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Edited Transcript of DTC.J earnings conference call or presentation 19-Oct-16 7:30am GMT

Thomson Reuters StreetEvents

Q2 2016 Datatec Ltd Earnings Call

Sandown Oct 19, 2016 (Thomson StreetEvents) -- Edited Transcript of Datatec Ltd earnings conference call or presentation Wednesday, October 19, 2016 at 7:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Ivan Dittrich

Datatec Limited - CFO

* Jens Montanana

Datatec Limited - CEO

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Conference Call Participants

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* Christopher Grunberg

UBS - Analyst

* Milan Radia

Jefferies LLC - Analyst

* Marian Ratnam

Midsap - Analyst

* Peter Takaendesa

Mergence Investment Managers - Analyst

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Presentation

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Operator [1]

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Good morning. Today, Ivan Dittrich, the CFO, and myself will be presenting our half-year interim results for the six months ended August 2016. Webcast participants can type in questions during the presentation, which we will answer afterwards. And as always, there will be an opportunity for Q&A at the end of the session when we open up the conference call.

We have modified slightly the format of our presentation today to provide better analysis of our performance but have not produced any disclosure as a consequence.

I will start by covering our results and summary with an overview of current market conditions and our operational strategy.

Revenues were down 8%, which is slightly less for the six months than the 11% reduction we reported in July after four months. On a comparable basis, we had indicated this period would be a challenge due to the rapid appreciation of the dollar which started 18 months ago. It was also during the latter part of last year -- sorry, last year's H1, that oil collapsed and many emerging-market currencies fell significantly. Our gross margins have improved, however. The reduction in revenues, mainly as a result of slower emerging markets, drove a reduced contribution.

The still-ongoing heavy cost of our ERP/SAP migration and business process outsourcing transformation also weighed on the profitability in the period in Westcon.

EBITDA overall fell 15% and underlying earnings per share by 25%. We have moved to a direct interpretation of our 3 times cover dividend policy, which we will track going forward -- sorry, which will track our earnings going forward.

Market conditions -- the macro environment remains challenging. Global growth is not synchronized, and many countries still have fiscal difficulties. The strong dollar still persists everywhere, even with the major crosses of the euro, yen and pound. Some emerging-market currencies have improved this year, and conditions appear to have stabilized. In our business, we still see solid growth in the technology segments we operate in, particularly in security and with cloud deployments driving infrastructure managed services.

It has been a grueling and painful four years of business transformation and system modernization in Westcon. By the middle of next year, all of the previous Oracle JD Edwards regions of North America, EMEA and Asia PAC will have been converted to -- sorry, will have been converted to SAP and operating with a common BPO organization, Genpact. Effectively, 90% of our business has been affected by this transformation which would have taken almost five years to complete by the time we get to this stage next year.

Our critical priority remains improving our financial ratios, especially those measured by operating margins and capital and equity returns. We expect our improved processes, enhanced systems and growing services mix across the group to benefit our financial performance going forward. We are tapping many of the trends shaping the adoption of cloud technologies with our strong position in securities solutions and infrastructure managed services.

I will hand over now to Ivan, who will take you through the financial results.

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Ivan Dittrich, Datatec Limited - CFO [2]

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Thank you, Jens, and good morning, everybody. Moving to slide 8, financial performance, when looking at the first-half financial results, it is important to bear in mind that we are betting against a very strong comparative H1 and particularly Q1 last year, especially from a revenue perspective. Revenues in the half were also impacted by a strong US dollar.

Revenues are down 8% year on year, or 5% in constant currency. Westcon revenues decreased by 10% and Logicalis revenues were up 1%.

Gross profit was down $10.4 million, being the major reason for the decrease in year-over-year EBITDA. Gross margin expanded to 13.8%, with improved gross margins in both Westcon and Logicalis. EBITDA was impacted by ongoing restructuring costs, of which $7 million was incurred by Westcon in the first half. Westcon will start the BPO process in North America in H2. Depreciation and amortization charges have increased on the back of increased capital expenditure, particularly in the second half of the prior year.

Moving to the next slide, net finance charges decreased due to lower finance costs in Logicalis Brazil, where lower activity levels resulted in lower working capital requirements compared to the prior year. The effective tax rate was 34%, being the forecast effective tax rate for the full year. Underlying earnings per share was $0.125, 25% down from the prior year, with [pips] of $0.091, 24% lower than the comparable period last year.

The Board had previously published a dividend policy of a cover of at least 3 times relative to underlying earnings per share. Since our 2013 financial year, however, the Board had declared a dividend in excess of this minimum policy. Going forward, the Board expects to pay a fixed cover ratio of 3 times relative to underlying earnings per share. This will be an arithmetical calculation.

Looking at slide 10, the EBITDA bridge, gross profit in the first half was $10.4 million lower than the prior year, impacting EBITDA. EBITDA was further impacted by $7 million of restructuring charges mainly in Westcon, which included the BPO initiatives in EMEA and Asia-Pacific. This included an overrun of about $2.5 million in EMEA compared to the original casting.

Logicalis UK had a $3 million EBITDA loss in the first half, compared to a profit of $2 million last year. This represents a delta of $5 million.

