Those of you joining us on the webcast. So thank you all, thanks, everybody, for joining us, particularly the senior management here from Endava on the second day of the Morgan Stanley TMT Conference, second day of four, so we're kind of getting through it. I'm James Faucette, the senior research analyst at Morgan Stanley, covering IT services, and I'm very pleased, as I said or mentioned as we were getting going, to have John Cotterell, the CEO, Mark Thurston, CFO, and Matt Cloke, CTO of Endava. Before I jump into our line of questioning with them this morning, I do have an important disclosure to read. Please see Morgan Stanley Research Disclosure website, the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.
So maybe I'll start, and John and Mark, I'm sure you've had this question posed quite a bit in the last few days. But as a reminder to the audience, can you help us calibrate your fiscal year 2024 outlook and talk about what is contemplated in both the low and high end of the guide, and kind of what led to the revisions that we saw most recently compared to how you were feeling at the end of last calendar year and headed into the second half of your fiscal year?
Yeah, sure. So I'm going to let Mark kick off on that because we'll get the numbers on the table first.
Yeah, yeah. So as you know, to James, we had quite a significant pullback from the previous guide. If I go back to sort of November when we were setting the guide for the full year in Q3, we were seeing momentum build in the business, particularly around the big deals. For us, that's over GBP 5 million. And what we saw during the course of the since then to the end of January is that the deals have continued to sort of go through our pipeline but not at the speed that we anticipated. So they have converted but slower. We've added to that pipeline. So we had about 15 big deals back in November. We have 17 now. So we've added five. We've lost three. The pipeline has converted, but it has converted slower than anticipated.
An example of that is the Equiniti deal that we announced on the date of earnings, which was a GBP 70 million deal over five years. We anticipated signing that in December. We actually signed it two months later, just before the earnings call. So that's indicative of what has been going on. So the backlog of work and by that, I mean, when we've won a deal, we usually go through an ideation phase, as we've historically referred to it, which is mainly around establishing what the backlog is of work before we sort of scale the opportunity. Those have proved very drawn out as well. We have examples where we've secured deals, and we are still in that ideation sort of phase. And when we've come into sort of the January, February timescale, we ask clients about why we're not progressing.
It's questions around budget, which is they have the budget, but actually they don't have the confidence to progress to that ramping stage. So put all that together, our assumptions about the conversion rate of our pipeline has been delayed. So specifically for Q4, we would particularly be taking a stance at the moment where we'd be carrying about 30% sort of pipeline in the figure that we're going with at the moment. Certainly at the top end of the guide, we have shaved that back to 20% compared to a 30%, and the bottom of the guide to about 15%. Now, that creates quite a range. So if things don't progress as we hope, we will have practically no sequential growth from Q3 to Q4. But if partly it converts as anticipated, then we would see a 6% sort of uptake.
We've sort of guided appropriately based on what we see. I can get into the profitability if you want, but that's basically the demand out.
Can I just ask a couple of follow-up questions? The first is, you mentioned that there had been some losses from your large deals. Were those losses to competitors, canceled, or did you just effectuate them and deliver, and so they kind of came out of that count?
There were three losses. One was a digital banking platform , actually in the Middle East, and the clients put it on hold. Essentially, the business case didn't stand up. There's some great details around it. And then the two others were losses. Essentially, as we got into the detail with the client, ERP skills were a necessary part of the solution. And so we were either going to need to partner with someone because it's not something that we do, or pull back from it. And we did the latter. And I think they're still selecting who they're going to go with.
Got it. And when you talk about kind of moving through the backlog into revenue conversion, if you will, I think the things that you're saying there, Mark, we've heard repeated quite a bit where people have projects, they feel like they're dimensionalized, they're ready to be sourced and staffed, et cetera, but the movement on them is either slower or paused. And by slower, they're kind of either stretching out the delivery time frame, or they may even be rescoping them a little bit to chunk them up a little bit more. Is that consistent with what you're seeing, and how would you assess what that implies? Is it just nervousness? Is it a change in return requirements because of higher cost of capital? Just kind of give us an idea of what the nuance and tenor is behind those conversations.
I mean, we're saying it's budgets, but the drivers in delay vary by each of the sort of sectors. So I mean, one of the deals we won and I'll go across some of them in retail, for instance. It's a U.K. retailer. The U.K. economy is technically in recession at the moment. So they have, I'll say, dragged out their discovery phase. They have not ramped as anticipated. If you go to banking and capital markets, I think that is response to the macro. So they are pausing stuff, and it may change quarter to quarter. Other areas, such as payments, it's more strategic decisions about whether they embrace a certain technology direction. So in that case, it would be Open Banking as opposed to the original sort of authentication work.
