Endava - Q1 2023

Transcript

Operator (participant)

Good afternoon, good day, and welcome to Endava's first quarter of fiscal year 2023 conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing star, then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Laurence Madsen, Head of Investor Relations at Endava Plc. Please go ahead.

Laurence Madsen (Head of Investor Relations)

Thank you. Good afternoon, everyone, and welcome to Endava's first quarter of fiscal year 2023 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.

Before we begin, a quick reminder to our listeners. Our remarks today include forward-looking statements, including our guidance for Q2 fiscal year 2023 and for the full fiscal year 2023, and other forward-looking statements regarding our business and operations. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements.

Actual results and the timing of certain events may differ materially from the results or timing predicted or implied by such forward-looking statements, and reported results should not be considered as an indication of future performance.

Please note that these forward-looking statements made during this conference call speak only as of today's date, and the company undertakes no obligation to update them to reflect subsequent events or circumstances other than to the extent required by law. Please refer to the risk factors section of our annual report filed with the Securities and Exchange Commission on October 31, 2022.

Also, during the call, we'll present both IFRS and non-IFRS financial measures. A reconciliation of non-IFRS to IFRS measures is included in today's earnings press release, which you can find on our investor relations website. A link to the replay of this call will also be available there. With that, I'll turn the call over to John.

John Cotterell (CEO)

Thank you, Laurence. I'd like to thank you all for joining us today, and I hope you're all well. We're pleased to be here to provide an update on our business and financial performance for the three months ended September 30, 2022.

We reported another solid quarter, with revenue totaling GBP 196.2 million for Q1 of our fiscal year 2023, representing a 33% year-on-year increase from GBP 147.5 million in the same period in the prior year. We ended the quarter with an adjusted profit before tax for the period of GBP 39.5 million, representing a 20.1% adjusted profit before tax margin. Despite continued global macroeconomic uncertainty, we remain in a strong demand environment.

The recent political challenges in the U.K. have caused apprehension in the market, and I'd like to emphasize that we have little exposure to U.K.-centric businesses. Around 80% of our revenue in the U.K. is derived from multinational companies with a global transformation agenda as we book revenue in the country where the service is delivered.

I'm pleased that we recently launched our second We Care sustainability report, which gives more insights into our ESG approach and priorities and can be found on our investor website. We are building on our commitment to prioritize the well-being of our people. We want to ensure that all our Endavans have options available to support their mental health and well-being, should they need it, at any point in their careers while working with us.

We now have a number of trained Endava well-being champions across the organization who act as a point of contact and are advocates of our well-being offer, helping direct Endavans to available resources. We're also making progress towards our environmental ambition of achieving net zero emissions from our organization and value chain. We've been working towards alignment with the SBTi criteria in setting and subsequently validating targets. This involved defining a baseline for our emissions data against which to measure our progress.

We engaged PricewaterhouseCoopers to provide limited assurance over selected metrics related to the greenhouse gas emissions disclosures included in our published sustainability report. On the revenue front, we grew in all geographies and verticals during the quarter. As usual, our revenue growth continues to be driven by both the expansion of work for our existing clients and the acquisition of new ones during the quarter.

We ended the quarter with 715 active clients. Up from 658 at the end of the same period in the prior year, a 9% year-on-year increase. Importantly, we continued growing the number of larger clients with a total of 140 clients paying us in excess of GBP 1 million per year compared to 93 in the same period last year, representing an impressive 51% year-on-year increase.

As the ideation phase is brought to life, we believe that the opportunity to scale the engagement into production systems is realized, significantly expanding activity and client footprint. For over 20 years, Endava's payment vertical has been providing payments expertise to the financial services sector. This includes helping banks, payment service providers, credit and debit card companies, acquirers, fintechs, and paytechs with their payments estates.

We see continued strong demand in the vertical, with a constant runway of work to cater to the ongoing digitization of payments globally. In parallel to this payments vertical, we have created the payments horizontal to help customers across industries integrate the online payments experience. This is essentially deploying our 20+ years of payments knowledge and capability in financial services into other industry verticals.