Looking at the contribution per division, we have seen a greater contribution from Logicalis to revenues, gross profit and EBITDA compared to the first half last year. Westcon generated 74% of revenues, 56% of gross profit and 56% of EBITDA in the first half. Logicalis contributed to 25% of revenues, up from 23%; 42% of gross profit, up from 39%; and 43% of EBITDA, up from 40%.

Looking at revenue and gross profit contribution by geography, revenue contribution from northern Latin America remained consistent year-over-year, with Europe and Asia-Pacific slightly higher, and Middle East and Africa lower. Revenues were impacted by the strong US dollar that persisted during the period. We have seen an increased gross profit contribution from North America and Asia-Pacific.

Looking at the balance sheet, slide 13, the increase in current assets is mainly as a result of increased receivables where extended credit terms were provided mainly in emerging markets. We will deal with the cash flows associated with increased receivables later in the presentation.

The increase in other noncurrent assets was mainly as a result of additional capitalized development -- sorry -- in other noncurrent assets was mainly as a result of additional capitalized development expenditure for Westcon's SAP implementation and $7.5 million worth of additional Angola US dollar indexed government bonds that we have purchased, which has reduced the foreign exchange risk in that market substantially. The net asset value per share was $4.12, compared to just under $4 at the end of the previous financial year. The increase in net debt is as a result of a decrease in cash, as outlined in the cash flow statement on the next slide.

Cash flows from operating activities improved slightly from the prior year's first half. Cash outflows from investing activities were higher due to increased investments in property planting equipment and systems as well as additional Angola government bonds purchased.

Moving the slide 15, showing the cash flow from operating activities, this is the first time we are presenting this slide in our results presentations. And this basically indicates the impact of working capital on our cash flows.

Westcon, as you know, is a highly working-capital-intensive business. Receivables increased on the back of a stronger Q1 -- sorry -- Q2 compared to Q1 from a trading perspective as well as extended credit terms in emerging markets. This was somewhat compensated by cash inflows from payables.

I will now hand back to Jens to cover the remainder of the presentation.

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Jens Montanana, Datatec Limited - CEO [3]

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Thank you, Ivan. I am now going to take you through the operational reviews, starting with Westcon group financial performance.

In dollar reporting, Asia-PAC was the only reason to show revenue growth in this period. Reported dollar revenues overall fell 10% to $2.3 billion. As we flagged at the beginning of the year, this period was always going to be comparatively harder due to, on average, much weaker emerging-market currencies year-over-year and a very strong trade -- and very strong trading in North America this time last year.

Pleasingly, the quality of businesses shown in gross margin has improved. This was principally due to continued strong growth in our security segment and product mix.

Operating costs were down in absolute terms but up in percentage terms on the back of a lower contribution across the Americas and higher costs in Asia and Europe related to SAP and our BPO transformation. ForEx losses in Angola were substantially lower.

Consequently, EBITDA was down 18% to $43 million. This was disappointing, but we believe this period should reflect a low point in our performance history going forward.

Revenue and gross profit contribution by geography -- revenues and gross profit grew in Asia-Pacific on the back of growth in security products across Asia. All other regions had softer revenues. Latin America, the Middle East and Africa had the weakest performance. Their combined gross profit weighting fell from 30% of the mix to 24% of the total, illustrating the headwinds of imports in these emerging markets. The weightings between the big regional blocs of North America and Europe remained fairly constant.

Slide 20 -- the Comstor division, which is the Cisco-dedicated business unit, fell slightly to 42% of the revenue mix. This was mainly due to lower sales in Europe, impacted by transformation disruptions. Service provider sales also dropped again, largely in Europe where some global customers were also affected by the slowdown in LatAm. Growth in the reseller segment of midsize companies was helped by the growth in Asia, which was entirely in this segment.

The security segment also grew in weighting, a reflection of the nondiscretionary nature of this critical part of IT CapEx. Unified communications products and many of those solutions used in data centers are still undergoing consolidation, as are some of the vendors in this sector -- HP's breakup, Dell and EMC's merger, and so on.

Historical quarterly sales -- the quarterly revenue growth trend is back intact, but the effect of a strong dollar and emerging-market slowdowns from 18 months ago is clear to see. We do believe that in the second half, we will see better growth when compared to the rebasing that took place last year in H2. Those currencies have begun the second half at or above the levels they were this time last year compared to the dollar. The exceptions are the pound and the Mexican peso, both impacted by the prospects of falling outside their regional trade blocs.

Gross profit and EBITDA by geography -- gross profit rose in Europe and Asia-Pacific. The biggest proportional setbacks in contribution were Latin America and the Middle East and Africa. Without the drop of $17 million between these two regions, the total would have been flat. This resulted in a drop in EBITDA of $9 million. Europe's profit rose, but still lags the convertibility of gross profit into EBITDA that North America has. This period also included higher-than-expected ERP and BPO transformation costs, which affected central costs as well as profitability in Asia and Europe.

Working capital -- accounts receivables grew mainly due to the increase in revenue in Q2 compared to Q1 of $120 million and the continued extended payment cycles in many emerging markets. DSO days were similar and inventory fell very slightly. Accounts payables grew to mirror the increase in accounts receivables debtors.

