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Edited Transcript of DTC.J earnings conference call or presentation 17-Oct-19 7:00am GMT

Q2 2020 Datatec Ltd Earnings Call

Sandown Oct 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Datatec Ltd earnings conference call or presentation Thursday, October 17, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Ivan Philip Dittrich

Datatec Limited - CFO & Director

* Jens Peter Montanana

Datatec Limited - Founder, CEO & Executive Director

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Datatec Limited interim results conference call. (Operator Instructions)

Please note that this conference is being recorded.

I'll now turn the conference over to Mr. Jens Montanana. Please go ahead, sir.

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Jens Peter Montanana, Datatec Limited - Founder, CEO & Executive Director [2]

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Good morning, everyone. Today, we are reporting on our first half FY '20 results. The presentation follows our normal format but with an extra disclosure this time explaining the adoption of IFRS 16. I will start with an overview and the highlights, and Ivan will take us through detailed financial reporting. And then I will present the individual divisional results.

Then moving on to the strategic update and the first slide of all of today's financial results summary. We had modest revenue growth of 3% in U.S. dollar reporting, which would have been 8% in constant currency. Unfavorable exchange rate movements in South America, in particular, hurt us in translation terms. The main highlight was the continued turnaround in Westcon International, which turned profitable in line with our expectations. The help to increasing gross profit was split mainly between Westcon and Logicalis. EBITDA jumped to $70 million, of which $17 million of the increase was due to the implementation of IFRS 16. Underlying earnings per share received a boost for a favorable one-off tax credit in Logicalis Brazil during this period.

Overview. All divisions made solid progress. Westcon International turnaround continued. Logicalis was boosted by Latin America, and Analysys Mason, the consulting arm, had an exceptional period driven by Mason's demand for 5G infrastructure and next-generation optical networks. We continued with our share buyback program, and then reduced our share capital and number of shares in issue by almost 20% since the beginning of last year.

We've made good progress addressing the valuation gap with growing EBITDA profitability, cash generation, share buybacks and the return of future dividends. During the period, almost $35 million or over ZAR 500 million of value was returned to shareholders. We remain focused on corporate transactions and M&A that can drive our progress in all of our divisions.

I'll hand over to Ivan for the financial results.

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Ivan Philip Dittrich, Datatec Limited - CFO & Director [3]

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Thank you, Jens, and good morning, everyone. The solid operational execution and the delivery on commitments from the prior financial year continued during the first half of this financial year, and in particular, the turnaround in Westcon International is clearly visible.

On Slide 8, financial performance. From a group perspective, revenues were up 3% with an increase of 3.5% in Westcon and approximately 1% in Logicalis in reported currency. In constant currency terms, revenues would have grown by 8%. Logicalis gross profit increased by 12% and Westcon gross profit by 13%. Operating costs increased by 5%. The prior year operating costs included a benefit of USD 15 million reduction in costs relating to the SYNNEX transition of services obligation in the first half last year, which had been accrued against the profit on disposal to SYNNEX in FY '18.

Foreign exchange gains were approximately [$600,000] comprising of realized foreign exchange gains of [$2.8 million] and unrealized foreign exchange losses of $4.2 million. In the prior year first half, total foreign exchange gains were $8 million.

Reported EBITDA was $27 million higher than in the prior year. The decrease in depreciation is mainly as a result of the adoption of IFRS 16. Operating profit was 31% higher than in the prior year.

Moving to Slide 9, the continuation of the P&L. Interest income increased over the prior year, mainly because of the positive Logicalis Brazil tax ruling. Interest expense increased as a result of the adoption of IFRS 16. Profit before tax almost doubled compared to the prior year, and all earnings metrics were substantially better than the prior year.

Slide 10, pro forma financial performance, excluding the adoption of IFRS 16. This slide shows the impact of IFRS 16 on our first half income statement. We are providing pro forma first half FY '20 numbers to enable a like-for-like comparison to the prior year. The adoption of IFRS 16 has resulted in an improvement in EBITDA of just under $17 million and an increase of $14 million in depreciation and $2.3 million in net finance costs. The impact on earnings per share was negligible.