We're seeing a significant demand for our services across various sectors, including retail, automotive, airlines, insurance, healthcare providers, and particularly in marketplaces. The underlying theme is that companies are increasingly taking direct ownership of their payments value chain. We are seeing a big increase in work helping clients analyze the payment experience they provide to their customers, and how they collect revenue for themselves and on behalf of third parties.

These projects include building onboarding and KYC solutions, real-time payments for claims and micro payments in insurance, in-car payments in automotive, and payment facilitators in healthcare to reduce payment costs and create new revenue streams. Across all verticals, one of the key areas we are active in is payments orchestration.

Many large global businesses have extremely complex payments estates as a result of global expansion, transition from brick-and-mortar stores to e-commerce, adoption of new payment options, as well as acquisitions and product diversification. As a result, these clients now have very siloed payment infrastructures by region, often with multiple regional partnerships and commercial agreements.

This makes integrations, maintenance, and partner management a very expensive process. Endava has been helping businesses across many industries to simplify their payment platforms, and as a result, has enabled them to reduce the cost of ownership and centralize supplier buying power.

This allows clients to go to market with new services quicker, to be more competitive, and to offer an improved customer experience. As a result, new revenue streams are created by increasing throughput of successful transactions and reducing costs. Endava is helping marketplaces with their payments complexity and is also helping businesses across all industry adopt marketplace models.

Marketplaces add value by streamlining supply chains, reducing costs, enabling access to a wider network of vendors, and more rapid product and service diversification. Marketplaces introduce new revenue streams for our clients, with payments becoming the key driver of revenue growth. We work with payments and financial services companies needing to transform their platforms to support their clients that adopt this business model. We also work directly with businesses that adopt this business model and need to transform their platforms.

For example, we are working with Paytrix, a payments company, to help them bring to market a product that would let marketplace platforms more easily pay suppliers in harder-to-reach regions, such as Asia-Pacific, while supporting traditional close-to-home payment approaches. In the mobility area, we are having more conversations and engaging in more projects around the future digital enablement of personal transport and the evolution of mobility as a service.

Car manufacturers are rapidly having to adjust to the digital user experience demanded by younger buyers. This includes the need to enable cars to become payment devices and a personal mobility device through digitally enabled subscription, sharing, and rental models. Our expertise with user experience, consumer-facing mobile and web platforms, API enablement, and critical scalable systems, coupled with our relationships in the automotive sector, have positioned us well for this emerging market for our services.

We are working with Lynk & Co, a disruptor in the automotive space. We initially helped them to bring one of the first car subscription models to market, rapidly followed by helping them enable car owners to share cars via a marketplace. This offers car owners their own revenue stream and extends the reach of the Lynk & Co brand to both direct subscribers and a wide network of occasional users. Additionally, there is a growing number of new financial services companies looking to offer business solutions.

Endava is using its payments experience to help those new companies scale and build out connections to hundreds of global payments platforms. We're also working with companies such as Stripe and Planet as they look to diversify their existing global portfolios further. We're working with a global payments orchestrator, helping them to solve complex payments challenges, improve efficiencies, and reduce costs.

Endava is helping them scale their latest technology to increase the number of solutions they offer to clients. Planet specializes in solving complex payments challenges in the retail and hospitality sectors and working with a network of global partners. Endava helped modernize their product offering, making it cloud-native and able to support both online, mobile, and in-person payments.

We continue to support their revolution as they build out their connected commerce platform that helps retailers and hotels connect software and payments to put the customer experience first. We're excited about our payment horizontal model as payments is increasingly becoming a key focus for companies outside of the traditional payment industry. We continue our geographical expansion and diversification. We recently announced the acquisition of Lexicon in Australia.

Lexicon partners with clients to build new digital solutions or accelerate digital transformation programs across enterprise systems, products, and IoT using an agile delivery methodology. Lexicon's 127 operational employees are in Australia and Vietnam. I'm excited about our growth prospects in the Asia-Pacific region.

Our client growth continues to translate into strong employee growth. We ended the quarter with 12,065 employees, a 25.5% increase from 9,616 in the same period last year. While competition for the best talent remains strong, we remain very successful in recruiting the people we need, and our attrition rate remains low. In summary, as demonstrated by our financial results, demand for our services remains strong.

