G8 Education Limited (GEM) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the G8 Education Limited Conference call. [Operator Instructions] I would now like to hand the conference over to Mr. Gary Carroll, CEO please go ahead.

Thank you, and good morning, everyone, and thanks for joining the trading update call for G8 Education. My name is Gary Carroll, and I'm the CEO and Managing Director of G8 Education Limited. I'm joined on the call today by the group's CFO, Sharyn Williams. We'll walk through the investor presentation that was posted on the ASX earlier this morning, and then we'll provide time for any questions. Slide 4 of the presentation pack sets out the summary of the achievements for the year-to-date, both from an operational and a strategic perspective as well as providing a high-level outlook for 2021. Starting with operations, it's been pleasing to see occupancy continue the recovery that was highlighted in our half year results presentation in August, with like-for-like occupancy currently at 75.5%. The group has continued to manage costs well, which, when combined with continued government support, has allowed us to increase investment in key areas such as in SEM sources and repairs and maintenance in the fourth quarter. Our unaudited underlying EBIT as of the end of November was $98 million, including current year wage costs relating to the employee payment remediation program. From a strategic perspective, the group has made good progress in its portfolio optimization activities, with the divestment program for our 52 impaired centers being on track and the sale of the Singapore business being completed. Our reengineered improvement program in which all activities, except for major asset refurbishments, were continued despite the challenging COVID-19-related environment has progressed in line with expectations with approximately 100 centers being covered by the program in 2020. As flagged in August, G8 undertook a comprehensive proactive review of its award and legislative requirements as part of the implementation of its new rostering system. This review identified award noncompliance and a remediation program has commenced with total one-off pretax costs estimated to be between $50 million to $80 million, and I'll talk more about this remediation program shortly. Looking ahead to 2021, the group will continue to focus on 3 main areas: firstly, the optimization of our portfolio involving the divestment of our previously impaired centers; secondly, the continuation of our improvement program; and lastly, the measured rollout of new greenfield centers using our revised investment model. While we do expect general economic conditions to be impacted by COVID-related events in 2021, the progress to date in our key focus areas gives us the confidence to increase the pace in these areas, particularly the improvement program. The cost of the program will be managed to ensure they are funded by the benefits of the overall strategic program. Slide 6 unpacks the trading results in more detail. The year-to-date underlying EBIT result has been driven by 2 factors, firstly, good operational delivery as well as the benefits of government support. I'll talk more about occupancy and wages in more detail shortly. I wanted to highlight 2 impacts in relation to the 2020 profit result. Firstly, the group did not implement a fee increase in 2020 as stipulated by the government subsidy arrangements. We have also chosen to increase our cost investment in quarter 4 by around $8.5 million, covering R&M and in-center resources. These investments are designed to continue G8's improvement in quality which will have positive benefits in future years. Capital expenditure for 2020 is expected to be around $31 million, in line with previous guidance, while the group's net debt has been reduced such that we are in a broadly cash neutral position. We continue to enjoy strong support from our lenders, with amendments to bank covenants in place until December '21 and the refinance process being on track to be completed in early 2021. Slide 7 shows the group's 2020 occupancy performance in detail. It's pleasing to see the group narrowing the occupancy gap by around 5.5 percentage points since the April low with the current gap to last year at approximately 4.5%. The growth has been reasonably even across the states, with the exception of Victoria, which took longer to ramp up due to longer lockdown periods, and the ACT where the group has experienced higher-than-normal turnover center managers. The impact of the lockdowns in Victoria is evident on Slide 8, which shows the attendance trends for the year. Importantly, all states are now demonstrating a normal differential between occupancy as represented by bookings and attendances. Slide 9 outlines the group's performance in relation to wage hours per booking in 2020, and on an overall basis, G8 delivered wage efficiencies in line with its targets for the year. Our straight year-on-year comparison is very challenging due to the very different occupancy levels in 2019 and 2020. To highlight the improvement in wage efficiency in 2020, we have marked the wage-out per booking result at the same occupancy level, in this case, 74%. The improvement in wage efficiency in 2020 at the same occupancy level is clear, with this result being achieved as a