G8 Education Limited (GEM) Earnings Call Transcript & Summary

Thanks, Bernadette, and welcome, everyone, to this analyst call. I'm joined on the call today by the group's CFO, Sharyn Williams. What we'll do is run through the presentation that was posted on the ASX this morning and allow time for any questions at the end. I guess, starting with Slide 4, which is the executive summary. The 3 key messages out of this slide are that performance for the group has continued to be very good in what has been a challenging operating environment. And by very good, I mean, we've continued to outperform in terms of financial results relative to consensus, and we're continuing to make really good progress on our strategic priorities and I'll go through those in more detail along the way. And then the third key point is that the environment remains uncertain in the coming months. However, we're confident that we've had a lot of practice at dealing with a dynamic changing environment, and we're confident we can continue to, firstly, keep our children, team and families safe, which is the most important; and secondly, manage the business well even in those challenging times. So if we go into the executive summary in a little bit of detail. From an earnings perspective, as at the end of November, operating EBIT, which is defined as statutory EBIT less lease interest, before any nonoperating items like gains or losses on sale and Software as a Service development cost was $76 million at the end of November and operating net profit after tax, which is operating EBIT less finance charges less tax at 30% of $43 million. Pleasingly, both of those numbers are ahead of consensus estimates. As flagged in our August half year release, we had closed the occupancy gap significantly on 2019. However, that momentum was impacted by the lockdowns that occurred from July onwards such that core occupancy as at the week ended 5th of December was 76.5%, 1.7 percentage points above 2020 levels and 2.1 percentage points below 2019. As was the case of the half, regional centers have continued to track above 2019 and metro and CBD centers are tracking below. The group continues to generate strong levels of cash flow and maintain a very strong balance sheet. Net debt is currently at $17 million after accounting for $38 million of wage remediation payments. In terms of our strategic priorities, we've made really good progress. Our improvement program has rolled out to 223 centers, and we've got a further 137 recently inducted into the program, and we continue to exceed our expectations, both from a financial and quality perspective, as we work our way through that program. There is no doubt that retention of educators is a real issue across the sector. And we have been implementing a number of targeted initiatives to ensure that we retain our educators and really try and manage our turnover levels to counter that challenge. And I'll go through those details a bit further on. Our greenfield portfolio continues to perform to expectations, and we've got a strong pipeline of attractive new centers to be opened in 2022, and we continue to make really good progress in exiting our impaired centers. Looking forward, the positive is that the government has continued to support the sector as an essential service. And we continue to enjoy ongoing bipartisan support, including some recent budget announcements that were positive for the sector. And the long-term fundamentals of the sector remain very positive. We did continue to enjoy specific government support to handle COVID closures that approximated to $21 million of support received. That is in the form of gap fee waivers and additional allowable absences for families. Clearly, the sector, including G8, was significantly impacted by extended lockdowns in both New South Wales and Victoria in the second half of the year. That, combined with continuing uncertainty about what impact COVID will have with the Omicron strain as an example, makes the job of forecasting opening occupancy for the start of 2022 extremely challenging. So while the operating environment is uncertain, we are unable to predict how many closures will take place in the sector and with G8. And as a result, what the revenue impact is uncertain. We are continuing to adapt and monitor the environment -- adapt accordingly, and I think do a really good job of continuing to generate great results in that environment. We have further details in the pack to allow people to estimate the impact on revenue of closures to allow you to do some forecasting as we move into the new year. If we turn to Slide 5. As I said, solid EBIT and NPAT results and core occupancy very much to speed, and I'll go through that in a little bit of detail. Revenue for the year will look reasonably messy due to the impact of parent gap fee waivers on our revenue line as well as the normal seasonal uplift trend not being present in New South Wales and Victoria. That does make year-on-year comparisons quite challenging. Also wanted to call out that following an International Financial Reporting Interpretations Committee decision, we are looking at reassessing how we treat Software as a Service development costs. As a reminder, the group predominantly employs Software as a Service through its key operating platforms. Those Software as a Service development costs that were previously treated as CapEx will now actually be reflected in the P&L. It is an accounting treatment change only. There is no change in cash flows. From a capital management point of view, our CY '21 CapEx program delivered in line in the non-COVID-19 impacted states. However, movement restrictions did inhibit some works in New South Wales and Victoria. As previously stated, our net debt is currently $17 million following the $38 million of wage remediation payments. They cover approximately 70% of the team members to be paid. Our dividend policy is expected to recommence with full year CY '21 dividend intended to be paid in CY 2022. Turning to Slide 6, which unpacks the occupancy trends in more detail. The key call outs here is that regional continues to perform extremely well, 3.1 percentage points above 2019 levels. Metro and CBD locations are 5.7 percentage points and 29.6 percentage points, respectively, below 2019 levels. As a reminder, the group's exposure to CBD is extremely limited. We have around 10 centers in CBD locations. And it is anyone's guess in terms of impact of lockdowns, et cetera, on what our starting occupancy position will be, particularly in New South Wales and Victoria. The table at the bottom of Slide 6 highlights the 2-speed nature of occupancy growth during the year where you can see the positive benefits of not being in lockdown as well as our portfolio optimization activities in states like WA and South Australia. And offsetting this, New South Wales and Victoria being 3 and 4 percentage points below 2019, respectively. Turning to Slide 7. We continue to be very pleased with the group's performance in relation to wage efficiency. The investments that we've made over the last 18 months or so in workforce planning support resources and systems mean that rosters continue to be managed very well in relation to attendance levels. You will see in the graph that wage hours per booking from fortnight 23 onwards has increased. That is a reflection of the higher attendance levels as states emerged out of lockdown. And given that our occupancy level is lower than 2019, that flows through in terms of a