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Edited Transcript of RHP.AX earnings conference call or presentation 18-Aug-19 11:00pm GMT

Full Year 2019 rhipe Ltd Earnings Call

Cheltenham Victoria Sep 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Rhipe Ltd earnings conference call or presentation Sunday, August 18, 2019 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dominic John O'Hanlon

rhipe Limited - MD, CEO & Executive Director

* Mark McLellan

rhipe Limited - CFO & COO

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Conference Call Participants

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* Alexander McLean

Bell Potter Securities Limited, Research Division - Analyst

* Jonathon Higgins

Shaw and Partners Limited, Research Division - Analyst

* Peter Ryan; Australian Broadcasting Corporation;Senior Business Correspondent

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the rhipe full year investor briefing conference call. (Operator Instructions)

I'd now like to hand the conference over to Mr. Dominic O'Hanlon. Please go ahead.

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Dominic John O'Hanlon, rhipe Limited - MD, CEO & Executive Director [2]

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Thank you very much, and good morning, everybody. I appreciate you taking the time to join us on the call today.

We're going to be working through the rhipe results presentation, which is available on the ASX, and we're going to be starting at Slide #5, which is highlighted -- sorry, headlined FY '19 Group Highlights.

So for the financial year, FY '19, rhipe has closed the year with gross sales increase of 28% to $252.5 million. Net revenue, which is what we used to call our gross margin, effectively was 36% growth up to $48.4 million. Our OpEx was up 25% to $33 million. We'll be providing a bit of breakdown on that shortly. And our operating profit was up 65% to $12.8 million.

Those of you who have been following the rhipe story for some time know that we guide to operating profit rather than EBITDA, and the reason for that is that we have FX, share-based payments and diligence costs, which are excluded from operating profit.

In the FY '19 financial year, there was a higher than last year share-based payment of $2.6 million, and that was largely because the share price went up over the period of the year. It was a noncash charge against the P&L.

As we go to the next slide, Slide #6, you'll see that reported EBITDA of $10 million. That's after the share-based payments, 56% growth year-over-year. Profit after tax up 103% to $6.2 million. In addition, the cash position was very strong at year-end. Despite spending $2 million on a share buyback, $3 million on dividends and $3 million in acquisitions, the cash position grew to $25.5 million at the end of the year.

Today, we're announcing a $0.02 final dividend for the year, so up to $0.03 dividend over the period of the 12 months, which is 100% growth year-over-year compared to FY '18.

So moving on to the rhipe value proposition briefly, and then we'll get into the financial results in some detail. I'll hand over to our CFO, Mark McLellan, to do that.

On Slide #8, rhipe, the cloud channel company, our business is about driving the adoption of cloud technology with Pay-As-You-Go monthly subscriptions. The way we do that is we have a platform called PRISM, which stands for Platform for Recurring Subscription Management, and we're adding resellers to that platform, moving their customers onto cloud-based subscriptions.

On the right-hand side of the slide, you can see where our headcount sat as at June 30, 108 people in Australia and 157 in the Philippines with others spread around the region. Year-over-year, we grew 110 in headcount. 55 of those were in the Philippines in our Solutions business unit, 45 were in our Licensing team and 10 were in other solutions business units, specifically the acquisition of DBITS, which I'll talk about shortly.

Moving to Slide #9. We have 3 strategic operating divisions. Cloud Licensing, which is our platform driving subscriptions. That business unit contributed $39 million or $38.7 million net licensing revenue to the rhipe P&L. Middle column is our Solutions business unit, and that contributed $9.8 million. The third business unit is Cloud Operations, and this is effectively our IP. It's our platform of the things that we do to help us to drive more customers onto Cloud Licensing and Cloud Solutions.

Slide 10 is a new slide which just talks to our strategy as we're growing the business. It's absolutely clear that the cloud is becoming mainstream and that rhipe's early position in the market helping customers move to the cloud has been very successful. We want to continue that.

So our 3-year strategy is to continue with geographical reach, expanding our markets in the APAC region. Secondly, adding new vendor programs and vendor products onto our platform. Realistically, the vendors that suit our platform are those that are serious about subscriptions, monthly Pay-As-You-Go subscriptions. They're the ones that we're driving. The top right-hand side, you'll see that we've added more value-added services such as Marketing-as-a-Service, Support-as-a-Service, Consulting-as-a-Service, all helping our resellers to look big in front of their customer, all helping average sellers to drive more and more consumption of licenses.

