RM plc (RM) Earnings Call Transcript & Summary

Hello, everybody, and welcome to RM's interim results for the first half of 2020. It's David Brooks here, RM's Chief Executive. And I'm joined on the video call by Neil Martin, our Chief Finance Officer. Neil and I will be doing a double act in this presentation. Once we've done the presentation, we'll move to questions and answers. And if you do have a question that you want to ask, there's a questions tab in front of you, so you can type into that. It feels slightly odd to be coming to you from my home study, but I guess we've all gotten used to working from home through this crisis. Before I go on to the agenda, I'd just like to start off by thanking RM's staff and customers and suppliers for the support and dedication through the last few months. I've worked at RM for a long, long time, including some really tough times in the business, but I've never experienced anything like COVID-19. And the commitment of our people through this time has actually brought, I think, the whole organization together to unite ourselves to get through this crisis. I'm going to start off by moving on to the agenda for today. Here it is in front of you. First off, I'm going to give you a few highlights for the last 6 months at RM, including details of how we've responded to the COVID-19 crisis. Neil will then move on and look at the financials in a bit of detail and give you a review of each of our 3 divisions. I'll then finish off by spending some time looking at the future to the end of 2020 and beyond. And then as I said, finally at the end, we'll have a Q&A session. We started the year in reasonable shape. By the end of Q1, we're pretty much on track for all our key measures. However, in Q2, as COVID led -- COVID-19 led to schools' closures and exams being canceled, our revenues started to be impacted, largely driven by a significant downturn in order intake in our Resources business. In the first half, our decrease -- our profit decreased by over 50% on the back of this revenue decline. However, our net debt position improved as we put in place a number of cash-conserving actions. Despite the drop in revenue, we continue to be profitable as a business in H1. And after stress-testing the business through a number of scenarios, we feel satisfied we're in a good financial position to see out this crisis. With the continued short-term uncertainty, we are, however, not proposing to pay an interim dividend. In the last few weeks, as the education system has started to open up again, we have seen trading beginning to improve. Let me now move on to a few details of the first 6 months. It was definitely a story of 2 quarters. We entered the financial year focusing on 4 year -- 4 areas, I should say, delivering on our 2 major capital programs to consolidate our distribution centers and update our group-wide IT systems. Secondly, continue to grow international business. Thirdly, reviewing our technology businesses to ensure a separate focus on software and services. And finally, to be more efficient as a group. By the end of Q1, as I said earlier, we've made progress against all these areas, and in fact, our revenue grew by 2% year-on-year. However, at the beginning of March, as we entered our Q2, COVID-19 was very much on the horizon. We put our business continuity plans into action and started meeting daily as an executive team to manage the fast-moving situation. As lockdown came into force, governments around the world announced closures of schools and cancellations of exams. We changed our distribution centers in terms of how they worked, so that we could keep them open, but keep staff safe. The rest of our staff in the U.K., in India and in Australia started to work from home. To conserve cash, we paused our 2 major capital programs, cancelled our final dividend. And during the COVID virus -- during the first -- sorry, the second 3 months of the second quarter, our revenue dropped sharply. I've got a slide here that shows you some maps on how things have been impacted around the world on school closures. So you can see from the maps on this slide that in mid-February, with the exception of China, all schools are open as normal. By mid-March, the picture was very different, with most schools closed. By June, the Department for Education in the U.K. said that school's attendance figures in England showed that 16% of pupils were attending schools, whereas 93% of schools were open in some capacity. Neil will go through the detail in a minute in his section of our divisions, but each of our 3 divisions were impacted in very different ways. For instance, the closure of U.K. schools and nurseries impacting RM Resources immediately and significantly. However, the schools needing their technology to work from home learning and keeping sites open for children of key workers, RM Education's revenue was not impacted significantly. We responded to this crisis in 3 distinct phases. The first phase was plan and stabilize. Our focus was on ensuring our staff could work from home or safely on-site as needed. We developed a set of financial stress tests to make sure we would be viable and see this crisis out. As I mentioned, we can serve cash through a number of actions. The second phase we called run lean, delivering for our customers in the leanest way possible. We stopped permanent recruitment, reduced the use of temporary staff and reviewed all our discretionary spend. The Board and executive team took pay cuts, and we selectively furloughed some U.K. staff, primarily in RM Resources, where the business revenue was most impacted. Our use of the furlough scheme stopped on the 1st of June as schools reopened, and we expect to repay the money claimed under this scheme this financial year. The final phase is recovery preparations. We have a dedicated team to look at how our market and customers would change on the back of COVID-19, and how we respond to this with our products and services. We will review our operating model, and we will also restart our capital programs in H2. I'm now going to hand over to Neil for him to run through the financials and the trading in each of our 3 divisions in more detail. Neil?

