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Edited Transcript of MP1.AX earnings conference call or presentation 12-Feb-20 12:30am GMT

FORTITUDE VALLEY Feb 19, 2020 (Thomson StreetEvents) — Edited Transcript of Megaport Ltd earnings conference call or presentation Wednesday, February 12, 2020 at 12:30:00am GMT

* Ashwini Z. Chandra

RBC Capital Markets, Research Division – Executive Director of Equity Research & Head of Australian Technology and Small-Mid Caps

BofA Merrill Lynch, Research Division – Head of Australian Research and Co-Head of Regional Telecom Research

Ladies and gentlemen, thank you for standing by, and welcome to the Megaport Half Year 2020 Results Conference Call. (Operator Instructions) I must advise you that this conference is being recorded.

I would now like to hand the conference over to your first speaker today, Mr. Vincent English, CEO for Megaport. Thank you. Please go ahead.

Good morning, and welcome to Megaport first year 2020 results call. I’d like to start by going through some of the company highlights for the period, for the 12 — 6 months ending 31st of December 2019.

Starting with our monthly recurring revenue for the period at the end of December was $4.6 million, up 26% from the period ending in June. Our annualized revenue similarly up 26% on a run rate of $54.6 million. Customers were up 13% at 1,679, and the total number of services on the network was 13,914, up 20% for the period. The total number of ports, customer ports that we had on the network was 4,863, also up 20%, and the total number of installed data centers was 317 at the end of December, up 6%.

Continuing on the company highlights. I suppose that, first of all, we’ve added Japan to our network, which now means that we’re operating in 21 countries with the launch and I have more to add on — color to add on that a little bit later in the presentation. We added — sticking with our strategic nature, with our cloud providers, our leading cloud providers, we added 24 new cloud on-ramps, with a total of 156, up 18% in the 6 months, and also added 12 new cloud regions to a total of 85, up 14% for the period.

This is — as I said before, this is a very strategic area for us and making sure that over 65% of our connections on our network today are customers looking to connect to at least one, if not more than one, cloud service provider on our network today.

In terms of our reach, not only do we have 317 data centers that were installed, and our total reach and enabled data centers is now 552. And earlier in the month of December, we had a successful cap raise of $62 million, bringing to total cash in hand at the end of 31st of December to $120 million.

Looking at the revenue performance for the first half of the year. Starting on the left-hand side, Asia Pacific, total revenue for the period was $9.4 million, up 58% or $3.5 million compared to the same period last year. Our North America business unit had total revenue of $11.4 million, up 108% or $5.9 million on the same period last year. And our European business had total revenue of $5.1 million, up 34% or $1.3 million on the same period last year. Total revenue for the first 6 months of the year was $25.9 million, up 70% or $10.7 million on the same period last year.

Switching to a review of the financial performance for the first half of the year. Looking at our consolidated profit and loss. As I said, total revenue for the period was $25.9 million, up 70% on the same period last year. Our profit after direct network costs were $13.2 million, which improved by $8.3 million on the same period, and our normalized EBITDA was a negative $10.3 million, which was an improvement of — compared to the previous period of 17%. Total net loss for the period was a negative $18.9 million, 14% down on the same period. The highlight point of this, and I’ll touch on this a little bit later on, again, is our profit after direct network, as internally we call it our gross margin, has significantly improved, and we have some more color on that as we break that down in each of our regions further on in the presentation.

I should say at the outset, in the appendix, we do have a like-for-like comparison with — including the AASB 16, which is the accounting standard that was introduced in the financial year related to operating leases, so we can have a like-for-like comparison on the period, which is there for anybody to review.

Moving for a quick breakdown on the revenue. Looking at the pie chart on your left-hand side, you can see now that the North America region in our business accounts for 44%, up from 36% in the same period last year, contributing $11.4 million followed by the APAC region with $9.4 million, contributing 36% of revenue and then with Europe coming in at $5.1 million, contributing 20% of the total revenue to breakdown. Overall, revenue was up 70%, driven by increased usage and services across all regions. And as I said earlier, our monthly recurring revenue was $4.6 million for December, up 68% compared to the same period.

Looking at our operating costs. The total direct network costs for the period were $12.7 million. This is an average cost of $6.9 million per physical installed location across our network, which is more or less in line, including the AASB accounting standard, more or less in line with the same period last year. But there’s been a significant shift or a growth in our gross profit or profit after direct network costs going from the same period last year from $4.8 million to 6 months ago to $7 million and now up to $13.2 million. It nearly doubled — just short of doubling in just 6 months.

In terms of our other operating costs, employee cost continues to be our largest operating cost as we continue to invest in our sales organization across the regions with new markets, but more importantly, we also continue to invest in our network and our product teams as we lead our innovation, which is one of the primary reasons for the recent cap raise, and we will continue to invest in our future and our product road map. Our total OpEx for the period was $23.4 million, up from 17.3% the previous — same period previous year.

Looking to the financial position, I suppose the main highlight here post the cap raise in early December was that the closing cash at the end of the year was $120 million at the end of December.

For the first time, we’ve introduced a historical financial performance table, just — and we have a little bit more color on this further in the presentation. Just want to draw your attention to the reporting period or for the month of December in the preceding 4 years. You can see how the business has tracked. The dark blue bar being — representing the revenue, the light blue bar, obviously, the profit after direct network costs and the gray bar highlighting the EBITDA position. And on the bottom of the chart, you can see how the percentages of the gross margin and EBITDA margin have changed and shifted over time as the revenue has continued to grow period-on-period. So our exit run rate in December ’19, our profit after direct network costs is running at 53%, and our EBITDA is at negative 30%.

