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

Welcome to the 3P Learning's Investor and Analyst Briefing. Today, you will hear from Matthew Sandblom, Executive Chairman; Jose Palmero, CEO; and Anton Clowes, CFO, as they present to you, 3P Learning's 2024 half year results. [Operator Instructions] I will now hand over the presentation by Matthew, Jose and Anton from 3P Learning. Please go ahead.

Welcome to 3P Learning's first half of the '23, '24 financial year report. A lot has been achieved by 3P Learning since my last report. This includes some major new product releases and the buyback from Edmentum of the U.S. school distribution rights for Reading Eggs. These actions are key parts of our overall strategic plan to be a market leader in major English-speaking markets across the core academic skills of reading, writing and maths. Now that the elements to deliver on this strategy are in place, our main tasks are to complete the build-out of these products and increase our market share, especially in the U.S.A. We have also just implemented a business refocusing program that has cut about $5 million in annualized costs from lower priority areas, so that we can increase the resources available to growth markets while still protecting our profitability levels. On the product side, we released the first Three grade levels, years 1 to 3 of Writing Legends late last year. We expect to complete the other 3 grade levels years 4 to 6 by late in the 2024 calendar year. Overall, our release schedule is about 8-months behind what we originally planned due to additional features we wanted to include in this program. We have received very positive feedback from the early users, but we don't expect large-scale adoptions until the full program is available. The other main product release during this period was the first of the new courses for Mathletics. We expect the new courses to become a core part of the program and the initial response from the market has been excellent. We should have new courses material completed for all core sections of the curriculum over the next 12-months. We expect, this will provide us the platform to grow the Mathletics sales in all major markets. Our direct-to-consumer business has still managed to achieve high single-digit billings growth in the face of tighter budget conditions for our core market of parents with young children. Key factors that have contributed have been improved customer retention and some modest price increases. We have also been disciplined with our marketing spend and improved our gross margin in this area. Buying back the U.S. school Distribution Rights for Reading Eggs from Edmentum was a key plank in creating a scalable sales platform in what we expect to be our biggest future growth market. Prior to this deal, our U.S. sales operation was subscale for the size and complexity of the market. Between Edmentum's Reading Eggs customer base of about 4,500 schools and our existing Mathseeds U.S. customer base of around 2,500 schools, we now have an overall market penetration after deducting overlaps of around 10% of the U.S. public elementary schools. We expect to more than double the size of our U.S. sales team over the next 12-months with the addition of at least 20 new team members. While the business has lots of good growth opportunities, we are always mindful of the need to maintain financial discipline, so that we can fund the best opportunities, including targeted acquisitions. In the last 2.5 years, we have done over $30 million worth of these deals. This includes the purchase of original -- of the original Writing Legends program, BrightPath Assessment and now the distribution rights from Edmentum. As well during this period, we have spent more than $60 million in product development and as well as be able to self-fund about $2.4 million worth of share buybacks over the last 6 to 8-months. So we've taken on no new debt and it's all from operational cash flows, which is a key reason behind the just implemented cost saving worth $5 million on an annualized basis. These savings come from across the business, although we have ring-fenced projects with high growth potential such as Writing Legends and the U.S. sales platform from these cuts. Based on current trends and the slower release of some new products unexpectedly reaffirms sales guidance at the lower end of the $112 million to $115 million range that we previously announced. With the cost savings implemented, we can confirm previous EBITDA guidance after one-off restructuring costs, which is in the -- EBITDA guidance is in the $13 million to $15 million. In summary, all key the pieces are now in place to give 3P the platform for long-term sustainable growth. Now we need to fully execute our sales and marketing strategies in all the major markets to fully deliver on these opportunities and the investments we have made. I will now pass on to our CEO, Jose Palmero, and our CFO; and Anton Clowes, who will provide further details on the first half results.

