Endava Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 23, 2024

There are 13 speakers on the call.

Operator

Good day, and welcome to Endava's Third Quarter of Fiscal Year 20 24 Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Ms. Lawrence Madsen, Head of Investor Relations and ESG.

Operator

Please go ahead.

Speaker 1

Thank you. Good afternoon, everyone, and welcome to Endava's Q3 fiscal year 2024 conference call. As a reminder, this conference call is being Joining me today are John Cottrill, 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 2024 and for the full fiscal year 2024, the impact of headwinds facing our industry and business our ability to capitalize on market opportunities and trends in our industry, including with respect to development of artificial intelligence, our expectations regarding the impact of our recent acquisition of Galaxy on our business, enhancements to our technology and offerings, demand from clients for our technology services, our ability to create long term value for our clients, our people and our shareholders and our business strategies, plans and operations.

Speaker 1

These statements are subject to risks and uncertainties that could cause actual results to differ materially from those contained in the forward looking statements. 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 Securities and Exchange Commission on September 19, 2023.

Speaker 1

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 measures 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. The link to the replay of this call will also be available on our website. With that, I'll turn the call over to John.

Speaker 2

Thank you, Laurence. I'd like

Speaker 3

to thank you all for joining us today and hope that you're all well. As we get started, I want to share some perspective on the current environment, which I think we all understand has been very challenging. My sense is that we have come off a period of aggressive tech spending post COVID. Clients now find themselves trying to sort through their spending priorities as they continue to face meaningful macroeconomic uncertainty. However, we believe that there is also significant pent up demand for technology services to undertake and complete digital transformation and to get ready for generative AI.

Speaker 3

Every industry needs to reinvent itself to some extent to take advantage of generative AI, but it first requires meaningful investments in technology and data stacks to be ready. This transformation goes beyond the digital systems, which mostly sit above the core and enhance customer interactions. AI requires access to the right data and systems to be truly effective. And therefore, transformation work must go much deeper into and opening up these core systems, the planning work is therefore taking much longer before scale production ready projects can be commenced. All of this has created a pause, a deceleration, but I also think pent up demand that may be more meaningful than what we have experienced in prior periods.

Speaker 3

While we aren't happy with our share price or multiple, I believe these are temporary as long as we maintain our competitive positioning. Our approach to this environment has been to continue to invest in our people and our ability to serve our clients and be ready for when the market turns. That's why we moved to diversify our footprint and delivery with Galaxy. We continue to build accelerators that will give us a nimble and very relevant set of solutions for this emerging market. Our history has been centered around leading edge technology capabilities.

Speaker 3

Agile development in very fast growing areas characterized by meaningful demand and helping our clients ideate and innovate. The key to long term success in services is a high quality talent pool that adds real value to clients and with a scale that is relevant to clients as they move from proof of concept to production, but staying nimble and agile. We see our size as a competitive advantage as our entire industry gets ready to pivot yet again. Our systems analysis capabilities, patent technology and deep understanding of the industries in which we operate enable a truly comprehensive enterprise modernization solution that supports our clients' overall business transformation, and which we refer to as enterprise transformation. We have been working with our clients to build a truly unique approach to enterprise transformation, which addresses this need for AI to reach data and processes at the core of the enterprise.

Speaker 3

We use patient technology that facilitates a low risk and controlled end to end transformation of core systems through data driven decision making. With these capabilities, we help transform clients' underlying technology, so it becomes more efficient and agile. Our bespoke data led approach not only helps reengineer core technology, but also any legacy business processes the technology supports, ensuring that we continue to deliver holistic market leading enterprise and business modernizations. With this tried and tested approach, we decrease overall impact and risk for the customer. And to date, have delivered visible results to over 150 clients across more than 1300 systems and with over 650,000,000 lines of codes.

Speaker 3

Clients trust us at a time when they feel very uncertain. In the coming quarters, we will discuss more and we are seeing signs that our strategic thinking is going to set us up well to catch yet another wave of massive change. Moving on to our results, let me now provide an update on our business and financial performance for the 3 months ended March 31, 2024. Our results for the quarter were within revenue guidance with revenue totaling 174 point £4,000,000 representing an 11.8% year on year decrease in constant currency from £203,500,000 in the same period in the prior year. We ended the quarter with an adjusted profit before tax for the period of £15,500,000 representing an 8.9% adjusted profit before tax margin and our adjusted diluted earnings per share of 0.22p was above our guidance.

Speaker 3

I'd like to cover in more depth our recent acquisition of Galaxy. Galaxy brings a strong senior executive team in the U. S. With an excellent track record of winning and growing Fortune 100 relationships. We are already seeing opportunities emerge including some early wins together.

Speaker 3

As a reminder, over 70% of Galaxy's revenue comes from clients in the U. S. Healthcare sector, which we believe is a very attractive vertical. Galaxy's leadership has proved successful at penetrating large U. S.-based payer services and pharmaceutical companies.

