Data#3 Limited (DTL) Earnings Call Transcript

Good morning, everyone, and thank you very much for joining us this morning for the first half FY '21 results briefing. We've got a series of content that we'll be providing. We've got a summary. We'll talk a little bit about our business. We'll talk around the pandemic and the impact on ourselves and our customers. We'll also -- I'll then pass over to Brem Hill, who is joining us, our CFO, who'll talk around our financial performance. I'll then round out with sector trends and the outlook, and then we'll hand over to questions. So if we move on to Slide 4. And I'll read this out. We are pleased with the first half performance, delivering another record result despite the challenging environment and changing market conditions. Once again, this result clearly demonstrates the inherent strength and relevance of our solution offerings in an evolving market, and we're delighted with the rapid growth in our cloud-based business. Earnings per share increased by 7.9% to $0.0609, and the Board declared an interim dividend of $0.055 per share, up 7.8% on PCP and representing a large 90.3% payout ratio. As I said, we, within the business, the management team and the Data#3 team are pleased with the first half results. The Board are also equally pleased with the record result. Now let's talk a little bit more about the environment and maybe talk a little bit more about our business. To put into context, what produced that result. Moving on to Slide #6 and start talking about our business. Our vision is to harness the power of people and technology for a better future. And we've had this vision for a number of years now. And probably the last 11 months or so during the pandemic, this has never been more relevant. And I'm really pleased to say that, moving on to Slide 7 in terms of talking about our business, that's when we talk about the power of our people, we have around 1,200 on a normal basis throughout Australia. And we have provided and worked with our customers to ensure that our customers keep operating efficiently and keep meeting their business challenges as well and meeting their business objectives. That's our overall goal is to utilize our people, the technology solutions that we provide, but more importantly, to help our customers achieve their business objectives. What that means for us in terms of Slide 7, for those of you who are familiar with us, some -- a little bit of background and history in terms of who we are as a business, been around for certainly a long time. And I think I'll pick one of the topics here on -- or one of the points here on Slide 7. Increasingly, we are reporting the percentage of revenue that we have under contract, as we see this as particularly important, and it's an increasing trend in our business. And I'll talk a little bit more about that in terms of the shape of our business going forward. Moving on, in terms -- as far as our solution sets, and this is how we represent ourselves in the market and how we provide the technology solutions to meet our customers' business requirements. These are, at the very highest level in terms of solution, the solution categories. Cloud, which is both public and private cloud. Workplace, which includes the likes of collaboration in which we are doing today in some form, obviously includes video conferencing, end-user devices as well. Security, always high on the agenda and high on customers' list of priorities, not least of which, when our customers have moved to a largely or almost exclusively remote working environment, the increase in security and security solutions has been very prevalent. The Data and Analytics continues to be a major solution area for us. And then wrapping it together in terms of connectivity, not only the networking, but also the software-defined networks that we are able to provide our major customers. And our customer base from the previous slide is very much around the larger corporates and public sector organizations. Now for each one of these solution areas, our aim is to provide as full a life cycle of services as possible. So the life cycle of services we see, and we define it starting with advisory or starting with consulting, where we help our customers define what it is that they are doing. And then we move into the design and implementation of technology solution, which is around -- usually around project services. And then we move into providing support services on a contractual basis, supporting the environment that we have implemented. So that's the -- what we term our life cycle of services. And moving on to Slide 9. We work with some of the largest organizations globally. The likes of -- and the top 4 that we pick out, that we invest deeply with is around Microsoft, Cisco, HP and Dell. We believe that -- and continue to believe that these are the organizations that continue to drive the markets in which we operate and particularly amongst our customer sets. And we've certainly seen that again in the last 12 months. If we move into the Slide 11 and move into what the pandemic looking back and also looking forward as well in terms of where we currently are, Slide 11 is designed to depict really a journey, if you like, in terms of -- from the start of the pandemic, if we go back to March last year, where there was a good deal of reaction and where our customers, including ourselves, were largely office-based, now working remotely and having to put in a range of different solutions very, very quickly. We see that -- we saw that phase, and that phase wasn't just a one-off, it was quite significant. And for some customers, in fact, a range of customers are at different stages of these 4 phases as we speak. So it's not one which is generic across all our customers. Those are all across all our sectors. And so each one of our customers has been -- is looking at either a react phase and adapt phase in terms of what changes they have made over to their network, to their environment, to their overall IT environment. There is also a -- then a review and a recovery phase, which isn't necessarily a recovery in terms of disaster recovery. This is more a recovery phase in terms of reviewing the work that we currently -- that we conducted over the last 12 months. And then we move into the planning phase in terms of growing back into, in particular, the growth around digital transformation and the technology that is needed to enable the digital transformation. Now each one -- as I said, each one of our customers and depending on the sector operates in a different way. What this slide is looking to show is that there are multiple solutions that we're able to provide our customers at each phase. So it's not just -- certainly not just a one-off. So on that note, I'm now going to pass over to Slide 12, and I'm going to hand over to Brem to provide a summary of our financials.

