that we've given. We've always guided the market around about 30% organic growth on average – you can see some quarters pop over it – is our sensible ceiling without growing beyond the ability to onboard, train and equip our teams to perform in the Endava way. Currently, our attrition is actually very low. We're still at 8%, which is well below the 15% that we target. So, that is enabling us to grow organically at greater than 30% max that we'd normally guide without destabilizing our expansion. However, as I just noted, it's still below the market demand that we're experiencing. So, we are actually having to turn some business away. So, that probably goes to the heart of your question, I imagine.

[Ashwin Shirvaikar:]

I would think that, based on your comments on pipeline as well as what you said in your prepared remarks on demand that this is not a temporary snapback, that this should inform your outlook when you finally give your fiscal 2022 outlook. So, this is a longer-term sequence of events and multi-year, hopefully. Would that be accurate?

[John Cotterell:]

Yeah. Absolutely, it feels like that at the moment with the visibility of those ideation phases that we're doing with clients. We'd expect a significant number of those to flow through into production systems, which is a significant step up on the engagement level with clients and the amount of spend on the induction phase. So, yes, feels more like a new normal than any sort of normalization back to the growth rates of historic guidance.

[Operator:]

You have a question from the line of James Faucette with Morgan Stanley.

[James Faucette:]

I just had a couple of follow-up questions – or at least one follow-up question to Ashwin's question as it relates to recruiting. In the past, at least you've talked about being able to recruit roughly one-third from referrals, a third coming from university partnerships, and basically a third coming from the market. Any change in that kind of mix? And I guess, tied to that, if there are changes or even if they're not, what are you needing to do from a compensation standpoint in your recruiting right now?

[John Cotterell:]

Only small changes. We're probably seeing about 40% of our recruitment coming through referrals, which has pulled back. The uni and market elements are small amounts. And there are some sign of staff cost pressures at the moment. But our major pay round annually is in December, and we actually address a lot of that pressure in the December pay round. And with the level of demand in the market, we do expect that we will see some cost pressures coming through. And we've taken that into account as we look forward. I expect that attrition will pick up from current levels and that will also inform our position on salaries as a market. But we remain confident that we can recruit and retain excellent people at that level of growth that we're comfortable with.

[James Faucette:]

On the other side of the equation, I guess, can you talk about the pricing environment and your expected ability to pass through costs? And I'm curious, based on your comments around the ideation, engagement, et cetera, are you able to manage – like, how does that impact your pricing with your customers? And are you able to build in some of these cost pressures, particularly if you're engaging kind of at earlier stages now?

[Mark Thurston:]

The pricing environment, you can really see in our revenue per head, it's remained relatively consistent quarter-on-quarter despite FX headwind. So, it's pretty solid. And we see that going out. I think given the sort of cost pressures that just sort of indicated, we will need to have conversations with our clients over the coming months about rates. But, against the sort of the whole backdrop of the demand picture out there, we're pretty confident that we can secure that pricing at sensible levels to get the talent that we require to deliver the solutions to clients.

[John Cotterell:]

Just add to that pricing conversation, which is oriented around the value that we're bringing through a transformative product that we've helped the client to envision is very different to a commodity style pricing conversation.

[Operator:]

You have a question from the line of Maggie Nolan with William Blair.

[Ted Starck-King:]

This is Ted on for Maggie. In the past, you've mentioned that margins can be strong on initial relationships with clients. Is that a piece of what's driving the current margin strength? Or has that dynamic changed at all?

[John Cotterell:]

We do get an element of that. Yes. When we're doing a small engagement, we tend to start a little bit closer to the rate card. And then, as we scale with the client and they're spending more with us, obviously, we offer some discounts against the volume and assurance of business going forward, which benefits us as a business as well, obviously. So, it's a sensible dynamic. It won't be a huge dimension in terms of moving the margin. I'm guessing less than 1%, Mark?

[Mark Thurston:]

Yeah.

[John Cotterell:]

But it is a small element.

