Below is the edited transcript from the ARQ earnings conference call
Half Year 2019 ARQ Group Ltd Earnings Call
Victoria Aug 23, 2019 (Thomson StreetEvents) -- Edited Transcript of ARQ Group Ltd earnings conference call or presentation Thursday, August 22, 2019 at 10:59:00am GMT
TEXT version of Transcript
--
Conference call participants - Mark Bryan - Wilsons Advisory and Stockbroking Limited, Research Division - Head of Research
--
Ladies and gentlemen, thank you for standing by, and welcome to the Arq Group Limited First Half 2019 Results Conference Call. (Operator Instructions) Please be advised that this conference is being recorded today.
I would now like to hand the conference over to your first speaker, Martin Mercer, CEO of Arq Group. Thank you. Please go ahead.
--
Martin Mercer, ARQ Group CEO:
--
Well, good morning, and welcome to the first half 2019 results presentation for Arq Group. My name is Martin Mercer, and I'm the CEO. And I'm joined by Fraser Bearsley, our CFO.
I'm going to start the presentation on Page 3 of the deck. I'm going to provide a summary of the results. And then as we go into the deck, we're going to talk to the group result. We're going to talk to the core and noncore results. We're going to talk about the recovery, what's been done and what's the impact been with the focus on SMB and Enterprise Services. Then we'll talk about net debt and covenants. And then I'll conclude with another summary.
So the first half really has been a story in 2 parts. There's been a really pleasing strong bounce back in the SMB division. But unfortunately, it wasn't enough to offset a challenging first half for the Enterprise division. Our comprehensive recovery plan has been implemented, and it is delivering results. So the SMB division had a very pleasing first half. Sales of subscription digital revenue are back to historical levels, and core underlying EBITDA was up 57% on the prior corresponding period.
Now it's early days in the Enterprise recovery. The momentum is building, and we'll talk more about that in the -- as we get further in. And of course, the return to performance is going to be underpinned by cost reductions, and we've got annualized savings of $3.5 million so far this year, and we expect another $2 million are to come out in FY '20. Our net debt position is improving. It improved quite considerably after we received the sale proceeds from TPP, and it now is expected to steadily improve over the remaining -- the remainder of this year and into the new year. Net debt sitting at around $51.6 million at the end of July. Our leverage ratio was about 2.1x. We expect to be back within our published target range of 1.25 to 1.75x towards the end of the first half of FY '20. And we will be reaffirming our full year guidance for 2019. The first half underlying EBITDA for the group was $9.6 million, and full year guidance is in the range of $27.5 million to $30.5 million. And that achievement of guidance is underpinned by a recovery in the Enterprise division in half 2. I will say that we're on track at the end of half 1, and momentum is building with each month.
Turning now to Page 4, and I'll take you through a summary review of the group results. At the end of the first half, we're actually slightly ahead of where we expected to be. We had revenue of $90.9 million, which is down about 19% on the prior corresponding period. Underlying EBITDA of 19.6 -- sorry, of $9.6 million, which is down about 62% on the prior corresponding period.
And as I mentioned on the previous page, it really was a story in 2 parts. Enterprise revenue has been down due to both a delay in turning on new revenue in the first half and also a shortfall in new business in the first half, particularly in Melbourne. I'll talk about the encouraging signs of improvement we're seeing there in a little while. But unfortunately, that dragged down Enterprise results. We have seen improvement steadily over Q2, and the pipeline for H2 is actually building steadily. From the SMB point of view, it was a very pleasing result. While revenue was down, underlying EBITDA was up over 10% to $10.4 million. The recovery is underpinned by sustainable cost-saving initiatives which delivered $3 million of annualized savings already. But as we move into H2, I expect to see the recovery in SMB driven by revenue growth rather than cost reduction.
Net debt is down to $51.6 million following the sale of TPP. And our net leverage ratio, we're sitting at 2.1x at the end of July, which is comfortably within covenants.
I'm going to turn now to Page 5, and we'll talk about the core and noncore results. Now you might recall that at the start of this year, we actually started presenting our results slightly differently. And this was really precipitated by the decision to exit the indirect part of SMB. And so we described the indirect part of SMB as noncore, and everything else was core. This table here presents the core and noncore performance. Most of the table is core, as you can see. Reading left to right, we have Enterprise, which is part of our core business. We have SMB direct, which is part of core, corporate costs, which are taken up in core, which gives you the Arq group result. And then finally, SMB indirect, which is the noncore part of the business.