Switching to the regional highlights. We’re going to do a little bit more of a deeper dive into the regions as we do each period. Starting, first of all, with the ecosystem. As I said earlier on, we’re in 317 installed locations and 552 enabled. Looking at North America, where, obviously, with 2 countries, Canada and the U.S., we’re now in 65 metros, installed in 153 locations, but we’ve enabled 313 locations where customers can connect to Megaport. Looking to Europe, as you recall, towards the end of our Q4 or into our financial year last year, we added 6 new countries. Our total countries now are at 14 in Europe. Total cities at 24. We’re installed in 85 and enabled in 146. And lastly, to the APAC region, we are now in 5 countries with the addition of Japan, which we added in December, bringing it to 5, total cities are 13, installed in 79 and enabled in 93.

Having a look at the Japan launch, which was towards the end of November. Megaport is the first software-defined network to operate in Japan towards the end of 2019. This comes 4 years after we launched in North America in early 2016. And just highlights with the way our technology and the way our business is and as we’re continuing to grow some of the primary reasons why we continue to look into Japan, not only due to our cloud service providers were looking for us to go into the Japan market and to work with them to grow their business. Japan is also the fifth largest global cloud spend in 2019 and over $7.4 billion. It’s the sixth largest financial center in the world. Towards the end of — at the end of December, we were installed in 3 and enabled in 8 data centers. And our plans for Japan during this quarter and this second half of the year is further expansion into second city in Osaka with additional 8 DCs to be deployed into. We’re fully deployed across 6 cloud onramps today live in Japan with AWS, Azure, Google, IBM, Oracle and Salesforce, and we’ve also localized some staff for customer support and for network support in market.

Looking to the APAC region. APAC business is EBITDA positive. Our total number of data centers installed is 79, up 11% in the region. Total number of ports is 2,157, up 16%, and the monthly recurring revenue is $1.7 million at the end of December, up 26% from June. Our total customers are 731, up 9%. Total number of services on the network is 6,384, up 16%, and the profit after direct network costs in our APAC region based on reported numbers is 72% at the end of December. A comparable figure pre- the accounting standard change for leases is 67%. In June, our gross margin was 62%. So it’s up 10% on a reported basis.

Looking to the chart on the next slide with operational leverage, and this has been our most mature region. This excludes Japan for comparison purposes. And you can see, again, here with the 4, the month of December for the 4 reporting years — previous years, our gross margin, our profit after direct network costs, has gone from 11% in December ’16 up to 72% in the 4 years and the EBITDA margin gone from a negative 86% 4 years ago up to plus 37%. And if you recall, some people were asking, what did we expect this business to look like. It would be north of 70% gross margin, and EBITDA position of circa 40% is what normal would look like.

Looking to North America, it’s profitable on a gross margin or profit after direct network costs. Total data centers installed were 153, up 5%; total number of ports 1,986, up 25%; the monthly recurring revenue was $2 million at the end of December, up 33% compared to June; total number of customers, 787, up 21%; and the total number of services 5,414, up 27%; and the gross profit or the profit after direct network costs on a reported basis is 38%, excluding the standard, it was at 28%; and in June, our reported gross margin was 22%, so up 16% on a reported basis.

Looking at the operational leverage within our U.S. or North America business. And again, you can see from the chart, quite significant shift from December 2016 up to December 2019. Gross margin is now running at 38% at the end of December on an exit run rate, and our EBITDA margin is a negative 10%, substantially reduced compared to the previous 2 years. A lot of that has been attributed to the investment in our network costs that we’ve had building out the network, but also in our operating costs in North America, ensuring that we have the right team and resources in place to manage our business there.

Looking to Europe. We have 85 data centers in Europe, up 2% for the period. As you recall, we heavily invested in data centers and markets in the second half of last year. The total number of ports on the network is 720, up 17%. The monthly recurring revenue is $0.9 million or $900,000 at the end of December, up 13%. Total number of customers 332, up 12%. The total number of services in Europe was 2,116, up 19%, and the profit after direct network costs reported basis 59%, excluding the lease impact was 52%, and the gross margin at the end of June was 40%, so it’s up 19% in the period.

Looking to the European operational leverage chart. On a similar basis, looking at December for the previous 4 years, our profit after direct network costs in Europe gone from 44% to $59 million and from a negative 65% margin up to a negative 15%, as it continues to improve on our operating leverage.

Switching to business update. Starting with growth trends, similar slide that we’ve had in previous presentations, just illustrating the previous 5 quarters as reported in the Appendix 4Cs. Our total monthly recurring revenue has grown to $4.6 million at the end of December, up 26% compared to the end of June. The total number of ports is 4,863, up 20%, and the total services, 13,914, up 20%.

The growth for the first half of the year and some of other key metrics, installed data centers up 6% at 317, customers up 13% at 1,679, ports up 20% at 4,863, and total services up 20% at 13,914. The average revenue per port is also up 6% at $936 per port.

Having a look at our cloud enablement. One of the things that we focused heavily on in the last — not just in the last 12 months, but specifically in the last 6 months, is the increase of the reach and working with our cloud partners. We have 156 cloud onramps today, up 24, up 18%, 6 of which we’ve added into Japan, as I’ve already outlined. And the total number of cloud regions, our new regions that have extended, the total is 85, up 12 or 14% in the period. As I mentioned earlier, this is one of the more strategic elements of our partnership not only working with data centers and working with customers and other service providers, 65% of all of our traffic, our customers are connecting to one or more than one of our cloud service partners.

So as they continue to build and extend their footprint into more and more regions and more physical onramps, we will continue to extend our network and to work with them hand-in-hand, enabling customers to connect to a cloud service provider via Megaport.