Speaker 3

Based on conversations with these clients, we believe we will be able to significantly scale the offerings. Here are some examples of projects Galaxy is currently working on for various clients. In healthcare, we are working with a leading health insurance plan provider, leveraging Galaxy's self-service portal platform to facilitate the complex management of pharmacy benefit plans across multiple third party pharmacy benefit managers. Additionally, the platform will be used to support the implementation of the new requirements for CMS, the government agency that regulates Medicare and Medicaid, allowing Medicare members to opt into a monthly payment plan for out of pocket expenses. Galaxy's platform uniquely de risks the implementation, while significantly improving accuracy, regulatory traceability and member experience.

Speaker 3

Galaxy is also helping a Fortune 50 health plan achieve its goal of building a high performing health services portfolio for delivery of innovative and flexible solutions to their clients. We are working with the client's leadership team to define goals to retire end of life technologies while implementing DevOps enabled cloud centric and product oriented systems. This is a multiyear initiative focused on providing scalable solutions, driving lower costs and improved quality with 0 downtime. Galaxy is working with a leading global bank to accelerate and advance their API migration initiative for their U. S.

Speaker 3

Operations. Utilizing our proprietary accelerators, the teams will map business functions, extract business rules, identify data and workflows, map functional dependencies and create testing scenarios in cases for complete future testing coverage. This approach is expected to help the bank reduce transformation costs while improving speed to market and quality. And finally, for a large FinTech client, Galaxy is mitigating and eliminating exposure to excessive extended security updates for end of life operating systems and database assets. By building a sustainable asset lifecycle management process, maximizing automation and integrated tooling, Galaxy's efforts are resulting in a significant cost savings for the client.

Speaker 3

Moving on to an update on technology, we recently announced the creation of our AgenTic AI Industry Accelerator internally called Morpheus. We have already been successfully using it as part of both our pre sales cycle as well as a foundation for quickly helping our clients get value from their AI investments. To date, large language models or LLMs and AI have existed in a black box with little insight into how the systems arrive at the answers they provide. Endava is changing this by operationalizing LLMs around data to overcome current barriers caused by hallucinations, ensuring that all activity is transparent, knowable and critically auditable. Rolling out this accelerator to regulated industries can deliver value in many ways, including helping insurers underwrite policies more efficiently, help analysts with legal or financial research, as well as due diligence efforts and drive the development and testing of new healthcare products.

Speaker 3

Multi agent teams represent a significant advancement in AI technology allowing for a more dynamic, flexible and comprehensive problem solving capabilities. We see it solving complex industry challenges, optimizing processes and delivering unprecedented value for our clients and their customers. AI is an exciting technology, which we believe will positively impact our clients and businesses. We are still engaged in demonstrating the art of the possible with AI. We are beginning to see production projects being signed off and investments being made.

Speaker 3

This last quarter, we signed new contracts in automotive, healthcare and sports for AI specific projects. In healthcare, we recently scoped an AI platform that leverages our Morpheus AgenTic AI application accelerator to significantly increase the efficiency of medical trials. Project like these highlight that with the right use case, Endava is well placed to benefit from an exponential increase in opportunities given the relatively low investment costs and potential high savings for our clients. Our people are top notch and we recently won the grand prize in the competition Hack Together, the Microsoft Fabric Global AI Hack. This event was a global online hackathon where participants had the opportunity to build innovative AI solutions using Microsoft's data platform fabric.

Speaker 3

Pinnovator's team won with a cloud native data solution, integrating OpenAI for document analysis, particularly for detecting personally identifiable information in files and images. International Women's Day in March was a wonderful moment to recognize women at Zindala, who each play a significant role in making a difference to our culture with our clients and solutions and in the world of technology. We ran a global campaign under the concept umbrella, Connect, Inspire, RISE and over 1,000 in Davens attended sessions on leadership, career growth, mental, physical and financial well-being. We received excellent internal feedback on a new training program under our Endava Well-being umbrella called Mental Well-being for Leaders. It's a program created help line managers recognize warning signs of mental health issues in their teams, and it provides them with the tools to address the issue.

Speaker 3

We ended the quarter with 11,025 employees, a 6.1% decrease from 11,742 in the same period last year. In the current environment, our recruitment is focused on areas of demand. Technology is our how and people are our why. And as such, we continue to prioritize professional development by training and upskilling our people in key emerging technologies and techniques such as machine learning, generative AI, next gen cloud, cybersecurity, product strategy and sustainable computing in order for them to remain at the leading edge of digital transformation. I'd like to take this opportunity to thank all in Davens for their commitment and determination as we persevere through current headwinds.

Speaker 3

We will continue to manage the business for the long term, maintaining our culture and organizational health, and creating exciting solutions for our clients and customers. 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 fiscal year.

Speaker 2

Thanks, John. Endava's revenue totaled £174,400,000 for the 3 months ended March 31, 2024 compared to 203 £500,000 in the same period in the prior year, a 14.3% decrease over the same period in the prior year. In constant currency, our revenue declined 11.8% from the same period in the prior year, within the range we provided to you last quarter and reflected a 5.2% positive inorganic contribution during the quarter. Sequentially, revenue was down by 4% in constant currency on the previous quarter. As a reminder, there was no contribution from Galaxy during the course just ended.

