RM plc (RM) Earnings Call Transcript & Summary

Good morning, everybody, and welcome to the RM plc 2021 Half Year Results Presentation. My name is Bethany, and I'll be coordinating your call today. [Operator Instructions] I will now hand the call over to your host, Neil Martin, CEO of RM plc. Neil, over to you.

Thank you. Hello and welcome, everybody, to RM's Interim Results Presentation 2021. I'm Neil Martin, and I'm delighted to present my first set of results as RM's Chief Executive to you today. Joining me will be Mark Berry, our CFO, and we'll take you through the results today. So there is a familiar format. I'll give a brief overview of the first 6 months of the year and also a review of the current market backdrop. Mark will then take you through the headline financials, including a review of each of the 3 divisions. And then I'll talk to you about some of my initial observations, priorities and our outlook before we will then open for questions. So if I move to the summary. I'm really pleased to be able to report that RM has delivered a good set of results against another difficult backdrop for the education sector, [ despite ] schools were closed and exams canceled. Revenue was up 21% on 2020, and actually in line with 2019 pre-COVID levels. This has been driven by really strong trading in RM Resources as the division took market share in a period where spending was focused on pupils' well-being, managing COVID transmission and curriculum catch-up. This strength of trading has helped operating profits to double versus 2020. Supporting this improving trading position, our balance sheet remains strong with both net debt and pension funding positions improved over the same period last year. And as we look forward, our digital infrastructure and automated warehouse investment programs are progressing and remain on track to deliver robust benefits materially from 2023, which, alongside a positive medium-term outlook emerging in the global education market, gives confidence that we have a good platform for the longer term. And as a result, we are paying a 1.7p per share interim dividend. If I move on and bring things back to the current market backdrop. Let me outline what we're seeing today as it remains a fluid picture. Starting with the U.K., schools were physically closed for most pupils for 8 weeks between January and March of this year. Furthermore, all U.K. school exams were canceled again for 2021. Going forward, the government has indicated that they are expected to run exams in 2022, but are likely to require modifications to ensure fairness. Research indicates that funding confidence in schools remains low despite the government commitment that education is their #1 priority, and underlying budgets are predicted to increase by 3% in the year ahead. The schools believe that this will be primarily consumed by staff costs. Additionally, the government's catch-up funding commitment now totals just over GBP 3 billion despite the request from the education policy unit that this would need to be in excess of GBP 15 billion to ensure that no pupil was disadvantaged through lost learning, and we continue to watch this space. Looking at the global picture, although the position is improving, there are still around 1 billion learners being impacted by COVID, with a number of geographies remaining in full or partial lockdown. Unlike the U.K., it is expected that exams will, in the main, take place this year, although exam volumes are expected to be lower. And like the U.K., there is widespread catch-up funding initiatives planned, in many cases at materially higher levels than currently being planned in the U.K. Let me now pass over to Mark, who will take us through the finances and the divisional reviews.