Having a look at an update on the Megaport Cloud Router. The average revenue per customer is $4,711 for and MCR customer compared to $2,473 for a non-MCR customer. And as you may recall, in June, an MCR customer was generating $3,967. This number is up 19% for the 6 months at $4,711. The predominant use case for Megaport Cloud router is for hybrid cloud usage, i.e., connecting to more than one cloud provider using the network. And as a result of that, the average services per customer is now standing at 13.5 for an MCR customer compared to a 7.8 for a non-MCR customer, illustrating the use of not just the MCR but more connectivity using the VXCs to connect to the services.

The total number of MCRs on the network at the end of December was 228, up 30% compared to the period at the end of June. And the average revenue per MCR has increased by 27% or $700, up from $550 at the end of June.

Having a look at our network effect. This may be one of the last times we’ll use this presentation. It’s turning into a bit of a dark blob on the right-hand side. But the spirograph on your top right-hand corner illustrates the number of ports on our network, which is the 4,800 ports. And the lines across the ports connecting across the ring illustrate the number of connections on our network or the number of services on our network. 65% of all of those connections are actually terminating with a direct cloud partner or at least one, if not more than one, 19% is for private connections or connecting to other service providers, excluding cloud service providers, and the Internet exchange connections are accounting for 16% of the traffic and connections on the network.

Just looking at the spirograph on the top right-hand corner, there’s 2 dark elements around the 2 o’clock position, which — one on the top of the 2 is Microsoft Azure and the one just directly underneath it is AWS. And the connections around 1 o’clock are actually the Google connections, which have increased quite a lot over the last 12 months.

Finally, just to have a quick review about Megaport. Just a reminder for all those on the call, Megaport is the leader in the Network as a Service using our software-defined network and looking at our value proposition in terms of pricing, the enterprise customers are using Megaport because they pay for what they use. It’s real-time provisioning in terms of customers can connect services as little as 59 seconds. Got geographic footprint, as we’ve outlined, so customers now can not only expand their business and bring the business together, not just in a country or a region, but now can actually take it global. The capacity is rightsized for the business as they scale and manage their IT and data needs. The terms are flexible, and we have a portal that delivers a one-stop shop for connectivity, where the customer or enterprise user can actually manage their network and manage their connections all on a self, easy-to-use intuitive portal.

And looking to our ecosystem. Just a reminder, again, with 1,679 customers, we’re connected into — as I said, installed into 317 data centers or 552 enabled, which is a combination of 99 unique data center operators that were independently connected and working with, some of which we have strategic partners with. So customers connecting across that data center footprint using Megaport’s unique value proposition can connect to over 346 service providers, which include some of the top cloud service providers in the world for their business needs.

And at that point, I think I will leave it there and revert to the questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from the line of Jon Atkin from RBC.

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Jonathan Atkin, RBC Capital Markets, Research Division – MD and Senior Analyst [2]

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So 2 questions. One on executive management and then one on — an operationally focused question, predominantly in North America. But I wanted to maybe get a little bit of color on the Chief Financial Officer role, and how long it might take to find a permanent CFO, given the change that you announced. And then as it pertains to revenue productivity in North America, there was quite a ramp. And I wondered if you could maybe talk a little bit about indirect channel productivity, whether it’s MSPs, SIs, cloud providers themselves or whatnot and their contribution to your growth in revenues, whether it was upsell, new logo generation, and maybe just any color around that.

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Vincent English, Megaport Limited – CEO & Director [3]

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Thanks, Jonathan. Maybe I’ll just start with the North American one first. It’s probably the easiest. Yes, I think there’s a combination of a couple of factors, Jon. If you recall during the financial year FY ’19, which ended in June, earlier in that year, we did a substantial amount of investment in our sales organization and helping to break that out in terms of what direct and indirect channels. We’ve seen — I think we’re seeing the benefit now come true 1 year on of the full impact of that sales organization and the relationships we’ve built.

I think we’re also seeing the impact of the brand awareness and our partnerships coming from some of the data center partners. A lot of the data center partners that we have were through an indirect fashion or indirectly promoting and selling Megaport. And thirdly, we haven’t seen as much true network service providers and managed service providers. That’s something that we focused a lot on this half of the year and this financial year. So it hasn’t really been a direct attributable factor in terms of the results in North America as of yet. But it’s — majority of this has stemmed from our investment back in the first quarter of Q1 FY ’19, and we’re seeing the full impact right now come true into this — the first half of this financial year.

As it relates to the CFO, as I’ve said in the announcements, Steve is stepping down the role. He’s here beside me, so I can let him speak to that in a second. But we’re delighted he’s staying on to run our Investment Relations role. It takes a bit of pressure off of me, for that regard, traveling. But in terms of the search for the CFO, we’re beginning that this week, and we expect to conclude that in the course of the next 3 to 4 months. Maybe, Steve, you would care to…

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Steve Loxton, Megaport Limited – CFO [4]

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Sure. So I think the underlying question is whether there’s going to be any disruption. So I’m still around, still contributing to the business. We’ve just upgraded our ERP system internally. And no doubt, I will continue with that transition and make sure we have an orderly transition to the new CFO and an appropriate handover.

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Operator [5]

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Your next question today comes from the line of Sameer Chopra from Bank of America.

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Sameer Chopra, BofA Merrill Lynch, Research Division – Head of Australian Research and Co-Head of Regional Telecom Research [6]

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I had 3 questions. Firstly, you guided on EBITDA margins in Asia, in Asia Pac. I was just wondering if you could repeat those numbers. And what would be your expectations for the U.S. and EMEA? Do you think you can get the sort of similar levels? I think you use the 40% number in the conversation. That’s kind of first question.

Second question is…

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Vincent English, Megaport Limited – CEO & Director [7]

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Did you want me to take that first? Or are you going to give me all 3?

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Sameer Chopra, BofA Merrill Lynch, Research Division – Head of Australian Research and Co-Head of Regional Telecom Research [8]

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Actually, why don’t we do the first one, we’ll do them sequentially.