Speaker 2

Loss before tax for 3 months ended March 31, 2024 was £500,000 compared to a profit before tax of £30,400,000 in the same period in the prior year. Our adjusted profit before tax for the 3 months ended March 31, 20 24 was £15,500,000 compared to £43,400,000 for the same period in the prior year. Our adjusted profit before tax margin was 8.9% for the 3 months ended March 31, 2024, compared to 21.3 percent for the same period in the prior year. Our adjusted diluted earnings per share was 0.22p for the 3 months ended March 31, 2024 calculated on 58,800,000 diluted shares as compared to 59p for the same period in the prior year calculated on 58,200,000 diluted shares. Revenue from our 10 largest clients accounted for 34% of revenue for the 3 months ended March 31, 2024, compared to 33% for the same period last fiscal year.

Speaker 2

The average spend per client from our 10 largest clients decreased from £6,800,000 to £5,900,000 for the 3 months ended March 31, 2024, compared to the 3 months ended March 31, 2023, representing a 13.9% year over year decrease. In the 3 months ended March 31, 2024, North America accounted for 30% of revenue, Europe for 28%, U. K. For 35% and the rest of the world accounted for 7%. Revenue from North America declined 19.4% for the 3 months ended March 31, 2024, over the same period last fiscal year.

Speaker 2

Comparing the same periods, revenue from Europe grew 0.9%, the U. K. Declined 22.3% and the rest of the world grew 3.8%. Revenue from payments declined 27% for the 3 months ended March 31, 2024 over the same period last fiscal year and accounted for 24% of revenue. Revenue from Banking and Capital Markets declined 24.2%

Speaker 3

for the

Speaker 2

3 months ended March 31, 2024 over the same period last fiscal year and accounted for 14% of revenue. Revenue from insurance grew 1.7% for the 3 months ended March 31, 2024, over the same period last fiscal year and accounted for 9% of revenue. Revenue from TMT declined 4% for the 3 months ended March 31, 2024 over the same period last fiscal year and accounted for 24% of revenue. Revenue from Mobility declined 22.4% for the 3 months ended March 31, 1, 2024 over the same period last fiscal year and accounted for 10% of revenue. Revenue from other grew 3.2% for the 3 months ended March 31, 2024, over the same period last fiscal year and accounted for 19% of revenue.

Speaker 2

Our adjusted free cash flow was £2,200,000 for the 3 months ended March 31, 2024 compared to £21,200,000 during the same period last fiscal year. Our cash and cash equivalents at the end of the period totaled £190,000,000 at March 31, 2024 compared to £164,700,000 at June 30, 2023. In April, we used £129,000,000 of our cash funds towards the acquisition of Galaxy. Capital expenditure for the 3 months ended March 31, 2024 as a percent of revenue was 0.8% compared to 2% in the same period last fiscal year. Now turning to our outlook for the quarter of 4 and the full year fiscal 'twenty four.

Speaker 2

When we announced our guide in February, we did not include the contribution from Galaxy, which at the time remains subject to regulatory approval. On the 10th April, following the expiration of the required waiting period under the U. S. Hart Scott Rodino antitrust improvements act of 1976, we closed the transaction. So the Q4 guide includes the contribution from Galaxy.

Speaker 2

The guide including Galaxy represents sequential growth of 12% to 13% at the bottom and top of the range. Excluding Galaxy, the guide otherwise generally remains flat compared to Q3. Our guidance for Q4 fiscal year 2024 is as follows. Endava expects revenue to be in the range of £195,000,000 to £197,000,000 representing constant currency revenue growth of between 3.5% and 4.5% on a year over year basis. Endava expects adjusted diluted EPS to be in the range of $0.22 to 0.23 per share.

Speaker 2

Our guidance for full year fiscal year 2024 is as follows. Endava expects revenue to be in the range of 7 £41,000,000 to £743,000,000 representing constant currency revenue decrease between 4.5% and 4.0 percent on a year over year basis. And DARPA expects adjusted diluted EPS to be in the range of $113 to $114 per share. This above guidance for Q4 fiscal year 2024 and the full fiscal year 2024 assumes the exchange rates on April 30, 2024 when the exchange rate was 1 British pound to 1.25 dollars and €1.17 This concludes our prepared comments. Operator, we are now ready to open the line for Q and A.

Operator

We will now begin the question and answer

Speaker 4

Can you help us understand how the integration of Galaxy Solutions is progressing? And can you remind us of the revenue and EPS implications over the next few quarters?

Speaker 3

Sure. So I'll pick up on how the integration is going and then Mark can see if he could talk about the revenue and so on. So it's actually going very, very well. We are already winning business together. 1 contract that we've signed for European telco, it was enabled by the fact that we have footprint in India now because as a telco, they are completely operating out of India in the space where we've done that piece of business, which is a call center AI deal where we're now doing the discovery for them.