[Ted Starck-King:]

John, I think you mentioned that, in the second half of the year, there's a gradual return to the office with a hybrid model. Can you maybe elaborate on what that hybrid model looks like? How does that impact kind of the T&E levels spend? And maybe how you use the real estate footprint?

[John Cotterell:]

Obviously, this is an area of huge discussion across the industry. We're seeing some companies take different directions on it. In Endava, we're very, very consciously trying to balance the two factors. On the one hand, we've seen major benefits from working from home with good productivity. Employees like having that flexibility. And they want to see it as part of their working patterns in future, all of which we will respond to. On the other hand, we also strongly believe that teamwork across multidisciplinary teams in an agile setting actually benefits hugely from in-person team activity, enabling better ideation, improved team spirit, and actually a social context for our people to thrive as a team. So, people are also keen to see that. So, as a result, we are planning for a hybrid model where people will have a lot of flexibility within their teams to have head down days at home or quiet spaces in the office. And there'll be other days where key agile ceremonies are undertaken as a team in person in the office. So, sprint planning, retrospectives, technical or business solution ideation, and so on within your team. So, we'll see a mixture of it. And I think that will give people the benefit of flexibility to work from home a lot of the time when they want to, but also delivering the team benefits that we need for our business model. Mark, I don't know if you want to say anything on the impacts on P&L.

[Mark Thurston:]

I think, over time, with the property footprint, we should get better utilization with people coming in less than the five days a week, and that will push up our occupancy. Whilst we're sort of in some longer-term lease arrangements, the requirement for space over the coming years will reduce. So, I'd expect our sort of property costs or potential revenue to tip down a percentage or two over coming years.

[Operator:]

You have a question from the line of Mayank Tandon with Needham.

[Kyle Peterson:]

This is actually Kyle Peterson on for Mayank. Just wanted to start with M&A. You guys have definitely been pretty active on that front lately. What's the pipeline like right now? And what are some key areas of priority for you and what you guys are looking for on future deals?

[John Cotterell:]

As you've noted, we've closed two transactions, one in March and one right at the beginning of this current quarter. And we're seeing a lot of opportunities. There are multiple deal opportunities running across our desk literally every day. So, there's a lot of activity out there. But actually few of them have got the right DNA, that ideation to production capability, the agile approach that utilizes next gen technology that we're looking for and we remain very choosy in where we engage now. There's nothing I can report on at the moment. As soon as there is anything material, obviously, of course, we will report it. In terms of the focus, it very much remains, firstly, around the geographic balancing. So, adding geographic locations. And, of course, the last two strengthened in the US. The previous to strengthened us in Continental Europe. And so, we'll be looking probably into Asia-Pac and maybe if there's right opportunities for further strength in the US and Continental Europe. Second area is around sector acceleration, particularly building out some of the key opportunities we see in our other segments. And then, there occasionally are some technology boosters that are valuable. And often deals bring some element of all three of these, and that makes those businesses particularly attractive from an M&A point of view.

[Kyle Peterson:]

I guess just a quick follow-up. The trends in the payments and BFSI vertical looks really strong this quarter. Is that new clients and projects ramping? Is there more spend in some of the existing base? And how should we think about how Levvel will impact your kind of reach and scale within the payments vertical moving forward?

[Mark Thurston:]

It was strong. Despite the headwinds, we had 14% consecutive growth quarter-on-quarter. And most of that has been across all of our geographies. So, we're getting real traction in our offering, riding that wave particularly well.

[John Cotterell:]

From a Levvel point of view, that business is split across mobility and logistics as being the largest area. And then, the payments and financial services, particularly mid-tier banks, is also a very, very strong capability. So, those will add to our existing sector focus and give us some depth and acceleration in the US in those sectors.

[Operator:]

You have a question from the line of Bryan Keane with Deutsche Bank.

[Bryan Keane:]

Just a couple of clarifications. A lot of my questions have already been asked and answered. Mark, when we look at the organic growth increase in the 4Q guide, I think you were talking about maybe 11% uplift. What's causing that versus previous expectations three months ago?

