Smartgroup Corporation Ltd (SIQ) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Smartgroup SIQ Half Year Results 2021 Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Tim Looi, Chief Executive Officer. Please go ahead.

Good morning, everyone. Thank you for joining us on the call today. My name is Tim Looi, I'm the Managing Director and CEO of Smartgroup. Joining me today is Anthony Dijanosic, our CFO. So Anthony and I will provide an overview of our financial performance for the half year and take you through some key operational highlights. We'll then take the question. Now let's turn to the investor presentation. So we're very pleased with Smartgroup's operational performance for the first half of 2021. We saw good momentum from improved business conditions and early successes from our Smart Future program, focusing on enhancing customer experience, digital capabilities and streamlining our operations. I'll touch on that program later on in the presentation. The highlights from the half year 2021 results are as follows: first, we delivered revenue for the half year of $109.4 million and NPATA of $33.5 million. The revenue is up 4% versus half 2 of 2020. The previous corresponding period during half 1 2020 did not have the impact of the insurance partner reprice, which was effective from July 2020. Now has it been effective from the 1st of January last year, half 1 2020 revenue would have been around $3.3 million lower. And on this basis, revenue for this half would have shown an increase of about 1% on pcp. NPATA was up on both the previous half and pcp. Second, we're pleased to report that we have successfully renewed or extended 100% of the top 20 client contracts that were due to mature this year, including our largest client, Department of Defense. Defense contract has been renewed for a further 5 years, inclusive of extension. This continues our long-standing partnership with them, a partnership that has spanned more than 2 decades at multiple renewals. The strong renewal rate continues to be a testament to the service we offer our clients and the loyal relationships we foster. Our growth in salary packages was strong on the back of the new wins from health sector clients as well as growth from existing clients, on our various leasing and fleet metrics of study. The new novated lease orders improved throughout the half and in Q2, returned to pre-COVID level. Vehicle delivery timeframe continue to be extended, and this has delayed the recognition of revenue from this growing order pipeline. The ongoing lockdowns throughout Australia are likely to have a negative impact on vehicle orders in half 2, but we have shown that the business is in good shape operationally, and we're well positioned for recovery and continued growth when lockdown ease. Third, we continue to simplify our business operation with the lot of our client transition progressing well. We're building a stronger customer-centric business with an early delivery of technology and process harmonization. And finally, our capital-light business model means we continue to generate a strong level of free cash flow. After-tax cash flows were at 107% of NPATA. We're pleased to declare an interim ordinary fully franked dividend of $0.175 per share. Now turning to Page 3. Our revenue has grown from the previous half, in line with new novated leasing activity. This and disciplined cost management has resulted in a strong EBITDA margin of 45% for the half year. Being capital light, together with a strong balance sheet means we're able to maintain our ordinary dividend payout ratio of 70%. Now turning to Page 4. We're pleased that we've renewed or extended all major clients with contracts maturing in 2021, including our largest client, Department of Defense. The continuation of these contracts is grounded in strong relationships and great service. A customer-centric approach is adopted by every one of our team members to achieve this result. In the first half of 2021, we continue to operate with reduced in-person site visitation and client interaction. Whilst we saw a lot of client interest in restarting off-site activity early in the half, the recent lockdown across the country have impacted our ability to be on-site as much as we and our clients would like. On-site activity, a strong channel that generates interest and demand for our business and we recorded good growth in our customer base for salary packaging, both from new client wins as well as organic growth from existing clients. Turning to Page 5, the number of novated leases under management has reduced slightly as a result of new motor vehicles, supply issues, which are delaying new lease settlements. Our fleet vehicles under management remained stable. Now on Page 6, you can see that despite these new -- these motor vehicle supply issues, our novated leasing settlement volumes have continued to improve both compared to half 2 2020, and the prior corresponding period. This has, in large part, driven by a strong increase in lead in particular, through lower cost digital channel, which has risen beyond pre-COVID levels, both in absolute terms and as a proportion of total lead. I'm pleased to say that our new novated lease orders have grown significantly and were pre-COVID level in quarter 2. However, as new motor vehicle supply remains tight and delivery time frames extended settlement are yet to reflect this growth. The revenue on these orders will be recognized when the vehicles are delivered. Yields were down slightly on half 2 last year, largely in line with the update provided in May. Now on Page 7, we have provided further detail regarding vehicle order levels and corresponding settlement. You'll see that historically, settlement levels as represented by the green line, have largely aligned with vehicle order level, which is represented by the purple line. In quarter 3 of last year, we saw that vehicle supply issue begin to result in delayed order fulfillment. This became more pronounced at the start of this year. Our vehicle orders are strong proxy for settlement given the conversion rate is 99% or better. At this stage, we expect the vehicle supply constraints to continue for at least the rest of this year. Now let me hand over to Anthony, who will take you through the financial results in more detail.