result of utilizing the technology platform that forms part of G8's new rostering system. Important to note these relative efficiency improvements are not impacted by the employee payment remediation program. The other key point in this slide is that wage efficiency is absolutely impacted by occupancy. This is clearly reflected in November 2020, where the drop in wage efficiency was driven by the 5 percentage point difference in occupancy. I'll now provide further details on the remediation program that is underway to address award and legislative compliance issues. Let me first start by saying that our team members are critically important to providing the best learning foundations for our children and support for our families and the commitment of our people, particularly during the challenges we have faced this year, is our key to success. As mentioned at the start of the presentation and outlined in Slide 10, a proactive review of award and legislative requirements was undertaken as part of our new rostering system implementation. That review identified inadvertent noncompliance issues covering the past 6.5 year period. These issues primarily relate to payment for overtime, minimum engagement periods and agreed hours of work and allowances. In many cases, the issues arose due to insufficient documentation of agreed hours. G8 is voluntarily self-reported to and is engaging with the Fair Work Ombudsman in relation to these issues. Total one-off remediation costs of these issues is presently estimated to be $50 million to $80 million on a pretax basis. This includes estimated direct wage costs of approximately $38 million to $60 million wage on costs, interest and remediation program costs. Worth noting that the direct wage cost impact represents between 1.5% and 2% of the total wage cost over that 6.5 year period. And for those wanting to understand the impact of the program on CY '20 EBIT, the year-to-date results includes a provision of approximately $12 million in relation to this program. Now these estimates are based on preliminary analysis and assumptions. These costs net of tax will be funded from existing cash reserves. Our remediation program is underway, and the group is committed to ensuring that all team members are paid correctly moving forward. The remediation program is expected to be completed by July 31, 2021. Our new rostering system, which is designed to automate certain award compliance and improve visibility is scheduled to be fully implemented across G8's network by the end of half one CY '21. In the interim, the group will be utilizing the centralized processes designed as part of the new HRS system to mitigate the impact of these issues. Accordingly, G8 does not expect any material impact to wage costs in future years as a result of these issues. Clearly, the group deeply regrets these pay issues have occurred, and we apologize unreservedly to all affected team members. Turning to Slide 12, which sets out the group's near-term strategic priorities. Firstly, rollout of the new rostering system is on track with the end-to-end process being deployed for the first pilot group of centers with a larger pilot currently underway. Full rollout across the remaining network will commence in early '21. Secondly, it's pleasing to see that 2019 pilot centers in our improvement program performing in line with expectations in terms of occupancy and other key metrics. Around 100 centers will be completed in 2020 as part of the program, with planning being finalized for the 2021 cohort. From a network optimization perspective, active negotiations are underway to exit 27 previously impaired centers in line with schedule. We outlined our revised approach to greenfield acquisitions in the half year update in August, with significantly reduced capital outlays per center, driving higher returns on capital. The group is progressing a number of negotiations using this new model with good acceptance from developers. Turning to our outlook on Page 13. The group expects 2021 to be a recovery year, as COVID-19 continues to impact, particularly on occupancy, either directly through movement restrictions or indirectly through economic impacts such as higher unemployment, lower occupancy levels in a regulated wage environment impact wage efficiency, this, compounded by the absence of the CY '20 fee increase, increases wages as a percentage of revenue. Near-term strategic priorities in CY '21 remain on executing the divestment of previously impaired centers, the improvement program and network growth. Improvement program is expected to gain momentum in CY '21 based on positive results to date and the medium-term earnings potential of this program. The cost of the increased activity will be managed to ensure they are funded by benefits of the strategic programs. Approximately 10 new greenfield centers are expected in CY '21 for a capital outlay of circa $4 million. Start-up trading losses in CY '21 are expected to be around $4 million. Based on current center opening dates with strong returns over the medium-term as the centers mature. CapEx deferred from CY '20 of $10 million will be released in 2021, taking the total to at least $50 million with further incremental spend based on return hurdles. That concludes the formal part of the presentation. I'll now open the floor to any questions.