[Mark Thurston:]

Basically, the acceleration across – very strong pickup in payments and financial services, as the last questioner sort of pointed out. And we are seeing an acceleration geographically as we go into Q4, particularly into sort of Europe and the UK. So, we're, we're firing on all cylinders in terms of geo expansion, and particularly the payments and financial services sector.

[Bryan Keane:]

Thinking about the EPS raise, the raise was material there even despite the acquisitions. Are the acquisitions accretive or they actually dilute to start in the fourth quarter?

[Mark Thurston:]

I think they contribute. In terms of the beat this quarter, it was really from a strong gross margin. So, it was stronger than we anticipated, which was higher utilization, people taking less holiday, the SG&A timing effect that I sort of pointed out, which should sort of normalize at the 18%. And basically, we see the margin that we secured in Q1 being maintained at that level. On an adjusted basis, that's 41.5%. We get contribution and a minor uplift from the acquisitions that we add in for the full-year effect – full quarter in in Q4 for Levvel and for FIVE.

[Operator:]

. You have a question from the line of Jamie Friedman with Susquehanna.

[Jamie Friedman:]

Mark, in your answer to a previous question, I thought that you had disclosed the specific growth in payments unless I heard you wrong. Can you reiterate what you had said previously?

[Mark Thurston:]

I was pointing out that, sequentially, quarter-on-quarter, going from Q2 to Q3, we've had strong growth, around 14%. And most of that has been across all our geos. That's payments and financial services. So, includes insure, tech, asset and wealth management and banking.

[Jamie Friedman:]

The headcount did grow a little bit faster than the revenue, Mark. And then, your attrition is really low at the same time. 8% is remarkable. So, is that headcount growth in anticipation of the standing up new business as soon as the fourth quarter, is that what that's about?

[Mark Thurston:]

Depends if you are looking at year-on-year or quarter-on-quarter. So, at the total level, we grew quarter-on-quarter about 7%. We had a contribution from M&A. So, let's call it sort of 6% in terms of our revenue growth. And the headcount tends – the better headcount metric to take is the average because it has a relationship with revenue rather than period-end. And that grew quarter-on-quarter about 6% or so. And even if you take out the contribution from FIVE, which was in there for one month, we're getting to around a 6%. So, we're growing really the revenue in line with the headcount. Now, we saw an improvement in the margin in the quarter because utilization went up marginally. So, we're eating into a bench that we had previously built up in the Q1, Q2. I think we're in a position now where we are still recruiting very strongly to meet that demand that we've outlined in the guide and probably our utilization will remain at around that sort of level. And that's why I think the gross margin will be in line with what we've delivered this quarter.

[Jamie Friedman:]

The comment I was making was year-over-year, but I understand sequential makes more sense as a way to look at it. John, your prepared remarks talked a lot about North America. And I realize that's, obviously, a very important geography for you, though, historically smaller than, say, the UK. Your acquisitions are both this quarter in North America. Would it be fair to map the growth in the verticals by the growth in the geographies? In other words, like TMT grew 32%, North America grew almost as fast. Is there more TMT in North America than elsewhere?

[John Cotterell:]

Not particularly. The mix doesn't exactly map on to the geography. So, it's not completely homogenous. But a lot of the growth in North America, for instance, is happening in the payments and financial services arena. So, there's more of a rebalancing and standardizing, if you like, of the proportions as you look across geographies and sectors that is going on. So, whereas, historically, North America probably has been a little bit more in TMT and other, it is normalizing as our organic growth comes through.

[Operator:]

There are no additional questions. I would like to turn the call back over to management for closing remarks.

[John Cotterell:]

Great. Well, thank you all for joining us today. I'm sure, as you will have noted, that demand for our services actually remains very strong. And we're seeing that across all our verticals and geographies. So, we remain very positive about our business position and look forward to seeing you at our next earnings call, which will be in September, given it's our full year. Thank you.

[Mark Thurston:]

Thank you.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. You may now all disconnect.