Endava - Earnings Call - Q3 2025

Transcript

Operator (participant)

Good day and welcome to Endava's Third Quarter of Fiscal Year 2025 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 Ms. Laurence Madsen, Head of Investor Relations and ESG at Endava. Please go ahead.

Laurence Madsen (Head of Investor Relations and ESG)

Thank you. Good afternoon, everyone, and welcome to Endava's Third Quarter of Fiscal Year 2025 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 presentation and our accompanying remarks today include forward-looking statements, including but not limited to statements regarding our guidance for Q4 Fiscal Year 2025 and for the full Fiscal Year 2025, the impacts of headwinds facing our industry and business, our ability to capitalize on market opportunities and trends in our industry, including with respect to developments with AI, our addressable market, our expectations regarding the share repurchase program, enhancements to our technology and offerings, demands from clients for our technology services, our ability to create long-term value for our clients, our people and our shareholders, and our business strategy, plans, operations, and growth opportunities. 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 we undertake no obligation to update them to reflect subsequent events or circumstances other than to the extent required by law. For more information, please refer to the risk factors section of our annual report filed with the U.S. Securities and Exchange Commission on September 19, 2024, and in other filings that Endava makes from time to time with the SEC, including our current report on Form 6K filed with the SEC on March 28, 2025. Also, during the call, we'll present both IFRS and non-IFRS financial measures.

While we believe the non-IFRS financial measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with IFRS. Reconciliations of such non-IFRS measures to the most directly comparable IFRS measure are included in today's earnings press release as well as the investor presentation, both of which you can find on our investor relations site or on the SEC website. A link to the replay of this call will also be available on our website. With that, I'll turn the call over to John.

John Cotterell (CEO)

Thank you, Laurence, and welcome, everyone. We appreciate you joining us for our Third Quarter Fiscal Year 2025 earnings call. The business environment continues to evolve rapidly, and the quarter just ended has been challenging. We are witnessing what I would characterize as inconsistent behavior from some clients, with their business priorities shifting rapidly. By that, I mean that clients' desire to innovate remains strong. However, they're slow to sign large contracts in the current uncertain macroeconomic environment. Our slowing growth in the quarter was primarily driven by the weakening of the U.S. dollar at the end of the quarter and some deals that did not get signed in North America and to a lesser extent in Asia Pacific. Mark will provide you with more details on our financial results shortly. Our pipeline of large opportunities continues to grow.

However, with an increased level of global macroeconomic turbulence since our last earnings call, the pipeline is not converting into signed deals and thus into revenue at the rate we anticipated last quarter. In this uncertain environment, we are focusing on what we can control to best position the business for the long term. We continue to invest in the business while at the same time closely managing our expenses to protect our margins. We are also increasing our share buyback authorization by an additional $50 million, which we believe is the optimum capital allocation tool for us in the current environment. We also plan to accelerate the pace of partnership formalization to enhance our solutions and further strengthen our value proposition. These partnerships are already contributing to deal flow and delivering opportunities. Just a few weeks ago, we announced our pioneering involvement in OpenAI's exclusive beta services partner program.

Together, we have already developed industry-first products and solutions for multiple joint clients. We're extremely excited about this next step in our journey with OpenAI. Last week, we announced that we are an implementation partner for Google Agentspace, a powerful platform that enables enterprises to embed intelligent, proactive agents across their workflows. At its core, Agentspace offers a multimodal search agent that serves as a central conversational interface for accessing enterprise knowledge. With AlixPartners, a global consulting firm, we're excited to announce our strategic partnership, building on over 15 years of successful collaboration across some of the most complex and high-impact digital transformation programs globally. This partnership is designed to address the full spectrum of client needs, from strategic formulation and diagnostic assessment to technology, design, implementation, and scaling.

Our joint approach ensures that clients benefit not only from the high-level strategic insight, but also from seamless execution that turns vision into tangible results, bridging the critical gap between strategic vision and technological realization. We have also partnered with SideFX, a leading developer of Houdini 3D procedural animation and visual effects software. The partnership combines our machine learning expertise and synthetic data with SideFX's renowned VFX software suite for simulation and procedural content creation. This process is particularly crucial for fields where precision and realism are key to innovation, like manufacturing line inspection and autonomous vehicle training. We have built a strong partnership with Backbase, a leader in engagement banking across both R&D and implementation streams. To date, we have jointly delivered digital banking solutions for seven banks, reinforcing Endava's role as a trusted and capable implementation partner.