The networking capital was lower than at year-end, but up H1 over H1. Similarly, the net debt was lower than at year-end, but greater than the previous comparative period.

Net debt -- a lot of the multi-year deterioration has been due to cash out for internal IT, both in the form of CapEx and OpEx. This has been running at nearly $60 million a year in the past three years and is set to fall from next year as the current BPO/SAP transformation cycle draws to an end after almost five years since it began. You could expect the next four years to possibly look the reverse of this.

Outlook -- mobile broadband and accelerated online usage continues to drive the network industry and, in particular, growth in security. We are nearing the end of the current phase of our process and system modernization program, which has been hard to implement, cost more than budgeted and taken considerably longer.

We believe the new systems once proven will allow us to better scale and improve our flexibility and control in emerging markets. To this end, we have made very good traction in the development of our cloud distribution relationship with Microsoft and our pioneering in markets such as Brazil and South Africa. We believe this will become a template for a more global relationship. At a trading level, we see no change in the strong dollar against most other currencies.

Moving on to Logicalis -- financial performance, an overall pleasing performance in Logicalis despite reorganization challenges and costs in the UK. Dollar reporting revenues inched up by 1%. Product sales were down mainly as a result of the weaker LatAm and poorer sales of IBM equipment. Pleasingly, services grew at a solid 9%, which helped raise gross margins to over 22%.

Operating cost grew by more than revenues, reflecting the acquisition in H2 last year of [ADIG] in the US. Profitability was hit in Europe from EBIT losses in the UK of more than $3 million.

Slide 28, revenue and gross profit contribution. North America revenues were flat, but margins were much improved. Last year's comparator period included a very large product sale. The dip in Latin America was due to weaker currencies and the effect it has had on imports and the translation of local service -- sorry, and the translation of services which are provided in local currency.

All our reporting is in US dollars, but services are always billed locally.

Europe had a similar picture with the lag effect of a weaker euro, but also exacerbated by the poorer performance in the UK. Asia-Pacific grew as it included the acquisition of Thomas Duryea Consulting in Australia last year.

Slide 29, the reduction in product sales in -- sorry, 29. The reduction in product sales and Latin America due to the much weaker Brazilian real and the drop in IBM sales overall was the main reason product revenues reduced as a proportion of the total mix. Pleasingly, services grew in all regions, and we are back to the roughly one-third services, two-thirds product mix that we have shown in the past few years. Services deliver over half of our gross profit. We expect this relationship to stay relatively constant with a drift of higher services over time as in-the-cloud computer infrastructure grows.

Slide 30 -- North America and Asia-Pacific had the benefit of two small acquisitions, ATIG and Thomas Derayer, respectively, and grew their gross profits accordingly. Latin America was impacted by the sharp drop in the Brazilian real in the middle of last year, which was always going to make comparisons to this half very challenging. At an EBITDA level, again, North America and Asia-Pacific showed progress. And if it wasn't for the big swing from profit to loss in the UK, overall EBITDA would've grown.

Of the almost $7 million drop in Europe year-over-year, $5 million of it came from the UK alone as it went from over $2 million of profit -- sorry, $2 million positive last year to almost a $3 million negative loss in this period. We are going through a complete reorganization of the UK business, as we have flagged in May, and expect this to complete in the next six months.

Slide 31, working capital. Very stable balance sheet and continued good working capital management. The networking capital grew as the inventory and receivables of the two small acquisitions in the US and Australia were on boarded. The cash position was affected by almost $50 million out to acquisitions in the past 12 months and a reduction in creditor payables. We are expecting a much better year-end position.

Outlook -- we are expecting the overall environment to modestly improve as the secular forces in our industry remain favorable. We have started tapping new growth areas by investing in security managed services and data analytics capabilities. Some emerging markets, Brazil in particular, are starting to recover. We don't expect any meaningful M&A activity this year, but will react with discipline to good opportunities if discovered.

I'm going to wrap up now with Datatec overall current trading and prospects. We remain in an era of global uncertainty, little synchronized economic activity between regions and lower growth. Despite that, we believe that some of the operational actions we have taken will deliver better performance and liquidity going forward. We do not see a further deterioration in emerging markets and consequently expect a better second half on both a sequential and comparative basis, leading to a full-year improvement. We don't expect any meaningful acquisitions this year. We are focused internally on driving improvement to reestablish operating leverage and convert the positive momentum in our industry into better profitability.

That brings to an end the formal presentation, and I will hand over now to questions from the conference call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Christopher Grunberg, UBS.

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Christopher Grunberg, UBS - Analyst [2]

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I just wondered if you could help with the (inaudible) the Westcon European version of (inaudible) you talked about that in the past. But just wondered if you could talk is there any assets you might have in place that -- to address that, any structural reasons why there is that delta or anything (inaudible) around shifting (inaudible).

