Endava PLC

NYSE:DAVA

Earnings Call Transcript 2023-Q1

[Operator]

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. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] 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 IR]

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 will 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 £196.2 million for Q1 of our fiscal year 2023, representing a 33% year-on-year increase from £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 £39.5 million, representing 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 would like to emphasize that we have little exposure to U.K.-centric businesses, and 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 am 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 to act as a point of contact and are advocates of our well-being offer, helping direct Endavans to available resources.

We are also making progress towards our environmental ambition of achieving net zero emissions from our organization and value chain. We have been working towards alignment with the SBTi criteria in setting and subsequently validating targets. This involves 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 and 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 £1 million per year, compared to 93 in the same period last year, representing an impressive 51% year-on-year increase. With the ideation phases 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 space. 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've created the payments horizontal to help customers across industries integrate the online payments experience. This is essentially deploying our 20-plus 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're seeing a big increase in work, helping clients analyze the payments experience they provide to their customers and how they collect revenue for themselves and on behalf of third parties. These projects 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 strengths. Across all verticals, one of the key areas we are active in is payments orchestration.

Many large global businesses have extremely complex payments space 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 supply of 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're 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're 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 young 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're 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 by their 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 was 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 are also working with companies such as Stripe and Planet as they look to diversify their existing global portfolios further. We were 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 evolution as they build out their connected commerce platform that helps retailers and hotels connect software and payments to put the customer experience first. We are 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 am 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 will 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 £196.2 million for the three months ended September 30, 2022 compared to £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 £38.6 million compared to £24.9 million in the same period in the prior year. Our adjusted profit before tax for the three months ended September 30, 2022 was £39.5 million compared to £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 and losses and fair value movement 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 £0.54 for the three months ended September 30, 2022, calculated on 58.1 million diluted shares as compared to £0.49 for the same period in the prior year calculated on 57.8 million diluted shares.

Revenue from our 10 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 10 largest clients increased from £5.3 million to £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 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 ended 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 the three months ended September 30, 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 ended September 30, 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 £21.8 million for the three months ended September 30, 2022 compared to £16.5 million during the same period last fiscal year. Our cash and cash equivalents at the end of the period remained strong at £182.4 million on September 30, 2022 compared to £162.8 million at June 30, 2022.

CapEx for the three months ended September 30, 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 £204 million to £206 million, representing constant currency revenue growth of between 23% and 24%. Endava expects adjusted diluted EPS to be in the range of £0.56 to £0.58 per share.

Our guidance for full year fiscal year 2023 is as follows: Endava expects revenues to be in the range of £843 million to £852 million, representing constant currency growth of between 23% and 24%. Endava expects adjusted diluted EPS to be in the range of £2.37 to £2.42 per share. This 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 £1 to $1.16 U.S. and EUR1.16. This guidance seems to take into account potential micro and macroeconomic headwinds.

This concludes our prepared comments. Operator, we are now ready to open the line for Q&A.

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from James Faucette with Morgan Stanley. Please go ahead.

[Unidentified Analyst]

Hi, this is Jonathan on for James. Thanks for taking our questions. 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?

[John Cotterell, CEO]

Thanks, Jonathan. I mean, we're seeing a mixture of responses to the macro uncertainties. Some clients are trimming or delaying, the others are accelerating in terms of what they're doing and growing their spend with us. There are some sector themes to this. So, 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.

And actually, those are areas where as a company, we have particularly high exposure. Across all those that I've just mentioned, is about 70% of our business. We're seeing some weakness become more apparent, particularly in TMT across all geographies, but the area that is most visible to us is around West Coast Tech, that is seeing a sharper pullback and that's probably the one change that we got from when we guided last time. It's not a huge part of our business. So, it has not had a huge impact. So, the rest of it is just maintaining the prudent caution that we had in our guide last time.

[Unidentified Analyst]

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% head count growth that you previously characterized as comfortable ceiling?

[John Cotterell, CEO]

Yes, so, 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 head count. And we will do the same in the year ahead. So, with that guide of 23% to 24%, we'd anticipate head count growth around the 20% mark, which is pulled back from the sort of 30% that we were hitting earlier in the year.

[Unidentified Analyst]

That was insightful. Thanks, guys.

[John Cotterell, CEO]

Thanks Jonathan.

[Operator]

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

[Bryan Keane, Deutsche Bank]

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

[Mark Thurston, CFO]

Pricing has been good for us basically. I mean, the Q1, you can see our gross margin was slightly stronger than anticipated as we sort of make comments about rebuilding the bench back to pre-COVID level, which we have done, which is a margin headwind in costs, in terms of the people costs where we expected, but actually rates were better than anticipated. So, it remains a positive pricing environment.

[Bryan Keane, Deutsche Bank]

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

[John Cotterell, CEO]

Yes. 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. And yes, I would put it in the -- it's been growing in the 20% to 30% range and it's probably shrinking 25%, 30% now. We are, as I mentioned, seeing stronger growth in other places. So, the displacement of those teams, who are strong teams, is helping with seeding growth in other clients. So, 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, Deutsche Bank]

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

[John Cotterell, CEO]

Thanks, Bryan.