Our work has helped transform retail banking services by delivering comprehensive digital capabilities ranging from web and mobile retail and corporate banking applications to digital lending solutions. AI remains a priority for many of our clients, and we continue to help them navigate their AI journeys. Let me take you through a few recent examples. In our ongoing collaboration with a leading global pharmaceutical company, our engagement has focused on refining their processes relating to regulatory clinical trial submissions, where precision, reliability, and speed are paramount. Facing the challenge of exceeding a rigorous accuracy benchmark measured against the output of a human clinical programmer, our team leveraged an advanced AI consensus mechanism enhanced by multi-shot training techniques designed to evaluate and capture an extensive amount of data. I'm pleased to report that across two pivotal data sets, we exceed the accuracy baseline by as much as 19%.

At the same time, reducing the time taken from hundreds of workdays to just a few hours. We believe this achievement embodies our AI-driven approach and underscores our ability to deliver trusted, high-stakes outcomes in regulated environments. At one of the world's leading insurance groups, we've recently collaborated with two operations teams to illustrate the transformative impact AI can have on their daily operations. Through a series of targeted training sessions, we demonstrated how precision, prompt engineering can unlock new levels of productivity and innovation. The result was accelerated workflows, reduced operational friction, and a clear path forward for integrating AI at scale. The enthusiasm and commitment demonstrated by the teams underscore the tangible benefits of embracing AI, marking a critical step forward in their digital transformation journey.

In our continued work with a premier golf performance brand, we are powering a strategic shift from B2B to B2C through AI-powered swing analysis and tailored coaching. We built a cutting-edge video analysis platform capable of breaking down swing mechanics with precision. Using synthetic data and privacy-first design, our models detect biomechanical movement with remarkable accuracy, and we're now advancing the analysis of intricate swing characteristics. For tailored coaching, we are developing an intelligent coaching agent, one that combines historical data with real-time analysis to deliver personalized improvement plans. This agentic solution adapts to individual goals and harnesses insights from our video analysis. What was once reserved for elite athletes is now scalable for a wider audience. Through this engagement, our dedicated product team has also worked closely with the client to refine the product strategy and overall consumer experience, from app functionality to market positioning.

Our recent engagement with a top-tier global services company showcased how generative AI can accelerate complex technical transformation. During a hackathon-style session, participants blended structure with speed while working in two agile teams. One team tackled the upgrade of a 37-module Java application from Java 11 to 21, iterating AI-driven code improvements. The other team led a major migration of over 1,000 entities into a modern data management framework using custom GPT workflows. Teams reported productivity gains of 50%-300% and a strong appetite to deepen AI integration, which is exactly the kind of transformation we aim to catalyze: hands-on, high-impact, and forward-looking. Now, I'd like to provide you with an update on our recent successes in adding to our opportunity pipeline of larger and longer-term deals. On recent earnings calls, I've been highlighting the work we have been doing in securing these larger and longer-term deals.

We consider these deals as being transformative for the relationships we build with our customers. Deals of this nature give us the ability to enter into true partnership discussions with our customers and elevate us beyond the technology domain into being relevant to the senior C-suite. I'm now going to take you through a few examples of deals that we're pursuing and have had recent successes with. In payments and banking, we've observed a key trend emerging around major global banks looking to modernize and reinvent their payments business and capabilities. We've started working with a number of banks in Europe and the Middle East. Our heritage in this space enables us to be able to engage knowledgeably with these banks about modern technology platforms as a driver of their payments business strategy. We are being increasingly trusted to design, build, run, and evolve entire payment platform ecosystems.

These deals are strategic and long-term in nature and require engagement with the senior leadership. They call on our industry expertise, our approach to core modernization, our delivery capabilities, and our ability to reimagine an AI-enabled future. In a number of our verticals, industry consolidation has led to overlapping ecosystems with multiple vendors, creating over-complexity, high-maintenance costs, and delays in responding to market demands. We offer customers compelling insights to start addressing these challenges using our accelerators and tooling. We have recently engaged in discussions with a capital markets infrastructure company, a US healthcare company, and a global financial services institution to help modernize their systems, and these deals are in our opportunity pipeline. We continue to support a leading fintech and payments provider in their strategic efforts to remediate technical debt and complete a major data center migration by fall 2025.