Thank you, Neil, and good morning, everyone. I'm Mark Berry, CFO of RM, and it's a pleasure to be taking you through our half year results this morning. So if I move on to Slide 6 and look at our financial overview for the half. After a challenging 2020, our financial performance improved during the first half of 2021. Group revenues were up 21% from GBP 79 million to GBP 96.1 million, and adjusted operating profits increased by GBP 4 million to GBP 8.2 million. Earnings per share increased by 3.9p to 7.1p. Net debt at the end of the period was GBP 10.5 million, which was GBP 3.9 million lower than at the same time last year. Our low level of net debt, together with our GBP 70 million revolving credit facility reflects the ongoing strength of our balance sheet. And turning to the dividend. For 2021, we're proposing to pay an interim dividend of 1.7p per share. And as a reminder, there was no interim dividend in 2020. Moving on to Slide 7. We focus on our year-on-year monthly revenue performance throughout the half, and it highlights what really has been a tale of 2 quarters. In 2021, U.K. schools were closed for the majority of Q1, whereas in 2020, they were closed throughout Q2. And as you can see from the chart, after a good start to Q1, which was driven mainly by hardware sales in RM Education, we then had a subdued January and February as schools closed at the start of the calendar year. Revenues recovered materially as we moved into Q2 following the reopening of schools on the 8th of March in the U.K. And this was driven by strong trading and resources, which benefited from an increase in resource spend on outdoor teaching, physical education and pupil well-being, well as the ongoing management of ongoing COVID transmission risk. It's important to note that our overall revenues were up 21% despite U.K. schools being closed for broadly the same number of days in both years. Moving on to Slide 8. We bridge our revenue and profit movements versus 2020. Group revenue increased by GBP 16.8 million or 21% versus the prior year and was mainly driven by our Resources business, which increased revenue by 37%. RM Results was broadly in line with the prior year, reflecting a partial recovery in global exam activity, being offset by the known impact of the in-sourcing of a key customer during 2020. RM Education was less impacted by COVID, and as a result, revenue was ahead of the prior year, driven by an increase in hardware sales as schools continue to prioritize their ICT spending. Adjusted operating profit was up 96% at GBP 8.2 million. The key drivers of the profit performance was the gross margin impact of higher revenues in Resources. However, this was offset by cost increases in respect of freight, product and costs associated with the impact of Brexit, together with the resumption of our key capital programs, which were paused during 2020. In RM Education, profit was lower than in 2020 due to the absence of onetime cost benefits in part related to COVID. Moving on to Slide 9, we set out the income statement and focusing specifically on the items below operating profit. Interest was GBP 0.6 million for the half and comprised the cost of servicing our debt facility, together with the finance costs related to our defined benefit pension schemes. Adjusted profit before tax was GBP 7.6 million, up 114% from GBP 3.5 million in the prior year. Tax in the period was GBP 1.7 million, and the effective tax rate was 22%. Lastly, post exceptional items were GBP 1.2 million in the half and relates almost entirely to the amortization of acquisition intangibles. Moving on to Slide 10. We take a look at our cash flow and pension positions. The top chart covers the key drivers of our cash flow during the half, and we start with our cash inflow from operations, which was strong at around GBP 8 million. And this included a GBP 3 million outflow in respect of VAT payments, which were deferred from 2020. From this, we ended up normal outflows relating to the 2020 final dividend, pension payments, tax and interest. All of these items were covered by operating cash flows. And we ended up CapEx of GBP 10 million to arrive at net debt GBP 10.5 million at the end of the period. CapEx spend in the half relates to our 2 digital and automation programs, which have now fully started having been paused in 2020. These programs alongside wider capital investments will maintain CapEx at this elevated level throughout 2021 before reducing significantly in 2022. Moving on to pensions in the lower half of the chart, our IAS 19 pension position improved by GBP 24.2 million in the period, moving from a deficit of GBP 18.7 million at the start of the period to a surplus of GBP 5.5 million at the end of May. The improved position was driven primarily by an increase in the discount rate, which reflects bond yields and better-than-expected asset returns. These were partially offset by an increase in the inflation rate. Our current annual cash flows in respect of the pension schemes are circa GBP 4 million per annum, and the latest triennial valuation of the scheme is now underway. I will now move on to look at the performance of each of the 3 divisions in the first half of 2021. So we start with RM Resources on Slide 12. For those of you less familiar with the business, RM Resources provides education resources and supplies schools and nurseries in the U.K. and internationally. And as we've outlined, the picture remains one which was again dominated by our experience of COVID and the associated U.K. school closures. The chart in the top right of this slide tells the story of our first and second quarters and shows how orders accelerated in Q2 following the reopening of schools. This flowed through to strong overall revenue growth, which was up 37% versus half 1 2020. And this was set against the backdrop of schools, as I mentioned earlier, being closed for broadly the same number of days in both years. In our view, therefore, it's clear we took market share during the half and highlights the underlying strength of our business, and in particular, our brand strength and curriculum knowledge. U.K. revenue recovered to be marginally ahead of 2019. However, the one area that continues to lag 2019 is the international schools market, where pupils in attendance remained materially lower than pre-COVID levels. The revenue growth I've outlined above, moved Resources back into profit in the half. Profit was GBP 2.7 million versus a loss of GBP 2.1 million in the prior year. The impact of revenue growth was partially offset by higher product and freight costs associated with COVID and Brexit. I'd also like to say we've made further excellent progress with our warehouse consolidation and automation program. One further site closed in the half, and our new single site is on track to be fully operational in 2022. Fit-out is complete, with staff ready to move in once working restrictions are lifted, and the automation and integration processes are underway. Overall, when looking ahead to the second half, the COVID overhang that Neil referred to earlier means there remains uncertainty in respect of the impact of the pandemic on supply chains in both the U.K. and our international markets. Moving on to Slide 13 and RM Results. RM Results provides IT, software and end-to-end digital assessment services to government ministries to exam boards and to awarding bodies in the U.K. and internationally. Revenues were marginally ahead of 2020, GBP 15.5 million, and was supported by the partial recovery of global exam activity in the period. This was a resilient performance given the scale of the exam cancellations. And as you can see from the table, in U.K. schools, which comprise the largest share of our revenues, almost all exams remain canceled in 2021, and overall activity was 95% below 2019. Set against this, however, were an increase in activity in other U.K. nonschool exams and an increase in exam activity outside of the U.K., however, activity remains below 2019 levels. Looking ahead, COVID disruption and travel restrictions continue to materially impact our sales pipeline development in RM Results. And at this stage, therefore, we remain cautious as to the short-term outlook for RM Results given that it is unclear when these restrictions will unwind. And then moving finally on to RM Education on Slide 14. RM Education provides ICT software and services to U.K. schools and colleges. This division has been resilient during the pandemic 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 environment in schools. Revenues were up 11% in the half, driven by hardware sales, and profit was adversely impacted year-on-year by the absence of one-off cost benefits in the prior year relating to COVID. Looking ahead, recent store closures have clearly put technical resilience and business continuity in the spotlight for schools, and the government spending backdrop for education generally is positive over the longer term. It is likely, however, that in the short term, school's ICT spending will decline in the next year as schools prioritized staff spending. I'll now hand back to Neil, who will take you through the priorities and outlook section.