somewhat less efficient wage hours per booking number, although certainly against our internal benchmarks, we're very pleased with performance. Turning to Slide 8, which gives quite a detailed overview of the COVID-19 environment, which the group operates, we thought it was important to give people a sense of what's occurred in our network over the last number of months, what it means from a revenue impact perspective, what the current government support requirements are, and then what we can do about that moving forward. So if we look at the impact of closures in the 5 months from July to November 2021, there have been 119 center closures throughout the G8 network for an average of 7 days. The average loss revenue per day, while the center has been closed, has been around $3,300. That does depend somewhat on state-based isolation requirements for children and team. We have continued to pay the wages of our team throughout any of those closure periods, so that revenue impact does flow through to earnings. We have really solid operational processes in place to expedite contact tracing so that we can minimize the closure duration. The potential number of closures in CY '22 is clearly uncertain, although we are very hopeful that they should progressively reduce as the transition to a COVID-19 normal environment is completed. And we then expect a corresponding positive impact on overall occupancy levels. In terms of government support, I'll continue to applaud the government for their willingness to support the sector with specific packages and support. They translated to about a $21 million support package during CY '21. That support takes the form of gap fee waivers. So when a center is closed or a child or member of their family is required to isolate due to COVID-19, we get the CCS component, which is about 57% of fees. And the remaining fee is waived, so parents are not getting a financial burden due to their inability to attend a center. The government has also provided access to 10 additional allowable absence days taking a total to 52 days. The clock started accounting on those from the 1st of July. We do, being a national provider, have quite a range of state-based isolation requirements that we need to be aware of and implement. And they currently range from the period it takes to get a negative PCR test for a close contact team and children in Victoria, through to up to 14 days for children and team in early childhood settings in other states. So as you can appreciate, that's quite a range of outcomes. The other point worth noting in terms of government involvement is the government for each state and territory that we operate in has announced a requirement for early childhood education and care workers to be vaccinated for COVID-19. In terms of flowing that through from a cost and fees perspective, we will be, as part of implementing our CY '22 fee increase, looking to balance the funding of increases in our cost base with the need to manage affordability for families. The increases in the cost base comes from 2 main areas. Firstly, we are seeking to improve the employee value proposition for our educators to drive retention. That included wage rate increases for our early childhood teachers. And we also implemented external cleaning for all centers in the network. Previously, we had external cleaners for only a portion of our network. And the second cost impact is actually the impact of COVID itself. That includes items such as increased consumables such as gloves, our dedicated COVID-19 support team. And then thirdly, an increase in agency costs primarily due to the inability to actually share team members across centers in COVID-19 impacted areas. And finally, in terms of an update on our strategic programs. As I've called out, we have rolled out our improvement program to 223 centers and recently inducted another 137 centers into that program. That leaves us well on track to get through the vast bulk of our network by the end of 2022. The financial performance of the prior cohorts continues to exceed target and all of our assessed CY '21 cohort centers have done well from a quality perspective achieved at least a meeting rating. We will continue our investment in center physical quality, targeting benefits in our NQS ratings as well as team and family engagement as a result of those activities. Turnover in the sector does remain elevated. And so we are very focused on how we can retain our team. And we've made a number of initiatives from the remuneration increases that I've called out. We've rolled out a much enhanced service awards recognition program, and we continue to implement and develop and drive our G8 Study Pathways program, which now has over 1,000 active participants covering Certificate 3 diploma as well as degree participants. From a network optimization and growth perspective, our greenfield cohort is performing well. The average occupancy of the 16 greenfield centers is nearing our maturity hurdle of 80%. And the CY '21 year-to-date EBIT earnings for that portfolio is $1.7 million. Approximately 6 greenfield centers will be transferred to the core from January 2022. During 2021, as a result of COVID, we had quite a significant number of deferrals in terms of new center openings. We've only opened 1 center during the year with 13 centers expected to open during CY 2022. We are very confident that after these centers reach their targeted occupancy levels, they will generate strong earnings and returns growth using our refreshed capital light approach that we'd announced to the market earlier in the year. As part of that earlier year presentation, we did call out that year 1 of the program would incur an EBIT drag as a significant number of centers are in year 1 of their operation. That impact will occur during CY '22, which really does reflect the first year of our program. To provide some quantum to that, we think those 13 greenfield centers are expected to create a negative $5.5 million EBIT drag on the CY '22 results as they gradually ramp up attendance and as our mature greenfield centers move to the core. We continue to make steady progress to exit our impaired centers. And with 21 completed, we have called out along the way that the last half of the portfolio will be more challenging given that they're larger with longer lease sales. We made good progress on those, but we don't expect anything -- we expect that the program will continue to be rolled out for the balance of the first half of CY '22. Our recent acquisition, Leor, is trading in line with expectations, although the earnings impact on CY '21 will be minimal. The focus that we've had since completing the acquisition has been on planning and securing the resources to best support Leor to deliver on its CY '22 growth strategy. And finally, turning to our systems and platforms, Stream, our HRIS and rostering system, build and testing has been completed. We've rolled it out to our support office, that was successful, included a move to weekly pay cycle. It's been very well received by the team. We are in the midst of rolling out to the first regional cohort of centers in our operating network that's due to be completed before this calendar year. And our second material system implementation is the upgrade of our financial management system. Testing phase is nearing completion on that with launch confirmed for early CY '22. That wraps up the formal part of the presentation. I'm now happy to hand it over to the floor for any questions.

