3P Learning Limited (3PL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the 3P Learning Limited FY '20 Half Year Results Conference. [Operator Instructions] I would now like to hand the conference over to Rebekah O'Flaherty, Chief Executive Officer. Please go ahead.

Good morning, everyone, and welcome to our FY '20 Half Year Results. Here's the agenda for today. I'll start with an update of our progress against our 20:22 Accelerate Growth plan. Simon will then take you through our financial results, and I'll then provide you with our outlook for the rest of FY '20 before opening it up for questions. Before I give a summary of our progress against our 20:22 Accelerate Growth plan, I want to first provide investors with an update on the work we have done to course correct the sales execution issues we had in APAC in FY '19. So first, just to recap, at our FY '19 full year results, we communicated that sales execution issues in APAC, which were caused by a decision to decentralize the retention team and move to a team-based rather than an individual commission model, increased churn in APAC, resulting in a loss of licenses across maths and literacy for the full year. This loss of licenses, as we expected, has negatively impacted our H1 FY '20 license revenue results for APAC. However, the corrective action plan we implemented is on track, as evidenced by APAC licenses up 4% for the period June-December. ARR is up 6%. Total retention and first year retention are up, and new business billings is up 2% on current products. Simon will take you through more detail around the APAC performance and outlook a little later, but I thought it important to give investors confidence that this issue has been addressed, and we expect moderate license revenue and EBITDA growth in APAC in H2 '20 versus H2 '19. Now an update on the progress we're making against our 20:22 Accelerate strategic plan. At the end of FY '19, we announced the completion of our 3-year strategic plan, which was focused on restructuring and building a foundation to support scalable and profitable sales growth. Having made key investments in building this foundation, we now have a more stable cost base, which will allow us to enjoy operating leverage as we accelerate sales growth. FY '20 marks year 1 of the 20:22 Accelerate Growth plan, which has 4 key growth drivers. The first driver is to leverage our expanded product portfolio and customer base. The second key growth driver is to accelerate profitable sales growth in the Americas. The third is to improve customer retention. And the fourth key driver is to build a growth-focused, high-performance culture. Let me now give you a summary of our progress to date against the first 3 of these growth drivers. First, we have seen encouraging signs that growth is being delivered by a stronger and expanded product portfolio and customer base. In H1, our business billings -- our new business billings on current products was up 2% in APAC and EMEA and 59% in the Americas H1 '20 versus H1 '19. We have executed a range of significant product upgrades to our flagship Mathletics brand in H1. And in H2, there is more to come, including Mathletics Spanish due for release. Similarly, Readiwriter Spelling was launched in November 2019, and we have seen strong sales momentum already, and our H2 Readiwriter Spelling releases should further support that momentum. Our second growth driver has a focus on the Americas, where we continue to see sales momentum that we delivered at the end of FY '19. License revenue was up 30% in H1 '20 versus H1 '19. ARR is up 11% versus 30 June 2019. We've seen a 59% increase in new business billings on current products H1 '20 versus H1 '19, and deferred revenue was up 8% versus 30 June 2019, which is a really good indicator of strong sales momentum. Encouragingly, we have achieved this sales growth while still delivering operating profit. And with Mathletics Spanish coming in H2, this will unlock additional TAM for this very important growth region. The third growth driver of our 20:22 Accelerate Growth plan is to improve customer retention in all regions, and I'm pleased to say that first year retention has improved in APAC, 83% up to 88%; and in EMEA, 80% to 82%. And while America total retention is down from 87% to 81%, this is skewed due to the end-of-school churn that naturally comes. However, with ARR up 11%, we do expect new business to outstrip churn and, in turn, continue to deliver double-digit growth for the full year. So in summary, even though the APAC FY '19 execution issues have impacted our overall group revenue in H1 as we expected, we have successfully course corrected, and at a group level, we are expecting revenue and EBITDA growth in H2 F '20 compared to H2 FY '19. On that note, I'll hand it over to you, Simon, to provide more detail around our financial results. Thanks, Simon.