Through our RAY and IMPRA accelerators, we are delivering an independent third-party perspective to help resiliency risks and unlock opportunities to enhance application monitoring across the products and services they deliver to their customers. Some additional projects worth highlighting are the following. Our partnership with a leading financial institution in North America continues on a major core modernization initiative focused on reverse engineering and remediating three core banking platforms using our Maps and Dash solutions. This engagement highlights our automation capabilities and enables our client to modernize their platforms, eliminate technical debt, and introduce new features and enhance performance. We are also expanding our presence in the U.S. healthcare sector with the addition of a new nationally recognized pharmacy benefit manager to our client roster.

We launched a comprehensive benefit plan discovery phase using our RAY accelerator, paving the way for future initiatives to automate the creation and ongoing management of benefit plans. Now, for an update on our people and innovation, our recent innovation lab, Global Final, held in Belgrade in March, brought together top Endava talent from around the world to showcase AI-driven solutions addressing real client challenges. Out of the many impressive entries, eight finalist teams competed, with Australia taking first place for an edge AI solution transforming healthcare. Germany secured second for bridging AI with diverse systems, and North Macedonia earned third for boosting digital accessibility through AI and open-source tools. Argentina's team won the crowd's heart with an AI-powered payment automation solution. Congratulations to all participants. Your innovation continues to drive Endava forward.

As of quarter end, we were 11,365 Endavan strong, representing a 3.1% increase from the same period last year. We continue to prioritize recruitment in high-demand areas, including data, AI, and cloud, to match the evolving needs of our clients. To all Endavans, thank you for your commitment and determination as we navigate the digital shift and discover the new opportunities that it brings. We remain focused on building sustainable growth, preserving our strong culture, and delivering solutions that help our clients not just adapt, but lead. With that, I'll hand over to Mark for a closer look at our quarterly financial results and guidance for the upcoming quarter and remainder of the fiscal year.

Mark Thurston (CFO)

Thanks, John. Endava's revenue totaled GBP 194.8 million for the three months ended March 31st, 2025, compared to GBP 174.4 million in the same period in the prior year, representing an 11.7% increase.

In constant currency, our revenue increased 12.4% from the same period in the prior year. The lower revenue versus our guide is explained by the weakening of the dollar at the end of the quarter and some deals we expected to get signed in North America that did not, and to a lesser extent in Asia-Pacific, whilst the U.K. and Europe performed as expected. Profit before tax for the three months ended March 31st, 2025, was GBP 13.6 million compared to a loss of GBP 0.5 million in the same period in the prior year. Our adjusted PBT for the three months ended March 31st, 2025, was GBP 24.6 million compared to GBP 15.5 million for the same period in the prior year. Our adjusted PBT margin was 12.6% for the three months ended March 31st, 2025, compared to 8.9% for the same period in the prior year.

Our adjusted diluted earnings per share was GBP 0.34 for the three months ended March 31st, 2025, calculated on 59.4 million diluted shares as compared to GBP 0.22 for the same period in the prior year, calculated on 58.8 million diluted shares. Our adjusted diluted earnings per share in Q3 was stronger than our guide for the quarter of GBP 0.31-0.32. We were able to offset the revenue miss with a strong cost control of adjusted SG&A. Additionally, the share buyback started last quarter had a minimal impact on adjusted EPS in the quarter. Revenue from our 10 largest clients accounted for 39% of revenue for the three months ended March 31st, 2025, compared to 34% for the same period last fiscal year.

The average spend per client from our 10 largest clients increased from GBP 5.9 million to GBP 7.5 million for the three months ended March 31st, 2025, as compared to the three months ended March 31st, 2024, representing a 28% year-over-year increase. In the three months ended March 31st, 2025, North America accounted for 37% of revenue, Europe for 22%, the U.K. for 35%, while the rest of the world accounted for 6%. Revenue from North America grew 37.1% for the three months ended March 31, 2025, over the same period last fiscal year, due mainly to the contribution of Galaxy. Comparing the same periods, revenue from Europe declined 10.4%, the U.K. grew 13.2%, and the rest of the world declined 16.0%. Our adjusted free cash flow was GBP 17.5 million for the three months ended March 31st, 2025, compared to GBP 2.2 million during the same period last fiscal year.