Moving to the contribution per division, Slide 11. Both the revenue and gross profit contribution per division has remained to be similar year-over-year.

Slide 12, revenue and gross profit contribution by geography. We had a greater revenue contribution from Middle East and Africa in the first half this year and a lower contribution from Europe. We had a larger gross profit contribution from Latin America and Middle East and Africa this year.

Slide 13, balance sheet summary. With no liquidates, goodwill associated with Logicalis and Analysys Mason as all goodwill related to Westcon has previously been derecognized against the gain on disposal to SYNNEX in FY '18. We have seen continued working capital improvement in both Westcon and Logicalis resulting in improved operating cash flows. The reduction in shareholders' funds is largely due to exchange differences on -- arising on translation to presentation currency as well as share repurchases during the period.

Net debt increased as of February 2019 mainly as a result of the adoption of IFRS 16. Excluding IFRS 16, the net debt would have been $102 million for the group compared to $101 million as of February 2019. Tangible NAV was $325 million.

Slide 14, the pro forma balance sheet summary, excluding the adoption of IFRS 16. The adoption of IFRS 16 was effective for the group from the current financial year FY '20. The principal impact of IFRS 16 was to change the accounting treatment of leases that's previously classified as operating leases. And under IFRS 16, such leases give rise -- give rights to the recognition of right-of-use assets and related lease liabilities, and these lease liabilities are included in net debt.

Slide 15, cash flows. Operating cash flows were much stronger than the prior year driven largely by working capital improvements. $32 million of cash was utilized for share repurchases and dividends. We have now completed our previously conducted share repurchases representing the scrip component of the $350 million dividend paid to shareholders in January 2018.

I will now hand over to Jens to cover the rest of the presentation.

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Jens Peter Montanana, Datatec Limited - Founder, CEO & Executive Director [4]

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Okay. Thank you, Ivan. I'll turn now to the operational reviews starting with Logicalis Group and on Slide 18, financial performance. A relatively flat revenue performance, which would have been much better in constant currency. All regions were impacted by the strong U.S. dollar, especially South America. Gross margin was boosted by a favorable product mix and helped by credit to sales from prior year's indirect taxes in Brazil. As a result, operating costs grew less than gross profit, but still by more than revenue.

Post the switch to IFRS 16, you would expect overall EBITDA margin to now trend over 7% going forward from previously approximately 6%. This change does not impact the net income or quality of earnings.

A fuller explanation of pre- and post-IFRS 16 adoption around the income statement is shown here in this table. The top and bottom of the income statement are largely unchanged with little impact in operating expense classification and, therefore, EBITDA. Depreciation, amortization and interest are all affected. Despite the flat revenue growth, EBITDA and operating profit grew by close to [1/5]. In constant currency, our revenue would have grown by 9%.

Revenue and gross profit contribution by geography. The big jump in Latin America was boosted by one-off sales tax credit to sales as a result of a final judicial order. The accounting effect of this is immediate, but the cash benefit is over time. As a result, in this presentation, the effect is that all other regions declined in proportion.

Revenue by segment and product revenue by vendor. Not much changed from the segmental revenues [dip] between product and services. All services are now close to 40% of the revenue mix and over half of the gross profit generated. Our long-term contractual integration and managed services businesses are now over 1/4 of the total. Cisco remains half of the total product mix, down a bit from last year. However, some of this is timing-related. There are 5 other vendors that now drive 3% or more each of our product portfolio, and the rest, including mainly security products, all fall into the other category.

Gross profit and EBITDA by geography. It was a flat first half for all regions other than Latin America with gross profit contribution mirroring the revenues, the overall stronger dollar was a major factor. Latin America had intrinsically better margin performance and was also boosted by the one-off sales tax credit I referred to in Brazil. The overall EBITDA, including the $9.6 million of positive IFRS 16 adjustments rose, $17 million to $56 million.

Central costs were unchanged. We continue to confront legacy operational challenges in the U.S. and the U.K. Some changes have been made to date, but further actions are planned.