Thank you, Rebekah, and good morning, everyone. Before we present the detailed financials, I wanted to talk a little bit about our H1 and H2 split this financial year. Over the past 3 years, our revenue has been split approximately 45% in the first half and 55% in the second half on a normalized basis. The main reasons for this are the peak invoicing season in APAC being in February and March, and revenue for third-party products invoiced in the second half of the year are recognized 100% on invoicing. We expect FY '20 revenue to have a stronger weighting to H2 due to 4 main factors. Firstly, the 12-month effect of the churn in APAC in FY '19 will impact H1 '20 more than H2 '20. Secondly, improved retention in APAC will buoy our H2 performance. Thirdly, recent product releases in H1 have already shown traction in the market, and this, coupled with pending product releases in H2, should support stronger sales in H2. And finally, growth and sales activity in general is seasonally weighted to H2, particularly in the Americas. So revenue will again be skewed to H2, and we have already seen lead indicators in H1 that give us great confidence in growth for the second half and full year. Similarly, our costs have been weighted to H2 in recent years. The average from FY '16 to FY '19 is 46% in the first half and 54% in the second half. However, after completing a 3-year period of restructuring of our global marketing, sales operations, customer support and education teams and the Americas sales team reset, our cost base is much more level from H1 to H2. And it can support a substantially larger business, and we do not expect to see any substantial cost increase in our BAU activities. This shift in our revenue and expense profile has resulted in a lower EBITDA in H1 '20 versus H1 '19. However, we expect increased license revenue and EBITDA in H2 '20 versus H2 '19 for the group. And importantly, we are happy with our progress in H1 in all regions that has delivered lead indicators consistent with this expectation. So looking at our half year results. License revenue was down 2% to $22.8 million with the Americas up 30% in Australian dollar terms, offset by declines in APAC and EMEA, as we had exited FY '19 with lower licenses in those regions. Overall group revenue was down 4%. This is after a reduction in other sublease income due to the impact of the new leases accounting standard. Our expanded and stronger product portfolio has driven new business billings on current products. We were up 59% in the Americas and 2% in both APAC and EMEA, and we expect growth versus H2 '19 in all regions in the second half of the financial year. Encouragingly, annual recurring revenue, or ARR, was up 6% since 30 June 2019 to $55.4 million, and we show detailed movements in ARR by region and other SaaS metrics in our analyst pack. Expenses are up $2.5 million for the half versus H1 '19, and EBITDA down $3.4 million due to increased head count in the Americas and product development to support our growth agenda. We have now completed the majority of our organizational restructure, and we will enjoy a more level BAU cost base going forward. However, operating leverage has suffered in H1 '20 as costs do not flex as quickly or as much as revenue. NPAT was down $3.9 million to negative $1.9 million. We will now take a look at each of our 3 core regions, starting with APAC. License revenue was down 8% due to the previously advised FY '19 churn issues. The corrective action we have taken in APAC sales is showing signs of success, and with improved digital marketing and the launch of Readiwriter Spelling and a stronger product offering in years 3 to 6 and 7 to 10 Mathletics, new business billings on current products in H1 '20 are up 2% versus H1 '19, and first year retention is up 5 percentage points from 83% to 88%. Encouragingly, ARR is up 6% from $31.6 million to $33.6 million. Average revenue per user, or ARPU, for the prior 12 months is calculated as the prior 12 months revenue divided by the average of opening and closing license numbers for that 12-month period. ARPU was $11.75 for H1 '20 compared to $11.65 for the 2019 full year, which is a better comparison than looking at H1 '19. Expenses are up $0.2 million, mainly because as part of improving our sales structure, we've changed our renewal commission plans to bring an increased focus on getting customers to confirm prior to Christmas of their intention to renew. We've paid partial commissions on receiving signed renewal quotes in H1 versus waiting for invoicing in H2. This has had no material full year impact to commission amounts. As we move to a more digital and globalized marketing function, regional staff numbers, which comprise mainly sales, marketing and a small regional finance team in each region, have reduced. Looking