[Operator Instructions] Your first question comes from Tim Plumbe with UBS.

A couple of questions for me, but I might just ask 2, and then I'll jump back in the queue again. Just in relation to the wage costs, obviously, it's dependent on occupancy. But how should we be thinking about labor cost as a percentage of revenue going forward next year in broad terms?

Yes. So there's 2 factors to take into account, Tim. One is no fee increase in 2020, but there were wage increases. So if you model 2 years of wage increases but only 1 year of fee increase, you'll see some margin compression off the back of that. And I think the percentages are quite straightforward for you. The second is the impact on wage efficiency, which we tried to provide some guidance on Slide 9. That will have an impact. Clearly, won't be quantifying it, but we're hopeful that people will take both factors into account when they're coming up with an estimate of wages. But wages will go up as a percentage of revenue.

Yes. And then just in terms of those greenfields, so it looks like $400,000 loss in year 1. How should we think about earnings profile or the expected earnings profile of those new centers over the next couple of years?

So the broad operating metrics of those centers, no different to the balance of our portfolio in that Navy place center depending on the fees, should be generating EBIT north of $300,000 per center on an ongoing basis.

Got it.

Yes. So that gives you a good sense of the return potential of that kind of portfolio.

And over what period would you expect to see that?

So our ramp-up period has varied across our portfolio. What we have done is model the impact of the centers at locations and other characteristics that we're currently negotiating it. We benchmarked it against similar centers that form part of our previous greenfield pipeline, and there, you'd say the ramp-up period is between 12 and '18 months to get to that maturity.

The next question comes from John Hynd from Wilsons.

Just follow-up with 2 questions around the greenfield. All 10 -- just confirming you're expecting all 10 centers to open in '21. Is there -- how should we think about this profile going forward? It looks like this is back on the agenda for you. And I guess, what gives you the confidence this time around about the centers in the earnings profile and the risks to supply given what we were -- what investors were dealing with in the last sort of 3 to 4 years with the previous portfolio?

Yes. So 2 key changes for me, John. We have changed a number of key members of that our team in our property development space, and I'm certainly very excited about the capabilities that our new people have brought to that team. The increased rigor around assessment of future supply/demand and ensuring that we're actually in locations that we're extremely pleased with versus a portfolio that was more on an inherited basis previously. And the second element is we're more proactive in our design of the center itself, so we're able to incorporate the elements that we want to see as opposed to inheriting a design from developers. That also enables us to have much greater control over the timing of opening as opposed to our previous arrangement. So you'd really say it's been pretty much completely reengineered in terms of site selection, site design, construction management and economic modeling of supply/demand, and we're very strict on ensuring that we're going into areas where we feel that there's an attractive supply demand balance. And as you would have noted in August when we did our impairment review that was an avenue in our previous greenfield portfolio in all centers.

Yes. So just following on from that, the centers, would you be dealing with an incubator partner or this is all on balance sheet? And I guess, have any -- how are the occupancy or inquiry levels looking as you start bringing these guys story centers out of the ground?

Yes. So a couple of points to note there. One, it's not an incubator in the sense that maybe others in the market have where they pick it up at a certain occupancy level. We will be inheriting these centers at open and building the occupancy from scratch. The capital outlay then reflects that, John, so we're essentially paying for the fit-out. The in-center resources may be a small contribution to other fit out. So you're talking about a $400,000 capital outlay versus $3 million in an incubator-type arrangement. To take account of that we need to build ramp up occupancy. The actual inquiries process hasn't really occurred because a number of these centers, the majority will be opening in the second half of the year in 2021. Just -- and that's a function of when we've started rolling out the new model and the construction profile that comes with that.

That's great. Just one more for me before I jump in the queue. The asset sales, I think there was $52 million originally flagged with your impairments. They were losing about $14 of EBIT. How much -- how has it progressed? When can we get, I guess, detail on completion set at this? I think it's 25 centers -- or 27 centers. And how far away are the rest? And also, how are you selling centers in the current environment? Are there any additional hurdles you need to get jumped over?

Yes. So what we intend to do, John, is keep the market updated as we progress through and complete negotiations because the reality is that they're not 5-minute negotiations. So trying to come up with a forecast in terms of time line is pretty difficult for us. We've certainly been happy with the progress made but it's very difficult, as I'm sure you can appreciate, to predict. And kind of into quarter-by-quarter, this is what we're going to expect. We have -- we're pursuing a number of options in terms of how we exit those centers for the nearer-term lease expiries. It may be a matter of getting to a lease surrender amount that's amenable to both parties and we exit the center that way for other centers where it's more long-term lease. It's a sales process. We have engaged a couple of partners to assist with the sale process for those longer-term leases. That process has just commenced, so it's quite difficult at this point to come up with any timing. The focus over the last 3 months has been on the exits from a surrender point of view, and we've made some pretty good ground. I expect us to provide a more fulsome update in February as we progress through.

And just from my knowledge -- so at least surrender -- some 20 or 25-odd centers that you've earmarked today, they are all -- I mean, they're essentially on holdover. Is that what it means, already?

Yes. No, none of them had a holdover. They all had a lease that had some period to run. The amount of the period varied from 12 months up to a very long period. So none of them were on holdover. We were able to obviously just give one month's notice and hand back the keys. That wasn't the case for any of them.

