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Ladies and gentlemen, thank you for standing by and welcome to Endava’s Earning Release for the Second Quarter Fiscal Year 2021. [Operator Instructions] I would now like to hand the conference over to your first speaker for today, Laurence Madsen, Investor Relations Manager. Please go ahead.
Thank you. Good afternoon, everyone and welcome to Endava’s second quarter of fiscal year 2021 conference call. As a reminder, this conference call is being recorded. Joining me today are John Cotterell, Endava’s Chief Executive Officer and Mark Thurston, Endava’s Chief Financial Officer.
Before we begin, a quick reminder to our listeners. Our remarks today include forward-looking statements, including our guidance for Q3 fiscal year 2021 and for the full fiscal year 2021, our expected near and medium-term revenue growth, the potential impact of the COVID-19 pandemic and associated global economic uncertainty, our expectations regarding digital transformation of existing businesses and industries, the necessity of digital transformation for many companies and Endava’s ability to benefit there from, anticipated client demand for Endava’s services, our expected ability to leverage our intellectual property to provide more cost-effective deliverables to our clients with greater speed and our expectation regarding expansion opportunities as well as other forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. Actual results and the timing of certain events may differ materially from the results or timing predicted or implied by such forward-looking statements and reported results should not be considered as an indication of future performance. Please note that these forward-looking statements made during this conference call speak only as of today’s date, and the company undertakes no obligation to update them to reflect subsequent events or circumstances other than to the extent required by law.
Please refer to the Risk Factors section of our Annual Report on Form 20-F filed with the Securities and Exchange Commission on September 15, 2020, which contains a discussion of important factors that could cause actual results to differ materially from those contained in any forward-looking statements. Also, during the call, we’ll present both IFRS and non-IFRS financial measures. A reconciliation of non-IFRS to IFRS measures is included in today’s earnings press release, which you can find on the Investor Relations website. A link to the replay of this call will also be available there.
With that, I will turn the call over to John.
Thank you, Laurence. I would like to thank you all for joining us today and I hope you are all staying safe and healthy. Mark and I are pleased to be here to provide an update on our business and financial performance for the 3 months ended December 31, 2020. Now while the coronavirus vaccination campaign has started in many countries around the globe, life is far from normal, with many countries, including the UK, still in lockdown or facing similar restrictions. Whilst we continue to adjust to the impact of the pandemic, demand for our services continues to increase, as we’ve seen the acceleration of digital transformation clearly differentiating the leaders from the laggards. When the second surge of COVID-19 cases hit our main markets in the Northern Hemisphere at the end of last year, I mentioned to you that our customers were much clearer on their priorities than they had been immediately following the declaration of the pandemic, and that we were seeing more business-as-usual type stability in decision making. We did not see sudden decisions to stop or reduce project activity and demand for our services continues to grow.
Endava had a solid Q2 for our fiscal year 2021, with revenue of £105.2 million, a growth of 22.5% year-on-year from £85.9 million in the same period in the prior year. Our strong revenue growth was once again driven by the expansion of work for our existing clients and the acquisition of new ones during the quarter. During the quarter, we continued to broaden our client base, and ended the quarter with 521 active clients, up from 367 at the end of the same period in the prior year, a 42% year-on-year increase. Average revenue from our top 10 clients grew by 21% year-on-year, and revenue from clients who paid us above £5 million over the past 12 months increased 34.3% year-on-year.
Additionally, we ended the quarter with 75 clients who paid us over £1 million per year compared to 65 in the same period last year, representing a 15% year-on-year increase. We have adjusted our sales and marketing approaches in response to the reduced travel and in-person attendance at industry events. In September, we highlighted that we were seeing an increasing flow of new client opportunities, which starts small with ideation or proof-of-concept engagements and then scale as we move into production system development. We’re continuing to observe this trend with a greater number of new clients in the second quarter and with expanded £1 million-plus and £5 million plus cohorts with top 10 revenue growth as engagements expand.