Thank you, Mark. With 4 months now under my belt as CEO, I wanted to take a few minutes to update on how I see the business, the drivers in our marketplace and how this all shapes and informs our focus. So I'm sharing my observations about the strengths that will help RM succeed and also the opportunities that we have to improve the business and better align to the market need. The strength center around the rich heritage and domain knowledge that is part of RM's DNA, alongside strong brands with market scale and a purpose-led culture and people that is evident across all teams in the group. This is a powerful foundation when coupled with its highly cash-generative characteristics and a strong balance sheet. Looking at the right to the opportunities, there are a number of areas, however, where I believe we can strengthen our position. Some of these start to be addressed by the completion of our capital programs that we've discussed today, such as reduced complexity and digital and data capabilities. The others will require additional focus, a clear ambition and investment in our talent. Moving over to the page, we look at the broader market context on the next slide. The pandemic has certainly elevated the focus on education and its priority position, bringing the attainment gap and digital divide into mainstream discussions. For example, the U.K. government stated that education is the biggest priority for the country, which is important in the medium term as sustained funding tends to follow policy priorities. This is resulting in specific funding initiatives being announced globally, with focus areas that play to many of our existing domain and brand strengths. Furthermore, we are seeing the COVID experience strengthen and accelerate a number of key market trends that will permanently supplement the learning landscape. A key thread across these trends is the increase in technology and digital assessment across teaching, learning and assessment models. Currently, education has relatively low levels of digital penetration and has been slow to adopt digitization, with only 4% of the vast global education spend being digital. This is predicted to increase more materially and will be the start of what we believe is a long digital maturity journey for schools and colleges. That said, it is important that we acknowledge that these trends impact the wider learning markets and not just schools. For example, we need to consider our approach to those areas such as higher education, professional learning and consumers. Moving on to the next page. From an RM perspective, we're making good progress, but the impact of the pandemic will take time to wash through as we look to recover to pre-COVID levels of profitability over the next 1 to 2 years. Continued revenue disruption and funding uncertainty is anticipated in the short term, along with the time it takes to recover from the overhang of delayed sales pipeline and decision-making, 2 years of canceled exams, project disruption and what we're seeing in terms of elevated product costs and supply chain challenges. However, if we look further ahead, we believe that the market backdrop is much more positive and well aligned to our domain strength of curriculum knowledge, innovation in early years and STEM subjects, digital end-to-end assessment and the use of technology and education. Critical to this will be the delivery of our digital infrastructure and warehouse automation projects in 2022, which have the opportunity to be a real game changer for RM in how we leverage data, interact with customers and deliver our products and services. So moving over the page, a look at positioning ourselves for the future will require some change, and I wanted to share the direction of travel that we've set out on and some of the work that we're doing to sharpen our strategy. As CEO, my clear priority is to build a path to sustainable growth, and there are a number of activities that will support this. Alongside looking at our strategy, my early priorities are working with the leadership team to build momentum behind the key enablers set out on this slide. Firstly, we're looking to foster an innovative and commercially accountable, customer-centric culture with a particular focus on our go-to-market approach. Given the significant change externally, and what we've experienced over a number of years in RM, it's not unsurprising that this is an area in which we need to focus now. Secondly, we need to be clear, where we do and do not invest. We have a number of opportunities to build scale positions in attractive markets. To do so will require investment in both market development and products. Thirdly, we can look to leverage our strengths across the group through better collaboration and a more effective operating model to ensure that the whole really does become greater than the sum of its parts and we leverage our breadth of customer relationships in a fragmented marketplace. And finally, the existing capital programs that are so critical to our success are due to complete next year. But alongside these, we need to develop the talent and capabilities to fully capitalize on the new systems and ways of working. I'm also very passionate that we remain a purpose-led organization, working to improve educational outcomes which remains key -- a key focus of our customers. Being successful in delivering this will sustain our success and support the priority of delivering sustainable growth, and I'll come back and update you in more detail on our progress in this later in the year. So finally, to conclude, I believe we've delivered a strong set of financial results in the half against another difficult backdrop for the sector. We are a resilient business that's navigated through an incredibly challenging time for education. We continue to strengthen our balance sheet and build on the good cash-generative characteristics that exist in our organization. COVID has caused significant disruption that will have an adverse overhang for a period, but fundamentally, it will positively move the market towards us. And we're focused on positioning the organization to capitalize on that opportunity, leverage the investments in our data infrastructure and warehouse automation, and I'm confident that we'll deliver improved long-term growth and shareholder value. Many thanks, everybody. I'll now hand over to Chloe, who will open the call to questions.

