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

Thank you for standing by, and welcome to the 3P Learning FY '20 Full Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to Ms. Rebekah O'Flaherty, CEO. Please go ahead.

Good morning, everyone. So we'll start with our FY '20 full year results. I'll provide an overview of our results and provide an update on our strategic plan. And then I'll hand it over to Dimitri, and he'll take you through our financials in more detail. And then I'll wrap up with our outlook for FY '21. So first, our financial overview for FY '20. First, an overview of our performance in FY '20. Royalty-adjusted annual recurring revenue, excluding any benefit from the large Ministry of Education agreement we recently secured in the Middle East, which begins in FY '21, was up 1% on prior year. Statutory revenue was up 1%, and licenses were up 3% on prior year, with all regions recording license growth. As expected, EBITDA was down 18% year-over-year, and that was driven by investments in the U.S.A., which delivered less than expected in sales growth due to COVID-19 market impacts and sales commission accruals for a large Ministry of Education contract. Encouragingly, our net dollar churn improved by 2 percentage points year-over-year, indicating an improvement to our customer lifetime value. We ended the year with a strong cash balance of $27.1 million. Now let me give you an update on our FY '20-'22 strategic growth plan. Let me now give you an update on our 20:22 Accelerate Growth strategic plan. At the end of FY '19, we completed a 3-year-long company restructure, including technical and product debt and investing in scalable sales, service and marketing platforms. We now have a stable and optimized cost base positioning us well to enjoy operating leverage as we accelerate sales growth. In August, we outlined our 20:22 Accelerate Growth strategy, which consisted of 4 key growth drivers: one, product and customer expansion; two, accelerated profitable growth in the Americas; three, improved customer retention; and four, develop a growth-oriented high-performance culture. Our plans remain unchanged. However, we have moderated our growth expectation for the Americas region as a result of funding uncertainty in the U.S. in the wake of COVID-19. We have adjusted our sales and marketing effort in the U.S.A. to better target those districts that have been less impacted by COVID-19 or those districts that are really seeking to accelerate online learning. Now a summary of the progress we've made against our 20:22 Accelerate Growth plan. A key proof point of our progress against our strategy was securing a USD 10 million contract with the Ministry of Education in the Middle East for Mathletics licenses and professional services. This contract will be recognized in FY '21 that was a huge achievement. This contract could expand to a whole of country opportunity and will serve as a lighthouse account for other countries in that region, which represent significant new addressable market for 3P. We could not have secured this ministry contract or developed a strong enterprise sales funnel had it not been for all of the work, the foundational and turnaround work we did during the 2017 to '19 period. Importantly, we entered FY '21 with a growing funnel of other large enterprise opportunities. These enterprise opportunities are typically larger than $1 million in contract value, have longer sales cycles and will accelerate our growth trajectory and complement our transactional business. In FY '20, we made significant improvements to our flagship Mathletics brand. We released over 30,000 new activities, refreshed our teacher and student experience and strengthened our 7-10 offering, and these new releases were all instrumental in the retention and new business improvements we saw in FY '20. We launched Readiwriter Spelling in November with strong market acceptance in our core Australian and U.K. markets, and we have commenced work on Readiwriter Writing, which puts 3P on its own path to have that comprehensive literacy offering. I'll now hand it over to Dimitri, who will provide more detail around our financial performance of FY '20. Thanks, Dimitri.