On the technology side, Endava possesses significant intellectual property embodied in our know-how and reusable assets. One type of Endava IP is our accelerators. These are reusable project delivery assets that allow us to provide clients with deliverables of greater value, more quickly and at less risk than starting from scratch. We develop our accelerators in response to repeated demand on our projects. So they are practical tools to accelerate our clients’ success by packaging our hard one experience. The accelerators reduce the time required for delivery and know-how within the accelerator allows us to leverage higher-margin deliverables at lower cost for our clients. Some of the accelerators we have developed recently are reusable components for payment systems, testing frameworks and programming frameworks for data engineering projects. For example, over the past 9 months, we built 15 payment accelerators that many payment implementation projects require, but that don’t create differentiation or competitive advantage for our clients, such as tokenization, self-service onboarding, fraud engines and card processing. We have implemented accelerators in 4 client programs, including for ClearCourse and Judea so far, and we are seeing an accelerating adoption. We provide these components in source code form to accelerate delivery of a larger program, enabling us to provide our clients with greater value in a shortened time frame. With time to market being a key differentiator, these accelerators can provide our clients with an edge.
I would also like to highlight today some of the work we are doing in the fast growing health tech sector. We believe digital transformation presents opportunities to transform the quality of services provided in health by making them more efficient, more secure and more data driven, whether in direct patient care settings or in the context of researching better ways to provide care. And this is where we have focused our energies. Endava has been partnering with WebMD Health Services for nearly 10 years, assisting them in their digital journey. We have helped WebMD develop corporate wellness solutions to help companies improve the health of their employees. We have also utilized our experience in distributed agile delivery to support the development of Pleio’s new digital platform, LIFT. Pleio builds meaningful relationships with patients on drug therapy using artfully scripted, live, patient-centric conversations supported by digital outreach. Pleio’s purpose-built LIFT technology platform brings science into the art of human engagement with pretty cool data science to craft a mindful patient journey.
A leading health tech provider partnered with Endava to develop a number of apps, allowing clinicians and patients to make the most of their time together. We built Triage app that configures online questionnaires, allowing clinicians to create a workflow through which patients can interact with a body map to highlight different areas of the human body where musculoskeletal pain is occurring before the patient is physically examined by the clinician. We built another tool allowing clinicians and patients to connect remotely via audio or video chat on computers and mobile devices. Additionally, we helped create a program called patient outcomes to allow clinicians to use home exercise or remote resolution programs in tandem with a patient’s profile and match them up to increase the likelihood of patient enrollment and adherence to the program. Endava has recently been chosen by a leading provider of advanced health care solutions for the management of blood plasma, tissue and cells to support them with the design and implementation of the application infrastructure in AWS for one of their clients in Germany. We are leveraging our in-depth technical expertise in cloud infrastructure and the AWS partnership to minimize implementation costs while migrating their on-premises software into the cloud.
Our solution will allow faster future cloud implementation for their clients as we automate the provisioning of infrastructure by building an infrastructure as code pipeline underlying all health tech is evidence-based practice drawn from scientific research. And we have been working with one of the pioneers in that area, eLife Sciences Publications, Ltd. eLife is a not-for-profit organization inspired by research funders and led by scientists. Their mission is to help scientists accelerate discovery by operating platform for research communication that encourages and recognizes the most responsible behaviors in science. This means building technology to help scientists share their findings quickly and effectively. So we helped build an article hosting platform that used modern web front-end techniques. The result was the launch of a new journal website, transforming the way scientists share their research, including two groups focusing on COVID-19 research. It’s been a privilege to build a solution that helps health care providers have a positive social impact in transforming patient care. Many of these examples have been innovative entrants to the health tech space. It was setting the pace in the transformation of health services and patient outcomes. Similar to our experiences with the fin-tech space, we believe this innovation will cascade up to larger providers in health as the dramatic benefit of digital transformation are demonstrated, providing a long runway of expansion opportunities for next-gen providers such as ourselves.
Our client growth continues to translate into strong employee growth. We ended the quarter with 7,464 employees, a 19.1% increase from 6,267 in the same period last year. We have increased our headcount organically every quarter since the start of the pandemic, and our attrition rate remains low. We recently added 2 employees in Sydney, Australia to support clients in the region. And in Q3, for our fiscal year 2021, we also added 1 employee in Singapore. As lockdowns and similar restrictions ease, we expect to add to our headcount in Asia-Pac. The majority of our workforce continues to work from home and productivity remains high. We’re still defining our post-pandemic hybrid model for the new work environment. And we continue to recruit people on the basis that they must be able to regularly attend an Endava office.
With this in mind, last quarter, I mentioned the launch of the Endava well-being program, which is designed to ensure that Endavans can access the well being support that’s right for them, be it through workshops, digital content or master classes. We are delighted at how this has been welcomed by our people, with overall engagement levels continuing to increase, since launch, close to 70% of Endavans have participated in at least one of these events. As shown by these results, client demand for our services continues to be strong as digital transformation continues to increase in strategic importance. Mark and I and the entire team are extremely pleased with our performance for the quarter just ended, despite the challenging pandemic situation. And we are excited about the opportunities emerging and remain confident in our ability to deliver value for all of our stakeholders. Let me end by thanking our people who, in these turbulent times, continue to deliver excellence, quality and value to our clients in diverse home working contexts and who thereby enable the performance just outlined. We appreciate your dedication and loyalty.