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

Gary, just 2 questions for me, and then I'll jump back into the queue. Just the first question, can you maybe talk about some of the biggest drivers to improve operational efficiency from your self-help initiatives going into calendar year '22? How should we think about the incremental earnings that can come through from those initiatives? And then the second part to that question, I guess, separately, when we're thinking about the blended fee increase versus the blended increase in some of those costs from increased staffing costs and cleaning costs, all else equal, how should we think about the sort of margin pressure that those movements make on the business going into '22, please?

Yes. So firstly, from an improvement program perspective, the drivers remain the same, Tim, in that we firmly believe that improving the quality of our learning environments, improving our center leadership team flows through in terms of team engagement and family engagement, ultimately, occupancy. And the EBIT target associated with that as we work our way through the network was that mid-teens EBIT uplift. And we're certainly on track to achieve that by the completion of the program. So the half we're on, we've generated a result consistent with that. And that momentum has been maintained even with the challenges of COVID as we track through impact on quality and engagement. So feeling pretty comfortable with that program. In terms of the fee increase and margins, I won't be nominating a percentage increase in terms of fee. But we are certainly targeting that we won't be going backwards from a margin perspective off the back of a fee increase in early 2022.

[Operator Instructions] Your next question comes from Cameron Bell of Canaccord Genuity.

Actually, a couple of questions, and I'll just run through them. So firstly, on the wage remediation. So you said $38 million, and perhaps you said 70% of the team. Does that directly translate to $38 million is 70% of the total? And will the remainder of that be paid in the first half calendar year '22?

Yes. So it's broadly comparable, Cameron, I'd say, would be the answer, yes. The timing is dependent on our ability to contact because the people that are left are no longer employed with the organization, and we have to go through the search process to contact them and then get their bank account details, et cetera, et cetera. As you can appreciate, we're going back 6.5 years. Some of those people are pretty hard to contact. So hard to draw a line in the sand in terms of how long that will take. And the second variable clearly is we remain engaged with the Fair Work Commission on that whole process and we'll be guided by their requirements in terms of how much effort and time is required to be undertaken to contact those prior team members. So I'd love to give you a timing. Would we continue to make good progress in the first half of 2022? Yes. Will we be through it? I don't know.