Thank you, David, and morning, everybody. So I'll now move on to Slide 8. This slide gives the headline financial metric, which as David has already indicated, were heavily and negatively impacted by COVID-19 in the second quarter. Revenues were down 17% on the previous year, and I will come on to outline that in more detail on the next slide. Moving on to operating profit. You can see from the revenue -- you can see that the revenue movements flowed through to profitability. The first quarter was up GBP 2 million on the prior year, benefiting from the revenue growth and also lower costs. However, this was materially offset by the impact of the revenue decline in Q2, which reduced our profitability by GBP 7 million. Over the half, this resulted in operating profit being down over GBP 5 million or 57%. Looking finally at net debt. This was GBP 14 million, which was lower than the same period last year and broadly in line with our year-end 2019 position. This level of debt retains good headroom against the group's revolving credit facility of GBP 70 million. Moving on to Slide 9. This shows in more detail the development of the revenue across the period and also the quarter 1 and quarter 2 splits for the divisions. As you can see, the momentum in Q1 was positive, with revenue in the 2 technology divisions increasing 12%. The Resources division was stable in Q1 with U.K.'s education revenues flat against a market backdrop that remained negative. The chart on the top right, however, shows the material impact of the lockdown in the second half of March and ran through the remainder of the quarter. Moving down to the chart to the bottom, you can see that the 3 divisions are impacted quite differently through this period. As mentioned, RM Resources was the most materially affected as school closures immediately stopped the purchase of resources. RM Results has a mixture of recurring revenues and volume-related fees associated with exam volumes, which, despite some contractual protection, clearly experienced a decline as exams got canceled and deferred around the world. Finally, RM Education was the more resilient with a high level of recurring revenues. Moving now on to the income statement on Slide 10. As you can see, revenues were reduced by 17%. To offset the impact of this reduction, actions taken delivered savings of GBP 7 million, primarily in staff-related areas such as temporary workers, travel and a hiring freeze, and also the benefits of a restructuring that took place in December '19 prior to COVID. Alongside these savings with -- other discretionary areas such as marketing were reduced. However, the full benefit of these savings were partially offset by the cost of the SoNET acquisition, that was not in the prior year, charges associated with increased customer credit risk and some higher IT costs and onetime items. The net effect was the 57% reduction in the adjusted operating profit to GBP 4.2 million. Moving further down the P&L, you will see that the interest charge is up in the year. This was in part associated with the adoption of IFRS 16, but also lower interest income. This is a result of us selling our investments in the Essex learning education partnership vehicle, which was an investment we held associated with our engagement in building schools for the future program. This was sold for GBP 1.6 million in the period, generating a profit on sale after tax of GBP 0.6 million, which was treated as exceptional. Our other exceptional items in the period are listed. We had another asset sale, which was the sale of the first warehouse to be exited as part of the consolidation program. This was sold for GBP 2.9 million, generating an after-tax profit on sale of GBP 0.6 million, which is also treated as exceptional. Offsetting these benefits was the acquisition-related intangible amortization, the December '19 restructuring and also a charge for a partial impairment of our group system's project work to date, which reflects design changes that we will implement as a result of the combination of the 2 technology divisions and our experience through COVID-19 to date. Now moving on to look at the cash flow on Slide 11. As previously outlined, net debt stood at GBP 14 million at the end of the period, which is a slight improvement on the GBP 15 million net debt position at the end of the previous year. Our normal cash flow seasonality is for the H1 position to be higher than at the year-end position, with the second half then being much more cash generative. This can be seen in the table, the 2019 year-end net debt of GBP 5.8 million increasing by GBP 15 million to GBP 21 million at the end of H1 '19. In contrast, however, in 2020, our net debt improved by almost GBP 1 million. There are a number of factors that have contributed to this. The cash conservation activities outlined here on the slide, which were undertaken to deal with the severe uncertainty that the business faced at the start of the pandemic. There was also an absence of usual material inventory build in RM Resources, and also the sale of the 2 assets for GBP 4.5 million, which I outlined previously. Just to add, these were both planned and not driven by the pandemic. It's also worthy of note that our customers, where possible, have maintained their payment profiles throughout this period, and this has been much better than we feared. I'd like to thank them for their support throughout. With regard to the 2 major capital programs that we paused, we're currently planning to restart these as they remain critical to the future success of the business. Our current plans would result in an additional GBP 6 million of CapEx spend in the second half. Finally, looking at our defined benefit pension schemes, you will see a sizable increase in the net deficit of GBP 23 million at the end of May compared to GBP 6 million at the end of 2019. This is wholly driven by the reduction in corporate bond yields, which are used as a discount factor under this accounting assessment. As you can see from the chart on the left, they are at the lowest level for a number of years, having to reduce to 1.55% at the period end, which has generated this level of volatility. Finally, in this section on Slide 12, it's just worth reiterating the parameters of the financial resilience of the organization as it will remain critical moving forward in continued uncertain times. We currently have net debt of GBP 14 million against a