I will now pass the call on to Mark, who will walk you through our financial results for the quarter and provide guidance for the coming quarter and the fiscal year.
Thanks, John. Endava’s revenue totaled £105.2 million for the 3 months ended December 31, 2020, compared to £85.9 million in the same period last year, a 22.5% increase over the same period in the prior year. In constant currency, our revenue growth rate was 21.4%. Profit before tax for Q2 fiscal year 2021 was £10.6 million compared to loss before tax of £17.3 million in the same period in the prior year. The loss during the same period in the prior year was the result of the declaration of a nonrecurring discretionary employee bonus, which we refer to as the discretionary EBT bonus, of £27.7 million in December 2019.
Our adjusted profit before tax for the 3 months ended December 31, 2020, was £20.6 million compared to £20.5 million for the same period last year. Our adjusted profit before tax margin was 19.6% for the 3 months ended December 31, 2020, compared to 23.8% for the same period last year. Adjusted profit before tax, adjusted PBT, is defined as the company’s profit before tax, adjusted to exclude the impact of share-based compensation expense, discretionary EBT bonus, amortization of acquired intangibles assets, realized and unrealized foreign currency exchange gains and losses, net gain on disposal of subsidiary, share-based compensation expense, amortization of acquired intangible assets and unrealized foreign currency gains on non-cash expenses.
Adjusted PBT margin is adjusted PBT as a percentage of total revenue. Our adjusted diluted EPS was 29p for the 3 months ended December 31, 2020, calculated on 57.1 million diluted shares as compared to 30p for the same period last year, calculated on 56.0 million diluted shares. Revenue from our 10 largest clients accounted for 37% of revenue for the 3 months ended December 31, 2020, unchanged from the same period last year. Additionally, the average spend per client from our top 10 largest clients increased from £3.2 million to £3.9 million for the 3 months ended December 31, 2020.
In the 3 months ended December 31, 2020, North America accounted for 29% of revenue, unchanged from the same period last year; Europe accounted for 27% of revenue compared to 23% in the same period last year; and the UK accounted for 42% of revenue compared to 45% in the same period last year; while the rest of the world accounted 2% of revenue compared to 3% in the same period last year. Revenue from North America grew 23.7% for the 3 months ended December 31, 2020, over the same quarter of 2019. Comparing the same periods, revenue from Europe grew 40.7%, and the UK grew 14.2%.
We grew in all three of our industry verticals during the quarter. Revenue from Payments and Financial Services grew 12.3% for the 3 months ended December 31, 2020. Revenue from Payments and Financial Services accounted for 49% of revenue compared to 53% in the same period last year. Revenue from TMT grew 42.7% for the 3 months ended December 31, 2020, over the same quarter of 2019 and accounted for 28% of revenue compared to 24% in the same period last year. Revenue from other grew 25.1% for the 3 months ended December 31, 2020 over the same quarter of 2019 and now accounts for 23% of revenue, unchanged from the same period last year. This growth was mainly driven by clients in the mobility and health tech sectors.
We now turn to our adjusted free cash flow, which is our net cash provided by operating activities, plus grants received, less net purchases of non-current tangible and intangible assets. Our adjusted free cash flow was £18.7 million for the 3 months ended December 31, 2020 compared to £8.0 million during the same period last year. The prior comparative period include the first tranche of a one-off discretionary EBT bonus cash payment of £10.7 million. Our cash and cash equivalents at the end of the period remained strong at £84.2 million at December 31, 2020, compared to £101.3 million at June 30, 2020. We spent £50.5 million net of cash acquired in the 6 months on our acquisition of Comtrade Digital Services in August. CapEx for the 3 months ended December 31, 2020, as a percentage of revenue was 1.6% compared to 3.7% in the same period last year.