Thank you, Tim. Turning to the profit and loss on Page 9, you can see further improvement in our financial performance following the impact on our business of the initial COVID-19 disruptions in the first half of 2020 as well as the insurance partner repricing that became effective on 1 July 2020. Our revenue has grown 4% compared to the last half, driven by increasing novated leasing volumes and higher recurring revenues. As Tim mentioned, had the insurance partner repricing being effective on 1 January 2020, revenue would have shown strong growth of 1% on pcp. Looking at staff costs, half 2 2020 benefited from a $1.2 million write-back related to the 2018 long-term incentive plan share we did not vest. That aside, increase in staff costs reflects both additional cost to support growth as well as investments in capability to support our Smart Future program. We have been disciplined in our cost control and that has resulted in a strong EBITDA margin of 45%. I would also draw your attention to net finance costs, where you will see that half 1 2020 and half 2 2020 were impacted by one-off items related to the 2020 debt refinance and a large debt repayment, respectively. The $1.1 million figure for half 1 2021 is in line with our expectations for finance costs going forward. You will also note a drop in amortization from half 1 and half 2 2020. Smartgroup's larger business acquisitions Advantage, Selectus and Autopia were acquired more than 5 years ago. Therefore, the acquired software and intangible customer assets have now been fully amortized. For half 2 this year, we expect amortization expense to be around $2.9 million, and we will see the related add-back reduced from $5.6 million in half 1 to $2.2 million in half 2. Notwithstanding significant reduction in the add-backs, NPATA grew 1% on the previous half and 5% on the prior corresponding period. Page 10 shows the high level of operating cash that our business continues to generate, reflecting our capital-light model. The increase in capital expenditure to $0.4 million reflects IT equipment purchase to enable new team members to work remotely and the usual refresh of existing IT equipment. All of our Smart Future program expenditure to date has been expensed. We anticipate some capital expenditure in the second half, however, at very modest levels. Now moving to Page 11. You will see that our balance sheet remains strong. We have very little debt -- very level net debt even after the payment of just over $19 million of special dividends in March this year. The payment of these special dividends has resulted in a small excess of current liabilities over current assets at 30 June. And given our rate of cash flow generation, we expect this to be reversed in the short term. We have around $19 million in the undrawn loan facilities available and recently refinanced our debt with an extended maturity date of 1 July 2024. The refinance resulted in a 50 basis point improvement in pricing. The movement in other current assets primarily relates to an increase in restricted cash funds that belong to our salary packaging customers for the purposes of making packaging payments. There is an equivalent salary packaging liability and both the asset and the liability increases due to the timing of client payroll processing runs. I'll now hand back to Tim.