We are successfully navigating a challenging global macroeconomic environment and remain excited about the opportunities in front of us and confident in our ability to execute on our objectives. I'll now pass the call on to Mark, who will walk you through our financial results for the quarter and provide guidance for the coming quarter and the fiscal year.

Mark Thurston (CFO)

Thanks, John. Endava's revenue totaled GBP 196.2 million for the three months ended September thirtieth, 2022, compared to GBP 147.5 million in the same period in the prior year. A 33% increase over the same period in the prior year. In constant currency, our revenue growth rate was 25.9%. Profit before tax for Q1 fiscal year 2023 was GBP 38.6 million compared to GBP 24.9 million in the same period in the prior year. Our adjusted profit before tax for the three months ended September thirtieth, 2022 was GBP 39.5 million compared to GBP 34.8 million for the same period in the prior year.

Our adjusted profit before tax margin was 20.1% for the three months ended September 30, 2022, compared to 23.6% for the same period in the prior year. Adjusted profit before tax, adjusted PBT, is defined as the company's profit before tax, adjusted to exclude the impact of share-based compensation expense, amortization of acquired intangible assets, realized and unrealized foreign currency exchange gains or losses, and fair value movements of contingent consideration, all of which are non-cash items.

Adjusted PBT margin is adjusted PBT as a percentage of total revenue. Our adjusted diluted EPS was GBP 0.54 for the three months ended September 30, 2022, calculated on 58.1 million diluted shares as compared to GBP 0.49 for the same period in the prior year, calculated on 57.8 million diluted shares.

Revenue from our ten largest clients accounted for 33% of revenue for the three months ended September 30, 2022, compared to 36% for the same period last fiscal year. Additionally, the average spend per client from our ten largest clients increased from GBP 5.3 million to GBP 6.4 million for the three months ended September 30, 2022, representing a 20.3% year-over-year increase. In the three months ended September 30, 2022, North America accounted for 35% of revenue, compared to 36% in the same period last fiscal year.

Europe accounted for 22% of revenue compared to 20% in the same period last fiscal year, and the U.K. accounted for 40% of revenue compared to 41% in the same period last fiscal year. While the rest of the world accounted for 3%, unchanged from the same period last fiscal year. Revenue from North America grew 26.1% for the three months ended September 30, 2022, over the same quarter of fiscal year 2021.

Comparing the same periods, revenue from Europe grew 41.7%, the U.K. grew 32.3%, and the rest of the world grew 74.5%. We grew in all three of our industry verticals during the quarter. Revenue from payments and financial services grew 38.3% for the three months ending September 30, 2022.

Revenue from payments and financial services accounted for 52% of revenue, compared to 50% in the same period last fiscal year. Revenue from TMT grew 21.5% for three months ending September 30th, 2022, over the same quarter of 2021, and accounted for 23% of revenue, compared to 25% in the same period in the prior year.

Revenue from other grew 33.9% for the three months ending September 30th, 2022, over the same quarter of 2021, and now accounts for 25% of revenue, unchanged compared to the same period in the prior year. We now turn to our adjusted free cash flow, which is our net cash provided by operating activities, plus grants received, less net purchases of non-current tangible and intangible assets.

Our adjusted free cash flow was GBP 21.8 million for the three months ended September 30th, 2022, compared to GBP 16.5 million during the same period last fiscal year. Our cash and cash equivalents at the end of the period remained strong at GBP 182.4 million as of September 30th, 2022, compared to GBP 162.8 million at June 30th, 2022. CapEx for three months ending September 30th, 2022, as a percentage of revenue was 1.7%, compared to 2.3% in the same period last fiscal year.

Our guidance for Q2 fiscal year 2023 is as follows: Endava expects revenues to be in the range of GBP 204 million-GBP 206 million, representing constant currency revenue growth of between 23% and 24%. Endava expects adjusted diluted EPS to be in a range of 56-58 pence per share. Our guidance for full year fiscal year 2023 is as follows: Endava expects revenues to be in the range of GBP 843 million-GBP 852 million, representing constant currency growth of between 23% and 24%. Endava expects adjusted diluted EPS to be in the range of 237-242 pence per share.