[Operator Instructions]

Good morning, everyone. We do have some questions on the webcast here. We have 3 questions coming from Brian Ashford at Polar Capital. I'll ask these in 3 parts. The first question is, could you discuss how you think the medium-term operating model and earnings power has changed since the last full pre-COVID year in 2019?

Thank you. I mean, I think where we sit today, our focus through COVID has been keeping the business resilient. So the operating model today is similar to 2019. I think the changes in the market and the opportunities that it does present in terms of those trends that we talked about in accelerating and strengthening digitization in education, lifelong learning and modernization of assessment does give us opportunity. I think also we are looking to see how do we create scale and leverage so that the whole is greater than the sum of the parts for us as an organization that is multidivisional. And I think that is part of our focus moving forward to ensure that we are sharing the domain knowledge of curriculum assessment and education technology, and we'll be looking to make sure that we can improve the efficiency of the organization. And again, that comes back in part to completion of those automation and digital infrastructure programs over the next 18 months.

Thank you, Neil. The next question from Brian is around RM Results and whether there are any -- are there any material Results contracts that you would consider vulnerable to in-sourcing?

I think the situation we had with the contract that in-sourced last year was quite a specific one. It was a large awarding body where we were running dual supply with another organization. And the -- that organization had a high concentration of its revenue with that customer and it acquired that competitor of ours. I don't think that is something we would expect to be replicated in other situations. So I don't see that in-sourcing of what is effectively an awarding body focused on exam delivery and the psychometrics of assessment would look to develop software platforms that also are increasing in innovation at the moment. So I don't see that's something that we would expect to be replicated more widely.