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Vincent English, Megaport Limited – CEO & Director [9]

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Okay. So did you want me just run down for the stats on APAC, again? Is that the first part of it was?

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Sameer Chopra, BofA Merrill Lynch, Research Division – Head of Australian Research and Co-Head of Regional Telecom Research [10]

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Yes, please.

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Vincent English, Megaport Limited – CEO & Director [11]

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Okay. All right. Data centers are at 79, up 11%. Ports, 2,157, up 16%. Monthly recurring revenue $1.7 million, up 26%. Number of customers, 731, up 9%. Total number of services, 6,384, up 16%, and then the reported profit after direct network costs, including the new leasing standard, is at 72%, up from 62% at the end of end of June. In terms of the operating leverage on the chart, on APAC, you can see there for the December ’19 exit run rate for the month of December, the profit after direct network costs is 72% for the month and regional APAC EBITDA number for the end of December — for the month of December is 37%. And when I was speaking to — and Steve and I have been speaking about the model and to analysts in general, we often talked about — often got the question what the steady state look like in a mature business. And it would start to look like this where you’re over 70% gross margin and you’re running towards a 40% EBITDA.

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Sameer Chopra, BofA Merrill Lynch, Research Division – Head of Australian Research and Co-Head of Regional Telecom Research [12]

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Okay. My second question was just on EMEA. And the customers in EMEA, what drives customer growth in Europe? Because it’s still quite soft relative to the — relative to U.S. and Australia. And what’s your kind of sense around when would that take off?

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Vincent English, Megaport Limited – CEO & Director [13]

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Sure. Yes, it is. I think Europe — the European business is the most — sorry, European region in terms of cloud connectivity, ICT, managed services is still very conservative. You can see originally from the original flat markets, which were Frankfurt, London, Amsterdam and Paris, and if you include Dublin, were the 5 major connectivity locations for the cloud. They’ve started to extensively break — branch out from there over the last 2 to 3 years and likewise, at the end of the last reporting period. Hence, we brought up more countries with Norway, Switzerland, Austria, et cetera, where there’s more and more cloud onramps being brought in. So because of data sovereignty reasons and conservatism around own data and where it resides and flow between countries. So a lot of that has been probably at the forefront of most buyers or IT users between both governments and security in terms of how they connect to the cloud service provider. And so the adoption of that is lower in Europe in general than it is elsewhere in the rest of the world based on our feedback. So I think it’s an element of just conservatism. It’s just a little bit slower. It’s going to take a little longer. But you can see from the charts in terms of where we’re managing the business, like the number of ports in the last 6 months grew 17%, number of services was up 19% and our revenue was up 13% as a result of that. And I think we’ll see that those trends continue for Europe. But even looking at the operational leverage, we’re very happy where it is, notwithstanding, we added 6 new countries in Europe and have the investment in the last financial year. We are very close to EBITDA breakeven within our business as we continue to focus on customers and services coming on into the network.

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Sameer Chopra, BofA Merrill Lynch, Research Division – Head of Australian Research and Co-Head of Regional Telecom Research [14]

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And just on that, Vincent, just to dive a little bit deeper, do you have customers in Europe that look and feel like the U.S. and Asia Pac, like customers who might have got 20, 30, 40 services? Or is the entire sort of European customer base quite conservative, and hence, you have that kind of 2.9 services per customer?

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Vincent English, Megaport Limited – CEO & Director [15]

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No. I think it’s a very mixed bag. The total service per customer is around 6.4 for Europe, which is a little bit down compared to other areas like in Europe — sorry, North America, it’s 6.9, so it’s only 0.5, the difference. In our APAC business, it’s 8.7. So it is lower than APAC and APAC has been our most mature. It was 6.9 in the U.S. versus 6.4 in Europe.

Now I will say each country in Europe is very different. So what we’re looking at here is a cluster of countries. For example, our U.K. business would be very similar to what the North America business looks like as would the Netherlands business and our German business. So those 3 would, at the moment, very much look like what North America looks like. And the rest of the countries are obviously in their infancy in terms of expansion brought into the cloud. We just recently brought up France. So we expect those to follow suit over the course of the next 12 to 18 months.

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Sameer Chopra, BofA Merrill Lynch, Research Division – Head of Australian Research and Co-Head of Regional Telecom Research [16]

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Great. Last question. You mentioned that some of the hiring done in the U.S. in the first quarter of ’19 has helped drive U.S. growth. I was just wondering if you could step us through, now that the capital raise has been done, what’s kind of your thinking around hiring plans in other markets, Japan, Europe over the next 6 to 12 months. Have you hired significantly through the December quarter? Are you hiring right now? Like what’s the kind of pace of your sales force?

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Vincent English, Megaport Limited – CEO & Director [17]

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Yes. I think on the sales force front, it’s not extensive. We’re doing it country by country. So obviously, with the launch of Japan, we’ve added 4 new staff across various different disciplines. Going from solution architects to network support to customer support, only because of the language and doing business there and just reach in helping customers. We will see a very indirect — very much focused on indirect selling, which should be selling through partners or through different channels as opposed to direct selling in some of these markets. For literally that reason, it’s just language and culture and doing business in some of these countries is very different. And so most of the hiring that we’re looking at now is — are across mainly our product engineering, software development as we continue to extend our portfolio of products and work with partners and customers on what else do they need. How further more can we abstract complexity from network decisions and allowing customers to connect to more things on the network or globally. So we’ve been very much focused on that.