The above guidance for Q2 fiscal year 2023 and for full fiscal year 2023 assumes the exchange rates at the end of October 2022, when the exchange rate was one British pound to $1.16 and EUR 1.16. This guidance seeks to take into account potential macroeconomic headwinds. This concludes our prepared comments. Operator, we are now ready to open the line for Q&A.

Operator (participant)

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speaker phone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from James Faucette with Morgan Stanley. Please go ahead.

Speaker 7

Hey, this is Jonathan on for James. Thanks for taking our questions. Yeah, when you initially provided your fiscal 2023 outlook, you talked about there being a level of conservatism contemplated in it. How has that changed over the course of the quarter, and what's being factored into your current outlook?

Mark Thurston (CFO)

Thanks, Jonathan. I mean, we're seeing a mixture of responses to the macro uncertainties. Some clients are trimming or delaying, but others are accelerating in terms of what they're doing and growing their spend with us. There are some sector themes to this. Some sectors such as payments, including the horizontal, that's cross-sector that I described during the opening remarks, banking, capital markets, insurance, mobility, that includes, especially automotive and travel.

We're seeing strong growth in those areas still. No sign of pullback. Actually those are areas where as a company we have a particularly high exposure, across all those that I've just mentioned is about 70% of our business. We are seeing some weakness become more apparent, particularly in TMT across all geographies. The area that is most visible to us is around West Coast tech.

That is seeing a sharper pullback. That's probably the one change that we've got from when we guided last time. It's not a huge part of our business, so it hasn't had a huge impact. The rest of it is just maintaining the prudent caution that we had in our guide last time.

Speaker 7

That's really helpful color. Thanks for that. How do you see that impacting your pace of hiring over the coming quarters relative to the roughly 30% headcount growth that you've previously characterized as, you know, a comfortable ceiling?

John Cotterell (CEO)

Yeah. We hire in line with the revenue growth, actually slightly below because with salary inflation and so on, which we push through into rates with clients, we grow revenue slightly faster than we grow the headcount. We will do the same in the year ahead. With that guide of 23%-24%, we'd anticipate headcount growth around the 20% mark, which is, you know, pulled back from the sort of 30% that we were hitting earlier in the year.

Speaker 7

Always insightful. Thanks, guys.

Mark Thurston (CFO)

Jonathan.

Operator (participant)

The next question comes from Bryan Keane with Deutsche Bank. Please go ahead.

Bryan Keane (Managing Director and Senior Equity Analyst)

Yeah. I wanted to ask about, Mark, the pricing and price increases. You know, what have you been able to pass through and, you know, what have clients been saying about those?

Mark Thurston (CFO)

Pricing's been good for us, basically. I mean, the you know, Q1, you can see in our gross margin was slightly stronger than anticipated. We sort of made comments about rebuilding the bench back to pre-COVID level, which we've done, which is a margin headwind and costs in terms of, you know, the people costs were where we expected. Actually, rates were better than anticipated, so it remains a positive, you know, pricing environment.

Bryan Keane (Managing Director and Senior Equity Analyst)

Got it. John, just to follow up on those comments on kind of the West Coast tech, is there a percentage of revenue that business is, and how do we get a sense of what the spend looks like? Are they, you know, they were going up, you know, growth was 20%-30% and now it's, you know, -10% to- 20%, or just trying to get a sense of the pullback in that particular vertical.

John Cotterell (CEO)

Yeah. I haven't got a detailed analysis on that, but it would be around the 5% mark of our total business that is exposed to West Coast tech clients. Yes, I would put it in the, it's been growing in the 20%-30% range, and it's probably shrinking 25%-30% now. We are, as I mentioned, seeing stronger growth in other places. The displacement of those teams, who are strong teams, is helping with seeding growth in other clients. You know, sometimes a little bit of a pullback in one space can be healthy for our business because it enables acceleration elsewhere, and that's what we're seeing here.