Speaker 3

So plus we have others that are in the contracting phase. We're also seeing opportunities in expanding across Galaxy customers essentially a couple of customers who are moving us up their preferred supplier lists, so that we can take larger pieces of work and have more prioritization from them. The diversification of geo and industry footprint is helpful and you'll start to see that coming through in the quarters ahead. And finally, as I touched on in the opening remarks, our enterprise transformation proposition has been significantly strengthened and we're getting a lot of interest as in more than 10 customers that we're talking to about those services following that strengthening. So we're very, very positive about the Galaxy deal and the organic opportunities that it's going to give us going forward.

Speaker 2

Mark? So, Jonathan. So as I said in the prepared comments, the quarter on quarter growth is represents 12% and 13% at the high end of the guide. Galaxy represents about sort of 12% of that uplift. So it's about sort of $21,000,000 run rate on the revenue perspective.

Speaker 2

As we sort of signaled at the time of the last call, integration costs are expected to be reasonably heavy this quarter. So there is negligible to 0 EPS contribution in the quarter. I think as we go through into our FY 2025, we should start to as we go through the integration process, their gross margins and just PBT should move up towards the Endava level, but it is too early to call out a metric on that at this stage. But certainly their gross margins will be in line with where we are in DARPA.

Speaker 4

Appreciate the details there.

Speaker 3

As a follow-up, what

Speaker 4

in your customer conversations gives you confidence in achieving your fiscal 'twenty four outlook, especially as we think about potential delays in ramping up projects that may already be committed versus some of the prepared remarks around pent up demand and potentially increasing discretionary spend?

Speaker 3

Yes, sure. I mean the fiscal year 'twenty four in our last quarter, so as just over a month to go. And therefore within our guide, we have a very high proportion that is contracted and committed as we call it. Mark can touch on the numbers in a moment. But that visibility and the work that we're currently doing is what gives us the confidence around the current quarter guide that we have, which leads to the full fiscal year.

Speaker 2

Yes, I think the contracted and committed percentage is 99% within that guide. So it's a very high level of coverage when you compare with what were our historic norms.

Speaker 4

That's helpful. Appreciate that, guys.

Operator

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

Speaker 5

Hey, good morning, good afternoon. Thank you. I may start with demand. So can you kind of give us a sense that since you last reported how that client behavior has progressed, particularly deal closure and deal ramps as you've gone past March into April May. Can you talk about the conversations you're having with clients?

Speaker 5

And understand you noted a flattish 4Q growth ex Galaxy. Can you just share any thoughts on how sequentials may progress as you work through the balance of calendar 2024?

Speaker 3

Yes. So client behavior is actually picking up a little bit. Perhaps worth unpacking the dynamics, I've discussed this on previous calls of our business, which is we have projects and programs running with clients and there's a natural closure as some of those complete. And so each quarter there's a sort of downward pressure which we overcome with the new business that's coming through. And so the discretionary spend as I was calling or the new spend by clients needs to be larger than the amount that's dropping off each quarter for us to drive growth.

Speaker 3

Clearly we've had a series of quarters where that has been lower. In fact it's been very quiet indeed leading to the drops quarter on quarter. With the flattening off that is showing that some of that discretionary spend is coming through and impacting the quarter. Not as much as we'd like, but I think it is early signs that some of that is coming through and of a strengthening underlying environment. The actual customer conversations, we continue to build a backlog business where we have done discovery work and where clients are still making the decisions about whether to go ahead with the programs.

Speaker 3

And I touched on some of that in the opening remarks and that continues and it is now a larger backlog than it was at the end of last quarter. And that gives us confidence that at some point it needs to break through. That confidence being based on the fact that if clients were never going to spend the money they on building out the production systems, they wouldn't continue to spend money on the discovery work that we're doing with them. Mark, any color on the numbers?

Speaker 2

Well, I think it's all down to visibility, Brian. So as you can tell with the guide at the moment, the high level of contractual committed coverage at 99%. So certainly near terms looking into the Q1, we have stronger visibility. I think it comes back again to this pipeline conversion issue where we're adding to the pipeline, it is growing. It is the velocity at which it proceeds through to sign and initiated work that continues to be the issue.

Speaker 2

So in terms of sequential growth when we anticipate the uptick, it is difficult to set at the moment. And obviously, we'll be giving clearer guidance when we get to September when we give our full year results and the outlook for our fiscal year to June 25.

Speaker 5

Okay, understood. And I guess as we think about gross margin inputs, we understand Central Europe has become more expensive as a result of the war in Ukraine. Can you just maybe talk about how you're navigating that just given your leading scale, particularly in Romania? Is that market becoming more crowded from a talent acquisition standpoint?

Speaker 3

So I'm not sure where you're picking up that Central Europe has become more expensive. That's certainly not true for us. It may be there are other organizations who previously operated further east than us who've had to move west into more expensive territories and that's pushed up their Central European costs. But for us we haven't needed to do that. In fact given the current environment and the lower demands that are going on, we're not seeing inflationary impact in Central Europe at all at the moment.

Operator

The next question comes from Ryan Potter with Citi. Please go ahead.

Speaker 4

Hey, thanks for taking my question.

Speaker 6

Just kind of looking across

Speaker 4

your verticals and the payments vertical looks to be where you're still seeing some of the most demand pressure.