Our headcount today is around the 190 mark at the end of December. So we will be adding circa maybe between 10 and 20 staff depending on the rollout and the build over the course of this next financial year. But a lot of the investment is aimed towards the network and then obviously, indirect selling as opposed to direct selling and enabling partners and how we manage and facilitate that. And the partners can be data center operators, that could be managed service providers, system integrators, network service providers and an indirect channel in general, depending on the market.

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Operator [18]

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Your next question today comes from the line of Tim Plumbe from UBS.

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Tim Plumbe, UBS Investment Bank, Research Division – Research Analyst [19]

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Just a couple of questions from me, if that’s the right. Just MCR 2.0, recognize that it’s still early days, but can you guys talk a little bit about the initial experience with the sales cycle, training up the sales staff, customer reception, et cetera?

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Vincent English, Megaport Limited – CEO & Director [20]

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Sure. Yes. MCR 2.0 is going really well. In fact, I can even tell you that our first customer in Japan who signed up this quarter took MCRs as our first product for the sole reason of connecting AWS to Oracle for their business. So it’s — we’ve been — we’ve done a lot of work on the network side of things with our solution architects helping customers understand how MCR works and how MCR can help solve a lot of problems for cloud-to-cloud connectivity and their data needs.

So we’ve kind of tackled it more on a technical aspect and a solution — how to help them have a solution for their problem rather than, I suppose, direct selling.

So Tim, it’s going really well. And the 2.0 is going well in the U.S., it’s going well in the U.K., and it’s going well in Australia and recently in Japan. So it’s — I don’t know if that helps, but it’s more on the technical side of things where we actually — our solution architects are involved in helping the customers more with their solution on their connectivity rather than the customer coming on board and just using an MCR directly in the initial periods.

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Tim Plumbe, UBS Investment Bank, Research Division – Research Analyst [21]

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Got it. Got it. And that $4,700 number that you guys use per MCR customer, I mean, how much high would that be if you just looked at an MCR 2.0 customer?

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Vincent English, Megaport Limited – CEO & Director [22]

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About 40%.

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Steve Loxton, Megaport Limited – CFO [23]

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It’s about 30% high.

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Vincent English, Megaport Limited – CEO & Director [24]

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It’s about 30%.

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Tim Plumbe, UBS Investment Bank, Research Division – Research Analyst [25]

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And just last question from me, just Japan, again, if you can talk about the initial experience, sales cycle, customer reception, et cetera?

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Vincent English, Megaport Limited – CEO & Director [26]

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Yes. So we launched in our Japan market — as you can see from the slide, we launched in Japan market towards the end of November. We had a special launch event there. We had over 150 people attend, which effectively — which was quite amazing. In the room, we had all the data center operators, we had all of the system integrators, managed service providers, and we had cloud service providers, which, in effect, when you think about in the room, they’re all in some shape or form in competition with each other. But because of our neutrality in our stance and because we’re the first software-defined network was very well received, a lot of — we’ve had a lot of partnership discussions, which are ongoing right now in terms of deploying and working with them as a resell model. So in that regard, and even following through with the PTC conference that we had in January, we had the same follow-up conversations from those. Like I said earlier on, our first customer came on this quarter and was very much around a solution to help the customer fix the solution between cloud connectivity from one cloud provider to another so they can move their workloads and data.

And so it’s very much — the Japanese market is very much 2/3 of all business or 70% of all business is done through an indirect channel, in general, how an enterprise consumes ICT or IT services. So we’ve been very much focused on that element, which fits in with how we want to operationalize it. Instead of having a lot of direct sales people, we want to focus on the indirect sales for doing business in Japan. And that’s the way it’s typically done anyway. So it kind of dovetailed nicely for us in terms of how we’re doing that.

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Tim Plumbe, UBS Investment Bank, Research Division – Research Analyst [27]

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Got it. And just last one, just a follow-up from Sameer’s question. When you were talking about the EBITDA and GP margins, is that — that’s pre AASB or post AASB?

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Steve Loxton, Megaport Limited – CFO [28]

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All of these are as reported. So that is post AASB 16. You’ll see, on every page, we’ve put the like-for-like comparison, ignoring AASB impact in the footnotes.

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Tim Plumbe, UBS Investment Bank, Research Division – Research Analyst [29]

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Yes. No, sorry, I was meaning the longer-term targets that you were talking about. I mean, talking to the longer-term target, is that on a pre AASB basis?

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Vincent English, Megaport Limited – CEO & Director [30]

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Well, the 40% would have been, yes.

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Operator [31]

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Your next question today comes from the line of Paul Mason from Evans & Partners.

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Paul Mason, Evans & Partners Pty. Ltd., Research Division – Executive Director of Technology [32]

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Just a couple from me, but I’ll ask them in sequence. So the first one, just on your sales force and the contribution that you’ve got, I suppose one of the expectations that I’ve been running with was that in the second half of this year, so starting in the third quarter, you guys were going to see a little bit of an uplift in your incremental MRR. I’d like to say, you’ve added about $500,000 of MRR every quarter over the last few quarters. And given the sales assets you’ve put on, I sort of had an expectation that was going to pick up.

Can you maybe comment on whether you guys are expecting something similar? Or whether the current trajectory of about $500,000 incremental is sort of going to be the run rate that you guys are thinking towards?

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Vincent English, Megaport Limited – CEO & Director [33]

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Okay. No, I think our expectation is that it will pick up on the run rate. I think just this quarter that we’ve gone in December, notwithstanding the reported numbers that you see in front of you. In North America, you really have to think about this is that it’s a 2-month quarter because you’ve got Thanksgiving towards the end of November, which you tend to lose pretty much a week, and then you’ve also got the Christmas period, which you tend to lose the last 2 weeks of December. So notwithstanding the December month, it really is only a 2-and-a-bit-month quarter. Not as much of an impact in Europe in terms of it tends to be the last week of December. And similarly here, the last 2 weeks of December kind of tends to open. Our North America business, notwithstanding what the numbers have reported, which have been — which we’re quite happy with on a normal run rate and a normal full 3-month basis, they would be higher.