Bryan Keane (Managing Director and Senior Equity Analyst)

Okay. Thanks for the color. Solid results here. Thanks.

John Cotterell (CEO)

Thanks, Brian.

Operator (participant)

The next question comes from Bryan Bergin with TD Cowen. Please go ahead.

Bryan Bergin (Managing Director)

Hi. Good afternoon. Thanks. Appreciate all the detail you offered on the payments business, and I wanted to dig into that vertical a bit more. Just given the long-term experience you've had in the sector and with past downturns, can you just compare their behavior now versus what you've seen in prior cyclical pullbacks? As you think about the exposure in the payments business, how reliant is the work that you're doing, how reliant is it on underlying client volumes in the space?

John Cotterell (CEO)

Sure. The behaviors that we're seeing are similar to what we've had in past recessions. You know, historically in previous recessions, payments was a bit larger proportion of our business than it is now. You know, in previous recessions, we carried on growing. Even during the global financial crisis, we grew in the 20%-30% range in 2008, 2009. A lot of that was driven by the payments work that we were doing. That remains solid. I think the one characteristic that I would call out is some of the larger payments processors are trimming a little bit, and that probably is volume related.

We're seeing, you know, that more than made up for by other more innovative payment products that have been created, that is continuing to grow the payments portfolio. Payments as a whole still growing strongly.

Bryan Bergin (Managing Director)

Okay. Makes sense. Then just on margins, so Mark, you mentioned the, you know, pricing helped gross margin improvement. Can you comment on how you see that progressing over the course of the year and also mix in utilization?

John Cotterell (CEO)

Yeah. I think for Q2, I think we would anticipate it slightly nudging up in terms of the adjusted gross margin. I think the utilization is gonna improve slightly over Q1 as we've reached that sort of bench position. I sort of alluded to, you know, pricing improvements actually as well. In the second half, I think it will step up again. I know we usually see our main pay round go through, so the average cost will move up. I anticipate that we will offset that with continued sort of rate increases. I think also, I think the utilization is going to nudge up as well.

I anticipate actually the gross margin to be potentially stronger in the second half than it has been in the first half.

Bryan Bergin (Managing Director)

Okay, very good. Thank you.

Operator (participant)

The next question comes from Margaret Nolan with William Blair. Please go ahead.

Speaker 9

Hi. Thank you. This is Jesse on for Maggie. First, John, it was nice to hear all of that color about the payments vertical and the horizontal model there. Are you able to provide any insights into the diversification of that vertical? How much does each contribute or anything else to get a sense?

John Cotterell (CEO)

No, we don't break that out. Where we do payments work in, say, retail, we count that as retail revenue because obviously it's a retail client that's pulling the work through. The payments horizontal is just, you know, number one, a very good way of us breaking into new sectors because it's a skill area that those sectors, retail being an example, need in order to improve the customer experience that they have. We wouldn't break it out as a horizontal. I think that would get quite complicated in terms of reporting.

Speaker 9

Okay. Understood. I had a follow-up on margins. The company's taken a measured approach to price increases in the mid-single digits you've talked about. Do you find that pricing conversations with clients are easier because of this gradual approach?

John Cotterell (CEO)

Yeah, certainly. I mean, we've adopted the view over the years that actually, we'd rather do gentler, more incremental adjustments to price rather than big ones. You know, customers appreciate that. Even through the boom of 12 months ago, we put in, you know, sensible lower single digit type adjustments. You know, I suspect, well, I believe that is actually helping with us continuing to have price adjustments now when things are a bit tighter with clients. We are seeing those adjustments coming through, as Mark mentioned a moment ago.

Speaker 9

That's great to hear. Thanks for taking our questions.

John Cotterell (CEO)

Thanks, Jesse.

Operator (participant)

The next question comes from Mayank Tandon with Needham. Please go ahead.

Mayank Tandon (Senior Analyst)

Thank you. Congrats, John and Mark, on a strong quarter. I wanted to ask more on the supply side, given that demand is still healthy but maybe moderating a little bit at the margin, as you've mentioned, does that mean the supply pressures that you are seeing are easing a little bit in terms of just being able to recruit the talent that you need to meet demand and the implications for attrition and wage inflation, if we do see this trend continue? Any commentary around that would be very helpful.