to H2 and beyond. At our June results, we said we would expect to see retention improvements with new sales leadership and improved products and customer experience enhancements. We have already seen retention over the prior year improve and expect this to continue in H2 '20. We will leverage our valuable and market-leading installed base in Australia with our expanded and stronger product portfolio, including a significant back-to-school product release in Mathletics, which includes a stronger 7 to 10 offering, and we are also seeing new opportunities outside ANZ to grow license numbers. The impact of the FY '19 churn will diminish in H2 '20, and we expect modest license revenue and EBITDA growth in H2 '20 versus H2 '19, and copyright revenue will continue to decline. As we build up our installed base, FY '21 will see a full 12-month impact of these improvements. Moving on to Europe, the Middle East and Africa. Continued uncertainty around Brexit put downward pressure on revenue, which was down 9% versus H1 '19. However, new business billings on current products were up 2%, and first year retention improved 2 percentage points from 80% in FY '19 to 82% in H1 '20. ARR is up 2% in the half versus H1 '19, reversing the decline in FY '19 and FY '18, which is a positive sign. ARPU is up 6% on H1 '19 but level with the full year '19. Expenses were impacted $0.4 million by a $0.3 million foreign exchange loss this year versus a $0.1 million foreign exchange gain last year. As we have done in APAC, we have reduced regional staff numbers as we move to a more digital and globalized marketing function. So in H2, we expect to continue to see retention improvements from improved product and customer experience. We will leverage our installed base with our expanded and stronger product portfolio, including important phonics releases in REGGS and 7 to 10 releases in Mathletics. We are ready to move quickly to capitalize on any improved trading conditions in the U.K. should the new U.K. government increase school funding as they have promised to do, and we will continue to diversify revenue outside the U.K. through our new sales leader. In the Americas, license revenue was up 30% in Australian dollar terms and 22% in U.S. dollar terms versus H1 '19, and the Americas continues to make a positive contribution to group EBITDA. New business billings on current products were up 59% versus H1 '19, which is an improvement on the 37% for the first quarter we shared at our AGM in October, as newly hired salespeople are starting to build some encouraging momentum. ARR is up AUD 0.8 million, which is 11% versus 30 June 2019. Licenses is down in H1 for 2 main reasons. The first is due to the seasonality of the selling cycle in the Americas. H1 contains the end-of-school year, so churn is higher in that half. Our sales are made all year round, but H2 is when most sales close in the U.S.A. and Canada. Another related factor is that H1 was the first period that we had Mathseeds churn since acquiring the distribution rights from January 2019. Expenses were up over H1 '19, as previously indicated, due to the hiring of additional salespeople and increases in marketing activity. So in H2, we are expecting the momentum from H1 to continue, buoyed by our expanded and stronger product portfolio as well as Mathletics Spanish, which is due for an April 2020 release and, as Rebekah mentioned, unlocks significant TAM in Latin America. Our sales model is working. We have a full complement of sales staff fully trained now, and with H2 being the key buying season where sales are traditionally higher, we are confident of that continuing in H2. Our cost base is expected to be level from H1 to H2 this year and up overall for the full year as we have built up our sales function now to deliver growth. We will continue to increase investment in marketing and sales head count commensurate with future growth, and our targeting of double-digit license revenue growth and higher EBITDA for the full year is borne out by our performance in H1. Our income statement shows that, for the group, expenses are level with H2 '19 as we have completed the majority of our organizational restructuring and are up $2.5 million versus H1 '19. This level of expenses is now our new waterline. However, given the skew to H2 in revenue, this results in a lower EBITDA in H1. However, all the improvements we have made and continue to make to product and sales will flow in H2 '20 and FY '21. Sales-related employee costs have increased $1.6 million. The head count increase from 253 at December '18 to 269 is due to the increase in sales staff in the Americas of 11 heads and an increase in product development staff to accelerate releases and support growth. Marketing expenses have increased $0.3 million to support the