facility of GBP 70 million. Our banks have also shown their support and did so at an early and uncertain stage, increasing the bank's covenants from 2.5x to 3.5x for debt leverage for the 2 reporting periods in 2020. The organization has good cash-generative characteristics and a portfolio that has shown certain divisions have a stronger resilience in these difficult times and others that bounce back quickly when the market reopens. At the moment, we do not believe additional funding is necessary as we have assessed a range of stress test scenarios, but we believe we can navigate appropriately. Trading is responding well to the gradual reopening of schools, but we remain very aware that the path forward remains uncertain and needs to be managed with due caution. We have been prudent in our capital allocation to date, but the desire to invest in the business as things improve is critical. Furthermore, we also acknowledge our responsibilities to those that supported us through a very difficult period. We expect to repair deferred payments in a timely manner, including the pension payment deferral and the government furlough receipts by the end of this year. This will allow us to consider responsibly the appropriate time to reintroduce dividend payments, which we see as an important fiscal discipline. If we now move on to look at the divisions in more detail. Starting with RM Resources on Slide 14. The start of the year was reasonably reassuring with U.K. education revenues flat in Q1. This was more encouraging than it may sound as we exited the second half of 2019 in a negative position and also the wider traditional market was in decline in this quarter. International revenues were down as expected due to the absence of a large order in South America that was delivered in Q1 of the previous year. However, as you can see from the chart on the top right, orders fell sharply in the second quarter as schools were closed on March 20 to the majority of pupils. School attendance was reduced to 2% of normal levels, and our order intake reduced by 70%. Sales were supported in some degree by increased orders that came from parents and noneducational environments like CARE. Sales started to improve after the Easter break and then more materially once the government announced that certain year groups would return from June 1. This resulted in an overall reduction in revenues of 29% for the half. Actions were taken to mitigate costs, which reduced overheads by over GBP 2 million year-on-year. However, this was offset by a GBP 1 million charge in the period associated with an extended credit risk profile, particularly associated with international distributors. Despite these actions, the division made a loss of just in excess of GBP 2 million in the period. Revenues have continued to recover following the gradual return of pupils to school. Statements suggest that the government remain committed to progress towards all pupils being back in school in September. That said, we do remain cautious in our outlook as schools navigate the journey to full capacity. We are experiencing some increased sales in hygiene products and those categories facilitate individual learning, and we may also benefit from catch-up funding provided to schools to support lost learning. However, this will not offset in the second half the negative impact of lower school capacity, a challenged early-years sector and the impact of schools managing virus transmission risk on shared resources. Moving on to RM Results on Slide 15. The division entered the year with strong momentum, with Q1 revenues up 25% benefiting from the acquisition of SoNET and a ramp-up of new client volumes. However, the actions taken to mitigate the spread of the virus resulted in a number of exams being canceled or deferred. The schedule on the top right outlines the expected reduction in exam volumes on our customers this year. And as you can see, experience vary around -- experiences vary around the world. As a result, revenues were down by 10% over the half, operating profits by 35%. The development of the sales pipeline was also being delayed through this period due to travel restrictions and disruptions to customers. This will adversely impact our exit sales rate from 2020 versus what we previously expected. That said, we are pleased to have been awarded a contract with the International Association for the Evaluation of Educational Achievement to deliver on-screen testing for their Trends in International Mathematics and Science Study. This can be delivered to up to 70 countries around the world, working with their respective ministries of education. Now finally, moving on to RM Education on Slide 16. This division has been the most resilient through the period of school lockdown with a portfolio of products and services that have a high degree of recurring revenues that supported the technology environments in schools. It's worth noting that in the early stages of school lockdown, even though school attendance was at 2%, around 70% of schools were opened to teach a number of pupil groups, including the children of key workers. And as David mentioned earlier, this has now increased to over 93% of those schools in England in June. Alongside relatively stable revenues, profitability was supported by the cost-saving program that was delivered in Q1 prior to the pandemic, the reduction in discretionary spend and some one-time benefits in the period. This has enabled the division to actually improve profitability during the half, up 12% to GBP 4.9 million. This division, like all others, has experienced a significant disruption to its sales pipeline. That said, we are pleased to have won 2 multi-academy trust managed service contracts, which are both a minimum of 3 years. Looking ahead, school closures have clearly put technical resilience and business continuity in the spotlight in this crisis. The schedule in the top right of this slide highlights a number of mainly government-led initiatives to support schools in this area, where we are seeing a significant uptake in schools in England looking for cloud provisioning with products such as Google and Microsoft as a result. RM remains well positioned to support schools on this journey and ensure that they have the right ICT resilience and capabilities in the future to support blended learning and a more digital environment. I will now hand back to David, who will take you through our outlook.