Mobility for us, which covers travel, airlines, et cetera, we have seen it where the underlying business looks fine, but again, there's caution based on macroeconomic outlook. Again, in the mobility space, if it's automotive, it's around decisions around the strategic direction of the platforms that certain manufacturers want to be pursuing. So there's a whole bunch of sort of reasons, but they basically sort of split into strategic technology choice or uncertainty around the macro. And that sort of transfers into what we're told, which is, yeah, we have the budget. We are going to proceed. We have scope to work with you, but we're not going to progress at the rate that we anticipated, or we need further levels of due diligence. And it's also the same in the deals with new clients that we're trying to secure as well.
Sure. I find that the comments on maybe uncertainty or reevaluating or already having made the decision to change a little bit the technology direction in particular, any way you can generalize or help summarize why that's happening, especially? Is there something in underlying technologies where people have said, "Oh, you know what? We just saw this shiny new thing, and we want to reevaluate. Does that become part of our solution?" Just try to get a sense for what's motivating that.
It isn't the shiny new thing space. Particularly AI, everyone's been asking the question, "Is AI causing people to pause spend in case it creates a whole different route to getting to the solution?
Yeah, yeah, yeah. Another route, yep.
We're not seeing that. We are working with clients on the AI side as well. So we see both sides of the picture there. It is more, as Mark said, that it's either the macro is causing them to go, "Do you know what? Maybe our industry is going to hit issues further down the year. Let's just be cautious now." Travel, for instance, they're doing well, the airlines, at the moment, but they're worried about there being a pullback later in the year. So they're trimming their budgets. Now, the expectation being if they keep their passenger numbers high, that they then start to push those projects through. It's that sort of dynamic. The other one is the more strategic, where actually these are pretty fundamental decisions about new product capabilities that are going to shift the direction of the enterprise.
People are thinking a lot harder about those decisions than they were in the previous two years. The whole CFOs have taken control again and getting proper business cases pushed through and extra levels of diligence in what they're deciding.
To me, that sounds like.
It's causing delays.
Yeah. To me, that sounds more like an artifact of higher cost of capital/more push to be profitable, make sure you're going to get a return, and.
I think it's also a kickback from the exuberance of the post-COVID days, frankly, where people spent so much, and they're going, "Actually, did we get the return on time?
Got it, got it. One of the things that when we once again, you guys are in a little bit different calendar than a lot of the other players in the space, but it seems like nothing that you're saying right now is different than what we really have heard from others, whether it be direct competitors or adjacent services companies or the customers themselves. But at least among other services companies, there seems to be this idea that, well, there's a little bit of a log jam, and that's really going to break in the second half of this calendar year, so the first half of your fiscal year. And because people won't be able to wait, we're seeing indications that that's the timing.
I mean, are there things that you can point at where you reach similar conclusions right now, or is this just a classic, "Well, whatever's happening in 6-9 months, it's going to be different and hopefully better because 6 months is not so soon as to be unrealistic," but?
So the dynamic that we're seeing that lines up with that is the prepared backlog of work. By prepared, I mean clients have spent money with us to do the discovery work, to do the detail work around what the products are going to look like and the impact it's going to have on their markets. So they've spent money to do the groundwork. That might be 10%, sometimes 20% of the total cost that's gone into that upfront work. And that backlog is now very large. Mark talked about numbers of deals, but actually the average size of those deals, these larger deals, is also 50% higher than it was in November. So that backlog is what everyone's talking about. It has to break at some point because they need to do these things.
The expectation is, does that hit for the second half of the calendar year? Does it come through a little bit? Does it start coming through a bit earlier? Does it wait a little bit longer? Is the big question everyone's wrestling with.
So that creates a really tough operational conundrum for you as a management team, right? I think you kind of addressed it late last calendar year as you were going through the end of your second or going into your second fiscal quarter, even the way that you're addressing it now. So how are you thinking about resourcing, keeping resources under contract on the bench right now versus ready to bring them off? Are you taking and saying, "Okay, we've got this backlog that should convert. Maybe the log jam breaks, if you will." But are you changing your assessment of expected values of like, "Well, this percentage is going to actually convert," and that kind of thing? I'm just wondering how you're trying to manage that and how we should think about its impact on profitability.