Thank you, Laurence, and good morning, everyone. I'll run through a quick overview of the first half financial results, and Slide 13 gives the key elements. So first of all, total revenue increased by 19.2% to $856.7 million, which is growing well ahead of the broader IT market as we continue to gain market share. And as mentioned previously, we're very pleased with the ongoing continued strong growth in our public cloud-based business, with public cloud revenue increasing by 37.4% to $346.1 million. Our interim financial report gives a more detailed breakdown of total revenue by the end of [ 2 ] business units, and the standout performer was our Software Solutions business. We saw revenue increase by 26.4% to $537.8 million. And in that number is the majority of our public cloud revenue, which is predominantly based on Microsoft Cloud offerings for Azure, Modern Workplace and Dynamics. To summarize the other business units, Infrastructure Solutions had revenue increased by 12.2% to $202 million. Project services revenue increased by 9% to [ $30.1 ] million and support services revenue increased by 3.8% to $46.7 million. And then our recruitment and contracting business saw revenue increase 3.3% to $29.4 million. Business FX consulting revenue decreased by 9.7% to $7.7 million, which reflects the deliberate decision to narrow the business units focus and which has also resulted in a considerable improvement in profit contributions. So it's a very positive result. And finally, Discovery Technology revenue decreased from $2.7 million to $2 million, largely due to reduced activity in the retail sector. But once again, they delivered an improvement in profit, which is a really pleasing outcome. So with a very strong growth in Software licensing and public cloud revenues, this is again out of the sales mix and reduced the overall gross profit margin percentage, down from 12.3% to 10.5%. And the total gross profit amount has actually increased by 1.2% to $89.7 million, which is compared to a very strong PCP results. Next, looking at our costs. Internal staff costs increased by 2.5%, and that's solely a reflection of headcount growth, and our other operating expenses decreased by 18.4% with a large reduction in travel costs, which is due to the pandemic challenges. There's some rent savings from the decommissioning of the Data#3 Cloud platform and also of just a concerted effort to contain costs more generally. So we've had improved operating leverage that helped deliver the solid profit growth with basic earnings per share increasing by 7.9% and the interim dividend increasing by 7.8%. So to put this first half result in perspective, the next slide shows the longer-term trend in revenue and earnings performance. So looking at Slide 14, this shows the past 6 first halves and clearly demonstrates our track record of sustained revenue growth. More recently, this growth has been fueled by demand for cloud-based solutions, which now comprise a very significant portion of our total revenue. And the chart on the right-hand side of the slide shows just pulls out the public cloud revenue trend for the past 5 first halves. Obviously, that's been a great result for public cloud and then licensing, but we're also very pleased with almost all our business units and all the regions have performed on or ahead of plan for the first half of FY '21. So it's a very balanced result. It's also reassuring that, as Laurence mentioned earlier, approximately 62% of our revenue is recurring. So that's contracts with -- under contract with either government or large corporate customers fulfilling essential IT requirements. So that certainly gives confidence in terms of future earnings and revenue. Next, Slide 15 gives a summary of the earnings trend. The first half produced a solid profit result, particularly considering the difficult environment and the operating conditions that we encountered. So that's a reflection of things like lockdowns and some delivery constraints. So despite all of that, we're very pleased to have delivered what was a particularly strong PCP result. And we've delivered yet another record result and maintained that longer-term growth trend. And just this chart show the first half of FY '18 was sort of an anomaly. Just to recap a bit on that. There were a number of timing issues and significant one-off events in that period that impacted earnings and resulted in a heavy skew to the second half of that financial year of FY '18. So looking more on the current period, the $0.055 interim dividend is -- it's fully franked, and it represents a payout ratio of 90.3%. This dividend will be paid on the 31st of March with the 17th of March record date. Lastly, Slide 16 gives a brief overview of the balance sheet and the cash flow. And we've continued to strengthen Data#3's position through diligent management of cash flow in the various balance sheet elements, and we have no borrowings. The net cash flow from operating activities is typically an outflow in the first half, and that's due to the timing of receipts and payments around 30th of June. So just to explain that a bit further, we have a traditional sales peak in May, June, which produces higher-than-normal collections before the end of June, and then those collections generate temporary cash surpluses, which subsequently reverse after 30th of June when we pay the associated suppliers. So in this current period, the first half net cash outflow with -- or from operating activities is higher than the outflow in the previous corresponding period, and that's due purely to the reversal of a higher-than-normal [ activity ] cash surplus back at 30th of June 2020. The underlying cash position has continued to strengthen. We've also continued to manage our working capital and collections very effectively, and our average day sales outstanding, which was 27.3 days for the first half, was ahead of target and remains the industry best practice. So then, I'll hand it back to Laurence, and many thanks for your interest in Data#3 and for listening to this briefing.