Thanks, Neil. We spent most of this presentation so far looking back over the last 6 months. I now want to look to the future. We're seeing the education -- we're seeing education becoming more of a priority for government. On the back of COVID-19, education delivery has had to change. We believe there are themes emerging from this change. Firstly, pupils have been forced to work away from classrooms, and we expect this to continue even as more pupils go back to school. This blended approach to learning in and out of the classroom requires technology to underpin the new ways of working. It does bring real benefits. For instance, marking of work is much easier in this electronic format and doesn't need the teacher to lug 30 exercise books home each day. Secondly, education in schools has traditionally being delivered -- not being delivered digitally. The crisis has forced schools and colleges to become more digital overnight. We've seen many schools really embrace this and make it work, but many schools are also still right at the beginning of this journey and need our help. Thirdly, most school high-stakes exams around the world are still done on paper. The COVID crisis won't change this overnight, but is making exam boards and educators debate more urgently the role of technology in these assessments. And then, finally, it's been well publicized the concerns around the education of our most disadvantaged children during school closures. We expect the U.K. government to make closing the attainment gap a key area of focus in the coming years and months. I guess the positive news for us is that our strategic themes are still appropriate as we help the education community steer this new course. Okay. Let me finish off, before we get to questions, around the outlook. Trading is improving and the education world is starting to reopen. We're financially stable and ready to restart our 2 capital programs and expect to make a profit in H2 as well as H1. However, we need to be aware that demand will still be difficult to predict in the coming months, so we will manage our cost base very carefully. With the continued uncertainty and changes to way of working, the education systems we serve need RM more than ever. Fundamentally, education will still need the products and services we provide, and RM will look to play a key role in helping our customers transition to the new teaching and learning models. Thank you for listening.