So I mean, in our guidance, we've taken a very conservative view on it. In terms of the headcount that we're keeping in the business, we're going through a restructure to take some of it out, but we're maintaining enough headcount to be able to handle what we have in the guide. If it comes through over and above that, we'll be recruiting again. Now, recruiting is something we're entirely familiar with and have been doing our entire existence. We would just step into that mode of bringing people in and ramping up alongside the client demand. I somehow don't believe that it's all going to break at once, and we'll have a 20% quarter-on-quarter jump that we have to cope with. Life never really pans out like that.
What kind of quarter-on-quarter jump are you prepared to be able to absorb and deliver on if it's not 20? Is it 18?
No, no, no. It'd be high single digits that we could revenue-.
That you could absorb. And then are you able then to recruit, do you think, fast enough to sustain that into a second consecutive quarter and beyond at that kind of high single digit rate, or?
Yeah, I would say that, but not three or four quarters in a row.
Right. But so you could do one, you can do two. That makes sense. But then three or four quarters, that's where it gets really taxing.
Correct.
Yeah. Got it, got it, got it. I've been kind of monopolizing questions here for the first part of the conversation. If anybody has any questions, just raise your hand, and we'll get you a microphone for the benefit of the webcast. So talking about staffing, and one of the other common things that we've heard generally has been that there have been some requests from customers to help get things going like, "Hey, can we find a way to deliver this at a lower cost?" or that kind of thing. And so some companies have been looking at different delivery geographies, et cetera, to help address that. Can you talk a little bit about the GalaxE acquisition? Does this fit into that narrative? Kind of what is the motivator there?
Give us some color behind the process and how you came to know GalaxE and why you decided this made sense.
Sure. So I was introduced to Tim back in October of last year, and the dialogue has been growing over that period. They went through a formal process driven by J.P. Morgan. We got into a lot of diligence work with them in terms of workshops with the senior team, going and visiting their teams on the ground, going out to India, seeing their delivery centers out there, making customer calls to actually check that the customers had the same experience that the GalaxE guys were taking us through, which were amazing, by the way. The customer calls were with CIOs, COOs of Fortune 50 organizations, and were very, very positive about it. The big driver for us was the diversification of industries. So healthcare being 75% of the business and diversification of customer geographies with 100% in the U.S.
Both have been. We've been calling out for a while, have been a strategic intent of ours to get diversification from that overweight in the banking, financial services space, and in the U.K. So that's all good news for us. They have India delivery capability, but we don't see us using India to do what we do nearshore. We see the nearshore franchise being around close to client, good relationships with product owners on the client side, facilitated by time zone overlap and not trying to do that in India. What India does, it brings complementary capabilities. And as we scale with our customers and we start doing more and more of their budget, they're asking us to take on some of their knotty problems like their underlying legacy systems. Those are a restriction to the digital transformation work we do. So actually being able to unlock that is good.
That's a strength that GalaxE has and taps into India for doing that transformation work.
No, that makes a lot of sense. And so with that being the case, I mean, then more generally, are you seeing much in the way of pricing pressure or requests for pricing relief on your more traditional capabilities or delivery, or is it just being manifested in kind of these delays?
It's manifested in the delays. I mean, you get a spectrum. So at the bottom end, there are some people putting pricing pressure on, but we're also getting price rises at the top end. If you look at our revenue per day worked, it's stayed absolutely flat for the last three quarters.
Got it, got it, got it. And on GalaxE, how should we think about its recent growth rates, how you would expect that to trend once it's incorporated? And remind us on expected timing close and impact to P&L and that kind of thing.
So we anticipate the new markets requirements early April. With the close of that, that will contribute two and a half months' worth of revenue to our full year. We anticipate that would add 4% to our full year guide. So that two and a half months adds 4% to our full year guide, so take it from -5% to -1%. They are a calendar year, but they grew from 2022 to 2023 at 10%. So that's very respectable in the given market.
Yeah, in that market, for sure.
Their profitability is pretty similar to us. So we've hit our margins in the high teens, touching 20%. And their revenue per head, despite the sort of disparate model, they have quite a high, about 30% of their headcount is onshore. Despite the Indian delivery there, revenue per head is very similar to ours. So they have good financial operating metrics. I think we're excited about the products that John was talking about, the accelerators in particular. I think the diversification into healthcare is also particularly attractive. I think the scope for us to go harder in that area because I think one of the feedbacks I think John got on the calls that we had was that one of the limitations that the current customer base has is the sort of scale that GalaxE are at, and we can bring that to the point.