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Jens Montanana, Datatec Limited - CEO [3]

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Sorry, the line is very bad. Was the question around the structural delta in -- was it to do with --

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Christopher Grunberg, UBS - Analyst [4]

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Sorry, I will say it again. Yes, so on Westcon Europe, you mentioned that you have got a full conversion of the GP to EBITDA. So (inaudible) be higher structural OpEx. You have talked about that in the past. I just wondered if you had any update on whether you thought that might be something you could address or an opportunity to go forward.

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Jens Montanana, Datatec Limited - CEO [5]

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Yes, absolutely. I am picking this from memory, but in the US -- North America structurally over the years, almost half of our gross profit converted to EBITDA. This equivalent ratio in Europe is between 25% and 30%. So it's a significant delta which you could say reflects the productivity -- a reflection on productivity and the higher cost of doing business across Europe. And as you know, notwithstanding that, obviously Europe is a multi-country -- is a region of multiple countries and multiple -- is a much more siloed business.

So, obviously our decision to go and use -- to transfer some of our internal shared services activities and use -- and go for a BPO transformation is a step in the direction of consolidating some of those pan-European and, in certain cases, duplicate areas of operations in terms of finance, order processing and other back-office functions.

But whether that is going to -- we don't think we're going to be able to move the meter the whole way and get the same convertibility of gross profit for EBITDA that we have in North America. But clearly we expect to see an improvement in our -- on the current ratios and BPO and, let's call it, the modernization of the business in general. We think we have to get the platform right, and then we'll be able to work further on garnering those efficiencies as a result of operating on a better platform.

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Ivan Dittrich, Datatec Limited - CFO [6]

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And Chris, if I could maybe just add to that, obviously in terms of the European EBITDA that was reported for this half and also in the previous financial year, the EBITDA position had been exacerbated by the incurrence of the restructuring charges to give effect to the BPO which is obviously going forward, not going to recur, after this financial year.

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Christopher Grunberg, UBS - Analyst [7]

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That's helpful. Thanks. And maybe (inaudible), can you give a -- should we just bank that whole restructuring cost as coming out entirely? Is there any overflow at all in this way (inaudible) or does that benefit --

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Jens Montanana, Datatec Limited - CEO [8]

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In Europe next year, there won't be a recurrence of those things that we've shown you as the restructuring transformation costs.

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Ivan Dittrich, Datatec Limited - CFO [9]

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That's right. What you will see in the next financial year, though, is the restructuring associated with implementing BPO in North America. So, we have indicated in our results announcement that for North America, we expect to spend just under $3 million this year on the BPO transformation and a component of just under $4 million in the next financial year. But Europe, from a BPO perspective, will be completely done by this financial year.

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Jens Montanana, Datatec Limited - CEO [10]

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And by May, June next year -- I think we said June -- we expect all of these costs to stop completely in terms of -- related to SAP and BPO. We will have finished.

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Christopher Grunberg, UBS - Analyst [11]

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Okay. Switching gears slightly (inaudible) the service component looks very healthy. That is to say the performance overall, fair-minded conditions is pretty solid. I am just wondering, once again, you're not anticipating any sort of late-cycle impacts here? There is no issue in your mind of those contracts rolling off? Any contacts that you are concerned about just heading into the calendar year 2017? Or I guess, equivalent question, what is the order book looking like now? Can you elaborate on that at all?

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Jens Montanana, Datatec Limited - CEO [12]

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Yes. I guess the standout for us is that there has been a meaningful improvement in our order book and backlog position in Brazil, quite meaningfully in Logicalis. And, to a lesser extent, we have seen the same in Westcon, albeit Westcon is more of a short- to medium-term trading organization in terms of its characteristics. But in both businesses, we have seen an improvement in, say, order book and backlog.

It has yet to translate into, let's call it, better P&L, what we are invoicing in real-time. But I mean there's always a leg effect like there was 18 months ago when we went down the hill. We expect the same will be the case now going back up.

But if currencies are anything to tell you in terms of a lead indicator, you will see that the Brazilian real is up almost 25% this year. And obviously our business -- a significant part of our business, we are a -- in all of these markets outside the US, we are an importer of technology. So that will obviously bring some benefits, we hope, over the next cycle where we see they will -- hopefully we will see now a modest and sustainable improvement in these markets.

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Christopher Grunberg, UBS - Analyst [13]

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Great, thanks. Just one on Angola. Can you just run through and elaborate fully on that derisking of your exposure there? Just to be totally confident and to understand your confidence in the first (inaudible) now.

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Jens Montanana, Datatec Limited - CEO [14]

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Yes. Just to be clear, we have laid this out now for 18 months, three reporting periods. We have about $35 million equivalent of working capital assets in Angola, of which most of it is now made up of -- there's still some receivables and there's still a tiny amount of -- small amount of inventory. The rest of it is made up of cash or cash equivalents in what Ivan explained before: in the form of bonds -- local government bonds.

So we have put -- so more than half of the total working capital assets in Angola have now been put into local government bonds which are of short-term duration. And they are dollar-indexed, so they're local bonds but dollar-indexed, and that provides us with an effective hedge against potential future depreciation.

Having said that, the Angolan kwanza has been relatively stable for the last few months. And clearly, like a lot of other countries in West Africa and other oil-producing nations around the world, obviously their currencies are very much a proxy for what happens with oil. And that has stabilized quite a bit in the last few months.