Thank you, Anthony. Turning to the next page. Earlier this year, we launched Smart Future, a program to invest in our business over the next 3 years with the aim of driving growth in earnings and dividends. We've long recognized great service of a key requirement to increasing the uptake of our products. Our customer experience is a natural extension to complement service. Aside from retaining loyal customers, the delivery of a great customer experience will also increase client and customer advocacy, they'll increase referrals as well as cross sell. For the last few years, we have been integrating multiple salary packaging platforms inherited through acquisitions. This process is expected to complete next year. This means we can increasingly focus investments on enhancing our digital capability. This investment can now be made across a smaller footprint of systems with the new completion of the integration work. This digital investment, together with a focus on streamlining operations to reduce complexity and to drive operational efficiency or build capability to grow revenue from across the broader client base as well as reduce our cost to serve. Our goal is to deliver great customer experiences enabled by technology, delivered by really engaged team members to build out our brand and to build scale within our business. Now moving to Page 14. Over the last several years, we've acquired around 10 private salary packaging and fleet business. These acquisitions have helped us build out a large client base that extends into not for profit private schools and corporate. Smartgroup is a B2B2C business. We contract with employers to provide benefits to their employees. In most cases, on an exclusive basis. We are uniquely placed to deliver education, awareness and services. We estimate that within our existing client base we're able to reach up to 1.5 million employees. We also estimate that those employees, those 1.5 million employees, own up to 1.2 million cars. Our largest clients are in education, they're in health, they're in disability and aged care as well as government. Employment in these sectors stable and growing, and their employees typically drive to work. But within this addressable market, we have approximately 375,000 customers after 20 years of operations and multiple acquisitions, we manage only around 65,000 cars. So there is room for organic growth over the medium term. Turning to Page 15. We are targeting an uplift of up to $20 million of annualized EBITDA following the full implementation of the Smart Future program. Approximately 2/3 expected to come from revenue expansion and the remainder from sales and service efficiencies. We expect this to be a sustainable increase, which is in addition to system growth. In order to achieve this, we estimate a $5 million to $6 million spend per annum over the next 3 years. Somewhat offsetting this cost will be the reduction in expenses following completion of the integration and brand consolidation. Costs relating to this exercise should reduce in later part of 2020, and we're expecting a $2 million per annum pretax reduction in operating expenses at that time. We are already seeing some early benefits from the Smart Future program with changes leading to stronger customer engagement and vehicles ordered. This gives us confidence that we're on the right path. On Page 16, you can see that we've made good progress already on the program. We released a new leasing calculator for our Smartleasing brand with early results indicating a strong uplift in traffic, in leads and also in engagement. We insure our robotics capability to enable a more cost-efficient deployment and support of our digital FTE workforce. We have continued to transition legacy technology and arrangement to ensure that we are ready to be more scalable from migrating telephony, data storage, project management and endpoint management to the cloud. These investments are important in transforming Smartgroup into a more resilient organization. We've now implemented a new digital experience platform, of which we will now begin to build all our website, our client portals and our app. This technology will allow us to rapidly deploy changes across all brands and improved data analytics capability. We've also implemented a new API platform that will ultimately allow us to integrate more closely and easily with suppliers and also increased automation. Now moving to Page 17. I want to give you an idea of the scale of what we have achieved in our efforts to streamline operations and to simplify our business. After acquiring so many businesses in the last several years, it was vital for us to integrate these businesses well and leverage our economies of scale. Over the last 2 years, in particular, we are focused on simplifying our business by transitioning clients and customers to continuing brand. Putting some of these numbers in context, on completion, we would have moved more than half our client base and 1/3 of our packages from legacy salary packaging leasing on novated leasing platform to continue in platform. But we still have a little way to go, but I can confidently say that while this was an enormous undertaking, we have successfully implemented our integration program, while maintaining strong business momentum and retaining loyalty within the customer base. All of this was done with team members from multiple disciplines working cohesively together. I'm immensely proud of our team and grateful to our wonderful clients who supported us through this process. Turning to Page 18. I'm pleased with how we performed in the first half of this year, and I'm also positive about what lies ahead. We successfully onboarded another large health care client and renewed or extended 100% from our key client contracts falling due this year, including the Department of Defense. Our investment in people, processes and technology are delivering results. Our volumes continue to grow with novated digital leads exceeding pre-COVID levels and vehicle orders at pre-COVID levels in quarter 2. Our capital-light business model continues to generate strong cash flows and we've declared a fully franked interim dividend of $0.175 per share. July results were pleased. However, the ongoing lockdowns throughout Australia unlikely to have a negative impact on vehicle orders in half 2. That said, we have shown the business did improve shape operationally, and we're well positioned for recovery and continued growth when lockdowns ease. Importantly, we continue to focus on longer term growth, progressing on the transition work with clients as well as building out the foundation for the Smart Future program. At the full year briefing in February, I said that the strength of our business model, our well-diversified, long-standing client base, our passion for strong customer engagement all positions us well for ongoing success. Our momentum in the first half of 2021 demonstrates just that. Thank you for your investments and continued interest in our company. We look forward to seeing many of you in the coming days. Now allow me to hand back to the moderator, who will invite you to ask questions.

[Operator Instructions] Your first question comes from Scott Murdoch with Morgans.

Anthony, just a few for me if that's right. Just firstly, on the yield, down 3% novated lease yield. Just interested in an update on the dynamics behind that? And I guess, specifically how the add-on insurance sales trial process is going?

Sure. You'll remember that in May, we provided an update, we said yields were around 2% below the average of the prior half. And we also called out the fact that as we're rolling out the new processes that are required for the deferred sales model, we expected there to be a bit of a modest dip. And then essentially, as the team members became used to the scripts and more confident in the new ways of selling that we would expect some level of bounce back. So we have seen a slight dip since then as we expected. And we would anticipate that as we refine scripts and the team members get better at that, we would see a bounce back as we previously said we thought we would.

Okay. Just on the group cost base. I guess there's a few things in this result from previous periods. I think you called out you had a number of hires still to make post the COVID cost out program and then integrate that with the Smart Future sort of $2 million saving expected. I guess I'm just wondering if that $2 million saving is sort of net of the current base? Or is this still a sort of a bit of a cost in from latent hires still to make?