Thanks, Rebekah. Overall performance of the company has been relatively resilient during the COVID-19 pandemic. Our people and services have not been impacted to date, and we've experienced an increase in demand for our products, albeit with regional market dynamics. License revenue was up 1% to $51.4 million, with Americas up 11% and EMEA up 1%. As flagged at our announcement on the 23rd of June 2020, the agreement with the national Ministry of Education from the Middle East will only start contributing to revenue from FY '21. Other revenue increased 12% due to an increase in copyright revenue, offset by a reduction in other income due to the impacts of AASB 16 on sublease income. Royalty-adjusted annual recurring revenue grew 1% from 30 June 2019. This value excludes the Middle Eastern national Ministry of Education deal announced on the 23rd of June 2020, which begins only from FY '21. Expenses were up 11% due to increased average headcount in the Americas and increased product development headcount to support our growth agenda. Headcount is expected to stay reasonably leveled into the future and is well placed to support higher volume of business into FY '21. NPAT was down $4.3 million to $1.6 million. Now looking into the performance of the APAC region. Royalty-adjusted annual recurring revenue was up 7% and licenses were up 4%, reflecting increased H2 '20 sales driven by COVID-19 demand as well as improved back-to-school retention and new business. Despite favorable royalty-adjusted annual recurring revenue and license growth, license revenue was down 2%. This occurred due to the way our license revenue was straight-lined over the subscription period for internal products like Mathletics, which meant that the FY '19 churn issues noted in the previous investor briefings impacted H1 '20 license revenue, whilst the strong H2 '20 performance was only partially recognized in FY '20. Copyright fee revenue was up $0.8 million due to increased usage of our materials by teachers during the school year. Expenses were up $0.6 million mainly due to increased variable costs such as commission and temporary resources to assist with school onboarding in order to meet the COVID-19 demand during H2 '20. Now turning to the FY '21 focus and outlook for APAC. Our key aim is to drive new and renewal sales with our refreshed Mathletics offering, which includes rich problem-solving and reasoning activities as well as our new Understanding, Practice & Fluency activities as well as other enhancements to teacher and student experience. This is in combination to our improved overall customer experience through improved onboarding and support. Readiwriter Spelling was well received during FY '20, showing promising traction in the market. We will continue to position this product as the class-leading spelling solution and look to complement it with Readiwriter Writing, which we will build out during FY '21. Next year, we will also look to leverage our enterprise sales know-how from other regions with an aim to explore new enterprise opportunities outside the ANZ. We expect H1 '21 revenue and EBITDA to be behind prior year due to accelerated timing of our third-party revenue as a result of billing in Q4 '20 rather than Q1 '21. Over the FY '21 full year, we expect single-digit revenue and EBITDA growth. FY '20 revenue increased 1% in Australian dollars or 6% decline in Great British pounds. The U.K. market remained particularly challenging during H1 due to the uncertainty around Brexit. During H2, we saw an improvement due to the certainty returning post Brexit and an increase in demand for our products due to the COVID-19 pandemic. Readiwriter Spelling performed well, contributing to the strong H2 '20 performance. And expenses were impacted $0.4 million by variable cost accrued on the agreement with the National Ministry of Education from the Middle East. And we recorded a $0.3 million FX loss, whereas in FY '19, we recorded a $0.1 million FX gain. Now turning to the focus and outlook for FY '21 for EMEA. Firstly, we will focus on delivering on the agreement with the national Ministry of Education in the Middle East during FY '21. To that end, we will focus on providing comprehensive teacher training, customer support and account management. This focus, coupled with our recent enhancements to the teacher and student experience in Mathletics, will position us well to secure the renewal and expansion. We should start to know more about the likelihood of renewal and/or expansion around the middle of H1 '21 after we can demonstrate active engagement from the customer, the teachers and their students. We will continue to build enterprise sales by pursuing large Ministry of Education or Department of Education deals and through our corporate social responsibility partnerships with companies in the U.K. and Europe. The U.K. and broader EMEA region is a core market for 3P and with a strong installed base of school customers. With that, it remains a priority to continue to drive retention improvements from our existing products as this is vital to supporting growth in the region. We will also leverage our refreshed Mathletics offering to drive new business sales in the region. And finally, we will leverage our installed base with our expanded and stronger product portfolio, including Readiwriter Spelling, improvements to Reading Eggs to better meet U.K. curriculum needs and significant content-related enhancements to 7-10 Mathletics. License revenue was up 11% in Australian dollars or 5% in U.S. dollars despite challenging market conditions that occurred in the U.S.A. market during H2 '20. In the U.S.A., K-12 education funding provided to districts and schools has been adversely impacted by COVID-19. However, 3PL drove growth through strong H1 performance and diversification into our other Americas markets, namely Canada and the LatAm region, which continued to perform well. Royalty-adjusted annual recurring revenue has been impacted by