And then the fourth crumb to our strategy is building out our IP, building a greater digital experience for our customers, adding more technology that we can drive through our sales of Office365 and other products with our own IP on top.

In terms of the operations update, the main slide that we usually talk to is how our Microsoft public cloud business is going, and that's highlighted on Slide #12. You can see on the left-hand side just our Licensing business in general and on the right-hand side what's going on with Office 365, and we'll talk about Microsoft Azure in a moment.

On the left-hand side, you can see that our Licensing sales grew $53 million or 28% year-over-year to $243 million. And you can really see the area in dark blue, which is Asia has been continuing to grow and become a strong and meaningful part of our business. The Asian business is now bigger than the Australian business was at the time we listed the company in 2014, and it's exciting to see the growth in that operation.

On the right-hand side, we'll see Microsoft CSP that's growing strongly, 254,000 seats at the end of June 2018, 450,000-plus seats in June 2019, which is a 77% year-over-year growth, averaging 16,000 seats a month versus 10,000 seats a month the year prior.

The area in dark blue or the line you can see above that actually is all Office 365 seats including academic seats. The last time we gave our result, we talked about the growth in academic seats that Microsoft is pushing in countries like Korea, and therefore, we're breaking that out for you so you can see the academic seats in total with academic and nonacademic seats were 600,000 or 450,000 just in paid seats.

If we go then to Slide #13, and this talks about Microsoft Office 365 recurring revenue and Microsoft Azure recurring revenue. You can see that from FY '17 to '18 to '19, there's been strong growth in Office 365, 69% year-over-year to $24 million in -- sorry, $24 million growth to $59 million in annual recurring revenue in Office 365. And on the right-hand side, this is the area that we've seen the strongest growth in. We do believe this business unit will become bigger than the Office 365 business unit, and that's Microsoft Azure. Microsoft Azure is Microsoft's direct compete against Amazon Web Services that has grown 200% year-over-year by $14 million from $7 million to $21 million in annual recurring revenue.

Slide #14 just shows some of the awards that we won for the year. We decided just to focus on the Microsoft ones today because it's the company that most of you probably know about. rhipe was a finalist for the Global Indirect CSP Partner of the Year. We were the Malaysian Partner of the Year. In 2018, we were also the Australian Partner of the Year and the Thailand partner of the year. Our relationship with Microsoft remains very strong, and we remain a globally managed partner of Microsoft, managed out of their Seattle team.

There's a couple of slides here in terms of recent acquisitions and announcements, so I want to spend a moment on those before I hand to Mark to go through the financials in a bit more detail.

Slide #15. We acquired in March 2019 a company called DBITS, Dynamic Business IT Solutions. The strategy here is very simple. Microsoft are now talking about their 3 clouds very openly. Cloud A is Office 365. Cloud B is Microsoft Azure. Cloud C is Microsoft Dynamics. And Microsoft is getting more and more interest in moving workloads away from the on-premise installations of Dynamics to the cloud. Our acquisition of DBITS has given us a group of people who can help our resellers move their customers into the cloud.

The total consideration of that acquisition was $8 million, $4.5 million paid at completion and the residual is tied to earnouts. We do not expect it to contribute at all to the financial year, but it did. It contributed $0.4 million in earnings, and we're expecting another $1 million to come in the FY '20 financial year.

But more recently, we've acquired a company called Network2Share, and they have a product called SmartEncrypt. SmartEncrypt is a user-friendly encryption product, which we plan to bundle with Office 365, Azure and put it on their own platform. It'll be our own IP and, therefore, we'll control all the margin from that product. And the idea here is that if we can bundle it with Office 365 seats, we can actually take more control of the margin on those seats. The upfront consideration is $2 million in cash with further consideration of $1 million each payable upon reaching license targets, plus further earnout tied to revenue over a 5-year period. We are continuing to invest in this product. It is currently deployed on Amazon Web Services. When moving on to the Azure stack, we will spend the next 6 months taking that product and getting it ready to bundle on our platform on Microsoft Azure with a launch in the early stages of next calendar year.