Thank you very much, Brem. If we move on to Slide 17. What we're looking to do here is highlight really the non-financial achievements that have taken place over the first half. And some of these may not be material from a financial point of view, but we see them certainly being great achievements. So I think I'd like to highlight 2 or 3 of them. In particular, we've won a series of awards. In fact, dozens of awards across many different vendors that we operate with. And I'd like to pick out one. In particular, there's a global one with Cisco across -- I think Cisco has 60,000 partners globally. We were fortunate enough to win another global award on the back of last year's one as well. This one is -- we believe, is even more significant as it represents a very large segment of Cisco's business, which is the commercial segment. And for Australian companies to win that, it's quite an achievement. So we believe that was certainly good news and a testament to the skills of our people within the Cisco team. What we've also secured is the certification for Microsoft Azure Expert Managed Service Provider, a little bit of a mantle, but it is a very significant certification. It's one that we've worked hard on for -- probably getting on for 2 years and has been a pretty reasonable investments, not only in dollars but also in time. And strategically, it positions us to be able to provide the support services. If you recall the slide that I talked about earlier in the presentation, in terms of the full life cycle across the Microsoft Azure stack. And not only do we provide the advisory -- the consulting and advisory services and the design and implementation, this provides us really with the seal of Microsoft's approval, that we are experts in providing the managed services component around their technologies. We see that significant -- certainly being significant going forward. Another one I'd like to point out, which is something which we've added to our portfolio, is an exclusive contract with an organization called CoreView, U.S.-based software-as-a-service organization, who provides management software for the Office 365 environment, particularly for the larger corporations, the larger corporations that are looking to manage that more productively. The CoreView is a significant additional product set that we have added to our portfolio. So again, not material from a financial point of view, but it is something which we believe our customers will enjoy in terms of the solutions that we are able to offer. And then likewise, as far as our people is concerned, over the last year, in particular, in fact during [ pandemic ], I don't think we're alone in this. But we've experienced really the lowest turnover of our people that we've ever experienced. And we've also achieved a number of great things with our people as well and continue to invest. And we just pointed out a couple of these, Employer of Choice being one and also launching our D&I program as well. Now let's move on to some of the sector trends. And moving on to Slide 19, which is -- goes on the back of an organization called Gartner, who tends to be the gurus in the IT industry in providing analysis. And I think last year was a little bit tougher for Gartner in terms of prediction and predicting the market because we ended up -- and these are Gartner's figures, that worldwide market was a 3% decline. Australia was a little less than that at 2.8%. And this is the calendar year '20. But more importantly, the prediction going forward globally is a very significant turnaround in terms of the spend in the sector in which we operate. And then in Australia, the spend going to plus 3.6%. We've not seen that before. And the areas which Gartner have predicted to grow faster than others is hardly unsurprisingly, which is education, health care and government. And which just happened to be the 3 areas which are the largest areas within our portfolio of customers as well. And then also from a solution point of view, and these don't necessarily match exactly how we position our solutions in terms of terminology, but they are exact as the replica of the services in which we offer, which is IT services, enterprise software, cloud and devices. And again, this is Gartner material that's looking to predict an increased spend in our market. So overall, our summary of the prediction for the market in which we operate is that we're very well positioned going forward in a growing market. Moving on to Slide 20. We've highlighted some of the key priorities in this year. And at the highest level, these are really across 4 areas as the solutions in which we provide our customers. And I've talked a little bit about each one of those. Brem also talked about the internal and the operational excellence that we have within our business. We're still looking to improve in the way that we operate more productively and then moving on to also the customer experience. And this is really 2 ways in terms of how we work with our customers through their journey of technology and technology solution implementation. And the customer experience is a lot more than the traditional customer satisfaction. It is getting to be a very scientific measure in terms of the data and analytics that we are able to work with our customers and provide detailed reporting in terms of how they operate their technology and what it means for their business. So customer experience is a big priority for us going forward. And of course, people and community is a very substantial one for us and continues to be for our staff. Now moving on to Slide 21 and 22. 21 is the FY '21 outlook. It looks very [ catmospheric ] illustration in terms of looking at Australia. The Slide 22, if I go on to the FY '21 outlook, and I'll read this out. We continue to see growth in the Australian IT market and believe we are well positioned to capitalize on that opportunity as we continue to develop and offer solutions for our customers' changing requirements. The solid first half performance and pipeline of opportunities for the second half give us confidence that we will achieve our full year financial objective, being to deliver sustainable earnings growth. Okay. On that note, I'd now like to open for Q&A for questions. We'll attempt to do our best to answer.