Our cash and cash equivalents at the end of the period totaled GBP 68.3 million at March 31st, 2025, compared to GBP 62.4 million at June 30th, 2024. Our borrowings totaled GBP 136.5 million at March 31st, 2025, compared to GBP 144.8 million at June 30th, 2024. Capital expenditure for the three months ended March 31st, 2025, as a percentage of revenue, was 0.6% compared to 0.8% in the same period last fiscal year. As an update on our share repurchase program, Endava has repurchased approximately 2 million ADSs for $39.7 million as of April 30th, 2025. As of April 30th, 2025, $60.3 million remained for additional repurchases under the authorization. Additionally, as John mentioned earlier, the Board of Directors of Endava has approved an additional $50 million of repurchases under the existing share repurchase program. Before providing the guide, I'd like to provide some additional details.

The U.S. dollar has continued to weaken since we closed Q3, and this is providing additional significant headwinds. On a sequential basis, in Q4, it is contributing a negative 3% impact on growth. In addition, in North America, the conversion of deals in the opportunity pipeline into revenue continues to slow, reflecting a high level of client caution on spend, particularly in mobility and healthcare. Additionally, the rest of the world has slowed more than expected when we last guided. The U.K. also continues to face headwinds while Europe is performing as expected. Now, moving on to our outlook. Our guidance for Q4 fiscal year 2025 is as follows. Endava expects revenue to be in the range of GBP 186 million-GBP 188 million, representing constant currency revenue change of between -1.0% and 0% on a year-over-year basis.

Endava expects adjusted diluted EPS to be in the range of GBP 0.22 - 0.24 per share. Our guidance for the full year fiscal year 2025 is as follows. Endava expects revenue to be in the range of GBP 771.5 million-GBP 773.5 million, representing constant currency revenue increase of between 6.0% and 6.5% on a year-over-year basis. Endava expects adjusted diluted EPS to be in the range of 111-113 pence per share. This above guidance for Q4 fiscal year 2025 and the full year fiscal 2025 assumes the exchange rates on April 30th, 2025, when the exchange rate was GBP 1.04 to $1.34 and EUR 1.18. 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 are using a speakerphone, 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 Brian Bergen with TD Cowen. Please go ahead.

Brian Bergen (Managing Director and Senior Equity Research Analyst)

Hi guys. Thank you for taking the question here. John, I wanted to dig into some of the challenges here and wanted your perspective on whether any changes internally over the last couple of years, whether the acquisition of Galaxy or anything like that, has potentially compounded issues around execution while client demand has been more challenged. As we kind of step back and see some peers talking about more stability, what do you see as the biggest differences here?

John Cotterell (CEO)

Hi, Brian. Thanks for that.

I think the biggest focus that we have is on getting some of these big deals that we have in our pipeline signed and over the line. They are big swing items for us. We expected, as we guided last time, that we would close around 10 of these big deals, and actually five of them closed. There were a number of factors. Two actually announced fairly quickly after our earnings call that they were in take-private discussions, and that refocused them, and they deferred doing those deals as they went through that take-private. One announced a big cost takeout program and also deferred. There were two tariff-related ones where they were in the automotive space, and they had a big focus on looking at their supply chain, which obviously they prioritized above what they were looking at with us.

None of those have gone away, but they have all been pushed back as a result of those external challenges coming in. Now, you're asking whether the internal changes have actually compounded things. We're not seeing that. We actually see the internal changes that we've made over the last two years have strengthened our conversations with clients. We're talking alongside the larger scale deals that we're working on. We're talking at more senior levels and much more imaginative types of work that we're working on. Those are directly resulting from the internal changes that we made, both in the technologies that we're bringing to bear, the ways in which we are structuring deals, but most importantly, in the go-to-market and the conversations that we're having with clients.

We do feel we're in a little bit of an air pocket at the moment as we're shifting from the digital transformation work that we were doing and going through into this AI-driven digital shift and the types of deals that go with that, shifting with it. We believe that we're positioning ourselves well. We can see those deals building in the pipeline. We now have 24 of those larger deals compared to 21 last time. Nine new ones. We won five. We lost one. Actually, it wasn't lost. It was just put on a very long pause. That took us up from 21 last time to 24. We continue to see that build, and our focus is on getting those conversions through so that we can get it into revenue and start seeing an uptick in the revenue.

Brian Bergen (Managing Director and Senior Equity Research Analyst)

Okay. All right. That's very helpful detail.

Thank you for that. I guess as you step back and navigate this more challenging operating backdrop, how do you think about the workforce? Do you need to have additional optimization? From a forecasting standpoint too, does it require a change in the approach just given the volatility in client behavior?

John Cotterell (CEO)

I'll pick up on the workforce. I'll let Mark talk about the forecasting guidance. On the workforce side, there is quite a big shift going on in the types of skills and types of work that we are doing. On one extreme, things like testing are dropping quite sharply. A lot of AI automation coming into that, needing fewer people to do the same amount of work.