Speaker 6

I was wondering if you

Speaker 4

could dive a little deeper into the trends you're seeing there and what it would take to start to see a recovery there? And also in terms of some of your larger clients in the vertical, if you could comment on role pay now that its majority stake is complete, if you're seeing any improvement there and then also if Mastercard's remain largely stable? Thanks.

Speaker 2

I'll let John talk about sort of payments and it comes back to our 2 largest clients Mastercard and Worldpay and then I'll pick up the balance of the portfolio.

Speaker 3

Yes. So on Mastercard, it remains a story of the work that we're doing on the RTP, the real time payments business continues to just slowly decline and is offset by the growth in work with the rest of Mastercard. It's actually very healthy growth with the Mastercard work outside of the RTP space just from a smaller initial start point. So the one isn't quite balancing the other meaning that we're seeing a slow decline across the overall Mastercard portfolio. But I think the relationship remains very healthy and underneath the surface we're breaking into more and more parts of Mastercard.

Speaker 3

So for the longer term future it's actually very healthy. In Wellpay, we are seeing the first signs of the work coming from that spin off and we'll pay receiving some of the funding around the restructuring that they've been planning and we are working with them on planning how we can help them execute on that. And I'm hopeful that we'll see a reasonable amount of that work coming our way.

Speaker 2

Yes. And I think if you look at the rest of the portfolio, it is flat progress really, cost banking, capital markets, insurance and TMT. The one area where we saw sequential decline was in Mobility. And that was most noticeable in North America. And it's placed the comments we made last quarter's earnings where it's a mixture of a large client coming off peak activity in the logistics space.

Speaker 2

We made some comments about airlines where again there were some conservatism around spend and rolling out programs due to the sort of macro outlook, which has come to fruition, if we want to have a better word. And then in automotive, again, we're seeing delayed decision making given choices of technologies. And those are the real sort of key drivers in that mobility. But in terms of the rest of the portfolio, it is relatively sort of flat, apart from those two areas.

Speaker 4

Got it. I guess maybe shifting to margins, the fiscal '24 EPS outlook midpoint was lowered here. Could you provide some details on the factors that are driving this, like how much is coming from potentially lower margin expectations? Can you comment on your margin expectation for 4Q and fiscal 'twenty four versus maybe higher interest expense or integration costs from Galaxy? And then on the margin side, what drivers do you have to improve margins from here, whether it be improved utilization or anything else to call out as you head into fiscal 'twenty five?

Speaker 2

Well, Q3 was a big EPS beat. We did much better on our G and A savings. So we secured through the restructuring quicker savings than anticipated at the time of the guide. And also the tax rate was significantly lower than anticipated at 18% due to the release of a tax provision, which is one off in nature. Now in terms of what we see going out into Q4 and this includes Galaxy's, we will see some improvement in the gross margin probably up to between sort of 33%, 34% as we continue to reduce bench.

Speaker 2

There isn't anything really in terms of pricing uplift, refresh in Africa, but that reduction in bench will lead to improved utilization. So this we will continue with our sort of restructuring through to the year. I mean as that program back in February, so we will continue with that. So that will give us some upside. And then I think our SG and A will start to sort of normalize as well.

Speaker 2

So the guide implies at the moment Q4 that there's not a significant uplift in adjusted BBT margin given that we've got a heavy sort of integration budget with Galaxy at the moment. Thereafter, I think we start to improve as we go through our next fiscal year in terms of the gross margin improvements and the leverage from SG and A that we get through that full integration with Galaxy.

Speaker 4

Got it. Thanks again.

Operator

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

Speaker 7

Thank you. Do you have a multiyear target for percentage of headcount in terms of geographic distribution that you're working toward?

Speaker 3

So our expectation over time is that we will diversify across the globe. So currently we are concentrated in Central Europe relative to our other global delivery locations and particularly concentrated in Romania where about a third of our staff are. We expect those all to continue to grow. But as the business expands, we also expect to see LatAm move up as a proportion of our business. And then over time, the delivery capabilities out of Asia Pac, mainly in Vietnam and India now will start to move up.

Speaker 3

Very much sticking to the delivery model and the delivery approach that we currently have. We're not looking to shift the market that we're operating in because of that geographic mix changing.

Speaker 7

Thank you. And as we approach the

Speaker 1

end of

Speaker 7

your fiscal year in June, can you remind us kind of what the typical method is in terms of how you'll build the guidance for your next fiscal year? Are you taking any additional considerations under your view, given that the visibility has been quite limited in recent quarters when you think about how you build guidance for next year?

Speaker 2

I believe to date and for our more recent history had a track record of decent rates. So we are going to be cautious basically in our guidance as we go sort of forward. And part of that is because we've done a sizable acquisition with Galaxy. So there are inspiration challenges. So we will aim to sort of guide appropriately.

Speaker 2

So I think as we go through the integration process between now and September, we sort of form that view for the fiscal year, we'll guide appropriately so that we hopefully don't deliver any surprises.

Speaker 7

Thank you.

Operator

The next question comes from Puneet Jain with JPMorgan. Please go ahead.