Thank you, Matthew, and good morning, everyone. We'll start with some commentary on our strategy to give context to the financial results and operational update. As Matthew mentioned, we have invested heavily in putting together a comprehensive content and assessment product suite for Reading, Writing and Math for B2B and B2C. We have built most of that organically for Reading Eggs, Mathletics and Mathseeds and by acquiring and further developing Writing Legends and BrightPath. In the first half of this financial year, we started moving from the product build phase to the go-to-market phase in APAC with very positive market feedback and response. And we also reacquired the U.S. school Distribution Rights for Reading Eggs from Edmentum. Our strategy, therefore, remains focused and we now control B2B and B2C distribution directly for our products in all major markets. I'll talk a bit more about what this means in terms of growth drivers for the company, but let's now look at the first half results. Just as a reminder, 3P generates about half of its revenue from APAC. Billings and cash receipts are therefore, stronger in the second half of the financial year. We also recognized revenue over the subscription service period, so these results don't include revenue for new products and upsells in APAC because schools are mostly invoiced in February and March. Nevertheless, revenue for the first half was $53.9 million or 2% higher than in the prior corresponding period, which was a bit lower than expected. This was mainly due to lower performance from third-party distributors in the U.S. B2B market with annual recurring revenue 2% lower to $64.2 million, which reinforces our timeliness in taking over direct distribution of the Reading Eggs U.S. schools business. Encouragingly, despite a tougher consumer market globally, B2C billings increased 7% to $21.8 million, which was a good result. As we transition from product build to go-to-market, our sales and marketing costs increased in this half, but we still delivered underlying EBITDA of $3.4 million. Underlying cash used in operations before tax was $2.4 million, which was $3.2 million improvement on the prior corresponding period. We will continue investing in product development, but we'll prioritize our spending on the strongest opportunities with less resources applied to low priority initiatives. As a result, we expect to achieve $5 million of annualized savings commencing March 2024. Looking now at segment performance in more detail. The consumer market was tougher overall, but B2C billings improved in all key markets and all channels with new subscription options and the January 2023 price increase contributing to the positive result. We also continue to be disciplined with marketing spend, which resulted in net billings contribution margin of 50%, which was 8 percentage points higher than the prior corresponding period. In the schools market, we saw a 2% decline in annual recurring revenue with good performance in APAC and EMEA for retention and new business, but lower retention in the U.S. in the first half and lower performance from our third-party distributor prior to 3P reacquiring the rights. As previously announced to the market, we entered into a binding agreement with Edmentum on 21 December 2023, and effectively took over the book of business on the second of February this year. By all accounts, the transition went well. So 3P is now directly responsible for all revenue and customer service functions for Reading Eggs schools customers in the U.S. As we cover the first half results, which are historical in nature, we're also looking ahead. So I will now provide some color on what we consider to be the company's key 3 growth drivers over the short to medium term. Starting with our B2B product Go-to-Market, we see our new products, Writing Legends and BrightPath Progress and the Mathletics upgrades, spearheading growth in APAC and EMEA. We already sell at least one of our programs to 6,000 schools in Australia and 4,000 schools in the U.K., which is a well-established customer base not just for stand-alone sales but also for upselling, cross-selling and offering bundled content and assessment packages. For EMEA, the main driver will be Reading Eggs starting with the retention of the customers transition from Edmentum and then using that as a base to upsell and cross-sell our other products. For that, we'll continue to focus on U.S. specific features like district reporting and alignment to U.S. standards. Our product roadmap, therefore, concentrates on the product and markets that reflect the best growth potential and opportunities, building out Writing Legends for years 3 to 5 for releasing APAC and EMEA, U.S.-specific features for Reading Eggs and new courses for Mathletics will therefore be priorities for product development for the remainder of calendar 2024. During the first half, we released future improvements for Mathletics to enhance user experience. These improvements included new student center, new avatar system, Teacher Assign functionality and new certificates and rewards. We launched the fractions module of new courses in early February for years 3 to 6 in APAC. New courses are the most substantial part of the Mathletics upgrade, so we are pleased to report that in the first week since release, we've had 20,000 users completing activities, which is a very encouraging result. We expect to deliver more new courses covering the core elements of maths by December 2024. We also released Writing Legends for years 1 to 3 in APAC in August 2023 and in EMEA in January 2024. In APAC, in the past 6 months, 1,300 schools have trialed the program and user feedback has been very positive. We aim to have all existing Reading Eggs customers trial Writing Legends in calendar 2024. We have already built the interfaces and single sign-on for these customers for faster onboarding and adoption. Our second growth driver is the U.S. market. I'll break this into 2 parts. The first will cover the impact of the deal with Edmentum and the second will focus on how we see the U.S. as a growth platform for 3P. The primary reason for the reacquisition of the U.S. schools Distribution Rights from Edmentum was the opportunity it provides 3P for significant expansion in the U.S., which is the largest edtech market in the world. Before reacquiring the rights, recent 12 months billing performance by Edmentum produced about USD 1.9 million in net EBITDA for 3P. For us to distribute directly, we have invested in our own sales, marketing and customer service teams, including about 20 new full-time equivalent staff and additional advertising at an annualized cost of USD 2.3 million. There will be some diminishing unwind of deferred revenue and distribution costs over the next couple of years, but we expect at least USD 1.2 million in additional EBITDA contribution from financial year '25 onwards. We accounted for Edmentum revenue on a grossed-up basis, so there is no change to accounting revenue. We will, however, get a cash flow benefit from all invoices paid and collected from now on. In terms of the opportunity in the U.S. as a growth platform, Reading Eggs is a key product for our growth strategy and controlling the entire product life cycle represents a significant opportunity in itself with no reliance on third parties. We now have direct access to about 6,000 elementary schools subscribed to our programs in the U.S., including districts, which represents about 10% share of the 67,000 public elementary schools in the U.S. We will focus on retaining the Reading Eggs customers with transition from Edmentum, but have also geared up for upselling and cross-selling to this long-standing customer base. We will first target the 5 states where we have the most market penetration followed by the next 15 states to build groundswell support and further brand recognition. As Matthew mentioned earlier, we have put in place the strategy pieces to now position the business for our third growth driver, Operational Leverage. We will start targeting our existing and long-standing customer base to grow B2B revenue with new products, upselling and cross-selling content and assessment solutions in APAC and EMEA, while retaining the customers' transition from Edmentum to enable us to do the same in the U.S. Our goal is to achieve double-digit B2B billings growth in all key markets from financial year '25. On the cost side, we have just passed peak product development costs and expect this to decline in the coming years both in absolute dollar terms and as a percentage of revenue. We will, of course, continue focusing on profitability and strong cash generation. and seek to improve underlying EBITDA margins from financial year '25. I hope this gives some more color on how we see the company developing in this next stage. I will now hand over to Anton for the financial and statutory report update. Thank you.