We feel very positive about the acquisition.
So on that point, I mean, if customers and potential customers particularly feel more comfortable with that increased scale and backing or incorporation into EPAM's larger organization, do you think about that as potentially being a revenue accelerator for the GalaxE business within EPAM or within Endava or sorry, within Endava it's been a long day?
I have a feeling.
Within Endava, or is it sustaining? Kind of, help us think through that?
No, no, we think there'll be revenue benefits that come from the merger, both ways. Matt, I don't know if you want to, we've brought you up here to unpack a little bit of the accelerator.
You're supposed to be the one running this, making it happen.
So when we did the due diligence on GalaxE, one of the things that they've done, which we think is quite unique, is they have a set of tools and automations, which they refer to as the GxForce suite of tools. And what that investment has allowed them to do is effectively go into the legacy part of organizations and do what I would refer to as kind of like medical imaging for an enterprise. And it consumes information around log files and infrastructure and CMDB and all of this stuff that enterprises have. But by analyzing the data, they build a virtual SME effectively. And then they have other tools which the decision makers and the people making the change can use to de-risk and provide observability about what's going to happen.
So when we look at that product set and we pulled our commercial teams together in London as part of the due diligence process, and we basically said, "Is this a thing that we think will work with our existing client sets as well as GalaxE's?" And what we saw in there was the fact that there was work that previously we would not participate in because it isn't in our core set of expertise. But by using these tools and the experience from GalaxE, we think that we can actually help people get onto the on-ramp of digital transformation a lot quicker because we can go and help them with this kind of messy back end, which we've historically avoided and our competitors tend to throw lots of people at, but very low-skilled and junior people, not senior people.
No, and that's actually a really interesting point and capability that Matt called out. So from that, should we take that there's a potential one of the great pursuits of services companies always is like, "Hey, is there some element of IP reusability here that can improve our pricing, our margins, or speed up growth?" How do you think about some of those things? Is this one of the areas where there is actually opportunity to reuse IP and get some leverage on the business?
We believe so. It's an interesting toolset that they've developed, and the opportunity off the back of it is to—it's a huge market. It's an absolute mammoth market of legacy systems that customers are constantly having to poke at for, I don't know, regulatory reasons. The sort of work we're doing, we're building on top of these legacy structures. And actually being able to help clients get into it and sort it out is a massive market, and it's done very, very manually at the moment. And these toolsets will help us to automate a lot of that process and make it. This is what the clients were feeding back to me, was that it gives them confidence and assurance around the outcomes they're going to get in their programs as they tinker with these systems.
Got it, got it. I want to turn quickly to the other aspect that you mentioned with the GalaxE acquisition, which is improved diversification, both in terms of verticals as well as geographies. We've had a lot of people that are newer to Endava and the business where they've kind of really piqued their interest in the last few weeks. Can you just give a recap outline of your current exposures? You've mentioned that you'd wanted to go into healthcare, et cetera, but what you, John, maybe what you think a good exposure overview or recap would look like if you were able to achieve all of the diversification you're pursuing?
Yeah, sure. I mean, at the moment, so once we consolidate in GalaxE, we'll end up just over 40% in the U.S. We'll be just over 50% in Europe and the U.K. between those, and just under 10% in the rest of the world. I think the rest of the world will creep a little bit above 10%. I'd like to see Europe come down below that 50% mark into more like low 40s and the U.S. go up towards the 50% end just on geographies. And then if you look at the industry mix, at the moment, the financial services space post this consolidation will be around the 45% mark. That needs to halve, which means we've got to double the rest of the business while still growing that.
And we want to push out into the particular areas we're excited about, mobility, which includes automotive, supply chain, and travel, anything that moves people and goods. Healthcare, which obviously this one will move us up to around the 14% mark. So that establishes it as our third largest segment, which will be great. But then also other spaces, TMT, we want to continue to push on. And then some of the smaller ones that are going to be coming up like retail will need a bit of work, probably some M&A along the way to give them that step up into significance.
Got it, got it. Even though you wanted diversification by the way, within financial services and fintech, et cetera, you did recently sign a new MSA with Mastercard, which has been historically one of your bigger and sometimes biggest clients. Can you break down a little bit why that contract, five-year MSA, matters, how that breaks down versus historic spend levels with you? Anything that we should keep in mind as it relates to Vocalink versus non-Vocalink work, et cetera?