Okay. Then just on the SaaS development costs, accounting change. So typically, how much is your SaaS development costs?

So in terms of our spend on IT, if you go to the half year, you'll see we spent around $6.5 million in that area. Now a couple of millions of that is hardware, et cetera. So that kind of gives you a bit of a ballpark what we spent in the first half. But Cameron, we are still working through those numbers, so much better placed at February to let people know what the impact of our HRIS and financial system will be.

Yes. Okay, sure. And then just on the occupancy numbers by state. Just that ACT performance. I know it's not a big state for you, but I was just kind of curious as to what drove that.

Center manager turnover primarily, Cameron. It's a very tough market to recruit and retain good center managers.

Okay. And then finally...

Sorry, and the second impact clearly was COVID because they had lockdown periods as well. So, yes.

Yes, sure. And then I suspect you don't want to answer this, and I understand the difficulty around opening occupancy and potential COVID closures, et cetera. But I was hoping to get some kind of indications with how you feel re-enrollments are going for calendar year '22, maybe how they've compared to previous years, for example?

Right. Yes, previous years is tricky as well because we've had an interesting couple of years in the sector. Am I happy with the process? Yes. Am I happy that we've tweaked the process to engage with families earlier in a more meaningful way? Yes. And so we're doing, I think, a better job than we had done in prior years. The key unknown we have, Cameron, is it's almost impossible to predict people's attitudes to putting their children into care when things like Omicron come along. Prior to that, there might have been something a bit more confident that we could say. But will parents hold off putting their children into care until they form a view as to getting on top of the latest variant, that's the stuff here that's really hard to predict. So they might have committed and said, yes, we'll be there, and they get nervous as the D-day approaches.

Yes. Fair enough. And just one final question. Just on the percentage of staff that you've had to let go due to the vaccine mandate?

Yes. No, we've been really happy with that. It's well south of 1% of our team have chosen not to be vaccinated and didn't qualify for medical contraindication exemptions. And that was probably a better result than what we thought would happen. But I think it's been assisted by every state government mandating it across the sector. So if you want to remain in the sector, you needed to get vaccinated and that's certainly assisted.

Your next question comes from Peter Drew of Carter Bar Securities.

Gary, just a question on just the earnings. So when we think about December's contribution to earnings, what is that sort of typically been as a percentage?

Yes. I think -- and Sharyn will probably step in and give her view as well, but I don't think we can actually use prior years as a reasonable guide, Peter, because 2 years ago, it would have been a much more material impact. We've had a couple of years of COVID-related impacts. So it makes it hard to just look at history and say here's what we think December is going to be. Sharyn, do you want to?

Yes, sure. Peter, it's usually a more subdued month. A lot of moving parts, such as when children leave earlier, so they're taking holiday discounts, et cetera, use of annual leave. But if you just treat it as a fairly subdued month, that's probably the way to do it.

Yes. So I mean, I guess the average EBIT contribution over the 11 months is around $7 million. So it's some number below that?

Yes.

Yes, I think that would be a fair way to look at it.

And then you highlighted the impact of the closures. And if you do the math, it comes out at about circa $3 million revenue impact, which I'm assuming pretty much all falls to the bottom line. Is that accurate, that those closures kind of impacted earnings by, say, circa $3 million?

Yes, I think that's a fair way to look at it for the 5-month period. Obviously, when you take that into next year, there'd be a bit of annualization, et cetera, you'd factor in depending on your view, of course, of how closures might play out, variants, et cetera.

Yes. Okay. And then I guess one thing I noticed, the tone around challenges of attracting and retaining staff. Is it clearly challenging right now? I mean, there's a lot of talk about labor availability. Are you saying that-- that has always been a big issue for the industry? So I'm just keen to [indiscernible] where that's at. And then just with the additional costs that [indiscernible], are you [indiscernible] have [indiscernible] that the fee increase that you put through will cover them and that you don't kind of need [indiscernible].

I struggled with a bit of that, Sharyn, I don't know if you've been so. Sorry.

Yes, I got the gist of it, but...