Our guidance for Q3 fiscal year ‘21 is as follows. Endava expects revenues will be in the range of £110 million to £111.5 million, representing constant currency revenue growth of between 20.0% and 21.5%. Endava expects adjusted diluted EPS to be in the range of £0.27 to £0.28 per share. Our guidance for the full year fiscal year ‘21 is as follows. Endava expects revenues will be in the range of £423 million to £426 million, representing constant currency growth of between 22.0% and 22.5%. Endava expects adjusted diluted EPS to be in the range of £1.10 to £1.13 per share. The constant currency growth figure quoted for the full fiscal year ‘21 guidance still includes the pro forma adjustment for the Worldpay Captive as it remains in the full year comparative. The above guidance for Q3 fiscal 2021 and the full fiscal year 2021 assumes the exchange rates at the end of January, when the exchange rate was £1 to $1.37 and €1.13.
This concludes our prepared comments. Operator, we are now ready to open the lines for Q&A.
[Operator Instructions] Your first question this morning comes from Bryan Bergin from Cowen. Please go ahead.
Hi, good morning or good afternoon. Hoping to dig in around the client expansion metrics and also North America traction, so there is a notable sequential uptick here in the greater than £1 million clients. Can you provide some color there as far as the verticals you are seeing the most momentum and the types of those programs? And I am curious about North America specifically can you provide detail around that client activity such as new logo wins and existing relationship expansion?
So North American growth, we are very sort of pleased with. We made quarter-on-quarter, year-on-year growth of 23.7%. Yet most of that is organic. It’s been across the piece. We have had strength in Payments – in particularly, Payments and Financial Services, so great progress. We are very sort of pleased with it. And in terms of number of clients, we are very pleased over the £1 million. Very pleased with the uptick that we have had there as well, now achieving sort of 75 sequentially on the quarter. Last quarter it was 66, has been great. And we have seen a big influx in the bottom of that over £1 million and £1.2 million. So it’s basically good evidence that we’re gaining traction in terms of growing the existing sort of client base.
So, hi, Bryan. I think one of the things that’s visible in the numbers is the trend that I was touching on over the last couple of quarters, which is that the way Endava works is we start off with an ideation phase or a proof-of-concept where we are helping our clients to get their heads around how our technologies could impact their business models and the way in which they operate. And then as they see that brought to life, the engagement can expand into production phases, where we are actually building systems that are going to go live and that’s visible. So you can see the broadening footprint of new clients coming in that I was touching on. And you can see some of that starting to come through into the larger client base with some of those moving up into the £1 million client cohort that Mark was touching on. And then of course, we continue to see the expansion into the higher cohorts with the spend levels of the top 10 and the £5 million plus clients also claiming. So, that’s the dynamic of what’s going on.
Okay, good to see. And then just on the margin strength, can you talk about the key factors contributing there and your confidence in sustaining these elevated levels? And I am curious, how your push around the accelerators that you described impact profitability? Are you able to gain more leverage through these?
Yes. So, the gross margin – adjusted gross margin was actually sequentially in line with Q1. And whilst we – Q1 we benefited from an R&D tax credit. So that was a slight headwind of about 50 basis points coming into Q2. It was offset by helpful FX as the pound strengthened against the dollar and the euro, but basically, the margin, sequentially, we saw utilization pick up slightly. The bench reduced. That people were taking less holiday. And we’re seeing an improvement in the pricing outlook as well. So, gross margins were strong. I think going forward, it will follow the typical pattern because we have our major sort of pay round, which goes through in the 1st of sort of July. So there will be some pegging back from that level, roughly about sort of 2 percentage points I think. And I think we will see utilization start to improve during the course of the year. In terms of Q3, I mean, we do have less working days, which does have a margin impact when you compare it with Q1 and Q2. But generically, I think the margins – gross margins are in a good place. You see also we had sequential reduction in our SG&A. I think that’s going to be a theme as we grow the top line. We keep our SG&A spend under control. We will expand our adjusted PBT margin.
Just on your question about accelerators, we use those to help demonstrate value and win business with clients because we are able to show them how we are going to get that product to market faster through use of the accelerator. And we roll it into the cost of the services provided to the client. That’s not done on an ongoing license basis. It’s done on a delivered capability basis, similar to if we were building it from scratch. So it does help us to get projects going faster with clients, demonstrate more value and therefore, win business. There is a small margin improvement overall on the projects that we win that way obviously, because we are not having to build that code from scratch. We give some of that to the client and we bank some of it in improved margin.
Okay, understood. Thank you.
Thanks, Bryan. Thank you.
Your next question comes from Ashwin Shirvaikar from Citi. Please go ahead.
Thank you. Good morning folks. Good quarter here. I just wanted to just follow-up a little bit to start on the accelerator question. I just want to understand the IP, if the IP belongs to you, if there is a potential to expand the concept from toolsets to full scale solutions and perhaps even start doing more along the lines of sort of a software model down the road and if that is – if the accelerator concept is limited to any particular verticals?