Now Fraser will talk more about this later on, but at the start of this year, we adopted a new accounting standard for the treatment of leases, AASB 16, which has an impact on reported EBITDA. This impact has been taken through corporate. So the segment results on this page are comparable to the prior year. And Fraser will talk more about AASB 16 in a little while. So core underlying EBITDA of $3.6 million for the half was up on the $3.1 million that we had expected back in June. And it's made up of 2 parts. Again, SMB direct is up 57% on the prior corresponding period, and that's driven by a material reduction in OpEx. As I said previously, the H2 performance, we expect to be up on the prior corresponding period last year. But this time, it will be driven by revenue growth rather than by cost reduction.
Unfortunately, the great result in SMB was not enough to offset the disappointing performance in the Enterprise. We had a poor H1 driven by revenue. And revenue being much lower than expected and lower than the prior corresponding period, the comparison to the prior corresponding view was always going to be hard because we had an exceptional contract in the prior corresponding period, but we didn't do ourselves any favors at all by having a poor execution in the first half.
We'll talk about the recovery plan later, but I will say sweeping results. I'm going to hand over to our CFO, Fraser Bearsley now, and he's going to talk us through the impact of AASB 16.
--
Fraser Bearsley, ARQ Group CFO and Company Secretary:
--
Thanks, Martin. And as mentioned by Martin, this is the first financial period under which the group's reported under a new accounting standard for leases, being AASB 16. As a result, we presented the half year results for the current half under the new standards and also the previous standards so we can ensure that there's a like-for-like comparison with the prior year results. I'll first speak to the results under the previous standard before moving to the impact of the adoption of AASB 16.
So as Martin said previously, group revenue was down to the prior half as a result of the delays in several key enterprise projects in the current half as well as some executional challenges in our Melbourne office. These factors, combined with a compounding impact of lower new solution sales in our SMB business in the prior year, has resulted in a drop of revenue of around $21.5 million or 19% from the prior comparative period. So that decrease in revenue has flowed through to gross margin, albeit not at the same rate due to savings in variable costs. The gross margin as a percentage of revenue has been impacted by a change in revenue mix in both the SMB business and the Enterprise business, reducing from approximately 56% in the prior comparative period to about 53% in the current half. We anticipate that that's relatively temporary though, and we do expect to see an improvement in this margin moving into 2020 as revenue growth recovers.
Pleasingly, operating costs have decreased in the current half as a result of a cost reduction program implemented primarily in SMB business with about $3.8 million in sustainable annualized costs already removed from the business. We're currently still in the process of reviewing our cost base to identify further opportunities over the second half. Putting those all together, these factors have resulted in an underlying EBITDA of $7.1 million prior to the adoption of AASB 16, the new accounting standard, with core operations generating $1.1 million of that balance. This is up slightly on our previous guidance of $0.6 million as disclosed in June.
The impact of -- just moving on to the impact of the new leasing standard. So this came in on 1 January 2019. Importantly, it has no impact from a cash perspective, but it does move around the accounting treatment from a balance sheet and a profit and loss perspective. Essentially, it's a reallocation of lease costs from -- the key impact on P&L is a reallocation of lease costs from operating expenditure. So above EBITDA to depreciation and interest cost sitting below. So this is the effect of nominally increasing EBITDA. For the current half, that impact is about $2.5 million. However, there is a corresponding offsetting impact to depreciation and interest. It has a minimal impact on net profit after tax. On the next page, we've included a reconciliation of -- between the old standard and the new standard, so you could see that in detail and how that impacts the P&L.
I'll pass back to Martin now.
--
Martin Mercer, ARQ Group CEO:
--
Thank you, Fraser. So I think that takes us to Page 8 of the presentation. So we had a challenging first half, especially in Enterprise division, and this has sadly taken the gloss off what for us has been a hard-fought history of consistent growth. Now we're determined to address the performance challenges and get back to growth. And what I'm going to do now is turn to the recovery plan and talk about what's been done and the progress we're making and the impact that it's having.