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Steve Loxton, Megaport Limited – CFO [34]

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And underlying that question, Paul, I think, is your — is the one around staff in the sales team. I think you’ll recall that as at June, we had 30 people on the frontline selling. We’ve increased that as of December to 36 and the split there is 25 direct sales and 11 account managers.

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Paul Mason, Evans & Partners Pty. Ltd., Research Division – Executive Director of Technology [35]

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Great. Now can I — just a second question that’s sort of different [check]. You guys seem to have reiterated your target for 380 data centers by the end of 30 June, so that obviously implies like a bit of a pickup in pace. So how should we think about that in terms of the other elements of your CapEx? Like I know in the first half of this year, you’ve done a lot on MCR and also on retrofitting existing pops with higher capacity. So is there going to be a bit of a substitution? Or is it just going to be like a more elevated CapEx program in the second half altogether?

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Vincent English, Megaport Limited – CEO & Director [36]

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It — it’s probably more of a substitution. We’ve done a lot of the heavy lifting that we wanted to do around MCR at this stage. And so now it’s only on an incremental or a new site or a new metro basis going forward. If you recall, this time last year, we were also — we gave our original target for 300 sites that we wanted to end of the financial year on. And it was very much skewed towards Q3 and Q4 in terms of our build-out. So this year, we’ve adopted the same approach. When you add on that many sites, I think we added 36 sites in our Q4 to the period ending in June, we wanted to make sure that, first of all, our sales organization, our data center partners and our sales machine, in general, was able to monetize those over the first half of this year. So we’ve been very much focused on that. We also brought up Japan, which is, as I said earlier on, is a brand-new country, and that, obviously, took a fair bit of effort to get that done. So we’ve been focused on that as well as we’ve been focused on the cloud reach. So we’ve been — they’ve been kind of very heavy focus areas for us in the first half of the year. So now we’re going to switch pretty much back to deployment mode and we’ll have a significant amount of work to do this quarter. And obviously, the last quarter will be very similar to the format that we had for the previous financial year. And CapEx-wise, it will be somewhat similar first half to second half.

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Paul Mason, Evans & Partners Pty. Ltd., Research Division – Executive Director of Technology [37]

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Okay. Just on sort of a similar tact. So also one of your main data center partners, Digital Realty, has being pretty busy. They bought a center last year in Brazil, they’ve probably gone to Korea, and they’re in the midst of a potential massive merger with Interxion. And so just in terms of all those activities from them, like is part of your plan just to basically once they close on those things — or in case of Ascenty, given they already are not, is that a large part of what your second half rollout is going to be? Or should we be thinking about it more as in existing markets where you’re sort of backfilling second to your data centers?

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Vincent English, Megaport Limited – CEO & Director [38]

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No, you’re right. I mean, Digital Realty, are a close strategic partner of ours and the acquisition of Ascenty, while it’s meant to happen towards this time last year, it’s taken a while for all that to settle down. And obviously, how they manage their own business.

We are going to add on 4 more countries before the end of June. I’m not going to say which ones because I don’t want to tip my hand. But — so there will be a combination of new markets as in new countries and then also new metros in existing countries or existing markets we’re in. But I’m looking forward to the transaction with Digital Interxion concluding, because I think — to the earlier question on Europe, I think that will — having Megaport and having a data center operator as strategic as that help us — will increase our sales and our target addressable market for our European business with the Interxion footprint.

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Paul Mason, Evans & Partners Pty. Ltd., Research Division – Executive Director of Technology [39]

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And just last one for me. When Jay Adelson came to the Board, you guys were flagging there’s going to be an innovation committee and associated budget, but you guys haven’t really talked about that much today. So is that still planned to have a budget allocated to it? Or does it already have a budget allocated to it, but it’s just not a big line item? Could you maybe give us some color on what’s going on there?

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Vincent English, Megaport Limited – CEO & Director [40]

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Sure. Well, we actually had our innovation committee meeting earlier this week — sorry, last — latter part of last week. We have them very frequently. So a lot of the conversations that are happening in and around the innovation committee are about the steering of the new direction or the new products that we want to get into. In terms of our CapEx, it’s not that we’re going to necessarily allocate CapEx to the innovation committee. It will be spent based on approvals or recommendations from the innovation committee for us as a business to deploy. So it’s not like we’re going to — I just want to make sure I’m clear on that. We’re not actually allocating a set amount of money. It will be whatever the business and the Board approve on recommendations from the committee that will then form a part of our business as usual and how we deploy that. So a lot of that is around product features and new developments as well as architecture. Do you want to add?

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Steve Loxton, Megaport Limited – CFO [41]

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Yes. And Paul, it’s Steve. If — the guidance we’ve given, you’ll see in the share price document and previously of $18 million or $19 million CapEx sort of year-on-year. That includes in that — in those indications that includes an expectation that there’s some spend related to the innovation committee.

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Operator [42]

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Your next question comes from the line of Ash Chandra from Goldman Sachs.

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Ashwini Z. Chandra, Goldman Sachs Group Inc., Research Division – Equity Analyst [43]

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Just a couple of quick ones for me, given most of mine have been already answered. You talked, I think, last quarter about trialing some price rises or pushing some price rises through. Can you talk to us a little bit about what your experience with that has been so far? How that’s informing your sort of future pricing strategy? Yes, any pockets or areas or services that we might see a little bit more — a stronger push on repricing over the next 12, 24 months? That’s the first question.