So I mean, just so the Mastercard one was actually done back in July. We more recently signed one with Equiniti, which was about three-quarters of the size of the Mastercard one, which we signed the day before earnings call, so 28th of February. We're always looking for those sort of longer-term commitments that clients will make to us. And those are underpinned by committed spend that the clients put in. The Mastercard one was the same. That gives us some assurance. What you get with those sorts of contracts is if clients do decide that they want to trim back for budget reasons or whatever, you're not at the top of the list because they know they have to spend the money with you and other people get trimmed. So we're always looking to put those arrangements in place.
We have them across a number of clients at multi-year deals at various stages through travel through the length of those deals.
Got it, got it. Okay, so that makes sense. This is something where not only with Mastercard, you're seeing it with others.
We had it with Worldpay before.
With Worldpay. That's why I wanted to ask about Worldpay is I know that they had been previously your biggest customer at different points in time. Private equity group GTCR just took their managing or controlling stake in Worldpay. Any color as it relates to future spending intentions? Is that something that would make sense to at some point you would hope renew, or what are the prospects there from your perspective?
We have a very good relationship with Worldpay. They very, very much liked what our delivery model nearshore to them. One of the kickbacks, if you like, within Worldpay has been under FIS ownership. There was a huge push for them to move delivery out to India, which mainly affected other people. We came down by maybe 20% at the peak with Worldpay through that process. But actually, they want to pull that back and get their delivery back into nearshore locations. They'll do some of that themselves. But we also see tailwinds for us in helping them make that shift back into a nearshore delivery model. The reason for it being that the new products that they're driving, they think they can get them to market much quicker with a much higher quality out of a nearshore delivery model, exactly what we do.
Got it, got it, got it. And then you've talked about in the past other areas within fintech, et cetera, and one of those has been embedded finance opportunity or payment as a service. Can you talk about those? And is that an existing customer set that's looking at those, new customers? How do you think about the opportunities there, and where is that going to make the most sense geographically or otherwise?
So this is one of the areas where we've been able to turn our sort of payments vertical, where we've provided services to the payments providers into a horizontal where actually payments impacts every other industry. And then the large players in automotive, for instance, when they're tackling the question of how do we turn the car into a software platform, one of the things that they want to do to monetize that is make it payments capable. So we're able to help them work out how to own that platform and the monetization of it rather than just subcontracting it to the traditional payments providers. The payments providers are good with that, by the way, because they still process the payment off the back end. But it takes us horizontally across other industries.
It's been a good entry point for us in that diversification journey that we were talking about earlier, to retail, into automotive, travel. All of these guys have payments challenges.
When you look at moving into as part of that diversification strategy, when we think about the role you'd be playing in travel or retail, is it primarily going to be these payments-oriented projects, or do you think that you'll be taking on and would expect to do lots of other things within those industries?
No, no. We'd see that as for a new customer, a good way of getting a foothold and then building out from that initial foothold.
And then if I take that and to circle back to the GalaxE acquisition, et cetera, to expand capabilities from that foothold within those new verticals, is that something that makes sense to develop internally? Or once again, are we going to be looking at kind of a relatively consistent pace of acquisitions to add those capabilities and get those opportunities?
So the organic growth we would do together with GalaxE into the healthcare space, that will be something that we'll invest in, making sure to be frank, their sales organization is not that strong. They've mainly grown through customer recommendations rather than building a stronger sales engine. We will bring that to them and drive a stronger sales engine and growing that healthcare space. The acquisitions will be more about at the moment, retail is, say, 3%. In order to make it significant and get it into double digits, we probably need to make an acquisition.
Right, right, right. Got it. That makes sense. I appreciate that. So John, in the last minute, a lot to do in the second half of year. Sounds like you're hopeful even as we get into the latter part of the second half of your fiscal year and beginning of next fiscal year, second half of the calendar year, that there's still building up a lot of opportunity. What are the key things that are kind of keeping you awake at night here in the near term to make sure that you're as flexible but also adept at taking advantage of the opportunities that may show up in the rest of this calendar year?
The number one thing is talking to customers about this backlog of work, what it is that is going to give them the confidence to turn that into revenue with us, and doing everything we can to take them down that road. The scaling and everything that would follow from that is absolutely within our playbook, and I don't particularly worry about that.
Got it. Well, John, Mark, Matt, thank you very much for joining us today. And any follow-ups, I'm sure they'll be happy to entertain questions. And once again, thank you for joining us here at the Morgan Stanley TMT Conference.
Thanks very much. Thank you all.