So if we go to Page 9, this is more of a summary page, but the recovery in SMB is largely complete, and we enter H2 2019 with a much stronger business in SMB. And the recovery plan for Enterprise is only just beginning. It's a work in progress, but there is encouraging signs. The table summarizes on the left-hand column the issues we encountered. And in the right-hand column, it summarizes the current status. So for SMB, we lost momentum in new solutions sales back in the second quarter of 2018. And that continued for 5 consecutive months. Now because this is subscription revenue, it had a compounding impact on H2, which meant that we had a poor H2. And our stepping off point for 2019 was much lower than our entry point for 2018. So we have a big mountain to climb. Now we've made a lot of progress. We've had a big focus on sustainable solutions growth, and that started to deliver results. We've had consistent month-to-month increases in new solutions sales from January right through to June. The trend has continued into July and August, and we're now back to historical sales levels. And we believe this is a sustainable trend.
For Enterprise, the challenges emerged much more recently. We had a delay in turning on new revenue in the first half. And as Fraser has mentioned, we also lost momentum in signing new business in Melbourne in the first half. We're seeing really encouraging signs on both fronts from -- revenue is now -- revenue from new contracts is now coming online as expected. And we have a growing pipeline of new opportunities. And in a very pleasing and pretty symbolic development, we won our first mobile project with a value of greater than $1 million in Melbourne in the last 6 months, which is a wind in the sails for the team, but also a function of the hard work that the team has been doing to turn that around.
From a debt perspective, we've had a fair few headwinds when it comes to debt. The biggest one has been a dispute with a major customer, and we currently have $9.5 million in withheld invoices. And to compound that, we had disappointing first half in Enterprise division. So we generated less cash than we expected to in the first half. Notwithstanding that, we're operating within covenants. As I said before, we expect to be back within our target range of the net leverage ratio by late in H1 2020. And a lot of the challenges were offset by the great work that Fraser and his team have done on cash conversion, which was above 100% in the first half, notwithstanding those withheld payments.
If I turn to Page 10, this is a bit of a snapshot of the changes that have been made across both people, governance, process and tools to address the root causes of the challenges that are -- we experience in SMB and more recently Enterprise. I won't go through them all, but the things that have really had a material impact in SMB, it was the restructure of -- redesign of the operating model across digital sales, account management and fulfillment to provide a much better customer experience, but also solutions that will more appropriately meet customer needs. And you can definitely see the benefit of that. We've had 8 consecutive months now of month-on-month growth. And our -- at the same time, our churn rates are down as a consequence as well. We've undertook -- taken a similar restructure in our Enterprise business, and it's been completely restructured in late June from a product-led to a customer-led focus, and we're seeing the benefits of this. I mentioned the mobile deal in Victoria, but we're seeing growing momentum in new customer acquisition in both Sydney and Melbourne, and it's different accounts, so Melbourne is getting its mojo back.
Another sort of key change has been around governance. We've removed a layer of senior management in late June. That's ensuring a much faster flow of information. And we also, Fraser and I, are now leading the weekly sales and revenue meeting, which is leading to a higher degree of rigor and a lot more integrity in the information that's being received. These -- a lot of other changes are being made, put them all together, and we're confident that the recovery is going to be delivered.
If I go to Page 11, this is a little more detail around the recovery in SMB. What we've done here is we've indexed revenue, new subscription revenue, starting from March 2018. Now why March 2018? Because it was in the second quarter of 2018 that we saw that decline in new subscription revenue. As you can see, we had 5 consecutive months where new subscription revenue was down. We had a bit of a [false tone] in the third quarter. Sadly, it was unsustainable. It was driven by an increase in sales incentives, which you can't make the horse run faster forever. And so unfortunately, that ran out of steam. We have a seasonal decline, as you can see, through December, January and February. In the second half of last year, we fundamentally restructured or redesigned the business model in our SMB business, as I mentioned before, completely changed the way sales work together with fulfillment, work together with account management. And you can see the benefits of that. Starting in March, we've seen consistent growth month on month on month. That trend has continued into July and again into August. In August, even at the mid -- just past the halfway mark in August, we're on track for August to be a better month than March 2018 was, and we expect this trend to be sustainable. At some point, it will plateau, but it will plateau at a level that's much higher than where we were back in March 2018. So we're very confident that the recovery is in SMB. And I expect the half -- second half of 2019 to be materially up on the second half of 2018, driven by revenue this time, not by cost.