Well, let's now move on to questions. As I said before, you can ask questions by tapping the question -- yes, by tapping the question tab. I'm going to ask Stephen Malthouse, who's from our financial PR company, Headland, to come and join us to help facilitate the questions. So Stephen, do we have any questions that are coming in?

Thanks, David. Yes. The first question is there's been a number of announcements and a great deal of commentary as regards spending on education over the last week or so. How's your view on the longer-term outlook for spending on education changed?

Okay. So I'll take this one. So I think the announcements that have come out in the last week or so have sort of shown a number of different things. I think, firstly, the government is committed to get all children back -- this is in England, all children back to nurseries and schools in September, and that is a new piece of news in the last week or so. So they're really clear that the way that the education system is going to be successful is by students and children being in schools and nurseries. I think the second thing is the blended learning and remote learning is here to stay for the foreseeable future. And again, the guidance talks about schools needing to provide that. The third thing is, if there are infections in schools, it looks like the government is very much into trying to keep schools open and isolating a year group or a certain group of students or teachers. And as a real last resort, close a school, which is a move -- a real move on as far as we're concerned. And then there's the A levels and GCSEs will go ahead next year. That might be in a slightly different form, but that's the first time we've really heard the government say they'll definitely go ahead. I think from a funding point of view, in particular, the government also announced -- they've been announcing GBP 1 billion for buildings, GBP 1 billion for helping the more disadvantaged children, but they reconfirmed the GBP 14 billion that they've been talking about for the next 3 years, and they've reconfirmed this. It's the first time we've really seen them do this. So I don't think it changes the overall big picture which is schools will still need to be very careful with how they use their funding in the future, and pension contributions and wages and -- for teachers will go up over time. I think it just gives schools the clarity that the funding that they will promise will be there, and they can plan for it.

Great. The next question is, can you talk about how you would expect costs to flex as activity levels start to increase across the various parts of the business? How much of the cost -- how much of cost savings will likely phase back over time to maximize new revenue opportunities?

Sure. Neil, if you want to take that one?

Yes, I can pick that one up. So I guess part of the challenge for us, like for all organizations, is trying to understand how this is going to continue to unfold. So we've announced that we are starting to ramp up the capital programs now. They are critical to the organization moving forward and the way in which we need to respond to COVID. So that has a material investment requirement. And we're also looking to repair some of the cash contributions that were deferred through the second quarter. I think as we move forward in other areas, we've got some teams looking at how the COVID situation will change, and we're regularly looking at all investment activities. And I think that we're just going to have to keep this in check as we move forward. We do want to invest in the business. It is important, as we've said on a number of occasions that we balance the long-term success and investment in our end that does require us to invest in the business alongside keeping control of the organization through a very volatile situation. So I think the answer, like many would be, that we're just going to have to keep it in check in a daily, weekly basis. And as the certainty of school openings and exam settings improve, then we will improve our investment profile in line with that.

The next question, and there's a couple of parts to it, so the first part of it is can you elaborate on how exam-awarding bodies are planning to deliver assessments in autumn and winter? Are any exams actually planned at this stage? Or is this year, effectively, a write-off? The second part, what is the accounting procedure for government furlough receipts, with the build, what is the total liability that you have wrapped up and that you intend to repay?

So I'll do the first half, and Neil will be delighted to the second half. He can hardly wait. He's jumping at it a bit. So I think in terms of exams, so U.K. exam-awarding bodies are looking -- well, certainly, English ones are looking for some more exams on the back of canceling the exams over the summer. It's not clear at the moment exactly what that volume is, but we've worked out a number of scenarios with our customers to ensure that they're able to deliver those exams and we're able to help them mark them successfully. A working assumption could be anywhere between 5% and 20% of those exams being taken. I think one of the key points on it is that the government has said, if you're doing a GCSE or an A level, you'll get a mark from an awarding body based on what your teacher proposed and the sort of the statistical stuff that the awarding body is doing around it. If you don't like that mark, you can take -- I was going to say retake, but the exams are canceled, so take the exam. And if you get a worse mark on your -- once you've taken exam, you can keep the original grade. So I do think that, that will mean there's no downside other than studying for the exam if you haven't got a grade that you like as a student. So I do think that awarding bodies are assuming that there will be exams in the autumn after having absolutely no exams in the summer. So that's the first half. Neil, do you want to talk about the furlough side?