Speaker 8

Hey, thanks for taking my question. So John, you talked about you gave us helpful perspective on how Gen AI could be hurting near term demand and yet it represents significant medium term growth opportunities for the sector. Could you review for us why Dawa or maybe digital engineering companies as a group have a right to win in this new AI age? Like what type of work you expect you will do? And why like the Dawa or digital engineering companies are the right names to be doing that for clients?

Speaker 3

Yes, great question, Sunil. So the way we see it is that if you look at what digital transformation has been over the last 20 years, it has largely

Speaker 9

for a lot of

Speaker 3

the enterprise customers being around creating a layer over the top of their enterprise core, a layer that has enabled improved customer interaction driven revenue and so on and hugely valuable to them. And we've been one of the organizations that's really benefited from helping drive change across that top layer. As we get into AI, it will need to drill into the systems, the data and the processes that exist in the core in order to provide the quality of change the business benefit that you can get out of AI, you've got to get the data that's in the core. Organizations who already have a very flexible core newer organizations typically are going to find it much easier to adopt AI and roll out the benefits that then the larger enterprises who have a more let's say legacy core. And so the opportunity is for the organizations who have both the digital transformation capability that we've demonstrated over so many years and the core modernization capability.

Speaker 3

Now what I was highlighting in my preliminary remarks was that Endava is actually incredibly well positioned for this. We have over the last 10 to 15 years been building a whole core modernization suite, which we have tried with many customers, 150 as I highlighted, across 1300 systems. And that actually enables in a data driven way to understand what the existing actually do and what changes need to be made to make them more flexible and opened up so that their data is available to the AI that's coming. So you put those two things together, you've got digital transformation taking a kick from the AI wave that's coming through and all the new ways of doing customer interaction, driving automation and so on that it's going to open up and the core modernization capability that's needed. And we see ourselves as being in a uniquely almost differentiated position against our competitors out there.

Speaker 8

Got it. That's very helpful. And then your headcount was down, give or take, about 5% this quarter on a sequential basis. How does your utilization look like right now versus your targets? I think, Mark, you mentioned there is some scope to improve utilization in Q4.

Speaker 8

So can you talk about utilization rates right now versus your targets?

Speaker 2

Yes, I mean, so utilization at the moment is being pretty sort of stable. So it's about a 66%, 67% for the quarter just gone. Our bench is pretty, pretty low. Currently about 8.5% is a 8.5% so to speak. So it will remain at that sort of level.

Speaker 2

The benchmark got a little bit lower, but most of our margin improvement is going to come from greater utilization basically. And historically when we've been delivering good margin, to a percentage point improvement on gross margin. Again, one caveat around that, we are integrating Galaxy. And so we need stronger hold around the metrics operating metrics of that business. But I think what I said is largely going to hold true for them as well.

Speaker 8

Okay. Thank you.

Speaker 3

Thank you.

Operator

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

Speaker 10

Yes. Hi. Mark, just wanted to ask on gross margin. I think it fell below the 30% threshold in the quarter, which is a little below we were expecting. Was there any callouts just for the quarter itself that I know you're talking about an improvement sequentially, but just trying to figure out the quarter itself why it fell?

Speaker 2

It's still Paul, but it was where we guided. So, I did see how you got your number. We think it's on adjusted basis 31.5%, so it's above 30% and it was in line with what we were guiding. The kicker on the EPS was basically through lower SG and A and the reduced tax rate. So maybe we just need to compare notes on the gross margin calculation difference.

Speaker 10

Yes, yes, we'll look at it. There might be some adjustments there. And then I think you gave us a Galaxy contribution. Any what's the other inorganic contribution we should expect in the Q4 from other acquisitions so we have the total inorganic contribution for 4th?

Speaker 2

It's a very minimal element from TLM which we had about a year ago, but it's pretty negligible. It's mainly all of Galaxy.

Speaker 10

Got it. Okay. I'll pass the line. Thank you.

Operator

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

Speaker 6

Hey, thanks guys for taking the question. Just a couple of quick follow ups. First, in terms of Worldpay, you said that you're starting to see some of that business and engagement come back as GTCR takes over management of that company. How are you thinking about like what the return and opportunity looks like there over what timeframe? Just trying to get a sense of any early

Speaker 3

a sensitive a sensitive area in terms of clients' investment decisions. We have very good stakeholders across the COO, CTO. So we're engaged regularly in conversation with them and with them shaping up their investment plans, their change plans, we feel very much involved and expect to be part of that going forward is about as far as I think we should go at the moment.

Speaker 6

Understood, understood. And then, wanted to ask quickly about kind of Galaxy and how you're thinking about that and integrating that into the rest of your operations? And what are the things that you're paying attention to in terms of competition for talent in that market right now? The pricing dynamics between at least traditionally where Galaxy had been and Endava more broadly. Just trying to think

Speaker 4

through the

Speaker 6

working relationship and how that will expand and improve Endava's capabilities down the road?