We obviously haven't gone and parked all of our liquidity in Angola in these bonds because we do expect -- even though it's been very slow progress so far this year, we do expect at some point the gates will open, albeit incrementally, and we will be able to start getting money out in terms of paying what is basically a large intercompany receivable of our end. Because obviously, we have had to fund that in terms of our suppliers from around the rest of the group.

So that's pretty much situations. So it's much more stable. We still, of course, have -- there is a liquidity side to it, and there is, of course, a P&L side to it in terms of the holding value of those working capital assets in Angola. But we think with -- we have got this thing pretty well ring-fenced now, and we don't expect the situation to deteriorate. And we look forward to improving the outflows and liquidity at some point overall.

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Christopher Grunberg, UBS - Analyst [15]

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That's great. Thanks very much for that.

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Operator [16]

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Milan Radia, Jefferies.

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Milan Radia, Jefferies LLC - Analyst [17]

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The first question was just on the vendor approach to the pricing increases. Clearly, they will be beating the same headwinds from currency. Are they proving to be helpful at all? Are they swallowing any of the kind of impact from that? And what assistance are you being asked to provide to your reseller channels in some of these key markets?

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Jens Montanana, Datatec Limited - CEO [18]

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What did you say Milan? The vendor approach to what?

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Milan Radia, Jefferies LLC - Analyst [19]

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The pricing movement from currency. How helpful are they able to be or being? And what are you asking -- being asked to contribute by your reseller partners?

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Jens Montanana, Datatec Limited - CEO [20]

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Well, it's interesting because we are dealing with us in real-time. It will be interesting to see how this manifests itself in the second half. But obviously you just look here in the UK in terms of the -- for a major currency cross, anyway, a fairly precipitous move in a very short space of time.

I mean, generally, environments -- businesses don't like dramatic currency moves. I'm sure some of that is, say, going to show up here in the UK. We are used to it, of course: many years operating in South Africa, Brazil and other emerging markets where you can get these 20%, 30% currency moves in a year. But as everyone knows, budgets, capital equipment in general, of which IT and technology is a major part of CapEx around the world -- businesses budget in their local currencies, and they operate in their local currencies. So when there are dramatic shifts, this is obviously an immediate -- a fairly immediate headwind to organizations, budgets and how they can deploy those budgets. The first thing very often the gets hit is a slowdown -- in our case, IT CapEx. So, that is inevitable.

Now, you can -- some of that gets backed up to the manufacturers. There is a leg effect because people in the supply chain like ourselves are hedged. So it will take time for the order book to unwind and the same for the project streams and so on at the customer-client end. But within one or two quarters, I think you're going to see -- just like we have seen in Brazil at this time last year, things started slowing. And I think it was four or five months after the currency got hit that the market -- the imports really started drying up.

And, as I say, we must -- we're going to see a bit of that here. We've seen a little bit of that in Mexico. Mexico was a very challenging market for us in the first half. The peso has gone from, I think, MXN15 to the dollar at the beginning of the year, went all the way almost to MSN20. It has recovered a bit now as the fears of NAFTA -- what's driven that is obviously the concern that Mexico falls outside of NAFTA or NAFTA economic zone breaks up or things like that.

But going back to your question, the vendors -- between us, the vendors, long-term projects and so on, there is always a buffer when you have these dramatic currency moves. But at the end of the day, a vast majority of IT, CapEx, hardware and software and, in fact, some services, but not all, are all priced in dollars. And that will have an impact.

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Milan Radia, Jefferies LLC - Analyst [21]

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Okay. And second question on the UK, what kind of shrinkage are you seeking to deliver there? Obviously, the (inaudible) contract precipitates some of this. But what is the scale of the reductions in revenue and headcount that you are budgeting for now in the UK in Logicalis?

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Jens Montanana, Datatec Limited - CEO [22]

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Well, yes, the UK -- somewhat unrelated to the events here of the last six months, you might recall we started at the end of last year a remodeling of that business as a consequence of us finishing -- or not being on the project -- not having the project anymore. We had a seven-year contract with the Welsh government network -- the Welsh government assembly to run that country's network and operate it. And that came to an end about a year ago, but obviously there was a white-out period. And that was a significant part of the UK's business. And since then, we've been going through a remodeling on a fairly -- on an inch-by-inch approach because obviously we have other business streams that we need support in the UK. But we obviously have significant costs which we have built up over the years which we need to model ourselves out of.

So that -- so I think that is distinct to -- from what I'm talking about now. Obviously, since the summer, it is clear that there is going to be a slowdown in importation here of capital equipment. Because, as I said, companies' budgets are in pounds. And, mid-flight, organizations don't just suddenly change their budgets by 20% or 30% to take into account sudden depreciation in currency. So I think there's two answers.

In constant currency, there is most probably not going to be much change to the UK. But in translated currency, it's going to be the effect of the depreciation and a bit, most probably. I think -- if that's the answer you're looking for.

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Milan Radia, Jefferies LLC - Analyst [23]

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Okay, got it. And just one final question. I think I heard you talk about specific weakness in IBM revenue. I just wondered if there were some comments just to flesh that out a little bit as to what the drivers are there.