[Operator]

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

[Bryan Bergin, Cowen]

Hi, good afternoon, thanks. I appreciate all the detail you offered on the payments business, and I wanted to dig into that vertical a bit more. So, 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? And as you think about the exposure in the payments business, how reliant is the work that you're doing? How reliant is the underlying client volumes in this space?

[John Cotterell, CEO]

Sure. So the behaviors that we're seeing are similar to what we've had in past recessions and historically, in previous recessions, payments was a bit larger proportion of our business than it is now. And in previous recessions, we carried on growing. Even during the global financial crisis, we grew in the 20% to 30% range in 2008, 2009. A lot of that was driven by the payments work that we were doing.

So, that remains solid. I think the one characteristic that I would call out is some of the larger payments processors, they're trimming a little bit and that probably is volume related. But we're seeing that more than made up for by other more innovative payment products that are being created that is continuing to grow the payments portfolio. So, payments as a whole is still growing strongly.

[Bryan Bergin, Cowen]

Okay. That makes sense. And then, just on margins. So, Mark, you mentioned the pricing help gross margin improvement. Can you comment on how you see that progressing over the course of the year and also mix and utilization?

[Mark Thurston, CFO]

Yes. So, 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 going to improve slightly over Q1 as we've reached that sort of bench position and sort of alluded to pricing improvements actually as well.

And then the second half, I think it will step up again. I know we usually see the main pay round goes through. So, the average cost will move up, but I anticipate that we will offset that with continued sort of rate increases, and I think also, the utilization is going to nudge up as well. So I anticipate actually the gross margin to be potentially stronger in the second half than it has been in the first half.

[Bryan Bergin, Cowen]

Okay, very good. Thank you.

[Operator]

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

[Unidentified Analyst]

Hi, thank you. This is Jesse on for Maggie. So, 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. So, 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, 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. But we wouldn't break it out as a horizontal. I think that would get quite complicated in terms of reporting.

[Unidentified Analyst]

Okay, understood. And then I had a follow-up on margins. So, the company has taken a measured approach to price increases in the mid-single digits you talked about. Do you find that pricing combos with clients are easier because of this gradual approach?

[John Cotterell, CEO]

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

[Unidentified Analyst]

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

[John Cotterell, CEO]

Thanks, Jesse.

[Operator]

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

[Mayank Tandon, Needham]

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 mentioned, does that mean the supply pressure 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? So, any commentary around that would be very helpful.

[John Cotterell, CEO]

Yes, 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. But Endava is in a strong position, we compete well for great talent and being able to bring them in. The -- 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, whilst the pressures in the market are a little bit lighter, it's still very competitive, and we are obviously operating in a world where cost of living pressures are high. So, balancing all of those things out, I think we are in a sort of sensible low single digit wage inflation environment lining up with the price adjustments that we have been talking about pushing through. So, actually pretty stable across those two elements even with all the underlying turmoil that goes into those figures.

[Mayank Tandon, Needham]

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

[Mark Thurston, CFO]

Sure. So, the Australian acquisition impact in Q2 is about 2% of revenue and for the full year, about 1.5%. And in terms of the movement, in terms of the currency staying up, they are pretty much back where they were when we guided at the end of fiscal '22. So, I think the U.S. dollar was, I think, 117, 116 and similar for the Euro as well.

[Mayank Tandon, Needham]

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

[Operator]

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

[Unidentified Analyst]

Hi 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]

Yes. So, the big driver was basically gross margins. So, if you're talking about the quarter, so for Q1 a year ago, we were just shy 43% on adjusted basis and we were at 40.4%. And the big sort of movements there was that we put through above 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.

And those two elements sort of net each other out. But 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 more normalized levels -- I said, we were building it from that point about 6% to 9% whereas now that's about three percentage points of utilization. That's the key impact, that's also 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 '22, is about sort of 15%. So while we had an adjusted PBT margin around almost 24%, it was pretty exceptional. It was just like everything went right quarter. And what you're seeing now at just over 20% is a more normalized view that we have.

[John Cotterell, CEO]

Yes, just to add to that, we're targeting holding that 20%, not carrying on down to 17%...

[Unidentified Analyst]

Got it. I appreciate that. And then wanted to ask about Paytrix, if I heard it 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 order to reach regions such as Asia Pacific. So, if you're buying internationally, Paytrix basically helps you to do that more simply and more cost effectively than setting out into bank-type rigs to do a similar thing.

[Unidentified Analyst]

Got it. Thanks so much, guys. Congratulations.

[John Cotterell, CEO]

Thanks, William.

[Operator]

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 and so we remain positive about our business position despite the context of macro uncertainty. And we look forward to speaking to you in early 2023 on our next earnings call. Thank you, all.

[Operator]

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