Moving to the next slide, which is the announcement we made on Friday. And apologies, it was such a late announcement that we signed it 5 minutes before we released it.

We've been working on a potential joint venture in Japan for a very long time. It is the second-largest market in the world for Microsoft. It is a market that traditionally has always been second largest. But most -- more recently, it's declined because of the fact that it hasn't had the cloud adoption of countries like America and areas like Europe. Microsoft has been working with rhipe to see how we could help them in that market for probably 2 years now. And we've entered into a joint venture with Japan Business Systems, JBS, to establish rhipe Japan. JBS is a company that has a very strong long-term relationship with Microsoft. They have about 2,200 employees, most of whom are Microsoft engineers. It has won Microsoft Partner of the Year award in Japan for the last 6 years running.

The JBS and rhipe JV will be held 80% by rhipe and 20% by JBS. And JBS will provide the offices, the local personnel and market knowledge, the relationships with Microsoft and with their customers to get us launched in market. They will be charging for those things, but they'll be charging for those on a cost basis with no margin for JBS. rhipe will be responsible for all the other aspects of the JV, and the most important one, of course, is our platform, PRISM, which JBS spent over a year evaluating before they decided to go ahead with rhipe.

One of the questions that everybody wants to know, of course, is what does this mean in terms of your operating profit guidance, and we're going to talk about that a little bit in the outlook. But the investment in rhipe Japan is subject to negotiation between us, JBS and Microsoft. We need to build a business plan before deploying it in market. In that business plan, we'll talk about how many heads we plan to hire, when we plan to hire, then what we're going to do in marketing, when we're going to do it. That negotiation is not final. It's ongoing with a plan to announce it at the AGM where we landed. But if people are looking for some guidance around this, it's probably in the range of $2 million to $3 million in operating profit rather than sort of $5 million or $10 million.

If I move to the next slide, it's financial results. So I'm going to hand over to our CFO, Mark McLellan, who's going to take us through those, and then we'll come to the outlook again at the end before questions.

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Mark McLellan, rhipe Limited - CFO & COO [3]

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Thanks, Dominic. Good morning, everybody. Before I sort of dive into a little bit of detail around -- behind the numbers, I thought it's important to point out that FY '19 was the first full year of a new accounting standard. And as a result, we're showing our gross sales, which includes the amount collected on behalf of software vendors, and our reported revenue, which is effectively our margin, and that is the margin we earn from customers plus any incentives we receive from vendors.

So Slide 18 shows the gross sales that rhipe has generated during the year. So looking in FY '19, sales were up 50 -- almost $56 million or 28% over the year, comparing to the prior year where we grew $40 million and up 25%. The sales growth was predominantly driven by Microsoft CSP, which drew -- which generated 65% of our sales growth in FY '19, and Microsoft CSP is now almost 1/3 of our sales. In relation to Microsoft SPLA, which is our private cloud product, which is a legacy product for the business, that grew 8% year-on-year or 13% excluding some of the one-off sales that we talked about last year.

As Dominic referred to, our growth in Asia was very, very strong, 75% growth in sales, predominantly CSP driven. And in relation to our non-Microsoft sales, which brought about 25% of overall sales, they were up 19% year-on-year versus 13% in the prior year.

Looking at our Solutions business, and it's important to note that our sales numbers is the same as our revenue numbers. It's recognized on a principal basis. In relation to our Solutions business, that grew by 43% year-on-year, boosted by the expansion in our support activities in Philippines plus the addition of DBITS.

Now moving on to our revenue on Slide 19. And as I say again, the revenue, that represents the margin that we earn from our customers plus the rebates whether they're standard or strategic incentives that we receive from our vendors. As you can see on Slide 19, our revenue was up 36% or $13 million on the year. Most of that growth was driven by Licensing business, which is up by $10 million or 35% over the year. And that $10 million in growth in revenue compares to $4.9 million in FY '18, so doubling of growth in the Licensing business. So a strong performance. And again, that was driven predominantly by our CSP operations and Asia.

In terms of Cloud Solutions, again they had growth in revenue. It was up by $2.9 million or 42%. Most of that was driven by support services plus the contribution from DBITS.