sales growth. Technology and occupancy costs have decreased by $0.5 million due to a $0.6 million reduction in occupancy expenses from the adoption of the new lease standard offset by $0.1 million of higher software license costs relating to digital marketing, sales lead management and dashboard reporting tools. Other expenses include 2 main components, a $0.8 million negative swing in foreign exchange losses from a $0.5 million gain in H1 '19 to a $0.3 million loss this half and also outsourced product development costs as our expense increased $0.3 million. There is an increase of $0.5 million in amortization reflecting office lease expenses presented here under the new lease accounting standard, and the full FY '20 year will see amortization increase approximately $2 million in total, $1 million due to the new lease standard and approximately $1 million due to the amortization of Readiwriter beginning this year. We have provided a normalized profit and loss account for the half year in the analyst pack showing the impact of the new lease standard. The effective tax rate has decreased due to prior year adjustments of $0.2 million, but we're not expecting any material change in effective tax rate for the full year. Moving on to cash flow. Operating cash flow before intangibles is up $0.1 million versus H1 '19. We had a higher-than-usual trade receivables balance at 30 June '19, which has resulted in an increase in cash collected this half and a smaller reduction in working capital versus H1 '19. We have released to market a significant amount of new product in H1 '20 and plan even more releases in H2 '20. Our capitalized product and system development costs are $0.7 million higher than H1 '19 due to a higher proportion of later-stage development work carried out. This is consistent with our recent product releases and pending releases in H2 this financial year such as Mathletics Spanish and understanding, practice and fluency. Tax payments are down $0.3 million due to timing differences in income tax payments in the U.K. and New Zealand. The cash flow conversion percentages shown here are shown for consistency. But as free cash is negative to EBITDA, the percentage changes [indiscernible]. The change in working capital and payments for product development are the only major differences from H1 '19, and we do not expect any material working capital movements for the full year. On our balance sheet, trade receivables are down $1 million to $12 million due to some small changes in the timing of issuing invoices in APAC. Some state education departments in Australia have changed their procurement practices. In previous years, they were happy to accept invoices before Christmas for signed renewals, but this year, New South Wales and others can't accept these until the new year. There is no full year impact of this. Our continued product development has resulted in an increase in intangible assets. We have started amortizing Readiwriter Spelling in H1 '20. Contract liabilities, which represent deferred revenue, are skewed to H2 by minor delays in invoicing in APAC, as I mentioned, and some contract renewals in America that have been delayed until January. This does not reflect a decline in users or ARR, but merely a delay in invoicing until after 31 December. No dividend was declared this reporting period, and we will continue to retain cash to support working capital and growth opportunities. Our continued investment in products and technology this half is broadly level with H1 '19, being $6.4 million versus $6.8 million last year. We launched Readiwriter Spelling and an enhanced Mathletics product with problem-solving and reasoning and strengthened 7 to 10 and expect to launch Mathletics Spanish and further Mathletics enhancements, understanding, practice and fluency, in H2 '20. As I mentioned earlier, because of the high volume of product releases in H1 '20 and planned in H2 '20, a higher proportion of product development is capitalized this half due to more later-stage development work in both maths and literacy as we continue to release new products and content. Product spend in the period FY '17 to FY '19 was focused more on building foundations for our go-to-market infrastructure and product. In '20 to '22, we will see more products and systems development and also introduce a stronger focus on selective offshoring development, which we expect to deliver product faster and be more cost effective. The cumulative capitalized investment of $3.4 million in Readiwriter is now amortized starting in H1 '20 and as for all software and curriculum content over 3 years. In FY '20, we'll see an increase of approximately $1 million in amortization charge versus FY '19 now that Readiwriter is launched. I'll now hand back to Rebekah to wrap up with our outlook.