On the other side, a big uptick coming in AI data and cloud in particular, and a lot of reskilling and a lot of the new people that are coming into the organization around those skills. That is also driving our attrition up a little bit at the moment as we make that shift from the older style skills that we had to the newer style. A big shift going on there. It is one we are driving through. We're not finding that we're short of people or unable to staff business that's coming through. We feel confident we're making that shift well. Mark, do you want to talk about the forecast?

Mark Thurston (CFO)

Yeah. A significant thing has been dollar GBP rates. I mean, since we guided mid-February, which was $1.24, we're guiding at $1.34. That's an 8% shift.

We have not really seen anything like this since Brexit. That has taken off, certainly for Q4, about GBP 7 million of the previous guide alone. It is quite a significant shift from an FX perspective. In terms of the big deals and in terms of the sort of guide, we have stripped them out because it is very difficult to predict timing. That is another big sort of shift. In terms of the guide that we have for Q4, there is a very limited amount of pipeline in it. Certainly, at the top of the guide, there is something like 1% or so of the figure. At the bottom of the guide, there is no basic pipeline in there.

So, we've taken what we believe is a very conservative view, given that the ability to predict when these bigger deals are going to land is proving extremely difficult. I think also the other thing is there is still quite a bit of uncertainty, certainly in the U.S., where we have seen things slow. It's difficult to pinpoint whether it is things such as the talk around tariffs, but we've certainly seen automotive sort of pull back and some of our logistics clients as well pull back. We've been conservative with the outlook, and we will remain conservative, I think, as we go forward.

Brian Bergen (Managing Director and Senior Equity Research Analyst)

Okay. Appreciate that. Thank you.

Operator (participant)

The next question comes from Tyler Dupont with Bank of America. Please go ahead.

Tyler Dupont (Equity Research Associate)

Hi. Good morning, John and Mark. Thanks for taking our questions.

I just want to start by asking if you can discuss some of the pricing conversations you're currently having, given the macro environment has remained, let's call it choppy. It seems like certain vendors and your peers are seeing relative stability, others competing a little bit more aggressively for work. When you're having conversations with your clients, are they discussing at all about any pricing dynamics worth mentioning, any concessions or anything like that that Endava has been engaging with to try to secure wins or maintaining the deals that you have?

Mark Thurston (CFO)

It's always competitive. It's got more competitive, is what I'd say. I think in terms of measured on an average basis, we are holding our day rates, basically. We obviously cut deals to win them. They tend to be at a larger level.

Some of the bigger deals, where to make it a more compelling proposition to the client, we will come to a construct that works for both of us. Pricing is competitive. When you look at it on the average, just certainly between Q2 and Q3, which is on an average revenue pair or an average workover rate, it is fairly stable. That remains the case in terms of the Q4 guide. We have heard that people are pitching very aggressively for work, but we seem to be profitable in the work that we secure.

Tyler Dupont (Equity Research Associate)

Great. That's helpful. I wanted to just touch on growth by geography. For starters, maybe I missed it. What was the organic growth in North America? You mentioned you've seen continued softness in North America.

In Europe, it seems like things are trending as expected, U.K. facing some incremental headwinds. Just want to gain a little bit of clarity on the types of projects that you're seeing relative stability in versus those that are beginning to see incremental pressure. Any sizing of that would be appreciated.

Mark Thurston (CFO)

North America has proved in terms of sort of like Q3 year-over-year, it's not a great comparison, basically, because you have the full year impact of Galaxy this year compared to last year. Certainly, sequentially, exchange rates are relatively stable. Where we get the big movement is when you look at it going from Q3 to Q4. We were anticipating in the previous guide a reasonable sequential sort of step up. We're no longer seeing that. It doesn't mean that North America is going backwards very sort of strongly.

On a reported basis, it will probably be slightly below the level at which it is at the moment, but it would have grown a lot stronger if not for those FX headwinds, which are something like nearly, I think, about sort of GBP 5 million-GBP 6 million. The headwinds that we're experiencing in North America in particular, most of it is FX driven, but there's certainly been a slowdown in terms of some of the bigger deal conversion that we're anticipating, as John alluded to. More generally also, it's been patchy in particular industry verticals like automotive, which resides within our mobility segment.