I think the final thing I would say on this page, if you look on what I would call our Licensing margins, that's really our revenue over our sales. That was, FY '19, 15.9% versus prior year of 15.1%. That was really driven by the impact of strategic incentives we received from one of our software vendors, but I also would say that the 15.1% in prior year was -- included some one-offs. So actually, that was really 15.5%. So on a margin basis, it went from 15.5% to 15.9% for FY '19.

Now if you move to the next page, Slide 20, on operating expenses. As you can see from this graph, our OpEx grew by $6.7 million to $33 million in FY '19, which is a growth of 25%. Now that is ahead -- the second half was certainly ahead of where it was in the first half, and that was driven by conscious decision that we've made to invest ahead of FY '20 to support the growth that the business is experiencing both in our Licensing business and the Solutions business.

Almost 80% of that increase in OpEx was driven by headcount. So as Dominic mentioned, we added 45 people to the Licensing business, we added 55 to the Solutions business and then, obviously, DBITS was a further 10. So that headcount is 80% of the OpEx increase, and the increase in headcount also drives additional occupancy costs, travel costs, systems costs, et cetera, and that's the remainder of the increase.

Now moving on to Slide 21. This shows you the impact of the growth in revenue and OpEx has on operating profit and EBITDA. On the left-hand side, you can see our operating profit went from $7.8 million to $12.8 million. So that's a growth of 65% or $5 million. That $5 million is broadly driven by $3 million in Licensing. So Licensing, close to 2/3, and then Solutions was 1/3. And then the Solutions business, again, was driven by the increase in Philippines operations support services.

If you look to the right-hand side of Slide 21, you can see the growth in EBITDA. So EBITDA rose from $6.4 million in FY '18 to $10 million in FY '19. That's a growth rate of 56% or $3.6 million. And in the table below, you can see the numbers, how you get from operating profit to EBITDA. And as Dominic has already mentioned, the main impact was around share-based expenses, which went from $1 million in FY '18 to $2.6 million. That was really driven by the uplift in the share price in FY '19, which has driven this increase in share price -- share-based payments.

The other thing I would call out was the FX cost or gain. There was a gain in FY '19 versus losses in FY '17 and FY '18. That was driven by effectively hold more U.S. dollars than we have in previous years. So the increase in the dollar helped us from an FX perspective. And again, with $3,000 nonoperating expense or gain.

Moving on to Slide 22, which is around the cash. The cash generation from the operating activities was broadly in line with the operating profit. The operating profit in FY '18 was $7.8 million, and that's what our cash was from operating activities. And in FY '19, the cash from operating activities was $12.1 million versus an operating profit of $12.8 million. So broadly, our operating profit matched into our cash.

So what did we spend that money on, that $12 million of operating cash? Well, we invested in property, plant and equipment of $0.7 million. We invested $2.3 million in our PRISM system. And then we also made the acquisition of DBITS, which was $3 million.

In terms of financing activities, we received $1.5 million in relation to some share options. We also spent $2.1 million on a buyback, which I'll talk about in the next slide. And then we also paid $2.7 million in dividends.

So net-net, our cash increased by almost $3 million year-on-year despite spending a significant amount on investments, including DBITS, and also $2.1 million in share buybacks and on the $3 million in dividends.

Moving on to the next slide on Page 23, that just gives you a full P&L. I think I've touched upon most of the highlights, but I'll just go through some of the key ones here.

And you can see our group revenue was up 36% year-on-year. Our OpEx was up 25%. That delivers an increase in operating profit of 64%. I think the main item I've called out on this page is around our tax expense. So even though our PBT went from $5.2 million to $8.5 million, so up 64%, our tax expense was relatively flat year-on-year. Now that was driven by the increase in profitability in Asia, which allowed us to offset previous carryforward tax losses. And as a result, our effective tax rate fell from 40% to 27%. As a result, our net profit after tax increased by 102% and our EPS was up over 100%.