John Cotterell (CEO)

Yeah. I mean, certainly the ability to attract great people is a little bit easier than it was 12 months ago. It remains a competitive market. I don't think it will ever step away from being that. You know, Endava's in a strong position. We compete well for great talent and being able to bring them in. Our attrition has continued to drop, so we're down to 12.6%, down from 12.7% last quarter, so not a huge adjustment. On the wages side, you know, while the pressures in the market are a little bit lighter, it's still very competitive. We're obviously operating in a world where cost of living pressures are high.

Balancing all of those things out, I think we're in a sort of sensible low single digit wage inflation environment lining up with the price adjustments that we've been talking about pushing through. Actually, you know, a pretty stable across those two elements, even with all the underlying turmoil that goes into those figures.

Mayank Tandon (Senior Analyst)

That's very helpful. If I could just follow up with a question around the guidance. What is the contribution from the acquisition that you did in Australia that is built in to the updated guidance? Just to be clear, what is the FX movements relative to where you guided last quarter, or what is embedded in the new guidance, just so we can frame it better?

John Cotterell (CEO)

Sure. The Australian acquisition impact in Q2 is about 2% of revenue, and for full year, about 1.5%. In terms of the movement in terms of the currencies, funnily enough

Mark Thurston (CFO)

They're pretty much back where they were when we guided at the end of fiscal 2022. I think the U.S. dollar was $1.17, we're at $1.16. Similar for the euro as well.

Speaker 9

That's helpful, Mark. Thank you so much.

Operator (participant)

The next question comes from Jamie Friedman with Susquehanna. Please go ahead.

Speaker 8

Hey, guys. This is William speaking for Jamie. Just wanted to ask a quick question on the margins. Noticed that your adjusted PBT margins fell year-over-year. Is this just the company reverting back towards its medium-term goal of around 17%? Can you go over some of the drivers of that?

Mark Thurston (CFO)

The big driver was basically gross margin. If you're talking about the quarter, for Q1 a year ago, we were just shy of 43%, on adjusted basis, and we're at 40.4%. The big sort of movements there was that we put through a big salary increase in January 2022 reflecting the hot labor market that we were in. We subsequently sort of recovered that through rate rises. Those two elements sort of net each other out. The key impact has basically been around sort of utilization, where we were running pretty hot this quarter last year. We were certainly up in the low 70s.

The building of the bench back up to our more normalized levels, I said we're building it from that point about 6% to 9% where it is now. That's about three percentage points of utilization. That's the key impact that's altered the gross margin. And then, year-on-year, if you look at SG&A, it is up. It was very low if I go back to Q1 FY 2022, it was about sort of 15%. So while we had an adjusted PBT margin around almost 24%, it was pretty exceptional. It was just like a everything went right quarter. And what you're seeing now at, you know, just over 20% is a more normalized view that we have.

John Cotterell (CEO)

Yeah, just to add to that.

Speaker 8

Got it.

John Cotterell (CEO)

We're targeting holding that 20%, not carrying on down to 17%.

Mark Thurston (CFO)

No, that's.

Speaker 8

Got it. Appreciate that. Wanted to ask about Paytrix, if I heard correctly. That sounds exciting. Could you say more about that?

John Cotterell (CEO)

I can't say too much more about it. It's a payments company that's operating globally. It's a marketplace type situation where they allow people to pay suppliers in harder to reach regions such as Asia Pacific. If you're buying internationally, Paytrix basically helps you to do that more simply and more cost effectively than setting up interbank type routes to do a similar thing.

Speaker 8

Got it. Thanks so much, guys. Congratulations.

John Cotterell (CEO)

Thanks, William.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to John Cotterell, CEO, for any closing remarks.

John Cotterell (CEO)

Thank you all for joining us today. As you'll have noted, demand for our services remains strong. We're seeing good demand in our verticals and geographies. We remain positive about our business position despite the context of macro uncertainty. We look forward to speaking to you in early 2023 on our next earnings call. Thank you all.

Operator (participant)

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.