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Jens Montanana, Datatec Limited - CEO [24]

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Yes, it's basically product mix. We have seen this for the last couple of years. In certain areas -- IBM reinventing themselves. For example, they are becoming a much more hotter and aggressive play in areas of storage, for example. Everybody knows at the very big end what they're doing with Watson and so on, but that's really more as a service. It's not hardware that gets resold through the channel. And in the server market, they have been losing market share steadily now over many, many years since they exited the low-end Intel X-based products to Lenovo a few years ago.

So, the flipside of that is we are seeing a corresponding pickup in some other areas: HPE, our Cisco business and so on. So we point out IBM because that was an area -- that was a vendor that has quite a bit of decline in the last period. And it's mainly data center consolidation and data center wars. And this arms race, if that's the right way to put it, in terms of consolidation is continuing. We do expect some kind of leveling off now in the data center in this fairly acute price-performance decay that has been going on now as a result of consolidation. And we think we may be nearing a -- going forward, there will be a rebasing most probably in some of these areas. But that's -- I think IBM has been a bit of a casualty in that space and obviously to other vendors -- to the benefit of other vendors.

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Milan Radia, Jefferies LLC - Analyst [25]

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Interesting. That's all very helpful. Thank you very much.

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Operator [26]

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[Marian Ratnam], [Midsap].

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Marian Ratnam, Midsap - Analyst [27]

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I've got a couple of questions. Firstly, (inaudible) the last result, you talked about the provision for (inaudible) compared to the previous five-year average. Can you give us a color as to what that looks like for this (inaudible) here?

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Ivan Dittrich, Datatec Limited - CFO [28]

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Okay, so in the previous financial year -- for the full year, there was an additional -- I think it was about approximately $80 million, $90 million of (inaudible) provision that had been raised, and the bulk of that had been raised in the second half in Westcon. And in the first half, there has been a small increase in bad debt provisions but nowhere near the magnitude of what we had seen last year. But there has been in Westcon a small increase, maybe about $5 million max.

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Marian Ratnam, Midsap - Analyst [29]

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Secondly, I understand that the program business in Brazil and (inaudible) the service providers had a (inaudible) the network operator. What sort of -- what are you seeing from them? Are you seeing a renewed (inaudible) interest from the -- CapEx interest from them? Or -- because I heard that I might announce the operator's name incorrectly (inaudible) had some issues than the balance sheet in the past.

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Ivan Dittrich, Datatec Limited - CFO [30]

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Okay, we couldn't hear the question clearly, but you were asking about the service providers in Brazil and our program Logicalis business. And I heard that sort of the last -- you asked a question about oil in particular, but we missed the middle part.

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Marian Ratnam, Midsap - Analyst [31]

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I understand that you look at the (inaudible) exposure is significantly (inaudible) rather than (inaudible). I'm just trying to get some color to how that's going and how is that business doing.

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Jens Montanana, Datatec Limited - CEO [32]

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Okay. Yes, in Latin America in general, we have significant exposure to service providers and telcos. And in Brazil, it is most probably tilted even slightly more in that direction. I think it's about -- it's almost 60% of the business. And as you know, telcos and service providers are cyclical businesses. And that has been an area of slowdown for us in the last 18 months and is one of the areas now that we have seen -- maybe not in terms of what the first-half activity was in terms of our current revenues. But in terms of our pipeline of backlog, it is in the service provider and telco segment that we are starting to see meaningful improvement.

So, that is yet to translate into better P&L. But as a lead indicator, it's clear that these guys are starting to plan and purchase again, and that's what we have seen.

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Marian Ratnam, Midsap - Analyst [33]

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Great. The next question is (inaudible) competition taking place versus (inaudible) space that (inaudible) might as well be taken up by the (inaudible) -- technology solution be taken up by tech space out. I just wanted to hear your thoughts as to how this consolidation would work out in terms of (inaudible) specifically.

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Jens Montanana, Datatec Limited - CEO [34]

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Well, it's hard for us to comment in real-time on such a question. Obviously we play in a global industry, and ongoing consolidation is always part of that. And in our business, there are always going to be players and participants are out there that are bigger than we are.

And -- but that doesn't change our operating format. We have been busy at this for 30 years, developing and building the group. And Westcon, as you know, now is an organization and presence in 70 countries around the world. We have gone through ups and downs. We have had some bumps in the last two years. But our -- I guess our mission remains undeterred. And obviously key differentiation for us is -- the global nature of our business is the niches -- niche areas that we operate in: security and network and communications.

And I think that's the (inaudible) to comment is globalization continues. There will be transactions in this space, and we aim to own and operate the assets -- our assets in the best possible way. And I think that's the -- I guess the best, let's call it, strategic outlook one can give.

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Marian Ratnam, Midsap - Analyst [35]

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I suppose my question comes down to pricing within the industry. So (multiple speakers) --

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Jens Montanana, Datatec Limited - CEO [36]

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Down to what, sorry?

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Marian Ratnam, Midsap - Analyst [37]

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Pricing. In terms of ability to price better. Normally --

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Jens Montanana, Datatec Limited - CEO [38]

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Oh, pricing.