Working capital. Year-over-year, deferred revenue increased as with inventory. There was a $117 million improvement in accounts receivable -- in account receivable/debtors and with the corresponding debtor days from last year-end. Payables days were higher this time last year. Net working capital deployed in the business fell, while overall net debt grew due to trading losses and restructuring in the U.K. and the adoption of IFRS 16.

Outlook. The rebalancing between legacy and on-premises IT infrastructure versus products for cloud-based solutions continues. We remain positioned in both segments as we migrate ourselves in respect with our customers' changing needs. Even though there is considerable uncertainty in Europe of the Brexit and the slowdown driven by growing global trade disputes, the growth in many nations and emerging technologies around the cloud is robust. But I think ForEx volatility will continue as risk-on risk-off market behavior becomes more erratic. Our growing services base, however, drives greater predictability.

In closing, I would just like to make mention of the planned Logicalis leadership succession is taking place at the end of this year. I would like to thank Mark Rogers with 17 years of service to the group, including his last 5 years as the CEO. He will be handing over to Robert Bailkoski, our current COO, at the end of this year but will be remaining on the Logicalis Board.

Moving on Westcon International financial performance. Modest revenue growth within the context of a strong dollar against all the currencies we're dealing internationally, it was a solid period. Most impressive was the quality of business reflected in the gross margin, which grew by 13%, setting up significant operational leverage. Equally impressive was the control over operating costs, which grew by less than revenues. EBITDA grew by over $13 million -- sorry, EBITDA grew by over $13 million reported. However, excluding last year's accounting benefit of $15 million related to our SYNNEX transitional services arrangement and the benefit of IFRS 16, the real underlying EBITDA swing was $22 million.

Let me show the pro forma financial position post the effects on the P&L of the IFRS 16 adoption. The real changes are in operating and finance costs and depreciation and amortization. In constant currency, our revenue would have grown 7.5%.

Revenue and gross profit by -- contribution by geography. The biggest geographic improvement came from the Middle East and Africa in both revenue and gross profit contribution. Europe remains by far the dominant region at around 60% with Asia-Pac representing 1/4 of the total.

Slide 29, revenue by business unit, customer and technology category. At the business unit level, Comstor, our Cisco division and the other vendors together, representing the Westcon brand, remains approximately 50-50. Similarly, our customer product analysis was unchanged with small and medium-sized, SMB, resellers driving the majority.

On the technology side, security and networking solutions continue to drive almost 60% of the portfolio.

Historical quarterly sales. The quarterly trend representation shows continued, steady, yearly, sequential and comparative growth. We have now had 8 consecutive quarters of comparative improvement.

Gross profit and EBITDA by geography. We had gross profit and EBITDA improvement in all regions. The gross profit contribution from the Middle East and Africa grew by 1/4, while Europe and Asia-Pacific grows approximately 10%.

Reported central costs last year were lower due to the $15 million accrued credit on providing the SYNNEX transitional services in that period. We believe we have now structured our central costs to where they need to be longer term approaching 1% of our future revenues.

On the central costs, we showed here again the progress that we made in our central costs. In the first half of this year, our central costs were $14 million. By the end of this year, we are targeting [half] of our total costs compared to where we were 3 years ago prior to the sale of the Westcon Americas business unit, which then represented about half the business in revenue terms.

Working capital. A very good period of balance sheet management. Accounts receivable and debtor days are now trending historical norms with slight improvement still targeted. Inventory levels and better terms are the result of our process and systems improvements, coupled with smarter management practices. Our payables increased, mainly receivables year-over-year, and our net working capital continued to fall. The net debt position would have actually been better than this time last year if it were not for the inclusion of longer-term lease commitments, which are now added as per IFRS 16.

In summary, the Westcon International outlook are continuing improvement in performance, execution and productivity. Working capital is improving. The balance sheet is becoming stronger. We are focused on next-generation requirements through both the technologies we provide and the way we sell, deliver and support.

This year, we're showing a recap of Analysys Mason, a consulting division, similar to how we reported previously, given its greater proportion of significance.