Yes. So just to be clear, we have just under GBP 1 million credit in the first half that is in the GBP 4.2 million number we reported. We have just under GBP 1 million of benefit in that. And the view being that we would expect to repay that before the end of this financial year in the second half. The mechanism for doing that isn't clear, and we're in touch with our HMRC relationship director about just giving an indication of how our plans expect to unfold over the second half. And I'm sure they will help us to facilitate any repayment.

Great. So the next question is, a number of private schools were already stretched pre-COVID-19. Have you seen any of those with which you trade go bust? Or do you see this as a risk for the next year?

So I'll take that one. So overall, in the U.K., only 7% of students go to private school and that's probably in our RM Education business. That's the kind of percentage of trade that we have with private schools. So it is a reasonably small element. We haven't seen any of our customers that I know of go bust yet. However, what we have seen is private schools more likely to be able to provide remote learning to their students as private schools want to need to -- not only want to, they need to continue to charge fees to parents. And even if they've given parents a discount, they need to charge the majority of the fees in order to keep going as a business. And therefore, they're providing -- what our experience is they're providing remote learning quite extensively in the private schools system. So it is a risk. It's not a huge risk for us. But interestingly, we do see private schools being pretty innovative on how they deliver the curriculum to their pupil so that they can still charge fees.

The next question we've got here is -- and perhaps building on that, is in RM Education, can you talk about -- talk a little bit more about the technology assistance you've provided in terms of things like remote learning and how we should think about how that might continue over the coming months as different counties have different opening policies -- sorry, different countries have opening -- different opening policies and the U.K. mandating schools have remote learning options?

So in RM Education, it's a U.K.-only business. So at the moment, we don't really sell anything internationally in our RM Education. We do in Results and Resources extensively, but not in RM Education. I think the support we provide for schools is ensuring that the technology all works to allow them to do remote learning and to do blended learning. And I think what we'll find going forward in the U.K. is that unless we get a huge second spike, when I guess every -- I guess, all bets are off in terms of that way. But I expect that we won't get widespread closures of schools in the same way as we have. I think, as I said earlier, maybe individual schools or schools in a certain area might close at once, which means the support we're providing for the moment with schools is to ensure that they can deliver teaching and learning inside and outside the classroom by making sure that they have a really good Internet connection to the school, they have ability for pupils to be able to use technology at home and for more disadvantaged children who don't have a technology at home, that they can borrow and use technology. They need to make sure that all their work is up in the cloud, so it doesn't matter where they are. And they need to have teachers able to feel comfortable setting work and setting tasks and often teaching in real-time using the technology tool. So we'll provide a package of different things that allow us to support teachers to do all of that.

Next question is in terms of recruitment and working from home, how should we think about your ability to hire and retain staff in the future? If you're not necessarily tied to an office location, could your ability to hire on a virtual basis and enable employees to work from home anywhere enable you to expand further?

So I mean, if we look at it from this way, RM has got about 2,000 employees, 700 of which are in India and the rest are in the U.K., except for about 35 that are in Australia. With the exception of our distribution centers and our on-site engineers who are in schools, everybody else is working from home. And in fact, many of the on-site engineers have been working from home and not been going into schools. We do think our footprint for needing offices will change in time. And we're not going back into offices until at least the end of September in each -- in the U.K., for instance. However, we still see the need for having office locations, both in the U.K., Australia and India, and we don't think that people will just work from home. We think that there'll be some more flexibility and people will spend more time at home, but not, not like, but will still come into offices. So I mean, I think in terms of expansion, I don't see it as a huge thing. What it might mean is that for very particular skills where we don't have an office close to that person, there's -- in the U.K., for instance, that it might be that we'll be a bit more open-minded to employing people who aren't as close to offices. But I still -- we still see a world in the future where it's about human interactions. These -- the video things are great, but it's not quite the same as seeing people face-to-face. So we still see a world where we will want and need to have people in offices. And more -- just as importantly, when you talk to our staff, they want to get into offices as well, maybe not as much as they have in the past, but certainly, they will want to regularly be in an office.