Okay, and so it sounds like you've sort of as you exit then, you'll be exiting for a small loss with this portfolio and the smaller portfolio.

So our focus, if we're looking to surrender the leases, to come up with an exit cost that we think is reasonable based on the lease time to expiry at the amount of the rent and the losses that we're incurring. And that's, as you can imagine, a balancing exercise, and the engagement level varies by landlord.

The next question comes from Gareth James with Morningstar.

Just keen to get your thoughts on the outlook for demand and supply or more for supply. Just looking at the SQL data, it seems to imply that supply is still pretty strong, and I'm talking in terms of number of places being added. I've got it currently running at about 4.7% per year, yes. Yes, so what are your thoughts on that going forward and potential impacts on G8?

Yes. Thanks, Gareth. Good question, and we've set out in now Investor presser in the appendix an overview of the supply/demand dynamics. So quarter 2 this year, as you'd expect, was a low point given the COVID environment, but it did rebound. And full year basis, we're seeing supply growing at about the same as historical levels. So I certainly agree with your initial assessment that supply growth hasn't materially abated, and our initial forecast is it won't abate over the coming period in any significant way. Even though we do think occupancy, off the back of employment conditions, will be at a lower level. The pleasing thing from our perspective is the impact on our exact network has been substantially reduced. Lots fewer centers opening within a couple of kilometers of a G8 center. So specific impact to G8 has been okay. It's actually been more positive over the last 12 months. What that will look like moving forward is anyone's guess, which is actually the impetus behind us accelerating our improvement program as our evidence still suggests that we improve our quality and we have a stable, engaged team. That is a really good defense against supply coming on board. So we are looking to up the pace of our improvement program to derisk any supply-related risks.

Okay. And just if I could clarify something. You talked about a $12 million provision in 2020. I think it was -- you're talking about relating to the remediation. So just to clarify, sir, does that mean that the total figure that you've quoted is the rest is going to fall in 2021?

No. So the -- that's a great question. Thank you. So the remainder of the figure falls into prior years. And there will be 2 steps here, and I'll -- Sharyn will, no doubt, correct me. But the amount relating to 2019 will flow through when we do our year-end accounts in terms of a restated 2019 number. The amounts relating to prior periods before 2019, because this goes back to July 2014 in terms of the review period, they will flow through in terms of an adjustment to opening retained earnings.

Sure. And just one final one for me. So just on the 27 centers that I think you were talking about are going to be sold, I was just wondering, with the EBIT -- underlying EBIT figure that you've given I guess that excludes losses from those centers.

I wish, but no. So we haven't -- the underlying EBIT includes the $12 million provision for employee payments, but it has all of our centers in it. They will only come out when they exit the network.

All right. So why was the $12 million provision included in underlying EBIT?

1 Because it's wage cost. So it's -- yes, it's relating to the cost of back payments relating to wages under the remediation program. And so it is the estimate based off the review work that we have done to date. The final amount will clearly be confirmed as we work our way through the remediation program.

The next question comes from Aaron Muller with Canaccord.

Gary. Sharyn, look, just in terms of the remediation program, can you just give us a bit more color about the issues around insufficient documentation?

Yes. So I'm sure, as you can appreciate, Aaron, we have quite a complex operating environment where we've got regulated ratios on a per-room basis across 470-odd centers, with daily movements in attendance levels and team member levels. And our team adjusts on a daily basis to ensure we remain within ratio. And with the mix of workers that we have, full time, part time and casual, under the existing award arrangements any changes to those people's hours, particularly relating to part-time need to be documented. Someone -- we have someone to do less hours than is under their contract to meet the demand, et cetera, or more hours, then those need to be documented. And our review has highlighted that in a number of cases, that documentation is not immediately evident. We now need to commence a more detailed center-by-center team member analysis to see if that documentation is, in fact, in place. If it is in place, then that's one set of actions. If it's not in place, then we clearly need to make a payment for that employee relating to that. So yes, it's -- I think the overarching root cause is around scale and complexity in a regulated environment with moving parts that occur on a daily basis.

Yes. Okay, okay. And the range that you've provided and the $12 million for this year, how confident are you that won't change?

That's a preliminary estimate based off, in a way, diagnostic review, which has been a very detailed diagnostic review. But I can't say with any certainty at this point in time until we get into record-by-record, team member by team member. We've got a reasonable basis for the estimation, but we now need to go and complete the work.

Yes, okay. And look, just on the network growth strategy going forward, should we assume it's going to be steered towards greenfields? And I mean, is this the main area you'll be looking to deploy capital?