And then finally, what potential is there to leverage our position in the educational software market through further international third-party distribution agreements or joint ventures? That's another question from Brian at Polar Capital.

Sorry, Chloe, could you just repeat the start of that question?

So what potential is there to leverage your position in the educational software market through international third-party distribution agreements or joint ventures?

So if I look at the parts of the business today that have got real international presence, they are through our Resources business, which does leverage physical resources through distributors internationally, and our assessment business where a large proportion of the contracts that we've won over the last 2 to 3 years have predominantly been international, but we have done that direct to customer. I think what you see in the education school software space, they do tend to be very focused on the U.K. and the specifics of the U.K. marketplace and not many of those are more internationally leveraged outside those are focused on international schools. So I think the real opportunity for us is in that international assessment market, looking at the digitization of end-to-end exams for schools, professional awarding bodies, higher education and language testing. And we're also starting to see a little bit of engagement in that direct to schools as they look at more formative assessment approaches. So I think that's where our real opportunity is, but that's -- has historically been working with some in-country partners in Africa and Asia, who -- where we need a part to deliver certain broader aspects of the service delivery for our software. And I think that remains a real opportunity. It will take time, as we've mentioned, for the COVID effects to wash through in some of those geographies, many of which are still experiencing quite high levels of disruption. But in the medium term, I think that remains a really good opportunity for us.

Andy Smith from Panmure Gordon has a question. Is it possible to outline the upside from the single site warehouse in terms of margin potential?

Yes. So I think just to remind people of what we're doing there is we started with 5 distribution centers where we were delivering products from 2 brands, one which was acquired in 2017, not with a high level of automation, and we are consolidating that in a new purpose-built warehouse in Nottinghamshire, which will have a level of automation and all brands being delivered from the same environment, which then coupled with what we are looking to do in terms of our front-end websites that have enhanced capability and digital engagement and experience for our customers. I think the obvious elements of the warehouse consolidation is it reduces our cost base through the automation and the consolidation. That's in the region of GBP 2 million a year. I think the broader benefit comes from the whole end-to-end digital engagement. We don't have a higher degree of customers buying from both brands, which I think when we start to leverage the digital and data opportunities that the new end-to-end engagement gives us, further delivered with the more efficient operation in the warehouse, which will improve our fulfillment statistics as well as our operating costs, I think there's a broad deal of benefit. I think it is worth mentioning, however, that we are seeing cost increases at the moment through freight post-Brexit dynamics and a lot of product inflation. And I think that we do expect margins to come under pressure, but it's great to have the backdrop, therefore, of the consolidation of that work and then the opportunity to really leverage the value of the end-to-end system moving forward.

We now have 4 questions coming from James Lockyer at Peel Hunt, but I'll pass these on one by one. The first is you mentioned exams are likely to take place next year but with modifications. And how might software play its part here?

I think we continue to watch and observe that, that news from the education secretary that exams will face some modification was quite recent. And therefore, I think that will remain under consultation as to see what those modifications are. Clearly, the focus for us it will be great if exams are set to the normal volumes. That makes a significant a difference for us, as you can imagine. And if there is an opportunity for us to support in that, then we will work with the Department for Education and the awarding bodies to help in whatever we can. But I think it's still a watching brief on how that unfolds.

Great. And then question two from James. Can you talk a bit more about the U.K. nonschool exams that were higher than FY '19? And is this a trend that could continue once we get back to a normal level of exams for the other areas of the business?

So the areas that we deliver exams in -- that are not school exams are in professional awarding bodies. So we have some accountancy awarding bodies. We have the Institute of Actuaries, for example. And then we have U.K. customers who actually deliver global language tests. Although they're a U.K. customer, they are delivered all over the world. I think coming back to the dynamics of what we're seeing in education, those areas, I think we will see professional awarding exams probably move more quickly in the digitization approach and it's definitely a market that we would consider. And we will increase our focus on not only in the U.K. but globally. We have accountancy awarding exams not just in the U.K. We have them in Nigeria, in Pakistan, for example. But I think that we will see organizations look at their end-to-end digital assessment. And what we've been able to do this year with 2 professional awarding bodies is convert what started off for us as an e-marking only contract. We've been able to turn those into online authoring, online testing, remote invigilation and then online marking. So I think that trend towards an end-to-end digital assessment approach is something that we will see more broadly once the COVID dynamic starts to settle down and people can focus on their operating model and where technology can support them.