Thank you, Jose. Moving to results and cash flow in more detail and looking at P&L key drivers. B2B revenue remained steady, up 1% on the prior comparison period. APAC and EMEA regions performed well, and this was offset by a poor U.S. new business and distributor performances. B2C revenue is up 5% on the PCP, stemming from billings growth combined with the new pricing from January 2023. From an expense perspective, sales and marketing costs were up $2.7 million from mainly additional investment in full-time employees and B2B go-to-market costs for new products in Writing Legends and BrightPath Progress. Product and technology costs up $1.5 million, also from additional investments in full-time employees. Underlying EBITDA was disappointing at $3.4 million, down $2.4 million from the first half of last year. This reflects softer revenue plus that higher additional investments in staff. Significant items include $13.7 million after-tax acquisition of U.S. schools Distribution Rights for Reading Eggs and $3.5 million depreciation and amortization of acquired products for Blake & Brightpath. In terms of the rights, because they are deemed internally generated intangible asset, we cannot capitalize under the Australian accounting standards, and therefore, they have been expensed in full in the period. Moving to B2C performance metrics. Gross billings, $21.8 million in the half, up $1.5 million or 7% from the first half of last year, and encouraging results. Licenses down by 7%. However, reflecting the price increases implemented from January 2023, ARPU up $10.3 or 16% to $74.9. Sales and marketing costs, some improved savings there, $600,000 or 6%, leaving a net billings contribution margin of 50%, which is a good result, up 8 percentage points from the first half of last year. From an accounting revenue perspective, revenue is up 5% to $21.7 million from $20.6 million in the first half of last year. Expenses, well maintained cost control, $12.9 million, leaving a contribution margin of $8.8 million, which is 17% up on last year or a contribution margin of 41%, which is 5 percentage points ahead of where we were same time last year. Moving on to B2B performance metrics. Opening ARR was $65.4 million, closing at $64.2 million. While this represents a 2% decline from 30 June 2023, encouragingly, our net churn has reduced by 6 percentage points to 8% or $5.1 million. Exit ARPU remains relatively stable at $12.4. From an accounting revenue perspective, the first half of '24, we reported revenue in B2B of $32.2 million, up 1%. And our contribution margin of $15 million, down 16%, leaving a contribution margin of 47% from 56% in the first half of last year. APAC and EMEA regions performed well, and this was offset by lower U.S. new business and distributor performance. Moving on to the cash balance bridge. We've got a good cash flow story. Underlying cash used in operations before tax in the half was only $2.4 million, which is significantly improved from $5.6 million in the first half of '23. BrightPath related payments of $1.1 million, which includes the earn-out $1 million payment made in October. We got net PPE and intangibles, including an additional $1.1 million investments in Writing Legends. Shares purchased under the buy-back program was a $2.2 million outflow leaving closing cash at the end of the half at $18.4 million. This includes $5.8 million of restricted cash as well as $0.5 million of short-term deposits and no debt. Moving to the final slide, EBITDA cash flow bridge. Underlying EBITDA in the first half of '24 was $3.4 million and after working capital adjustments of $5.8 million, underlying cash used in operations before tax was $2.4 million. This is a significant improvement on the first half '23, which was $5.6 million used. This has been driven by improved working capital outflows, much lower at $5.8 million compared to $11.3 million last period. And this reflects some partial FY '23 timing tailwinds, improved B2C billings in the period combined with lower payments compared to the same half last year. Aggregated with BrightPath related payments and net PPE & intangibles and shares purchased under the buy-back program, total cash utilized in the first half of '24 was $8.6 million. That concludes the presentation this morning. Thank you to Matthew and to Jose and for all, for listening in, and we now open the floor to questions.