I think the answer wouldn't have changed from the last couple of years, Aaron, in that we'll balance all the elements of our strategic program, improvement program, divestments and sensible network growth, and we're agnostic between brownfield and greenfield. There's pluses and minuses to both brownfield to get the opportunity to get an existing earnings stream and providing all the other metrics and key factors that we look for in that center stack up. You have supply demand, quality of team, quality, and we would pursue that. Just so happens that to date, there had been a very few, really none, attractive brownfield opportunities for us to assess.

Yes, okay. Just going back, just picking up a question by Tim Plumbe, just on the wage costs, your wage-to-sales ratio going up next year. Are you assuming that the divested centers are still in the business?

Yes. We have not made any firm assumptions about the timing of the exited centers because they're always subject to negotiations. So we haven't, yes.

[Operator Instructions] The next question comes from Tim Plumbe with UBS.

Just a couple of follow-up questions for me, if that's all right. Gary, can you maybe talk about the pipeline of inquiries for next year? How is that looking relative to this time last year and how do you feel that places the business heading into calendar year '21?

So far we're ahead of last year in terms of our lead pipeline, Tim. So inquiries at tours, et cetera, were tracking ahead of last year. And we're certainly pleased with where we're sitting, but the overall position will only be fully ascertained. The key January, February period is still an important period for us. As you know because you've been covering the sector for a long time, it really splits into 2 periods. People ought to secure early. Certainly, volume has been pretty good. And then there is quite a significant volume that comes through at the very start of the year in January and into early February. And the lead times on those are compressed, but they also contribute a fair amount to our sort of starting position in February. So I can't talk to how that's looking at this point. Certainly, progress to date has been pretty good.

Got it. And I know you guys put it, I think it was on Slide 8. Could you give us a sense what are the actual numbers? So 75.5%, I think, was inclusive of Victoria. If you looked at all other states, excluding Victoria, what was that number and what was that number down relative to last year?

Yes. So I'll probably frame it in terms of how we're tracking against last year. So you say can states like Queensland and WA are reasonably equivalent. New South Wales, a touch behind, but pretty solid. And Victoria is still ramping up. It's still got a little bit of a gap on last year. And ACT is actually our worst-performing center, and that's actually a G8 issue around center manager turnover. It's only nine centers as well in terms of overall network. So I'd say if you exclude Victoria, people have absolutely closed the gap. Although we are still slightly behind last year. Victoria is catching up, but it's a little way behind the rest at this point still.

Great. And just one last one. Those 27 underperforming centers, I mean, $14 million is across the whole portfolio of 52 or whatever it is. And I know that there's some larger bigger loss-making greenfields included within that portfolio. How do we think about the EBIT loss of the $27 million that you're currently looking to exit out of that $14 million?

Yes. I can't really give you a number on that, Tim, because it does vary. And also their results flowing through into next year will be clearly subject to how they start the year from an occupancy perspective. So it would be a real guess at this point in time. It's -- clearly can't do an arithmetic average and say it's about half. The best thing we can do for people is to give you an update as we go, and we can quantify the impact as we're rolling along.

Got it. Okay, I might try and squeeze one last one, if that's all right. $98 million of EBIT includes $12 million provision, so that's $110 million compared to what we thought it was before we knew about that issue. On my numbers, that compares to about $70 million of adjusted consensus for pre-AASB. So a pretty big beat, and that's November year-to-date. How do we think about a typical December EBIT contribution for this sort of business?

Well, in a trading update, we wanted to focus on what -- where we're tracking year-to-date. We weren't going to provide any guidance as to how December looks. We are still, in our view, in quite a volatile operating environment. And if things happen, as we've seen even in South Australia reasonably recently, that can knock things around. So we're not providing guidance as to how December looks. We're clearly happy with what we've done November year-to-date, and the business is performing well in all the fundamentals. We're just not going to be providing a number at this point.

The next question comes from James Bales with Morgan Stanley.

Just for clarity, should we be including the $12 million provision in the underlying cost base that we extrapolate going forward? Or the new systems, does that go away?

Certainly our intent, James, is that the new systems will mitigate the impact of the results of the review. So we're not anticipating any material increase in future wage costs.

Thank you. There are no further questions at this time. I'll now hand back to Mr. Carroll for closing remarks.

Well, thanks, everyone, for your time today. No doubt we'll be catching up with a large proportion of you in the next day or 2. And thanks once again for your time and your questions. Much appreciated. I'll let everyone get back to their day. Thank you.

Thank you.

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