Your first question comes from Nick Harris with Morgans.

Laurence and Brem, congratulations. That was a good result. And clearly, some really tight cost control there and also some pretty amazing partner awards. So well done.

Thanks, Nick.

Thanks, Nick.

So just a couple of questions. On that Slide 11, Laurence, so I appreciate this is how long is a piece of string question. But obviously, you've got those 4 stages that react, adapt, et cetera. Just wondering, do you kind of have a feel on average for where customers are along that? Are they more towards the start or the end? Or maybe asking the same question in a slightly different way, do you think there's a long-term kind of customer upgrade cycle as they move to remote working and re-engineering businesses?

It's prudent to be long term. There was an initial spike. And now it's a long term, which is probably in a more planned fashion, which we will like to work within, not the least that we check customers. So the -- in terms of where we are and what the average is, it's very difficult to actually answer an average. We'd probably say that we are. Adapt and recover is between the orange or amber and the green. And we shouldn't read this into -- this is very much designed around the solutions in which we are operating. So that read directly the financial or financial predictions in terms of forecast directly into this, even though there's a chart which is going upwards from left to right. But it does give you -- and it certainly provides our customers a path, a road map that they are working with. And this is the same for every customer, but we do have a road map, which did have a spike at the beginning and is now smoothing out. That's probably the overall point.

That makes sense. And maybe just a couple for Brem. Just obviously, in the current half, your OpEx reduced lower travel, rent, not the Data#3 cloud anymore. Just sort of the best few moving parts. Just looking into the second half, should we be thinking your OpEx sort of broadly holds versus the first half? Or can you give us any ideas? And then just 2 other questions. The financial ones were average cash balance. Do you still talk about that? Or could you give us a bit of an idea of how much surplus capital you think you got in the business? And then my last one was just, obviously, gross margins came down a little bit. Is that mostly just the mix as in selling more lower margin stuff? Or are margins being moved around the board by your suppliers?

Thanks, Nick. So look, I'll work backwards there. So kicking off with regards the slides on -- so probably if we go to your first question. But on the gross margin side of things, it's definitely a mix issue. So we've seen a very strong growth in public cloud and licensing, which is relatively lower margin compared to some of the other parts of the business. But it's also a bit of a reflection of the type of work that we're doing. So comparing this first half with the previous first half, I think we've seen the previous first half would have benefited probably from more large integration projects. So it's a different sort of mix of business -- style business coming through, whereas in this current first half in more large licensing contract wins, which you're dealing with, with very large contracts that typically are at the lower margin anyway. And we haven't seen the big integration projects in the first half, but that's now coming back on the agenda as customers return to their efforts in digital transformation agenda come in that sort of recovery growth phase that Laurence was talking about just as earlier. If I look at the operating costs, certainly, the standout for the saving in travel and rent. Now the saving in rent is -- that's a given. That will continue. So we're no longer leasing a whole lot of space in data centers for the Data#3 Cloud. The travel saving, which was significant, it was about $1 million saving in the first half. It is hard to predict what that will be. We certainly do not expect it to go anywhere near the levels that it was previously, and it's probably likely to stay very low for the foreseeable future because the fact is that we have changed the way we do business, and that's kind of a permanent change. So there will be -- we expect to maintain costs at a similar sort of level moving forward, gradual increase at most. And sorry, Nick, what was your first part of the question? I had actually forgotten it.