Speaker 3

Yes, sure. I mean, the first thing to say is that if you look at the average revenue per workday in Galaxy, it's not a lot different to in DAMA because of their mix of onshore and offshore. And so we would expect to maintain that sort of value add pricing in what we do. The second thing is that the strengths that we have are very complementary. So the digital transformation work that we do is something that is mainly an Endava strength.

Speaker 3

If you look at the core modernization stuff that the data numbers that I put out there about 2 thirds of that was in data work and about a third of it was from the Galaxy experience set. So they've strengthened that. And I think if you look at that core modernization side, the India is a good place to do that. There's a lot of experience that they have in India and can bring to apply that. And if you put that alongside the patented technologies that we have, the tool sets and the accelerators that we use to deliver that service, it gives us a strong differentiation against the Indian pure plays for work that we do out of India.

Speaker 3

And then when you add the digital transformation capability to drive true enterprise transformation as AI comes through. Put those two things together and you end up with a strong differentiation still pulling on our near shore capabilities as well as India. And so that's very much how we're seeing it. We see it as being able to protect price and being earning is enhancing over time. So I think that's probably economically what you were searching for there.

Operator

There. The next question comes from Moshe Katri with Wedbush.

Speaker 11

So two questions. First on bookings, can we get some color on some of the new bookings in terms of verticals, regions? And then in general, are we seeing any sort of changes in terms of how bookings have been converting? Obviously, there's been an issue with conversion slowdown and the fact that conversion has been pretty inconsistent. So any color there will be helpful.

Speaker 11

Thanks.

Speaker 2

My comments are really on the larger deals that I sort of focused on. I mean the pipeline has been growing as John said. So quite significantly in terms of the number of deals and the average sort of size of them for the last time we talked on the earnings call. What hasn't changed is the pace at which they go through from proposal to contracts or being doubled, you haven't been successful. That remains sort of slow.

Speaker 2

And then partially the sort of reason, mainly the reason that we are in the quarter where we're guiding towards what was our previous sort of bottom. So it is an issue basically of progression through the pipeline in terms of velocity, not one of win rate.

Speaker 11

Okay. And then just on Galaxy, can you just remind us of Galaxy is growing this year or any sort of kind of color on their growth rates?

Speaker 2

It is too early to say that. We've sort of took control as I said in the comments, 10th April. We obviously have a budget to put together for ourselves for June to June 25. So we are going through the process at the moment of looking at their forecasts and establishing what those growth rates look like. Certainly, they were growing and they have a calendar year by the way.

Speaker 2

They were certainly growing as year on year between calendar 'twenty two calendar 'twenty three.

Speaker 3

I think the big opportunity with the Galaxy lies in the deals that we can collaborate on and win together. That's where we're going to get the acceleration. Either their clients allowing us to expand footprint because of the larger scale and capabilities that data brings or in data clients benefiting from the footprint capabilities, particularly the enterprise transformations thing that I've been talking about. The Galaxy really solidifies for us. So that's where we're looking to see the growth rather than just them organically operating by themselves.

Operator

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

Speaker 12

Good morning. Good afternoon. I wanted to follow-up on Puneet's earlier question, John. In terms of your right to win in AI, is it possible to share your perspective maybe with this the lens of Slide 13? It's the one where you talk about your capabilities.

Speaker 12

So even if you don't have it in front of you, but it's where you if you look at AI in the context of these service lines, say, digital production or engineering or data delivery, where are you seeing revenue realization at this point or expecting to see it?

Speaker 3

Yes. So I mean that's pulling out the underlying capabilities rather than what we go to market with. So we go to market with digital transformation propositions that are all about helping a client transform their business whether that be driving revenue or efficiencies on the cost side. And that's been the classic digital transformation space that we performed in and done so well over so many years. The right to win I think comes from being able to combine that with patented unique approach to call modernization that really de risks that modernization program.

Speaker 3

And there are so many large enterprises out there that have been wary of getting into the enterprise core modernization space. And actually we can give them a much more solid route to doing so. Now as you do that, it really opens up what you can do on the digital transformation side. So because of the access to data that you get because of the process cleanup that you can drive through the organization. And we have been able to put those 2 capabilities together in a very differentiated way, that's where we see our right to win.

Speaker 3

Okay.

Speaker 12

And then, Mark, I just had a question about the free cash flow. And I think you had called this out last quarter, so it wasn't a surprise. But the 1.2% adjusted free cash flow as a percentage of revenue down from 10, Is I see that obviously a lot of it's the revenue pressure and the profitability pressure.

Speaker 2

But what else in here

Speaker 12

should we be looking at?

Speaker 2

Well, we have we typically have some 6 cards in the cash flow. So it is usually a low quarter cash flow, not as low as this as a percentage of revenue. We have taken the cash component of the restructuring of about $7,500,000 through the cash flows of 4,000,000 dollars So I think that's about I think about a couple of percentage points to it. I don't think this is representative of sort of the cash flow generative position of Dara going forward. I think it is a combination of us going through the restructuring.

Speaker 2

There definitely has been a sort of slowdown because it's related to the profitability of the revenue, which is low. And as our profitability sort of improves going forward, that will drive a strong sort of free cash flow position.