John Cotterell (CEO)

Just on the types of projects, the growth areas are the AI data, cloud-based areas are where we're seeing the greatest demand, greatest quick demand, if you like. The pipeline has a lot of core modernization demand.

We're closing some of those, but we're not closing them at the rate yet that we would like to see. The areas where we're seeing clients turning things down or it being more competitive is the more commodity end. Obviously, we're driving away from the commodity end anyway in terms of our focus as a business. Things like the application maintenance and so on, it's not a huge part of our portfolio, but we are seeing clients going, "Is there a way of doing that cheaper?"

Tyler Dupont (Equity Research Associate)

Very helpful. Thanks, guys.

John Cotterell (CEO)

Thanks, Tyler.

Operator (participant)

The next question comes from Harry Read with Redburn Atlantic. Please go ahead.

Harry Read (Research Analyst)

Hi. Thanks for taking questions. Just wanted to ask on headcount. When I try and strip out Galaxy, I've got underlying headcount reducing by around high single digit.

I was just curious how much of that is AI efficiency driven and how much is a reflection of potentially a more muted demand forecast for the next quarter and then into FY 2026?

John Cotterell (CEO)

There is productivity coming through, and that's partly what's helping maintain the pricing that Mark was touching on earlier. There's also a shift from the sort of lower value activities that I was talking about earlier, things like testing, towards higher value. By higher value, I mean higher unit rates for things like data, AI, and cloud, and so on. The revenue per head over and above that shift is staying roughly stable. That explains the underlying drop in headcount versus the revenue.

Harry Read (Research Analyst)

Okay. Great. Maybe more of a housekeeping one. It looks like share-based comp as a percentage of sales has dropped versus the last couple of quarters.

Do you think 3% is a sensible level to be modeling going forward?

Mark Thurston (CFO)

Part of that is a fall away because of the performance. We are not going to meet the incentive targets for this year. Also, as we're looking at FY 2026, some of the awards which are multi-year are also falling out of the equation, so there's a reversal there. You have a big reduction in quarter due to those two factors. It is not representative of the as a percentage of revenue going forward. I think more realistic level is where we've usually guided, which is about a 3%-5% of revenue.

Harry Read (Research Analyst)

Okay. Thank you. You mentioned testing on an area of kind of efficiency gains. Are there any other areas that you have exposure to?

One that comes to mind is BPO or any other areas where you're seeing AI automation driving some efficiencies?

John Cotterell (CEO)

We're not in BPO. Let's be clear on that. AI driving efficiency applies to pretty much our whole business. Whether it's requirements gathering, doing consulting, doing development, and so on, we're applying AI to that to make our teams more productive. I touched on quite a few on the call. We're seeing quite good productivity gains coming through. A lot of clients take that and actually then add additional work. We're getting through their backlogs faster. It's not turning down the amount of work, but it is making us more attractive from a delivery point of view to our clients because of the extra productivity that we have.

Harry Read (Research Analyst)

That's great. Thank you very much.

John Cotterell (CEO)

Thanks, Harry.

Operator (participant)

The next question comes from Jonathan Lee with Guggenheim.

Please go ahead.

Jonathan Lee (Managing Director of Equity Research)

Great. Good afternoon, guys, and thanks for taking my questions. I appreciate the candor around the current air pocket dynamic you called out earlier. With the time it takes to ramp core modernization deals once they're signed, as well as the delays related to client decision-making you're seeing today, what gives you confidence that maybe there isn't risk of an extended revenue air pocket later this calendar year and potentially into next, driven by a potential lack of large-scale momentum here?

John Cotterell (CEO)

I mean, I've sought through this call to give quite a bit of color on the deals that we're working on. I've highlighted that it is actually crucial for us to get out of this air pocket to start closing these deals.

We have tried to give a little bit more disclosure on the ones that we are working on, how they are building up, the reasons why we did not close quite as many, which were, I took you through those earlier. We are trying to give you a lot more color than we would normally do to give you that understanding of what is coming through. It is a strange contrast for us because, on the one hand, it is very exciting to have so many large deals progressing to late stages in our pipeline, but at the same time, extraordinarily frustrating that we are not seeing the signatures on them that push them over into seeing the revenue growth come through.

We're just trying to give you a bit of color on that that I believe will start to pull us out of the air pocket much earlier than the time frames that you were just talking about.

Jonathan Lee (Managing Director of Equity Research)

Thanks for that color, John. Just one follow-up from me. Given some of the ownership changes at one of your top customers, are you seeing any impact on spending or budget priorities there? If so, how is that contemplated in your outlook?