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Marian Ratnam, Midsap - Analyst [39]

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(multiple speakers) consolidation in the industry. In this consolidation in an industry, the participants are able to price a little better. Now, is that something we can expect in this space, or not really?

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Jens Montanana, Datatec Limited - CEO [40]

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No, not really. The pricing -- there's generally a level -- amongst the large players, you get pricing for global players. We are global. You get -- so we don't -- there's no -- we are a $5 billion, $6 billion organization. If we were a $20 billion or $30 billion organization, there wouldn't be any extra leverage on the pricing end. Where there is leverage is on the go-to-market, where you have more efficient processes in the systems to get those products to market. So, your cost of delivery or your cost of execution or your cost of sale, all those things becomes -- there, you benefit from scale. Your input prices, let's call it the -- yes, your input prices don't really change. There is no leverage. If we did another $1 billion with Cisco, it wouldn't change our input costs, but it would change (inaudible) $1 billion dollars with anybody.

But it would change our -- most probably our efficiency and our cost of delivery because we would be able to amortize those support engineers, those other specialty skills we've got, importation, some of the general G&A. Those are the part -- there, you get the scale benefits.

But obviously, we have -- we are aware of the need for continuing scale and process and system modernization, which is why we have been going through the agony ourselves of improving our processes and systems in the last four years. It's because we obviously -- we operate as if we are going to be one of the long-term players in the industry. And, in particular, we -- and we've indicated this a number of times, we need to still get better scale in some of those more -- those further endpoints in our organization, especially in developing in emerging markets where we have a presence, but, in some cases, insufficient scale. So we are addressing all those things.

So that is where you would expect to see improvement going forward. And that's where -- that's why there is consolidation going on in the industry because, obviously, participants of both sides see the logic in some of these win-wins.

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Operator [41]

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Peter Takaendesa, Mergence Investment Managers.

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Peter Takaendesa, Mergence Investment Managers - Analyst [42]

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Just wanted to ask one question maybe for now. You sound optimistic that (inaudible) better than the first half and cash generative will improve, so why (inaudible) the dividend by that much?

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Jens Montanana, Datatec Limited - CEO [43]

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Sorry, Peter can you just repeat that? We are struggling to hear you.

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Peter Takaendesa, Mergence Investment Managers - Analyst [44]

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Yes. I don't know if you can hear me better now. My question is if you are expecting a better second half sequentially and you are also expecting improved cash generation, so why is (inaudible) reduce the dividend by that one?

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Jens Montanana, Datatec Limited - CEO [45]

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It's a dividend question. We have always had a policy of 3-to-1 cover on -- relative to our underlying earnings. And we obviously broke from that cover ratio three years ago when our earnings dipped below -- it would have been $0.45, $0.46 per share, because obviously we have been paying a dividend of, I think, $0.16, approximately, on average -- $0.16, $0.17. So that is actually more like $0.48. So if you applied that strict dividend policy, to pay $0.16 we would have to have $0.48 earnings per share.

And I think our last time we -- our last high watermark where we reached that earnings -- those earnings were -- exactly, were in 2012. So basically this would be our fourth year now where we have kept that, I guess, floor under fixed dividend.

And we just concluded that it is very difficult to telegraph to the market long-term what the dividend policy is if we continually have an exceptional policy, I guess. And I guess at the beginning of this year, or at the end of last year, we would have hoped or expected that maybe there was a more rapid V or recovery in the earnings growth of our business. And that hasn't turned out to be the case.

So, on the way hopefully back up now, I think we would rather go back to operating with our previously published policy and not --. And I think that also makes it -- whilst obviously it is a disappointment to have a lower dividend than a higher dividend, I think it also removes an element of will they, won't they in terms of what the dividend is going to be.

And we're basically indicating that, going forward, you will just be able to take our earnings, divide it by 3 -- as Ivan said, arithmetically -- and that's what we're going to pay. So I think it will remove uncertainty, and it will be -- our dividend will become a tracker to our earnings as opposed to an arbitrary fixed amount. And hopefully you'll see --

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Peter Takaendesa, Mergence Investment Managers - Analyst [46]

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So I guess that's what --

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Jens Montanana, Datatec Limited - CEO [47]

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Okay, yes.

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Peter Takaendesa, Mergence Investment Managers - Analyst [48]

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Yes, I got that. So maybe just one follow-up on the (inaudible) someone asked about Europe, the UK in particular. The (inaudible) that really becomes important for you (inaudible).

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Jens Montanana, Datatec Limited - CEO [49]

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I'm sorry, we can't hear. This is terrible. Sorry. The line is very, very poor. Can you say that again, Peter?

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Peter Takaendesa, Mergence Investment Managers - Analyst [50]

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Okay, thanks. I will ask another time.

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Jens Montanana, Datatec Limited - CEO [51]

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Okay. I'm sorry. For some reason -- I don't know if you can hear -- I hope you can hear us okay, but the incoming calls are very hard to hear. Do we have any questions from the webcast?