Speaker 12

Okay. That makes sense. Thank you.

Operator

The next question comes from Tom Blakey with KeyBanc. Please go ahead.

Speaker 9

Hi, everyone. Thank you for taking my question. I just my question was, it's good to hear about the new bookings seeming to offset some of these the pressures of down sells and whatnot. When you look out, John, to the next few quarters here, maybe into fiscal 'twenty five, not exactly a question on guide, but how far through are we in terms of these potential downward pressures? What does the portfolio look like in fiscal '24 that seem to have kind of like uptick in terms of downward pressure when you kind of take a look at it from a portfolio like your current business as we look out the next few quarters that we kind of think helpful for everybody?

Speaker 3

Yes, I don't want you to take away that this downward pressure is an unusual thing. This is something that has been happening through all of the boom times of growth as well. It's just the natural projects coming to an end cycle. What we've been experiencing over the last 18 months or so is the new spend that's been coming through has not been offsetting that. And that's where this quarter we're seeing it offsetting it and enabling stabilization.

Speaker 3

We're also seeing that big backlog of work where we've done discoveries for clients, paid discoveries where they're not yet making the decisions to go ahead with it. So it's too early to call that upward trend that's coming from new discretionary spend coming through that's enabled stabilization in Q4 is going to accelerate to the point where we anticipate an upturn. But that is the core question is when does that happen, when does this backlog of opportunities break through and actually start to lead to the uplift. And right now, we're not ready to call that. We'll see in September.

Speaker 9

And that's helpful in terms of the relatively normal cadence of the downward pressure. That's helpful. And then maybe just switching back over to the Galaxy topic. I was under the understanding just given prior research and whatnot from Galaxy that EBIT margins were in the high teens from an organic perspective. Just walk us through maybe the puts and takes there as we look to kind of like model out the next year or so.

Speaker 9

And if there's any seasonality in their revenue organically, that would be helpful as well. Thank you.

Speaker 2

Well, I think it depends on what numbers you've been looking at. So I don't disclose any public sort of numbers. We have been putting them on to IFRS. That's part of the integration challenge and looking at the accounting policies. There is integration activity which will be quite marked for us certainly in the 1st 6 months.

Speaker 2

So that's really until probably longer until about sort of December. I think as John said that bill rates is in line with our revenue per head. They do have a higher proportion of onshore compared to us. But we think that we can achieve over the course of what will be fiscal 2025 taking them up to levels of gross margin that we achieved. And then we will also be looking at the SG and A because there will be some synergies there basically.

Speaker 2

So I'm not going to spend it half in short. I think you're going to have to sort of wait until we guide in more detail for fiscal 2025, which we will do in September.

Speaker 9

Okay. And Mark, just any seasonality that Galaxy has been typically experiencing off that $21,000,000 $22,000,000 GDP?

Speaker 2

It's too early to tell to be honest. Certainly in terms of the budgets that we are looking at through the due diligence process, it looks like strong growth. Again, we have to sort of dejuke it for our revenue recognition, which we try to do at the due diligence sort of stage, but we're sort of working through that. I don't think there is any cyclicality or seasonality that we could pick up in terms of the timing of the spend that they have with their clients. But we have to do further work really before I can comment.

Speaker 9

Yes.

Operator

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

Speaker 3

Yes. So thank you all for joining us today. And as I mentioned in my prepared remarks, we talked about pivot in digital transformation that's underway driven by AI, specifically the need to drive change in the enterprise core. We've touched on that a little bit during this call. We believe Endava is well positioned for this with both the digital transformation capability to ideate and innovate alongside patented technology to help make enterprise core systems and data accessible to AI.

Speaker 3

The combination of these capabilities positions us excellently for the next wave of digital transformation driven by AI. We will continue to invest in these capabilities in anticipation of the market turn. I look forward to updating you on our next earnings call, which will be our full year numbers. Thank you.

Operator

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

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Key Takeaways

  • Management highlighted a normalization of technology spending after the post-COVID surge, noting a pause and deceleration as clients reprioritize but also pointing to significant pent-up demand for digital transformation and generative AI that hinges on deeper core modernization.
  • For Q3, Endava reported revenue of £174.4 million (down 11.8% in constant currency), an adjusted profit before tax margin of 8.9%, and adjusted diluted EPS of £0.22, which exceeded guidance due to faster cost savings implementation and a one-off tax benefit.
  • The acquisition of Galaxy Solutions, closed April 10, adds a £21 million annualized revenue run rate, strengthens Endava’s U.S. healthcare vertical, brings an experienced executive team, and has already yielded early joint wins.
  • Endava launched its AgenTic AI accelerator “Morpheus” to operationalize large language models with full transparency and auditability, driving initial AI production projects in automotive, healthcare, and sports sectors.
  • Q4 revenue is guided to £195–197 million (+3.5–4.5% constant currency, including Galaxy) with flat organic growth, and full-year revenue of £741–743 million (-4.5 to ‑4.0% CC) alongside adjusted EPS of $1.13–$1.14.
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Earnings Conference Call
Endava Q3 2024
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