John Cotterell (CEO)

We are not seeing any negative dynamics there. We are seeing contracts continuing to sign, etc. There is a lot of momentum on the programs that we're working on.

Jonathan Lee (Managing Director of Equity Research)

I appreciate that. Thank you.

John Cotterell (CEO)

Thanks, Jonathan.

Operator (participant)

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

Jamie Friedman (Financial Analyst and Valuation Thought Leader)

John, the commentary on the customers is noted and appreciated and helpful. Thanks for that.

In terms of, though, looking at some of the things beyond your control, like exchange rates, I was just wondering, Mark, if you could help isolate some of the exchange rate impact either by some of the other dimensions. Which of these segments is more impacted by exchange rates? Because payments was down 13%. Is there any way to land a constant currency approximation for that? I have a quick follow-up.

Mark Thurston (CFO)

You're talking about quarter on quarter or when you're posing that question, you're talking about Q4 or you're talking about Q3?

Jamie Friedman (Financial Analyst and Valuation Thought Leader)

It would be helpful if you could do it year-over-year. If one of these segments, I think expectations based on the pure performance was that some of these segments were stabilizing. If the as-reported numbers for you belie that, could it be because of foreign exchange to some degree?

Mark Thurston (CFO)

It is.

I mean, certainly against the guide, there was an impact about this is we were previously guiding at the top 200, and basically, the FX impact was about $1.5 million. Most of that, you would expect in North America. Actually, we do get some of that hit in the U.K. because the U.K. does bill some of its clients in U.S. dollars. The main impact by sector going from Q3 to certainly against the guide has been mainly in banking and capital markets because most of the pullback in banking capital markets was U.S. in that space. We also felt it in the healthcare sector as well. We have a big client, North American healthcare, so we felt it there as well.

It is mainly those two sectors where it is certainly against Q3 that we are experiencing that sort of headwind from an FX perspective.

Jamie Friedman (Financial Analyst and Valuation Thought Leader)

Okay. The top client, by my math, it contracted as a percentage of revenue about 190 basis points, which is about $4 million of revenue. What is the backstory on that one? I am just looking at row 63 of your fact sheet.

Mark Thurston (CFO)

Yeah. There is a good chunk of that that is going to be FX.

Jamie Friedman (Financial Analyst and Valuation Thought Leader)

Yeah. Okay. Okay. Got it.

Mark Thurston (CFO)

Also, there was some follow-on work in terms of that we were talking about in the big deals that got delayed as well. A small amount, but there is also a delay in some forward work that we were expected to happen.

Jamie Friedman (Financial Analyst and Valuation Thought Leader)

Okay. Then similar and last question about the total clients that are greater than a million. That one shrunk too by about six.

It's hard to put a number on that because we do not know where greater than a million starts or stops. I mean, we know where it stops. We do not know where it starts. You know what I mean? We do not know how big these are. Anyway, anything you could share about why you had six less clients doing greater than GBP 1 million?

Mark Thurston (CFO)

The greater than GBP 1 million is on a rolling 12-month basis. There is an element of clients dropping out of a quarter 12 months ago and additions this quarter. As you have that down, it is a little bit of a backward-looking metric. The sort of movement in those five, we felt most of it has been in TMT, which is a segment that has not grown particularly well for us, and the rest of the sectors like payments, BCM, insurance were basically stable.

Jamie Friedman (Financial Analyst and Valuation Thought Leader)

Got it. Thank you. I'll drop back into Q.

Operator (participant)

The next question comes from Phani Kanumuri with HSBC. Please go ahead.

Phani Kanumuri (Equity Research Analyst)

Hi, all. Thanks for taking my question. The first one is regarding utilization rate. What are your current utilization rates, and where do you expect it to trend during 4Q? The second one is regarding your guidance for EPS. What are the cost elements that are impacting your guidance for EPS? What is your gross margin that you're looking at? Are there any measures to get the EPS back if the demand environment doesn't improve?

Mark Thurston (CFO)

Utilization in Q3 was reasonably good, so about 72%. We anticipate it'll actually be about that level in Q4. In terms of the EPS, if you're talking about the Q4 reduction, previously, we were guiding about implied guide, about 35.