Yes, yes. So I'll leave the second one to Sharyn, because that was the one I struggled a bit more. But in terms of staffing and resourcing levels across the sector, there's been probably 3 impacts that have hurt. One, not having any migration, particularly of teachers. The sector has historically relied to some extent on overseas teachers coming in to supplement. I mean clearly, the background context of that is people continue to open centers, so demand for educators has continued to grow. The second is that graduates from universities have been reducing year-on-year for the last 3 or 4 years. So supply is nowhere near keeping up with demand, particularly from a teacher perspective. And then the third one is, in terms of educators, it has been an incredibly stressful time for the sector. We've been open every day and our teams have been at the frontline of COVID. And a number of people have chosen to exit the sector. This isn't just a G8 issue, because they're reasonably lowly paid and they do have other career options. For example, the big 4 banks have dramatically increased their need for contact center people, and we do know a number of educators leaving the sector and they work from home at a CBA Contact center and getting paid $10,000 or $15,000 more. So the relative attractiveness of the sector given the impacts of COVID has also made life challenging for all sector players. Hence, why we've been devoting a lot of time on how we can try and retain our team, Peter. We've started to make some little inroads, but certainly not enough for us to call it as a trend at this point in time. But there's been a little bit of promise in some of the things we've been doing. And I think the cost one, Sharyn, was more around our confidence level on that the fee increase will cover the wage increase. Is that right?

Yes, that's right. So the way we broadly look at wage rate in the sector is that the annual fare will increase, which over the last few years it's ranged from 1.75% to say 3%. Then you'll recall, we've got another 1% as people move up their levels. On top of that, we have moved on the ECT to make sure we're keeping our incremental competitiveness in the market, and that's probably another 1%. So it's those moving parts, Peter, to give you a feel for it's fair work plus another couple of percent. So that's something a fee increase could cope with.

[Operator Instructions] Your next question comes from Chami Ratnapala of RBC Capital Markets.

Gary and Sharyn, just quick 2 questions. Heading into sort of mid-December, how is the inquiry pipeline looking like? Any sort of commentary that you can provide on there?

Inquiry pipeline is really solid, Chami, ahead of prior years. So that's been a positive.

Great. And just on the staff turnover, just to quantify it, I think just a year or so before, you provided one figure, just wondering whether you can quantify it at all at this stage.

So ECT turnover, which had been tracking down from the mid-30s, is around 40%. Center manager regrettable turnover is in the mid-teens. Our target there is somewhere 10% to 12%. So center managers aren't the main issues. ECTs are a key concern, because that turnover has increased. And overall team turnover has gone from the low 20s to the mid-20s.

And if I may, just one more question. Are any of the centers seeing pressure just on the ECT front where new enrollments have to be pushed away? Or any centers in the portfolio seeing this sort of pressure at the moment?

No, we're not seeing that. At this point in time, no.

[Operator Instructions] Your next question is a follow-up from Tim Plumbe of UBS.

Just 2 quick follow-ups for me, if possible. Gary, you touched on it briefly. But can you maybe talk about the incremental supply that you've seen into the industry in the last 5 months? I think in the first half, we've seen about a 20.7% year-on-year increase in supply. Has that accelerated in the last 5 months or maintained at the same sort of level? And then just the second question. Queensland, you saw probably the biggest improvement across the portfolio. I think that was tracking at down 3.3 percentage points as of the first half and has now turned positive. Can you talk to any changes or anything different that's being done in that part of the portfolio versus the rest?

So we have been rolling out our improvement program in Queensland as part of the cohort. We do think that's had a positive impact. We've done some slight tweaking around our portfolio, Tim, as well. So that's probably had an impact. And it's felt a lot more sort of normal because it hasn't had the impact of COVID. But I think the predominant driver we think of the improvement is that we've rolled out our improvement program. Answering your supply question. Year-to-date, supply is actually below last year. So the third quarter was lower than the prior year, which is not unexpected given COVID lockdown. And so as at end of November, there were 252 new centers versus 316 from the prior year. In terms of G8 impact, down slightly. More pleasingly was the occupancy impact of that supply close to us continues to be diluted. And we think that's one of the benefits out of the improvement program we can defend out to better and we are certainly seeing that come through in the numbers. The number of centers that get an occupancy hit and particularly as well as the quantum of that hit have been steadily reducing as we've countered that with our improvement program.

[Operator Instructions] There are no further questions at this time. I'll now hand back to Mr. Carroll for closing remarks.

Thanks, Bernadette, and thanks, everyone, for making the time available. We look forward to catching up with a number of you in the days ahead. And if I don't speak to you beforehand, I hope everyone has a fantastic Christmas. Thank you.

Thanks, everyone.