That was the first question. The middle question was just the average cash balance.

Yes. So there are different ways to look at that. If I look at the average daily cash balance here, it tends to fluctuate from about $30 million, but that's not free cash. Therefore, I would try and look at what is true free cash. That's probably in the region of sort of $10 million to $12 million, around that figure. But it does -- we have such seasonality in our cash flows. Our cash balances fluctuate. Yes, they're always positive, but they can go up to $150 million plus, down to, yes, probably a couple of million. So it is -- it fluctuates within a month, and it fluctuates within a year depending on the cycle. But it continues to strengthen, and there's certainly no concern there at all.

Your next question comes from Adam Dellaverde with Taylor Collison.

Just a few questions from me, if you will indulge, maybe start with an easy one. At the AGM, you came out and it was really quite a cautious guidance. And then in 31 December, we've seen 20% revenue growth. Just wondering if you could explain what's changed between AGM and the end of the year? We tend to end up with those kind of revenue numbers? Or is the gross profit number then what we should really be focused on?

Yes. That's gross profit is where we typically focus, Adam.

Yes.

So yes.

Yes. The -- we got -- we don't tend to focus at any level in our business on revenue.

But the -- yes, the reason the revenue can change quite dramatically, particularly with large licensing contracts of -- yes, tens of million dollar contracts. And the timing of those can really shift revenue, but they have a much lesser impact at the gross profit level. So we typically work from gross profit down, and that's what our managers used to expand on.

Got it. And so this commentary around difficult environment to describe the first half, would you still classify the current environment as difficult or challenging?

I would say that it's moving from challenging to changing and continues to be changing. I think we are -- we and our customers are learning new ways of doing a range of different things. So -- and it's something which we've got to continue to make sure we adapt quickly to customers' changing requirements. And customers' changing requirements at the highest level probably don't change in that they are still on a digital transformation journey for the most part, every customer is. And the technologies really don't change as well. It's how they actually implement those digital transformation challenges and in particular, how they're implemented in a remote and distributed fashion when the workforce in some cases, tens of thousands of people are now working from home where they were in a centralized fashion and working within an office environment. And we see that's -- that not return, as Brem said earlier, based on the big operating expenses and travel expenses. We don't see that changing rapidly in the near term and probably won't in the long term either.

So challenging in the context of logistics. But what about in terms of customer spending patterns, budget deferrals, any challenges there?

Yes. Customer spending patterns, I think in the first half, when I say, I think in the first half, particularly for public sector, customers at all levels of government, they -- there were challenges of having budgets, which were handed down and then, therefore, understanding what technology spend was available. So some of those -- those delays were quite understandable, particularly when there were very large-scale stimulus packages being implemented at the time, at the beginning of the financial year. But that has now settled down, and we are -- we now understand what we're working with. We now understand what the customers are working with, and we have a range of projects and spend back in a pattern that is more predictable. So from that point of view, it sort of moves from challenging to changing. But what happened was move from challenging to easy.

Of course. And just on that supply chain, I guess in some other sectors, we're seeing shortages of chips.

Yes.

And definitely, the big OEMs are talking about still quite strong demand for devices and having trouble getting stuff into the country?

It's -- Brem highlighted that even the first half, we had some challenges, which were largely -- we largely overcame those challenges in the first half. We still see it on the horizon that there are some supply chain issues, which we are well placed to manage. We've got an excellent team of people who focus solely on managing the supply chain and the alternates on the supply chain. And it is something that we've certainly highlighted for the second half for a part of our business. As you rightly say, the device market is actually ones predict -- continue to predict it to grow. And we're just going to make sure that we've got -- we're able to fulfill the customer demand. Of course, alongside that, with the devices, the connectivity side of things and the cloud base, whether it's private or public, continues to grow at equally a stronger rate as well. And of course, for the majority of our business, we don't have supply chain constraints. It is software driven.

Okay. And just kind of final, I really wanted to unpack that gross -- the gross profit comments a little bit more. Just in the context of software licensing up 26%. I'm assuming that those kind of numbers will involve customers taking more products per customer or higher-value products per customer. Just is there a mismatch between the kind of licensing revenue growth you're achieving and what the customers are rebating?