product mix and discounts offered through multiyear retention strategies. Other revenue declined due to an adoption of the new leases accounting standard, AASB 16, which has meant that sublease income is no longer recorded as revenue. And expenses were up, as previously flagged, due to higher average sales and marketing headcount during H1 '20 versus H1 '19. Now turning to the focus and outlook for FY '21. COVID-19 is driving increased demand for online education products across all our key countries in this region. However, the U.S.A. market continues to have uncertainty due to the educational funding challenges mentioned earlier. Accordingly, we have calibrated our sales and marketing efforts to those districts less impacted by COVID-19 and continued to stay attuned to changes in both state and federal education funding. Outside of the U.S.A., we have a pipeline of enterprise opportunities that are well placed to close in H1 '21. We will grow our new and renewal sales with our refreshed Mathletics. Specific to the Americas region is the new Spanish version of Mathletics, which will help us drive enterprise sales into the LatAm region, while the combination of problem-solving and reasoning, along with our common core aligned understanding, practice and fluency content, and activities, provides a substantially enriched Mathletics offering going into FY '21. As a result of these initiatives, we expect there to be billings growth in H1 '21. However, we expect revenue growth to only come through in H2 '21, due to our revenue recognition policy on license revenue. Employee expenses have increased by $3.7 million. Contributing to this increase was higher average sales staff headcount in the Americas, an accrual of variable selling cost on the deal with a national Ministry of Education from the Middle East. Under the accounting standards, there is a requirement to accrue the cost despite the cost not being paid until the subsequent reporting period after the cash is being collected. And the final element is the variable selling costs that arose from increased demand as a result of the COVID-19 pandemic. This came in the form of increased commission and increased temporary labor costs required to onboard new customers. Marketing expenses increased by $0.3 million across all regions to accelerate growth. Technology and occupancy costs have decreased by $1.2 million due to the $1.5 million reduction to occupancy expenses from the adoption of AASB 16 leases, offset by a $0.3 million increase in license fees and other system costs. Other expenses include a $0.7 million swing in FX losses. As previously flagged in our 31 December 2019 half year briefing, $1 million of increased amortization is due to the impacts of adopting AASB 16 and $0.9 million is due to the amortization of Readiwriter Spelling, which began this year. There is $0.1 million of corporate advisory costs after tax, which has been excluded from the underlying EBITDA, underlying EBIT and underlying NPAT. The effective tax rate is impacted by the contribution of the Americas carryforward tax losses, which were not recognized, and due to the full utilization of blackhole expenditure in FY '19, which arose from the 2014 IPO. FX and other noncash has increased due to FX differences, increased share-based payments and increase in noncash customer contracts. Pleasingly, change in working capital improved $3.5 million compared to the prior year. This reflects 2 key factors: firstly, improved H2 billings in EMEA and APAC, which were partially collected by 30 June; and secondly, strong working capital management around supplier payments. During FY '20, we released a significant amount of new product features. Our capitalized product and system development costs accordingly were $1.6 million higher than FY '19 due to a higher proportion of later-stage development work carried out in line with our product release road map. Repayment of lease liabilities and receipts from subleases occurred as a result of adopting AASB 16 leases. In the prior year, these costs were included in EBITDA. Cash of $27.1 million is up $1.3 million with no bank debt. Lease receivable, right-of-use assets and lease liabilities are a result of adopting AASB 16 leases accounting standard in FY '20. Refer to appendices for further details. The increase in intangibles is due to the continued investment in product development. Trade and other payable increased due to the VAT deferral release scheme implemented by the U.K. government in response to the COVID-19 pandemic and due to higher third-party royalties accrued at year-end. No dividend was declared with cash being retained to support working capital and growth opportunities. We exit FY '20 with a stronger product portfolio, having launched Readiwriter Spelling and enhanced Mathletics with Spanish language; created 700 problem-solving and reasoning activities for grades 3 to 10, expanding product into depth of knowledge 2 to 4; created 30,000-plus understanding, practicing and fluency activities, addressing global curricula; and improving the overall teacher and student experience. The high level of releases have increased the year-on-year split of CapEx and OpEx. In FY '19, we had lower proportion capitalized as it related to early-stage R&D investment. In FY '20, our focus returned to later-stage development activities and, therefore, capitalization rates were much higher and more consistent with FY '18. From May 2020, we started using a lower-cost external provider to assist in developing our products. This investment was achieved within the same cost envelope and is expected to provide additional development efficiencies into FY '21. Software and curriculum content is amortized over 3 years. During FY '21, we expect CapEx to increase to $12 million to enable development of features which open up new markets or expand opportunities within existing markets. I'll now hand it back to Rebekah, who will summarize the company's FY '21 outlook.