Right. So, our focus around the accelerators has been to put them into places where there is a standardization. It’s a sort of thing that every project in that space requires and there is little differentiation between clients that comes from those accelerators. So that then you can focus the energy with the client around building their differentiation rather than just the underlying services that come through the accelerators. So, they are not full package services products that we would take to market and we have no intention of building them out as such. One of the huge benefits that we are able to offer to our clients is the knowledge that we are not going to take the IP that we develop with them or the know-how that comes from it and turn that into differentiated products that we sell to their competitors in the market. So, it is very, very consciously focused on the non-competitive arenas so that we are not causing any concerns with our clients of it migrating across to their competitors. It’s – we have done it in a few areas. Payments is the one that I have called out this time and we will be touching on some of the areas in the quarters ahead, where we have pushed the accelerators out doing different things. Some are domain related. Some are data transformation framework. Some are testing related. Others around looking at clients’ existing code bases and the challenges in transforming that as we introduce digital transformation into their services.
Got it. Got it. Second question was on headcount, you see the very healthy headcount growth. But could you kind of break that down a bit and talk about headcount growth by geography? Does sort of the regional response or the country response to COVID impact your decision to hire or not hire in a particular place? And it was good to see the APAC headcount additions that you talked about, is that with the intention of sort of being a bit more Asia-focused in the future or is that just a one-off with a couple of clients?
Yes. So, the headcount growth has not been restricted in any of our locations by the pandemic backdrop. We are still able to recruit, albeit a lot of it is done in a virtual context. Although it’s in some of our jurisdictions, it’s been fine to do interviewing over the past 9 months as well face-to-face. So, there hasn’t been a restriction around the pandemic in terms of where we have grown and we tend to push work to places where we get access to the talent that we need where – and we do it in a fairly even way. If we focus too much on 1 or 2 cities, then the demand that we would place on those cities would drive cost inflation because we’re a big player in the markets where we operate. So the more even and distributed that we are, the more it helps us to control cost inflation with the recruits and expand in a balanced fashion. In fact, as the business grows, one of the things that we’re always planning ahead for is provisioning new locations into our geographies, so that we’re never going to be overloading any individual cities that we are growing into.
The Asia-Pac question, yes, so that is absolutely around building client relationships in the more advanced locations across Asia-Pac, Singapore, Australia, Japan, etcetera, in due course, and, therefore, being able to support some of our clients who are global – on a global basis. And that’s constant ask that we experienced that we’ve had to push back on until we were ready to expand into Asia-Pac. So we’ll build out that close to client capability in due course we also expect, in line with our near-shore delivery model, but we will put the delivery centers in the Asia-Pac time zone as well. That enables agile delivery to operate with that good time zone overlap. So we’re just starting on that. It’s been existing clients that have pulled us into that growth in the rest of the world figure that you’ve seen over the last couple of years. And now we’re ready to stop putting people on the ground looking for new clients as well as expanding existing ones in that geography.
Got it. Thank you. This is good performance in a pandemic.
Your next question comes from Mayank Tandon from Needham. Please go ahead.
Thank you. Congrats on the quarter. John, I wanted to just maybe talk a little bit about the contribution from new clients versus growth from the existing account base, just how that’s been trending. And I’m really curious to sort of hear your thoughts on what is the penetration today of Endava of the existing installed base? Is there a way to maybe put that into perspective? And how much more room to grow within your core clients?
Okay. So actually, even through this pandemic, our model that we’ve experienced for the last, well, 5 years visibly in the numbers, but before that as well, which is that between 89% and 90% of our growth of our revenue each year comes from our existing clients growing. And then the 10% that sits on top of it is new clients that we acquire during the year. And that model is still largely true over the last 9 to 12 months. And what that means is essentially existing clients are growing and driving a big chunk of the organic growth. And then the new clients are taking it up to that over 20% mark that we target each year. So if you look across the final part of your question around growth opportunities in existing clients, there is very large ongoing growth opportunities in that client base. Many of them are very large Fortune 100 type organizations who are looking for partners to work with in this digital transformation space and who are expanding their budgets and their spend in this space and where we are getting the opportunity to expand with them as they do more. Having said that, it remains very important to us to also be working with some of the smaller clients, the disruptors, who are entering industries, that’s often where we play with the technologies, find new business models, do things with those players that causes disruption in the market and gives us the capability to then take to the larger players as they also seek to respond to the transformation that’s being driven by it.