If I go to Page 12 of the presentation, it's a similar picture, but this time for Enterprise. And we're looking at revenue per billable day. Now you might ask why we've gone right back to the first half of 2017. And this is because the comparison with the first half of 2018 is distorted. It's distorted because of the inclusion of an exceptional contract in 2018. If you look at first half of 2019 compared to the first half of 2017, you can see that 2019 is slightly up on first half of 2017. Now that's not nearly good enough because we want to be growing, not tracking sideways. And so if you look at the first half of this financial year, you can see an improvement start to emerge in June. And I can say that the pipeline for the rest of the second half is building steadily. We've seen consistent upward revisions month-on-month to the pipeline since June. Now the recovery in H2 is going to be critical to achieving guidance but acts as springboard to a good year in 2021. It's a work in progress, but we're seeing some very encouraging signs, as I mentioned, and the recovery we've engineered in SMB gives us confidence that we'll engineer a similar recovery in our Enterprise business.
So with that, I might hand over to Fraser. He's going to talk about the balance sheet and specifically net debt.
--
Fraser Bearsley, ARQ Group CFO and Company Secretary:
--
Thanks, Martin. As Martin mentioned before, net debt, it currently sits at about $72.3 million at the end of June. However, subsequent to this, the sale of the TPP reseller business was completed, and the group received $21.3 million of upfront consideration from the purchaser with a further $3.1 million to be received over the next 2 years. Now that was used to retire debt, bringing our net debt subsequent to 30 June down to $51.6 million, and that implies a net debt-to-EBITDA leverage ratio of about
(technical difficulty)
Importantly, we continue to operate within our banking covenants and forecast to do so going forward. And what we've seen is with the bulk, the position of net debt was largely driven historically by a number of one-off cash outflow events relating to the fit-out of new offices in Melbourne, Brisbane and Sydney, the launch of the Arq brand and earnout payments relating to Infoready.
Importantly, most of those are now behind us, with just the remaining portion of the third and final earnout of Infoready due by the end of this calendar year. So once that's done, combined with what was a pretty strong half in terms of free cash flow conversion, we anticipate that, that will continue going forward. For the half, it was 123% of EBITDA, once allowing for that customer dispute that Martin mentioned earlier. So once that's underway, we expect that with no more extraordinary cash outflows once we've completed the earnout payment. Combined with that healthy cash conversion, we expect net debt to continue to decline and for the group to be back within our target range of between 1.25 and 1.75x EBITDA by late in the first half 2020.
With that, I'll pass back to Martin.
--
Martin Mercer, ARQ Group CEO:
--Thanks, Fraser. So we're in the home straight now. We're on Page 14, which is the outlook slide. As I mentioned before, we're affirming guidance. Our guidance -- we've had to restate guidance for the impact of AASB 16. Previous guidance was prepared in the basis of the old standard. We've restated the guidance for the new standard. What I want to make very clear is that there's been no effective change to the original guidance. So you can see Fraser mentioned that the impact of AASB 16 in the first half was $2.5 million of EBITDA. For the full year, that's $5 million of underlying EBITDA. So you can see what we've done simply is increase the original guidance or restate original guidance by $5 million. The achievement of guidance is really going to be driven by a recovery of the anticipated recovery in Enterprise in the second half of the year. There'll be a modest contribution from SMB, but the heavy lifting has to be done by Enterprise. And so I expect you'll be closely tracking our performance on that front over the months to come.
Finally, I'll just conclude. So the recovery is delivering for us, as I mentioned, SMB was up 57% on the prior corresponding period. It's early days in the Enterprise, but very encouraging signs. Cost savings are delivering a nice foundation. Net debt has kind of steadily improved within our published target range of 1.25x to 1.75x by the first half of 2020. We've affirmed our full year guidance. We're on track. Momentum's on our side. With each month, we're improving. I look forward to delivering the full year results February next year. Thank you very much.
--
Questions and Answers
--
Mark Bryan, Wilsons Advisory and Stockbroking Limited - Head of Research:
--
A couple of questions, if I may, perhaps one for both of you. Martin, firstly, on Enterprise, you've talked around the initial signs of turnarounds coming through for that division. I'm wondering if you just might be able to dig a little further into that and maybe make some comments on where staffing numbers are, what you're doing recruitment-wise, where utilization is and perhaps some qualitative comments at least around the length of the book and the visibility for that division.