Thanks, Dimitri. Let me now provide you with an outlook for FY '21. In our Asia Pacific region, we expect single-digit revenue and EBITDA growth for the full year. In EMEA, we are well on track to deliver significant revenue and EBITDA growth following the closure of our Ministry of Education agreement as well as other enterprise funnel opportunities in that region. In the Americas, we expect continued market uncertainty in the U.S. due to funding challenges in the wake of COVID-19. However, we continue to expect license revenue growth for the full year. On a group basis, we expect double digit revenue, ARR and EBITDA growth in FY '21. Our cost base is now set, our mix of cost is optimized, and we have a strong platform to deliver profitable growth. We enter FY '21 with strong operating leverage, allowing our existing headcount to drive significant revenue growth at high margins similar to other SaaS businesses.

I'm now passing over to the Chairman, Sam Weiss, to discuss today's announcement.

Thank you very much. And good morning, ladies and gentlemen. I'm in the 3P Learning Limited boardroom with Rebekah and Dimitri. And I suppose this is perhaps an alternative look at fiscal '21. I'd like to start by thanking Rebekah and Dimitri. And for those of you who don't know Dimitri, this is his inaugural performance as the Chief Financial Officer of a publicly listed company, and I'm sure you will all agree that he has done a sterling job and has a long and illustrious career ahead of him. I'd also like to recognize the whole of the 3P Learning team who are scattered around the world for a very positive full year result. But for those of you who were watching the ASX this morning, you will have noticed that in addition to releasing our full year results, we announced today that 3P Learning Limited has entered into a scheme implementation agreement with IXL Learning, Inc. and IXL Australia Proprietary Limited, which is a wholly owned subsidiary of IXL, Inc. to acquire 100% of 3P Learning. Proposed acquisition by IXL will be affected via a scheme of arrangement and is subject to shareholder and court approval as well as FIRB approval and certain other conditions. Under the terms of the scheme, 3P Learning shareholders will be entitled to receive $1.35 in cash for each share that they hold. This consideration values our equity at approximately $189 million with an enterprise value of $166 million and implies an enterprise value compared to fiscal year 2020 EBITDA of a multiple of 11.4x. The scheme consideration also represents a 32% premium to the 1-month volume weighted average price per share and a 45% premium to the 3-month VWAP per share. IXL Learning, for those of you who are not familiar with it, is a privately held company based in San Mateo, California. It was founded by Paul Mishkin in 1998 after Paul had a brief tenure at Oracle as a software engineer. The mission of the company is to develop education technologies that people cannot live without. And over time, you will come to appreciate that the value and purpose of IXL are very closely aligned to those of 3P Learning. The Board of 3P Learning reviewed over the past year a wide range of strategic alternatives always with the objective to achieve maximum value for 3P Learning shareholders. And after careful consideration, the Board has come to the unanimous conclusion that this scheme is in the best interest of our shareholders. The scheme provides 3P Learning shareholders an opportunity to realize certain and immediate value for their shares at a significant premium to recent trading and at an attractive valuation multiple. And we are also very pleased that a leading educational organization, IXL, has recognized the strategic value inherent in our company. The Board of Directors of 3P Learning Limited will recommend unanimously that shareholders vote in favor of the scheme in the absence of a superior proposal and subject to the independent expert concluding that the scheme is in the best interest of 3P Learning shareholders. Further details on the proposed transaction can be found in the Scheme Implementation Agreement, which was announced to the ASX earlier this morning. And I should remind you that there is no need for 3P Learning shareholders to take any action at this time. I believe we're now going to open the line for questions both of Rebekah and Dimitri about the fiscal year 2020 results as well as questions about the proposed transaction. Thank you.

[Operator Instructions] Your first question comes from Shuo Yang with Microequities Asset Management.

Just a few questions on the scheme announced. In the SI document, there was a reference to a material adverse clause. Is that against FY '21 internal budget?

Thank you for that question. It's a much more general purpose clause, and Dimitri, who has done quite a bit of the work with our advisers and with the data room, will give you a general answer to the question.

Thank you. So my understanding is that the clause is, as Sam suggested, is more general and is related to kind of normal performance of the business rather than against a fixed budget, FY '21 budget per se.

Okay. And in terms of due diligence, just to clarify, there is no due diligence clause as part of the scheme?

The due diligence has been completed.

Okay. Understood. Just a question on the Ministry of Education contract for Rebekah. What's the payment terms with that contract? And in terms of P&L recognition, is the entire USD 10 million recognized in the first half of FY '21?

I'll make some comments about the payment schedule, and then Dimitri will answer the question around rev rec, Shuo. So it's a USD 10 million contract. USD 5 million is the first tranche, and we expect that to be paid before the end of August. And then there are 2 other tranches of USD 2.5 million, and that comprises the $10 million. Do you want to tackle the rev rec?