Slide 36. Just a quick run-through on what the smaller division does. We are one of the leading focused TMT strategy consultants with truly international coverage. The business contains a dedicated research arm with content generation based in New York and London. The main sectors -- customer sectors are telecom operators and other service providers, software and cloud companies and governments and regulators.

Analysys Mason financial performance. This is a snapshot of the first half. The business has had 2 years of sequential and comparative growth fueled in part by the early build-out of 5G networks and the longer-term impact that it's having on (inaudible) networks. We have not seen operating margins at this level in the teens since over 10 years ago. Overall, we've been extremely pleased with this exceptional progress.

So moving on to a summary of the presentation, the final slide, prospects and outlook. So we believe the foundations for progress were set in all divisions. We do not expect synchronized performance improvement across all markets. In fact, we see regions reacting differently to challenges and trends. We are set to return to operating leverage, especially in Westcon.

Targeted M&A and appropriate corporate initiatives remain at the forefront. Our improving financial performance and better liquidity will result in a return for our dividend strategy with continued share buybacks. The most recent months have shown a potential for economic risk from a downside. With Brexit still unresolved, possible recession already underway in Germany and the U.K. and the global trade disputes, uncertainty abounds.

That's it for the closing remarks, and I will hand over now to any questions from the audio conference and the webcast.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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Jens Peter Montanana, Datatec Limited - Founder, CEO & Executive Director [2]

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Any questions therefore on the webcast? Go ahead.

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Unidentified Company Representative, [3]

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Actually, we do have a question from (inaudible) from (inaudible). Actually, a couple of questions. The first one is what is the size of the benefit from the tax holding in LatAm? Second, considering the impressive movements of Westcon, has there been any further thoughts with SYNNEX around the possibility of a takeover? And finally, do you have a sense of what the tax line will look like going forward and do you have a sense of where you expect you can get to utilize losses, et cetera?

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Ivan Philip Dittrich, Datatec Limited - CFO & Director [4]

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Okay, so I'll answer the first and the third questions, and then Jens can answer the second question. So in terms of the impact of the timing of judicial order related to the multiyear overpayment of sales, taxes and the (inaudible), we do not disclose the certain amounts of the -- certain magnitude of the impacts.

With regards to the effective tax rate, as you can see, the effective tax rate has currently scored quite high, and it's impacted by the fact that, particularly in Westcon, and deferred tax assets are not yet recognized in terms of pretax losses we incurred in certain jurisdictions. There is still a significant amount of unrecognized deferred tax assets, which one would expect to relatively materialize in future years. And consistent with prior practice we developed in improving the pace (inaudible) deferred tax assets. In terms of the longer term, we will normalize tax rates for the group, one would expect that to be in the low to mid-30s percent.

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Jens Peter Montanana, Datatec Limited - Founder, CEO & Executive Director [5]

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Well, in terms of our strategic path going forward, there is no -- there are no specific discussions with SYNNEX. SYNNEX owns 10% of Westcon International, they sit on the Board. We have a commercial partnership with them and an ongoing working relationship, but there's no specific initiatives or discussions in this regard. And might be worth to talk, but rumor is currently in the marketplace not around us and SYNNEX, but Tech Data, one of the largest global players in our industry is really to be taken private by Apollo private equity for over $5 billion. So it shows that there's still considerable interest in consolidation and realignment in the industry that we operate in.

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Unidentified Company Representative, [6]

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Now for the questions from the webcast?

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Operator [7]

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There are no questions on the lines.

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Jens Peter Montanana, Datatec Limited - Founder, CEO & Executive Director [8]

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Nothing further from the webcast?

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Unidentified Company Representative, [9]

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Nothing further.

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Jens Peter Montanana, Datatec Limited - Founder, CEO & Executive Director [10]

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All right. Well, thank you, everyone, for participating and will talk to you at our full year results in May 2020.

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Operator [11]

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And thank you very much, gentlemen. Ladies and gentlemen, on behalf of Datatec, welcome to today's conference. Thank you for joining us. You may now disconnect your lines.