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Vincent English, Megaport Limited – CEO & Director [44]

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Okay. Yes, we had a small segment of our business where we just rebalanced our pricing, particularly around less than 1 GB ports or 1 GB capacity. It didn’t have a significant impact on our business. It was more — mainly for us just tidying up things and making it simpler and easier. We continually look at pricing in general. So for example, with the launch of our Japan market, it’s very hard to draw comparisons with — in-market rates are very different from — without a software-defined networking in that. So we get a chance to relook at our position and relook at our pricing rather than adopt existing prices and converting them into yen. So I think it’s something that we always continue to look at. And the real change for us is as we move from layer 2 products and move up into layer 3 and we add more features and functionality and it creates a higher value-added product and so it gets — it allows us to demand a different set of pricing for those services and products, and that’s what — as more of a solution and a more — it removes complexity and brings more value-add to the customer, we get to demand a different set of pricing for those product features.

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Ashwini Z. Chandra, Goldman Sachs Group Inc., Research Division – Equity Analyst [45]

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And so those new feature sets as they rollout will be like MCR, premium price services that sit on top of what is otherwise a competitive baseline offering?

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Vincent English, Megaport Limited – CEO & Director [46]

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Correct.

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Ashwini Z. Chandra, Goldman Sachs Group Inc., Research Division – Equity Analyst [47]

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Is that how we should be thinking about it?

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Vincent English, Megaport Limited – CEO & Director [48]

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Yes.

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Ashwini Z. Chandra, Goldman Sachs Group Inc., Research Division – Equity Analyst [49]

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Okay. And then the other question I’ve got is, just in general terms, what’s — what are you noticing with respect to or what’s happening in the business with respect to churn rates across your portfolio? Obviously, it’s not stumping your capacity to hit where the market is, at the moment, benchmarked on revenue growth expectations. But yes, just interested to get your thoughts on stickiness of customers now that you’ve been in the market now for several years. Any comments you could make in and around that?

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Vincent English, Megaport Limited – CEO & Director [50]

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Yes, it hasn’t really changed much since — it’s a question we keep getting asked pretty much every period and in separate kind of analyst meetings. It hasn’t really changed much. What we’re finding is more and more customers are coming onto our network because I suppose there’s — I keep calling it like there’s 3 axes that are kind of really important for our business. One is geographic footprint and reach. So customers now are not local and region-ed. They’re now looking at more [expansive] locations, particularly larger multinational companies with subsidiaries and with businesses in multiple locations, not just in one country, but like, for example, or Europe, North America or in Asia, Australia, we’re able to connect together.

I think also the advent and multi-cloud has driven up the number of services and the ability to use that and connect to that as well as most cloud service providers have the — are asking customers really to have both a primary and a secondary port for redundancy purposes and for SLA purposes, connecting into cloud service purposes.

So a lot of that starting now to filter through in terms of customers using that. And typically, once it’s installed and set, it tends to be left alone because it’s critical infrastructure they’re connecting together and they’ve got critical data needs and data flows that they’re using across the cloud service provider. So it tends not to be disturbed. Sure, they can scale it up and down in terms of the amount of traffic they’re putting through it at any point in time in the day or night or in a month or in a year, but the ability for it to stay there and to be in use, we’re seeing that continue. So churn hasn’t really been — hasn’t really changed much from that. We’re obviously very focused on adding more and more customers, and I think as Steve mentioned, our account management team that we’ve invested in is really important as we continue now to work with our existing customers just as much as we’re working on bringing on new customers, so that we’re constantly supporting them both from a solution point of view, additional features and functions, a choice of regions and cloud availability, et cetera. So that stickiness remains.

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Ashwini Z. Chandra, Goldman Sachs Group Inc., Research Division – Equity Analyst [51]

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And maybe I’ll just squeeze in one last one. Again, it’s a relatively standard question. Anything in the last 6 months that’s kind of change in the competitive landscape given at least one of your competitors raised a bit of new money in the last 6 months or so? Yes, anything at all that you’re bumping up against in Japan, Europe, North America?

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Vincent English, Megaport Limited – CEO & Director [52]

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No, the short answer. I don’t know how else to explain it. But no, we don’t come across that at all. Like I said, in Japan market, we’re the only software-defined network. So we actually have a lot of businesses and partners who are looking to use Megaport as a differentiator because nobody has it, and I think in — I think is a testament to our growth with our cloud service providers and the number of customers we’re getting, we — our cloud service providers are actively promoting Megaport as a way to connect to your AWS, your Azure, your Google or your Oracle or your IBMs. Within each of those organizations, they see it as a huge value-add.

So we do tend to get a lot of self-promotion internally in the organizations to use Megaport to connect to their services because it works, it connects, it’s seamless. You can provision services. Like I said, in the value proposition, you can connect services seamlessly. And as I said before, our competitors can’t do that.

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Operator [53]

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Your next question today comes from the line of Bob Chen from JPMorgan.

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Bob Chen, JP Morgan Chase & Co, Research Division – Research Analyst [54]

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Just a few questions for me. Just in terms of regional expansion post Japan, you mentioned a few sort of new countries that you’re entering into. I mean, is it getting more difficult to identify new sort of data center locations or regions, especially given what you’re seeing in terms of slower adoption of cloud services outside your, sort of, Tier 1 cities?

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Vincent English, Megaport Limited – CEO & Director [55]

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Well, I don’t think I said slower reduction in Tier 1 cities. I think I mentioned slower adoption in Europe, in general, just because of the conservative nature of it. Look what tends to happen is, I think, I explained this to a few people before. With the cloud service providers themselves, we have what we call our QBR, quarterly business review, with them on an ongoing basis. And we work through where they’re going next, and why they’re going there next, and then how we can complement them. So we get a lot of our steer and our direction and our planning for the next 6 months or next 9 months from what they are doing.