Yes. Thank you. So in relation to the revenue recognition, the provision of services are predominantly of professional development and of -- provision of our Mathletics licenses, and those services are expected to be performed or provided over the course of the FY '21 financial year. Therefore, the revenue will be recognized over that period.

Okay. And just to clarify, there are no incremental costs associated with this USD 10 million revenue?

When you say incremental costs, there's costs associated with the professional services, but the margin associated with this, and we've stated this previously, is really akin to the very attractive SaaS margins that you would know of.

Understood. Last question for me. In terms of tackling the enterprise, some of these enterprise opportunities, is there any headcount investment required or can you do that within your existing headcount?

Great question, Shuo. And no, within the existing headcount, albeit if that gets very large, then obviously, we might need to review that. But today, we enter FY '21 with a really solid enterprise funnel, and we have an increased headcount as a result of that. And I really credit that to the work that we did 2017, 2019 in really building a platform that enables us to now grow at scale and really enjoy that operating leverage, so no. And you shouldn't expect us to walk into FY '21 inflating headcount at all. It will be pretty constant.

Okay. Sorry, just last one for me. On the cash CapEx spend for FY '21, can you just outline what that will be?

Yes, pretty constant year-over-year. We took a decision in last financial year, in FY '20, to offshore. So we're actually going to be enjoying doing more with the same amount of dollars. And obviously, as we build out our literacy product, we're using a lot of offshore resources there. So pretty constant CapEx year-over-year.

[Operator Instructions] Your next question comes from Ben Bailey with Harvest Lane Asset Management.

I just have a couple of questions, more specifically in regards to the scheme of arrangement you announced this morning. I just noticed in the document that between entering a confidentiality agreement and then exclusivity agreement with IXL, we're a couple of months apart. I just sort of want to get a feel of, was there a process run to derive the best price available for shareholders and sort of what extent that was run? Two, were there other parties in the data room? If you're able to comment.

I'm not sure I got those questions. So I'll just play them back to make sure that I did. Was the first question in regard to the process that was run and the second as to whether there were other interested parties?

Correct. Yes.

Yes. So I'll start with the second one. We can't really make any comment on other interested parties. I can tell you that over the last 3 years, we have had approaches virtually every month from different organizations around the world. So both -- well, Mathletics, in particular, is a very well-known product and people have been interested in the company the entire time I've been involved with it. In terms of the process, we were approached by IXL and went through a process reflective of our responsibilities as Directors of the company to review the bona fides of IXL, its capacity to pay and then whether or not the premium that they were prepared to pay was something that we thought should be brought to the attention of the shareholders. And in the end, we came to the conclusion that they were a good -- would be a good long-term owner of 3P Learning and that the value that was inherent in their offer was worthy of consideration of the shareholders and worthy of the unanimous endorsement of the Board.

That sort of leads me well into my next question just in terms of that shareholder vote process. It's a pretty top-heavy register, obviously, with a lot of concentrated shareholding. Has there been any engagement with shareholders as to what feedback is to this proposed scheme?

Well, we haven't been in a position to speak to shareholders directly. We -- you're absolutely right that we have a concentrated register, and we have usually very cordial relationships with our major shareholders, although none of them are bashful about letting us know when they disagree with the things that we're doing. I expect that we'll have a very direct conversation starting immediately after this call.

All right. Fantastic. And just one last one for me. I can't seem to find too much in my preliminary research on IXL, but is there any concern potentially around the FIRB application process? Anything that might jump out?

Well, IXL has unusually highly regarded advisers, one of whom has said to me categorically based on his long experience with these matters that he doesn't expect to have a problem. In our view, we recognize that one of the great joys of being involved with 3P Learning is that we get to provide education to school children, but that carries a great responsibility with it as well. And we are very highly aware of our duties in regard to cybersecurity and data privacy, and we anticipate that the FIRB will consider that in its assessment of this particular transaction.

[Operator Instructions]

Sorry, can I just interject? I just wanted to add some further information to our previous response that we made. I think it was quite a technical question on the scheme of arrangement that was raised by Shuo Yang, so I just wanted to make a mention that the technical kind of bits are documented within the Scheme Implementation Agreement and fully set out in the terms of conditions. So you should make reference to that for a fulsome explanation to that question.

We are showing no further questions at this time. I'll now hand back to Ms. O'Flaherty for closing remarks.

So just in closing, thanks, everyone, for joining us, and I'm sure we'll get to see lots of you over the next couple of days. Thanks so much.

That does conclude our conference for today. Thank you for participating. You may now disconnect.