Got it. That’s helpful.
So those parts play a key role.
Okay. Sorry. I just wanted to follow-up with one more question around – it’s good to see the hiring strength, but I’m interested in terms of how should we think about the contribution from pricing and utilization to revenue growth going forward? How much more room do you have on both those fronts to drive revenue?
So let me pick up the pricing, and then Mark will talk a little bit about the utilization. So on the pricing side, we did see a flattening – actually a slight drop in our pricing in our quarter four of last year, the April to June period, as the pandemic was at its height. But since then, pricing has been picking back up again, steadily, actually following historic norms from that slight drop back then. And the last quarter, utilization picked up. Do you want to pick up from that, Mark?
Yes. So our utilization did pick up in Q2 as we started to reduce the bench, which we built through the pandemic. And utilization will continue to rise. It won’t be impactful in the current quarter, in Q3, because there are less working days. So that needs to be taken into account. But utilization will start to rise. It will still be heading towards the typical sort of 70%, 71% I’ve talked about as a sort of high watermark. And we’re still in the sort of high 60s at the moment. So there is the ability to increase or flex the gross margin for utilization. And in terms of sort of the – you can see that in terms of our revenue per head, looking at that again sequentially. So I think it’s around sort of 63,500 this quarter compared to 61,300 the quarter before. And that’s sort of the function of the two drivers that we have been alluding to, which is utilization and price.
Thank you so much. Congrats on a quarter.
Thank you.
Your next question comes from Charlie Brennan from Credit Suisse. Please go ahead.
Great. Thanks for taking my questions. I’ve got two if I can one medium-term and one short-term. Just in terms of the medium-term outlook for margins, it feels like you have touched on key points here that that all suggest upward pressure on margins, whether it’s increasing pricing or the use of accelerators or SG&A leverage. It all feels like future margins should be going higher. Are you in a position to talk about where you think medium-term margins should settle for Endava? And then on your assumption, there is some upward pressure on margins. Philosophically, would you rather see that come through in the margin line or would you rather reinvest that for faster top line growth? And then just on a more short-term question. If I try and back out acquisitions, it looks like your third quarter guidance is assuming underlying revenue growth that’s 2% or 3% higher than you delivered in Q2. Are there any metrics you can give us around the order book or bookings that give you comfort that we’re going to see that underlying acceleration? Thank you.
Thanks, Charlie. Let me just kick off, and then Mark will pick up with some of the detail. So yes, you picked up on the mindset that we have, which is that actually, as we drive some improved margins, whether that be a gross margin level or indeed for the reasons that you highlighted, or indeed leverage against G&A, we do intend to put some of that, if not all of it, into the sales and marketing arena to sustain and perhaps even accelerate our top line growth rate. Obviously, as we get larger, our expectation is that we’ll need to push more into the sales and marketing line to sustain our growth rate. Let me also just pick up on the bookings question, and then I’ll let Mark pick up some of the detail on that. So without going into any detail, our bookings in Q2 were in good shape, running ahead of both Q1 and the previous year, in line with the acceleration in client demand that I’ve been touching on in these reviews. Mark, do you want to pick up on the detail?
Yes. I think – I noticed when I look at some of our models, they flat line our gross margin quarter-to-quarter. It doesn’t flow that way, mainly because of the main sort of pay round, which is going through this sort of quarter. So we do get a step down as we go into the second half. But if you look at it year-on-year, it is robust, and it’s a function basically of utilization. And as I said, I think as we went into COVID, utilization went down and the bench built and we have started to eat into that bench as utilization is coming up. So we’re getting back to more normal levels of utilization. We’ve got a little bit further to go to get to that sort of high 60s, 70%, 71%, etcetera. And also, we are seeing pricing. Although we’re cautious about it, we’re seeing pricing start to improve. So our gross margins have that ability to expand. But again, we have to focus on the cost side, which is basically, the people that we employ to deliver the services. So as long as we keep that in balance, and we’ve been through with a few of you, that model to contain cost, then I think we have a robust gross margin outlook. And then just to repeat what I’ve always said as well. As we grow the top line, we will get leveraging of our SG&A. We may get an acceleration of that because of the change that COVID has put us through in terms of the property footprint. So the change in terms of the spend on property may come down at that. But then again, we may decide that we want to reinvest that and accelerating sales through investments in sales and marketing. So I think at the adjusted PBT level, we’ve again delivered good level of margin for this quarter at 19.6%. It will come down somewhat in the second half. But I think we’re a business that can generate towards that 20% adjusted PBT margin. We have that capability.