The third question from James is around the warehouse and automation program. So whilst the warehouse automation won't be completed until next year, will we start to see some of the benefits of it soon such as SKU rationalization?

Yes. So there's a lot of work going on in ensuring that we know what SKUs that we take into the new warehouse, what SKUs will then work through automation. And therefore, there is a glide path of how we progress ahead of the consolidation through to then what we will be managing within the consolidated warehouse. I don't think they'll be material until we really start getting into the effects of being able to have transitioned to all the warehouses into one really running full tilt with our automation. So I think we're still going to see the material benefit be when the work is fully completed. But we'll start to see some potential cash flow inventory management improve.

And then the final question from James is on the supply chain issues. This is impacting other companies outside of education. Can you talk a bit about your strategies to mitigate this? And might your position as an education provider with a large client base help here?

So I think the areas where we're seeing real challenge in one area, like everybody at the moment, the lead times on devices. So where schools are trying to build their digital infrastructure, I think we're going to start seeing in the second half much longer lead times for devices for education, which will both impact our hardware sales, but also the progression of some of the work that we do around installations and refreshes of technology in schools. I think our ability to influence that more broadly is probably quite challenged, given that's a global challenge. The other area that we are seeing products is, I think, in Resources, we have probably a broader international supply chain than the rate -- some of our competitors in the market because of the proportion of our sales that are through our own developed products that many are then developed through a network of partners internationally. I think actually, on one level, we were probably quite surprised by the level of demand that we had in and around lockdown. And the demand we've been able to generate associated with the strength and the curriculum knowledge of our Resources business has been great, but it is then challenging us in container freight and lead times and cost in being able to meet that demand. So we are doing all that we can in looking to accelerate that and bring that forward. But I think it will be a constant battle through the second half in terms of managing expectations and lead times for customers.

And then we have a question from Alan Clifford at Lazard. He has 2 questions. The first is, with the pension fund and surplus, is there any possibility of derisking further or a buyout?

So the pension and surplus is on the accounting basis, but the trigger dates that we see that is the same trigger date for our triennial. So we're going to move into discussions with the trustees on our 2 pension schemes from this point forward. I think where we've got to is we are at the level where we have quite a high level of hedging, almost 90% on our interest rate and inflation. And I think that the only challenge around buyouts is that we would consider -- or buy-ins, I won't bore you with the specifics of why we do buy-ins rather than buyouts, but it does create opportunity, but you do need a scale of pensioners who are at the right stage. We did a buy-in a number of years ago to GBP 30 million. I think we will look at them as we go when we get to the pockets of scale of members that are pensioners as we look to do that, and we -- it is our focus to get to self-sufficiency on the pension and to derisk it as much as possible.

Alan's second question is, what are the key risks on the warehouse consolidation project from here? And when does it go live as the sole source fulfillment with no dual running costs?

So I think the -- all of these programs and the size and the complexity that we're managing have risk. I think in all of the homework we did as we were getting into this, I think the real area of challenge for people is when they start connecting up systems and moving into go-live that you manage the inventory and the system integration successfully. We've brought in a really good team of people who are experts in this area, and we've built a lot of knowledge in it. So those risks will exist as we progress, but we're confident in the team that we have to manage our way through that. So we're looking to go live in system integration with Resources through the first half of next year, and then we will start transitioning the warehouses in a phased manner through into our new single-site facility. And I think given these, I would probably say that we would start to see the real benefit of that in 2023 and will give us the window of 2022 to manage that carefully through.

Thank you very much, everyone. And with no further questions on the webcast. I'll pass back to Neil for some closing comments.

So many thanks, everybody, for joining us. If you do have any further questions, then please don't hesitate to get in touch with us through Mark and myself or Headland. And I very much look forward to talking with you and updating you on our progress through the remainder of this year and into prelims. Thank you very much. Have a good day, everybody. Bye-bye.