The FX has a very outweighed hit there. It is about GBP 0.6 bringing it down. Then you have the revenue and gross margin compression that takes it down significantly. We are able to offset some of that through G&A savings and by contribution from the share buyback. In terms of the sort of gross margin, as you go from Q3, which on an adjusted basis was about 33.5%, it does benefit from a reversal of the bonus accrual because of the shortfall in performance, which is about 1.5%. A normalized gross margin is about 32%. What we have got implied in the guide is that we will move up the margin by roughly half a percent through a mixture of holding pricing and an improvement on utilization.

What really takes it down significantly to a level of about 31% is this FX impact on the dollar because the proportion of revenues that we now have, certainly in sort of Q4, are significant. There is something like 45% of revenue. If you have a pullback in terms of the FX rate from 1.24 to 1.34, you have a significant sort of headwind and reduction in the revenue, which you have outlined in the guide, about $7 million. The cost base is not dollar-heavy. That pullback on FX has quite a significant impact on the gross margin. Just to give you a sense of the sort of sensitivity to the dollar, if the dollar moved to, say, 1.30, we would potentially get something like a 1% movement on the gross margin.

Phani Kanumuri (Equity Research Analyst)

Okay. Yeah. That is helpful, Mark.

One other question that I had was that you mentioned that you had some integration benefits from Galaxy that would start flowing through this quarter. Going forward, are all the integration benefits already factored in the guidance, and have all of them been recorded in 3Q?

Mark Thurston (CFO)

Most of the benefits that we were getting were in G&A. We have obviously sort of baked that in. As we saw the comments around the Q3 EPS, we were able to absorb weakness in the revenue and gross margin by savings on SG&A. We have not only done it through the integration with Galaxy, we have done it elsewhere. We are absorbing revenue shortfall and gross margin impact by those synergies that we have secured thus far.

I mean, there is further to go, I think, looking forward into FY 2026 with further integration with Galaxy as we put together our global delivery model. That will become through operational efficiency, if I can put it that way, through the gross margin rather than SG&A.Thank you.

Phani Kanumuri (Equity Research Analyst)

Thanks, Mark. Thanks, Tommy.

Operator (participant)

The next question comes from James Fawcett with Morgan Stanley. Please go ahead.

James Fawcett (Managing Director and Senior Equity Research Analyst)

Thank you so much, and appreciate all the color here. I wanted to ask a couple of questions related to types of engagement. First, any meaningful traction that you're seeing around GenAI and scaling of those from proof of concept and movement there as we think about that as a growth driver?

John Cotterell (CEO)

Yeah. We are seeing a pickup in that.

There is also a shift, and we are seeing more opportunities resulting from the shift, which is in the commercial world using agentic AI, which essentially is teams of AI agents. You can get much better quality of output, much better reliability, much better accuracy, and you are bringing more intelligence to bear. Actually, we are finding there are more applications for that that are really viable in the enterprise space. We are seeing more pickup into the larger project delivery activities that we are doing, some of which I touched on in the opening remarks, than we are in just the pure GenAI type solutions. It is one of the areas where we have been working really well with OpenAI and Google, hence the announcements about the partnerships and the leads that are coming through that. Yeah, we are seeing real traction in that and move into larger scale engagements.

James Fawcett (Managing Director and Senior Equity Research Analyst)

Interesting.

As that's happening, how should we think about that, or maybe how are you thinking about that as a proportion of work or bookings? I just wonder if that's going to, if you're thinking about that as displacing some of your normal run and course of work, or are you looking at those as incremental or just any color on sizing would be helpful? Thank you.

John Cotterell (CEO)

We actually see it as a digital shift where the traditional digital work that we have been doing is shifting into an AI-enabled space. Over the next couple of years and over the last year or so, the shift of product work that we've been doing historically that was very digital-oriented in many sectors is shifting to be an AI-enabled product capability.

Ultimately, we see the entire organization either in the functionality that is AI-enabled or in the way in which you deliver it being AI-enabled. We are well into that shift now.

James Fawcett (Managing Director and Senior Equity Research Analyst)

That's great. Thanks for all the commentary this morning. Thank you.

John Cotterell (CEO)

Thanks, James.

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. Thank you all for joining us today. As I mentioned in my prepared remarks, the business environment continues to evolve rapidly. We are witnessing an increased level of global macroeconomic turbulence since our last earnings call. While our opportunity pipeline continues to grow, it is not converting into signed deals and thus into revenue at the rate that we anticipated last quarter. As a result, we continue to have an elongated ideation to production cycle.

In that environment, we are focusing on getting those deals closed and to control what we can to the best position the business for the long term. I look forward to speaking to you all on our next earnings call in September. Thank you.

Operator (participant)

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