And then secondly, might be one for Fraser. The $9.5 million customer dispute, that's the first I've heard with that -- heard of that. I'm wondering if there's anything more you can say around the likely recovery of that data.
--
Martin Mercer, ARQ Group CEO:
--
Thanks, Mark. That's great. And thanks for the questions. I'll take both of those, if you don't mind. So on the question of Enterprise and the initial signs of the turnaround. I mean the key indicator is growth in billable headcount. And I can say that in the first half -- not the first half, sorry, in the -- yes, in the first half, we increased billable headcount by about 5 people net. Last week, we increased billable headcount by 11 people. And so -- which is an indication of the growth in new work we are winning at the moment. Utilization is running at about 83%, 84% on average, which is just around budgeted levels.
And from a pipeline perspective, I mentioned earlier that we're seeing -- we do a regular weekly pipeline review now with the sales team. We're seeing every week that the weighted pipeline is increasing period -- week-on-week. We're winning quite a lot of new work at the moment. A lot of that is not signed, so I can't actually say who with yet. But the volume of work in the pipeline, the unweighted pipeline is more than enough to achieve the result we need to achieve. The important thing is how the unweighted pipeline translates to a weighted pipeline and hopefully translates to revenue. And yes, we've got a 3-month -- we've got visibility, reasonably confident visibility after 3 months out, then it gets a little more foggy. The risk adjustment we place on those things that are early in the pipeline is we risk adjust about to 90%, which means they make a very small contribution to the weighted part. But as those opportunities mature, we will see that weighted pipeline increase. And yes, we -- as I said before, we have momentum on our side at the moment, and we're feeling more confident as each week passes.
On the $9.5 million customer dispute. We did actually disclose this right back in the annual report. And then I think we had an update in June. But in terms of recoverability, we're in litigation at the moment. We've got legal advice, where we are confident of our position. We've commenced proceedings. That's working its way through the courts now. I think it's a case of watch this space for the time being. We're going through the sort of preliminary procedural stuff at the moment.
--
We have no further questions from the telephone at this time. Thank you, and please continue.
--
Martin Mercer, ARQ Group CEO:
--
Thank you very much. They say silence is golden. I do thank you for your attention. It was a very busy day today. I think 31 companies reporting. So I do appreciate the people who have joined this call.
I would just summarize by saying the recovery plan is delivering. SMB, as you know, has had -- or you can see it had a very good first half, 57% up on the prior corresponding period from a core perspective. It's early days in the Enterprise, but the signs are very encouraging. Cost savings are coming through. Net debt's down materially after the receipt of the proceeds from the sale of TPP, and our leverage ratio is going to steadily converge towards our published target range. We expect to be back there by H1 2020. We affirm guidance. We're on track. Momentum's building with each day and with each month. We have momentum on our side, and we are going to drive hard for the final result. Thank you very much for your time.
- Forums
- ASX - By Stock
- 5GN
- Ann: Half Year Results Webcast Details
Ann: Half Year Results Webcast Details, page-7
Featured News
Add 5GN (ASX) to my watchlist
|
|||||
Last
14.5¢ |
Change
-0.005(3.33%) |
Mkt cap ! $44.90M |
Open | High | Low | Value | Volume |
15.0¢ | 15.0¢ | 14.5¢ | $14.62K | 98.94K |
Buyers (Bids)
No. | Vol. | Price($) |
---|---|---|
9 | 565736 | 14.5¢ |
Sellers (Offers)
Price($) | Vol. | No. |
---|---|---|
15.0¢ | 2216057 | 17 |
View Market Depth
No. | Vol. | Price($) |
---|---|---|
9 | 565736 | 0.145 |
4 | 403610 | 0.140 |
2 | 507407 | 0.135 |
2 | 506000 | 0.130 |
2 | 258007 | 0.125 |
Price($) | Vol. | No. |
---|---|---|
0.150 | 1601866 | 14 |
0.155 | 2495531 | 30 |
0.160 | 223346 | 9 |
0.165 | 146843 | 4 |
0.170 | 117911 | 4 |
Last trade - 16.10pm 30/08/2024 (20 minute delay) ? |
Featured News
5GN (ASX) Chart |
The Watchlist
1CG
ONE CLICK GROUP LIMITED
Mark Waller, MD
Mark Waller
MD
Previous Video
Next Video
SPONSORED BY The Market Online