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Unidentified Participant [52]

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We do. First question is from Craig Shapiro. The question is after stripping out the ForEx losses in the H1 2016 base, operating costs were $12 million higher. Given the year-on-year weakness in currencies and the expected cost savings from last year's European restructure, I would have expected operating costs to be lower. Why are operating costs so much higher, and will this increase in costs recur?

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Ivan Dittrich, Datatec Limited - CFO [53]

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Maybe I can answer that. Clearly, in operating costs in this half as well was a significant amount of restructuring expense. So, that had an impact on the increase of really large restructuring costs this year than they were last year.

And in terms of the European BPO transition process, sort of the operating leverage has not yet been seen during this first half because the process stall continued for part of this half. So you are only really expecting to see the operating leverage coming through more meaningfully in future reporting periods.

That said, cost management and gaining operating leverage and efficiency is one of our key areas of operational focus, both within Westcon and Logicalis. And we are implementing multi-year sustainable cost management programs to make sure that we do deliver that leverage and cost improvements over time.

And we are also taking, particularly in the second half, a lot of additional short-term immediate actions to reshape Westcon's cost base to make sure that we deliver the second-half result at the end of the day. We are implementing things like higher freezes, travel freezes, stopping all discretionary spend. But a lot of these things are obviously short-term measures but also building more sustainable, long-term cost containment programs.

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Unidentified Participant [54]

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The next question is from Andrew Darley at FinnCap. I think you touched on the disruption to Comstor from the global BPO transformation. How long should we expect this to affect operating margins, and is it more relevant as a cause of subdued revenues or short-term restructuring costs?

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Jens Montanana, Datatec Limited - CEO [55]

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Yes, obviously there's been the collateral -- there are -- there have been collateral consequences of the transformation program in Westcon Comstor. It's not just as a cost to these initiatives -- the cost of moving to outsourcing, the cost of implementing a new -- moving to SAP of a multi-year program and so on. But there's also a collateral cost, as I said, in the form of people are diverted from their day jobs or day tasks into being involved with the planning and preparing for these changes. And that's been going on for some time. So that's why we indicated before.

So I think the answer, Andy, is the line in the sand. I guess by the end of our first quarter next year, by May, June -- by the summer of next year, we should expect to be able to say that people are no longer being contaminated or cross-contaminated or affected in their productivity because they have been pulled away from their day jobs, and they have been involved in transformation, new system implementation, dealing with outsourcer, so on and so on. Those things, we think, will -- it is clear that those things have been impacted in our business. You can't measure it other than the direct costs of CapEx and OpEx that goes into these projects. But absolutely, they are consequential -- there's consequential impacts -- impact, rather, across a big part of the workforce.

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Unidentified Participant [56]

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His second question is, your dividend is annually based on a 33% payout ratio. But is it also to be expected to be typically an in-year interim-to-final split of one-third interim, two-third final?

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Jens Montanana, Datatec Limited - CEO [57]

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It would be if the first-half earnings represented one-third of the full year and the second half represented two-thirds. But there is no one-third -- the one -- the 33% or one-third factor is to do with the earnings we declare and would track the same ratio in the first half and the second half.

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Ivan Dittrich, Datatec Limited - CFO [58]

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So it's purely taking the earnings with its -- the first-half earnings or the full-year earnings and divide it by 3. Correct.

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Jens Montanana, Datatec Limited - CEO [59]

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In aggregate.

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Unidentified Participant [60]

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The next question is from [Mohammed Ibrahim] at [Perpetua]. Please could you talk about the migration to cloud? How quickly is this happening, and what proportion of your business benefits versus losses from this?

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Jens Montanana, Datatec Limited - CEO [61]

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Very high level. And of course there's private cloud and public cloud. We have -- we are less impacted by public cloud. We have some exposure to small businesses, SMB sector and so on. This would break out in our Westcon reseller segment.

But in general, the part of our business that has impacted by the shift to cloud is the IT CapEx that is being spent and used in the data center. And we have some exposure to this in Logicalis and a very tiny exposure to this, or a small exposure -- yes, we have a small exposure to this in Westcon and a more meaningful exposure to this in Logicalis. And we touched on some of this before -- those manufacturers such as IBM, Sun Oracle, HP, Dell EMC, these manufacturers. So there's been shrinkage in IT hardware and software CapEx as a result of the migration to cloud in terms of traditional computing, in terms of how people spent their budgets in the past.

But in terms of some of the next-generation spending, there are also increases in many of the areas that we participate in -- and, in particular, security. In particular, areas such as IT service management and areas such as data analytics. So whilst there has been a consolidation of traditional hardware and software as a result of the shift to cloud, there has also been an increase in how data is managed, how it has moved, which is communications and networking, and in those areas, we are a beneficiary. And the majority of what we do is networking, communications and security-related. And the minority of what we do is what we refer to as in the data center.

So it is a hybrid answer where there's things going up and things going down at the same time.

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Unidentified Company Representative [62]

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There are no further questions from the webcast.

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Jens Montanana, Datatec Limited - CEO [63]

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Thank you.

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Ivan Dittrich, Datatec Limited - CFO [64]

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Thanks everybody.

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Jens Montanana, Datatec Limited - CEO [65]

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Thanks, everybody.