And just one very small follow-up, you touched on potential property decisions. Are there any obvious big lease expiries coming up that are going to crystallize decisions for you?
No. What we’ve got, actually – I mean, it’s related to our CapEx. Our CapEx has been pretty low, certainly, last quarter, is relatively low this quarter, but it’s starting to pick up again and that – part of that is because the property element. We – basically, everybody is at home, so we haven’t expanded the property footprint. We are committed, though, in a couple of locations to some buildings, which we are going to fulfill and fit out. But we are thinking about how we fit those buildings out to accommodate a new model that John was referring to. So I think we’ll get some savings on the property line, but it will probably take a little while, in a little while, maybe 1 year, 2 year, 2.5 years for it to work its way through to something that is noticeable as in SG&A as a percentage of revenue.
Perfect. Thanks so much. Well done on the quarter.
Thanks, Charlie.
Your next question comes from Maggie Nolan from William Blair. Please go ahead.
Hey, this is Ted on for Maggie. Thanks for taking our questions. So, earlier, we were discussing how you are seeing higher volume small initial projects. I was curious how does the overall mix of project stages compare to normalized levels maybe pre-COVID as kind of a benchmark?
So, it is a little higher than it has been pre-COVID and that to some extent is visible in those new customer numbers that we published and that [Technical Difficulty]
Ladies and gentlemen, this is the operator. I apologize, but there is a slight delay in today’s conference. Please standby. We will resume as soon as possible. Thank you for your patience. Alright. So I will put you in separately. Are you able to hear me?
Yes, I am here.
Hi. Just letting you know that we lost the main speaker line. They actually disconnected.
Okay.
So if you just hang on, I am just looking to reconnect them here.
Okay. Anyway I am still in the question queue.
You absolutely are. Give me just one moment here, please. Alright and we have returned.
Great. So this is Mark and John back. Sorry about that. We dropped out for some reason. So I’m not sure what you heard from me, so I’m going to start from the beginning, so yes, the opportunities that we have with the new clients coming through is expanding. You can see that in the numbers of new clients that we’re adding to our roster. And for many of those, that is the initial quite small ideation or proof-of-concept work that we do in the early days of working with them. The numbers of those is higher than usual, and that is what has depressed our average client spend across the wider portfolio outside the top 10. But the opportunity for us is that many of those will get traction and grow into larger deliverables as we move those systems into a production-type service. So that’s the big opportunity for us over the next 9 to 12 months is to see many of those clients convert into larger opportunities and begin to scale, obviously, alongside our existing large customers continuing to scale.
Okay, thanks. That’s helpful. I wanted to – as a follow-up, I wanted to dig in on the hiring trend. So with the better visibility in the second half of the year, should we expect to see any change in the hiring volumes in the second half of the year?
Yes. So we are gearing up to slightly faster levels of hiring. And that is – some of that was visible in the last quarter. We’re pushing a little bit harder on the accelerator for this quarter and expect that to continue into Q4. Obviously, we have been expanding our footprint as well. The contract digital services business gave us a lot of locations across the Adriatic, and we’re tapping into those as well in terms of our ability to do that expansion.
Great. And if I could just slip in a quick housekeeping question, what was the organic growth rate embedded in the third quarter and full year guidance? Thank you.
Third quarter, we are sort of middle double-digits, so around sort of 14%, 16%, that’s for Q3 and then we accelerate from there. Q4, you can do the math.
Alright, great. Thank you.
Thank you.
Your next question comes from James Faucette from Morgan Stanley. Please go ahead.
Great. Thank you very much. I just want to follow-up on a couple of questions that have already been addressed. But when you look at your incremental opportunities and growing opportunities in the APAC region, combined with the hiring expansion that you just talked about looking to do, how should we think about organic versus inorganic needs and perhaps opportunities to supplement both regional opportunities as well as headcount and additions etcetera?
Great. Thanks, James. So obviously, the underlying business model that we have is to drive – as we come out, the slight dip that we had with the pandemic to drive 20% plus organic growth and then supplement that with tuck-ins through M&A. Also using the M&A route to help rebalance our portfolio from a geographic as well as sector point of view. So as we get traction in Asia-Pacific, we will look to some M&A as an opportunity to establish a more significant presence there. That could well be a 1 year or 2 down the line. So I don’t see anything as rushing through there. But also, we’ll be looking at M&A in terms of pushing ahead in the U.S. as well, which is – we have been doing really well from an organic growth point of view, as Mark highlighted, but actually pushing that a little bit faster through M&A is also something that we’re considering.