[Operator Instructions] The first question today comes from the phone. It's from James Bales from Morgan Stanley.

I just had a question on your expected returns profile from the Edmentum transaction. So it looks like you're acquiring those rights for $13.6 million and then investing another -- at least $2 million in incremental OpEx. And I think in the release today, you talked to an incremental -- sorry, $1.2 million in earnings expected in the first year. Can you maybe just help us understand what sort of additional earnings contribution you expect from the deal? And how you expect -- or how you set those return targets for deploying that capital?

Thanks, James. So I think to start off with the most important thing about the Edmentum deal is the opportunity it gives us to grow in the U.S. market, because of the already established customer base for Reading Eggs and Mathseeds products that we have there. So that in itself gives us an opportunity to upsell, cross-sell and bundle the different products that we've got rolling out into the market, yes. In terms of the deal itself, if I look at it as a stand-alone proposition, right, what we've listed in there in terms of additional contribution to EBITDA is a like-for-like comparison, yes. Anything that we get above that in terms of new sales, upsells, cross-sells will be additional because we would run it at a more efficient and more profitable -- in a more efficient and more profitable way than a distributor. So in what we've put in there as the $1.2 million additional is just like-for-like. Within the people that we've employed, obviously, our first objective is to retain the existing customers, and that's the bulk of the investment, but we've also brought in three new business development people to try and grow new business in the U.S. from day one. And we've already got a healthy pipeline just in the first week for Reading Eggs. So I'd always just caution about looking at the Edmentum deal in terms of what we paid because that -- the significant opportunity is one thing, but also the like-for-like comparison is with EBITDA, yes.

Sure. So obviously, there's an opportunity to win more customers and you're obviously investing hard in that. But on the other side of the equation, when you talk about being able to operate this business much more efficiently, what do you mean there? And what -- can you quantify the benefits that you expect?

So the benefits are net $1.2 million, yes, because if we talk about the contribution that we were getting from Edmentum, that was about USD 1.9 million before the deal, right? So that means that there were costs of about $3.2 million to $3.5 million, whereas now it's going to cost us USD 2.2 million to USD 2.3 million a year, yes. And that includes the retention people plus the new business people, yes. So on a like-for-like comparison, we're running it more efficiently and more profitably, but we're also having the potential for new business on top of that, yes.

Okay. So the $1.2 million is a net number after all additional investment?

Correct.

[Operator Instructions] The next question comes from the webcast. Brett Rock would like to ask, can you bridge the gap between 1H profits and FY guidance?

Thanks, Brett. So if we look at the bridge, the second half of '23, we made about $10 million in the second half of last year. Substantial part of our EBITDA that we produce is produced in the second half, which is from -- basically from the APAC region and the renewal season that we're currently in at the moment. So the gap essentially between first half '24 and full year guidance will be made up in the second half. There's obviously a couple of levers that play there. We've got the $5 million of annualized savings, which, to a certain degree, will be offset against some of the additional FTEs for the Edmentum transaction, but that's the gap.

[Operator Instructions] Thank you to all the participants. As there appear to be no further questions, we have reached the end of 3P Learning's 2024 Half Year Results Briefing. We wish you a pleasant rest of the day.