Moving on to Slide 25. This is talking about shareholder returns. You can see our EPS went from $0.0183 in FY '17 to $0.0226 to $0.0453 in FY '19. So the growth rate up 100% year-on-year. That was driven by our operating profit and also the lower tax rate that we incurred in FY '19. The strong cash position allowed us to declare a $0.02 final dividend, which we paid in October. That's fully franked. That resulted in about $2.7 million in cash going out the door and is equivalent to about a 66% payout ratio. Also, it's important to note that we spent $2.1 million in our buyback early in FY '19 at an average price of $1.19.

And with that, I'll hand back to Dominic to talk about the outlook.

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Dominic John O'Hanlon, rhipe Limited - MD, CEO & Executive Director [4]

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Thank you, Mark. Now moving to Slide 27, which is our FY '20 outlook.

You will note that we gave guidance of a $16 million operating profit for FY '20, excluding any major geographical expansion and excluding a number of other things that we're not doing in the business today. But we did include in that operating profit guidance enough headroom for our DBITS acquisition and also the more recent acquisition of SmartEncrypt, the investment that we're putting into that. So the $16 million operating profit guidance, excluding geographical expansion, is maintained.

We are now evaluating the size of the prize in Japan, and we're spending some good time with Microsoft on that business planning for us to figure out just how much cost we want to put in the business this year to get returns in future years. Those of you who've been following us for some time know that it takes multiple years after we launch a new geography before we make money in that geography, but we want to use that money very wisely and carefully. So we're negotiating along the lines of what does the business plan look like, what is the returns, when are they coming, how much is the headcount that we're going to put into the business, and we expect to have that concluded ahead of our AGM in a few months' time. As I said before, it's probably $2 million to $3 million, something like that, but it's not finalized yet.

I think with that, we can hand to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Catherine Adam of Shaw and Partners.

(Operator Instructions) Our first question comes from Peter Ryan of Australian Broadcasting Corporation.

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Peter Ryan; Australian Broadcasting Corporation;Senior Business Correspondent, [2]

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I just wanted to see again just in terms of the outlook whether there are any concerns about what's happening with the U.S.-China trade tensions and just how difficult that is making for you in terms of making decisions about the company.

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Dominic John O'Hanlon, rhipe Limited - MD, CEO & Executive Director [3]

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Thanks for the question. We haven't seen any impact from that in our business. The reality is that our business is about small- and medium-sized businesses moving away from on-premise applications to cloud-based applications, and that is growing strongly. We do not have any operations in China, and we don't intend to have any operations in China.

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Operator [4]

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Our next question is from Catherine Adam of Shaw and Partners.

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Jonathon Higgins, Shaw and Partners Limited, Research Division - Analyst [5]

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It's Jon Higgins here. I'm not sure why it's coming out with Cath. Just a couple of questions for me. One, firstly, just in regards to gross profit, it looks like your gross profit margin sort of expanded pretty substantially on that sales number, up from 18% to 19%, I believe. Is -- firstly, is that predominantly being driven by just that mix towards the public cloud activities? I think there's incentives driving that.

And just the second part of that question, you've got a pretty substantial sort of ARR run rate into next year within that division, and you added close to $12 million in gross profit and $6 million or $7 million in operating expenses. Can you give us some idea where you're spending that extra operating expense into FY '20?

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Mark McLellan, rhipe Limited - CFO & COO [6]

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It's Mark here. I can probably take both of those questions. I might look at the second one around expenses since we are investing in all areas of the business. So we're investing in the Licensing area. So we've added more people in the front line. And so most of the investments are on front-line people around the Solutions business. And we're looking at really around expansion into our support activities, around expansion into DBITS, around the Dynamics. We're also looking to expand that Dynamics into a channel-type practice of focusing on our channel partners. It's really where the most investment has gone and is continuing to go.

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Jonathon Higgins, Shaw and Partners Limited, Research Division - Analyst [7]

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Just in regards -- so another one from me. So you've ended the year at $25.5 million in cash. You're adding something like $2 million of cash flow each month into next year. I mean you've spent a little bit on an acquisition at the start of the financial years. Is there any thought towards that increasing cash balance and what you want to do there? Is it driving towards that growth in Japan? Is it potentially other accretive acquisitions? What would you market towards?