Yes. That makes sense. And just to build on that quickly is that are you seeing – I mean, what kinds of opportunities are you seeing? And are you looking at things or would you be considering things that largely complement your existing vertical exposures or is – are acquisitions going to be a key way to expand kind of the industries that you’re targeting and can address?
Yes. So the priorities for us, as we look at targets, are, number one, that there is a good cultural fit, the way in which they do things is very, very aligned with the way that Endava does things, that they have the right DNA, if you like meaning that they have that ideation to production approach, that they utilize agile right through the way that they operate and that they have got their teeth into next-gen technology in the way that they do it. So we see a lot of companies. I think, in the run-up to Christmas, the 3 or 4 months running up to Christmas, we were seeing about 5 companies a week pushed past us. But very few of them have the right DNA. So we remain pretty choosy. And what we’re looking for is organizations that will help our geographic rebalancing. So as I just touched on, looking into the U.S. is one of the areas in downstream, looking at Asia-Pac. That focus, because we’ve given Europe a really good push over the last 15 to 18 months. The sector side of it is also important. Obviously, we have a big weighting in the Payments and Financial Services side. And so we’re often looking for businesses that are in other sectors. What we are looking for there is we have a thesis around long waves of technology change, the sectors that are being driven over a long period of time by technology in terms of the way that their business models operate. So on payments being historically one that we’ve been in, that still has a while to run, but also mobility, insurance, the way in which technology is starting to drive change in that and so on and many others that I’ve gone through over the years. So we are looking for businesses to add in those sectors rather than just any sector. And occasionally, we spot a business that has a technology capability that we want to add. But I have to say, normally, we’ve been able to develop our own technology capability rather than having to – needed to buy that in. So that’s the focus around M&A where it comes up.
That’s great color. Thank you very much.
Your next question comes from Bryan Keane from Deutsche Bank. Please go ahead.
Hi. So I wanted to ask, John, just on thinking about any pent-up demand. As vaccines roll out and we get into the second half of this calendar year, do you see any pent-up demand with clients in the pipeline as we get a little bit further ahead and get COVID behind us?
So the short answer to that is yes. There is demand where some clients are still holding back because of sensitivity over the outcome of the pandemic. Particularly, this is true in travel-related activities, which isn’t just the travel industry. There is travel insurance. There is the cross-border payment type activities in the payment world and so on. So the restrictions on travel and hospitality actually spill over into other sectors that are not obviously in the travel industry. And in those areas, you see some strain on budgets being released. Whilst in other areas, which is what’s driving our growth, clients are hitting the accelerator quite hard. So I do expect that as we get through the pandemic and sort of – and things start to open up, some of those other budget areas will open up as well, providing incremental opportunity for us.
Got it. That’s all I had. Thanks so much.
Thanks, Bryan.
Your next question comes from Jamie Friedman from Susquehanna. Please go ahead.
Hi, thanks for taking my question. John, I was just curious and I will just ask one question, drop back in queue, but being the time of year that it is, calendar year, any view at this point on IT budgets for 2021, especially in a couple of your key verticals? Have those come together yet and how are things looking?
Yes. Thanks, Jamie. I mean, we – I hear a lot of our other players in the IT services world talking about client IT budgets at this time of year and how it impacts them. To be honest, we see less of that. We don’t tend to see clients restraining themselves in terms of the spend that they funnel into digital transformation based on the annual review cycle that they are having, as they kick in off each financial year. I mean, there is a small amount of it. But largely, as you’ve seen over – in the last quarter, there is acceleration that comes throughout the year. And in many cases, that’s not decisions and issues that clients have decided on at the beginning of their financial year when they were budgeting. So clients do make money available for the sorts of services and initiatives that we’re involved in. And that continues to happen through the year. Of course, there is a little bit of it. And sometime that is visible and coming through as clients are making their decisions through January and February. But it’s a much, much smaller dynamic for us than we hear from other players in the IT services world. So I think that’s it for questions, operator. Are we dropped again?
Yes. There are no further questions left in queue.
So thank you all for joining us today. As you all have noted, even although the pandemic is still reaching a terrible impact, we are confident that our clients have incorporated those challenges into their investment plans. And we’re therefore seeing good demand in our main verticals. And so we remain positive about our business position looking forward. I look forward to seeing you all at our next earnings call. Thank you.
And ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.