Thanks, Simon. Let me now provide you with our H2 outlook. In APAC, sales execution issues have impacted our growth in FY '20, but our corrective action is on track, and we expect to see modest license revenue and EBITDA growth in APAC in H2 '20 versus H2 '19. In EMEA, we have a well-qualified pipeline of large opportunities that are well placed to close in H2, and we are ready capitalize on any improved trading conditions in our core U.K. market. In the Americas, we expect to see continued accelerated profitable sales growth. On a group basis, we are expecting increased revenue and EBITDA for H2 '20 versus H2 '19, but full year '20 EBITDA will be down year-over-year. On that note, I'll hand it over to you for questions.

[Operator Instructions] Your first question today comes from Tim McArthur with Asymmetric Asset Management.

Can you just perhaps talk a bit more about -- perhaps refresh our memory on FY '19 and the sales execution issues. And then with the churn, how much of that churn is related to losing out to competitors? And how much of it is schools sort of trialed your product and perhaps used it for a period of time and then decided to move away from having a digital learning strategy?

Yes. Look, I'll make some comments, Tim, and then hand it over to Simon. I don't know what that sporting metaphor is, but when you kick your own goal, it was really that. We decentralized our retention team, and then we moved to team-based commissions. So we really lost that individual accountability tied to accounts. And as a result of that, that's where we saw around 220,000 licenses across maths and literacy churn. The competitive landscape did not change, and I think that's the thing that I feel most sad about FY '19 because it was really our own doing, really. And I think as evidenced by the improvements in retention in APAC both at the total and first year, I think that shows us that the product is landing. It was just us poorly executing. So Simon, did you want to add anything?

Yes. So very, very few schools actually are ceasing using digital Mathletics software in classrooms. Now some of the feedback we've had anecdotally is that some schools have gone to a competitor and realized that our curriculum content and alignment is a lot stronger. And we are seeing quite a few schools come back. But generally speaking, very, very few schools have actually stopped using software altogether.

Right. So those 220,000 that churned, they did go to a competitor product, are you saying?

Yes. Yes. They would have gone to a competitor, but there was no reduction in the use of digital assets. So yes, it went to a competitor, but because we implemented an aggressive win-back campaign and made those changes both to the organization and the commission model and put an old-fashioned kind of sales discipline back in, we are seeing really encouraging signs around retention in APAC. Added with that, we did some significant launches through H2 in Mathletics to position us well for back-to-school in February, and we are doing more launches as we speak now for back-to-school. So the retention teams and sales teams had a lot to talk about with our APAC customers or Australian customers in the -- at the end of last calendar year and now as we move into back-to-school.

Okay. Simon, just a couple of questions for you, please. Where do you see the cash balance at 30 June 2020, please? And secondly, could you just remind me what percentage of your sales are direct, sort of like a retail sale as opposed to via schools and just school departments?

We do have a small B2C business, which sells direct to parents, but our general business is direct to schools. So generally, it's either school-by-school, or in the U.S. and Canada, more frequently, we're selling to school districts. Our B2C business would do somewhere between AUD 1 million and AUD 2 million a year direct to home. But generally, we're selling to schools or school administrators and districts.

And the only thing I would add there, Tim, is as we've now dealt with a lot of the product and technical depth, the product is now able to adapt more easily to different markets, so different countries. And I alluded to in EMEA and even in Latin America, we're seeing some really encouraged countrywide or ministry deals that we're feeling hopeful that we'll have something to talk about throughout the course of H2 or at the full year result. So sometimes you do see department and countrywide deals, but largely district schools is the sales motion.

Yes. Tim, just on your cash question, I think, $25.8 million at June '19. We should see a modest increase on that in June '20.

Your next question comes from Mike Younger with Rest.

First question just on U.S. licenses. Just if you could expand a little on the reasons for licenses falling in the period. I mean seasonality, I guess, is something that you face each year in that area.

It is and probably slightly higher than we would ideally like. But I think you get the beginning of school year around September. So the subscriptions do end around that time, and you do get a seasonal dip. It's probably the first year where we've had a significant increase, taking on those Mathseeds licenses. So we are selling way around. And we do expect to see license growth for the full year commensurate with the sort of the ARR and the revenue growth we're targeting as well. But you do tend to get a dip in particularly that first quarter of the year, which is that September quarter.

Right. And then the uplift that you've had in ARPU, is that just a function of the timing of that churn on the license numbers?

Yes, it's very much a calculation based on the license numbers in the revenue.

Right. Okay. And then could you comment on the current strategic plan as to how you see revenue growth versus cost growth coming out over that period?

In the Americas or in general for the group? Do you mean...

Across the group.

While we do expect to see, let's say, modest license revenue and EBITDA growth for the second half, clearly, the impact of the FY '19 churn for the group in APAC has a 12-month impact and has impacted H1. But we expect to see half versus prior year growth in H2, both in revenue. And, let's say, our costs are reasonably level now, so we would expect to see our group OpEx for the first half continue at a similar level in H2.

Yes. Sorry, the question was more around looking out over this current 3-year strategic plan period.