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Mark McLellan, rhipe Limited - CFO & COO [8]

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Yes. I'll let Dominic answer that one. Just going back to your first question on margin, so the margin, as I said, in terms of the group and our overall gross margin was driven predominantly by our Licensing business. And that was because of the expansion in the public cloud and also the fact that we've received strategic incentives from one of our vendors. So there's 2 aspects driving that increase in margin.

In relation to cash, Dominic, do you want to take that?

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Dominic John O'Hanlon, rhipe Limited - MD, CEO & Executive Director [9]

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Sure. Yes. Jon, the reality is that where we are in the business at the moment, we're being presented with more opportunities than we can realistically execute against. And we do need to preserve some cash for those opportunities that we decide to pursue. Whether they be new vendors or new geographies, we're actively working on all of the above in the business.

And so we do look at that cash and think we need to preserve some of it for acquisitions or for expansion in geographics or expansion in vendors, and I think you should be looking for us to do that. We've given our guidance to the market very clearly with a view that we want enough headroom to continue to invest and grow the business because we think we're riding a pretty big wave at the moment, and we want to be able to ride it well.

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Jonathon Higgins, Shaw and Partners Limited, Research Division - Analyst [10]

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I might ask another one, if that's okay, just quickly. You've begun -- you obviously began a number of years ago investing into Southeast Asia, which is starting to bear fruits obviously around that run rate. I think you're in something like 8 -- 7 or 8 countries now up in Asia. How many of the countries are profitable on a local or region basis?

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Dominic John O'Hanlon, rhipe Limited - MD, CEO & Executive Director [11]

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I mean most of the people are shared amongst countries. We don't really have many people that -- for example, our Head of Asia is based in Thailand, our Head of Products is based in Singapore. So I don't -- can you...

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Mark McLellan, rhipe Limited - CFO & COO [12]

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I mean they kind of distort the P&L. But what I would say around most of the countries, Jon, they all obviously hit profitability and are obviously going from the red to the black.

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Dominic John O'Hanlon, rhipe Limited - MD, CEO & Executive Director [13]

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But Korea.

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Mark McLellan, rhipe Limited - CFO & COO [14]

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That with Korea is the only one. So I think all of those, excluding Korea, have hit black ink from red ink.

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Operator [15]

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Our next question comes from Alex McLean of Bell Potter.

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Alexander McLean, Bell Potter Securities Limited, Research Division - Analyst [16]

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Mark, one for you. Just those strategic incentives, can you give us an idea as to what the margin would have been without that? And can you confirm if they will be -- if they're included in FY '20 guidance of $16 million operating profit?

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Mark McLellan, rhipe Limited - CFO & COO [17]

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What I would say, I mean, obviously, it's commercially sensitive around the quantum. But I would say that excluding the strategic incentives, the margin was broadly flat year-on-year. And I think for FY '20, there will be some additional strategic incentives available. I don't think it will be at the same level as it were in FY '19. But yes, there's some built into that FY '20 guidance.

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Alexander McLean, Bell Potter Securities Limited, Research Division - Analyst [18]

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Okay. And barring any sort of early progress in Japan, do you think the Office 365 seat count will be able to maintain positive momentum on a month-to-month basis, obviously, okay?

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Mark McLellan, rhipe Limited - CFO & COO [19]

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I think I would say difficult to predict. But based on what we're seeing, we're not seeing anything that's telling us otherwise. So I think yes.

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Alexander McLean, Bell Potter Securities Limited, Research Division - Analyst [20]

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And one final one just on the tax rate. Obviously, that came down quite a bit. How should we look at that going forward?

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Mark McLellan, rhipe Limited - CFO & COO [21]

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So we -- obviously, as I said, we had a benefit in FY '19 through carryforward tax losses in Asia. So our effective tax rate was 27%. I would see that going to slightly above 30% going forward because we still -- obviously, as I said, we're going to make losses in Korea. So our net effective marginal rate will be slightly above 30%.

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Operator [22]

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Mr. O'Hanlon, we have come to the end of the Q&A session. Would you like to make some closing comments?

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Dominic John O'Hanlon, rhipe Limited - MD, CEO & Executive Director [23]

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I would just like to thank everybody for taking the time. We look forward to catching up with a number of you (inaudible) period of the week. Thanks again.

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Operator [24]

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Thank you. That concludes today's conference. Thank you for joining us. You may now disconnect your lines.