We consolidate that with our existing data center partners to see if they’ve got footprint in those markets or those regions so that we can overlay a build-out properly. And so that tends to be how it starts out. Then we typically reach out to new partners that we have in the region, our new data center operators who will be in a region that maybe they’re not elsewhere with us on our network, and we tend to see if they can complement or we can complement what they have to see if that works. And we overlay one over the other for a new country.

The more important issue for us in terms of why it might not be as fast or why it’s — why we take our time with some of this is that, as you recall, for the last 2 years, we’ve been — the last 3 years, we’ve been heavily invested in making sure we got our North America business right, with the right partners, with the right team and giving it enough time, so we didn’t distract ourselves going too fast, too hard into new regions and new countries, which can be a little bit more complex. And the — this first half of the year, with the launching in Japan, is a combination of probably 12 months’ work by a small group of — a small team in Megaport, who’ve been focused on that and making sure we’re making the right moves, right partners, we’re making the right moves with the locations and why — how our go-to-market business is going to look like for Japan. And similarly, like I said, in other countries we’re doing the same thing. So we’ve got a kind of a pipeline of that. And we’re just making sure that we don’t overload ourselves. It’s easier to build into existing markets where we’ve already got a footprint and we’ve already got a team. It’s a little bit harder when you’re starting from scratch, and we just want to make sure that we do it right the first time. So I would say it’s difficult because each one has its own unique set of challenges. It’s understanding that and making the right decision at the right time of how we do that, which is likely important. So it takes a little bit of time.

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Bob Chen, JP Morgan Chase & Co, Research Division – Research Analyst [56]

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All right. Great. And then in terms of sort of partnering with some of the cloud service providers, I mean you’ve got most of the major logos on there. Are there any further opportunities to look at maybe some of the other sort of Tier 2 cloud service providers to add on to the network as well?

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Vincent English, Megaport Limited – CEO & Director [57]

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Yes. And we’re actually in the middle of a lot of that at the moment. Sorry, that’s the short answer. I don’t want to tip my hand.

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Bob Chen, JP Morgan Chase & Co, Research Division – Research Analyst [58]

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Yes. Sure, an easy one. And then just to recap. So previously you mentioned that you’re not really seeing too much competition in the market. I mean, I just saw some reports around sort of Pureport and PacketFabric doing a bit of a partnership in North America. Have you sort of met with them at all? Because it looks like Pureport is targeting that sort of multi-cloud sort of connectivity piece as well.

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Vincent English, Megaport Limited – CEO & Director [59]

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Yes. I mean, I’ve heard of them, yes. We’ve — they’re a small regional player. But again, I think like everything else, we need to do the research and understand why exactly their product offering is compared to what we are doing. So it’s not a like-for-like comparison.

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Operator [60]

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Your next question comes from the line of Roger Samuel from Jefferies.

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Roger Samuel, Jefferies LLC, Research Division – Equity Analyst [61]

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I’ve got a couple of questions. First one is just on your outlook. I remember at your 2Q trading update, you mentioned that you are very focused on achieving profitability and also EBITDA improvement quarter-on-quarter. I’m just wondering if you’re still standing by that comment.

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Vincent English, Megaport Limited – CEO & Director [62]

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Yes. I mean, I think we can see that from when we introduced the regional charts today and the operating leverage. So you can see what the exit run rate in each of the regions are and how they’re all tracking month-to-month. So I think, yes, the short answer.

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Roger Samuel, Jefferies LLC, Research Division – Equity Analyst [63]

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Yes. Okay. And second question, just on the corporate costs. Looks like there was a big step-up in cost from $6.7 million in the PCP to now $10.7 million. Just wondering what’s the driver of that step-up in costs? So is this outside of regional countries?

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Vincent English, Megaport Limited – CEO & Director [64]

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Maybe I’ll let Steve take that one.

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Steve Loxton, Megaport Limited – CFO [65]

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Sure. The principal driver of those costs is headcount. I’ll start with our sales and marketing expenditure sits in OpEx. This is different than how some other people do it. And within that, our largest driver of that is direct salespeople and their sales incentives and commissions. We’ve also got some additional costs like we’ve opened the San Fran office and a few other things like that coming through. And you’ll recall that each of these sequentially will pick up the impact of decisions that we’ve made in the second half of FY ’19. So what we’re experiencing now is a full year of that flowing through. What we’re obviously looking to do is keep tight control over those OpEx costs so that the operating leverage you see coming through on a regional basis also flows through on a group basis. I think that’s on Slide 12.

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Roger Samuel, Jefferies LLC, Research Division – Equity Analyst [66]

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So just on sales and marketing, so you don’t really allocate those costs into each region?

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Steve Loxton, Megaport Limited – CFO [67]

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We do where it’s directly impacted, yes, but there’s also an element of that spend that’s actually covered off in overall the group, and it’s not necessarily allocated. So it’s for the whole of the business, so you can’t really direct it as marketing and sales for the company.

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Operator [68]

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Your next question comes from the line of Gary Sherriff from Royal Bank of Canada.

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Garry Sherriff, RBC Capital Markets, Research Division – Executive Director of Equity Research & Head of Australian Technology and Small-Mid Caps [69]

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Yes, most of my questions have been answered.

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Operator [70]

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We have no further questions on the line. I would now like to hand the call back to management for closing remark.

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Vincent English, Megaport Limited – CEO & Director [71]

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Thanks very much. Thanks, everybody, for joining on our call. We’re available over the next couple of days. If anybody wants to reach out for one-on-ones, we have some time scheduled in Sydney over Thursday and Friday. And then if anybody needs to do any one-on-one calls or anything like that, we’re available to schedule those. Other than that, thanks, everybody, for participating on the call.

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Operator [72]

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Ladies and gentlemen, that does conclude today’s conference call. We thank you all for your participation. You may now disconnect.

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