Sure. I'll break that out and answer it in 2 parts. First of all, the $2 million we were talking about in terms of the Smart Future and the client transitions that was to come in when we completed the transitions, which is due next year. And as far as the staff costs specifically, you remember that we previously called out that the organizational restructuring changes we made last year would have a saving of $4 million compared to 2019, but we did have an elevated level of vacancies, you're right. Now we have filled some of those vacancies, but we are still running at an elevated vacancy level. And so there is a little bit more cost to come back in. But naturally, we'll manage our costs in reference to our revenue levels.

Okay. And just on the order number on Page 6 of the presentation, just interested in, I guess, how we correlate. So orders are up 20% on the prior period. Just interested in how we correlate that into future volume? Is it as easy to suggest if that -- if the current orders continued, that volume would follow that trend and be up 20% maybe not in the second half because of lockdowns, but x lockdowns volume would be up 20% given those order levels.

So the conversion rate from order to settlement is a bit above 99%. So ultimately, you would expect that to fall to revenue. Now given the current lockdowns, but also the vehicle supply, there's obviously a delayed revenue aspect there. So ultimately, that will fall to revenue. It's just the timing that it's uncertainty.

Okay. So does it sort of correlate exactly to volume though? I mean does orders up 20%, should we see volumes following that big jump up in trend to 20% in future periods or it doesn't quite correlate?

Scott, I might answer that question, right? So the -- so very simply, if you look at vehicle orders, vehicle orders are pretty much subject to timing differences equates a settlement. The fact is that our vehicle orders are up at the level of pre-COVID. And under normal circumstances, we probably would have settled most of those vehicles. It just so happens that under the current environment where we're finding it hard to get stock, but customers are happy to wait for it to get the car. It just means we're going to recognize those revenues a bit later. So when I talk about our business being operationally much improved, you can see that from the vehicle order perspective.

Okay. Just one last one for me on the Smart Future program. Just, I guess, interested in, I guess, how you expect the shape of that EBITDA uplift to come, the $15 million to $20 million. Obviously, you've given us some dates where you expect that to be achieved. But is it sort of a steady uplift commencing from that second half '22? Is there one big hurdle that you need to achieve a piece of IT before you actually get confidence that, that run rate is going to be successful?

Yes, Scott. Look, I'm really excited about the Smart Future program, right? So we're really seeing some of the benefits coming out of it. I note that when we launched our Smartleasing improvements right to sort of calculator. It's still early days, but the -- what we're seeing from there is better customer engagement, more leads. And that's the first version. We're going to refine that as we go along. Similarly, it's not just about tech. It's also about people practices and process improvements. And again, some of the changes we've made last year are now starting to yield some good results. So it is going to be progressive. There is a lot of tech involved in our build as you know, as we've talked about historically, because we had so many platforms to manage before. We couldn't -- we weren't able to -- or we want to spend a lot of money trying to have tech across multiple platforms, what we want to do is streamline those platforms, and we've done that. We've got 3 continuing platforms. We've built tech over the top of it to make sure that we can get some scale across that. Now that's going to happen over the next 2.5, 3 years.

Your next question comes from Phil Chippindale with Ord Minnett.

Just following up from one of Scott's earlier questions just on this yield point you made on Slide 6. So Anthony, you said before that you do expect a little bit of a bounce back in terms of the yields from the add-on insurance changes. So should we expect a slight improvement in the yield in second half of this calendar year versus first half, that appear sort of assumption?

So the deferred sales model is effective in October. So we've been progressively rolling out changes to sales practices across the sales team. And it's fair to say that we're not fully processing sales in line with the new deferred sales model yet. So I would anticipate, again, a slight shift down before a bounce back.

Okay. Just again on Slide 6, this 74% of volumes came from new novated leases. Can you give us a sense of what the trend was over the half year? I sort of don't want to put too fine a point on it, but the number is consistent with what it was pcp, but still below that sort of previously historical level. I guess I'm just trying to understand, are we getting closer to where it was historically? Or is it reasonably flat, it could also be getting worse. Can you give us comment on that.

It's reasonably flat in the -- I'll give you an indication in the latest month, we had some delayed settlements because of lockdowns and maybe it was a couple of percentage points different to that, but it would have been slightly better than that if we hadn't had some of those delayed settlements. So it hovers within like a percentage of that from month to month. So it's pretty flat.

Okay. Just turning to sort of the delay time from order to settlement. Can you give us a sense of sort of the quantum of that at the moment and maybe how it compares with pcp. Is this a -- are you sort of looking down the barrel of those settlement times continuing to extend at the moment? Are they even shortening at this point? Or just be interested in how that's tracking at the moment.

So I can only speak to the first half and say that they have pushed out a little bit. But obviously, with vehicle supply being somewhat uncertain, it's difficult to tell what the next 6 months is going to hold in terms of whether that continues. We don't expect it to improve significantly in the second half, but there's no evidence that we've got to say it will push out further.

I understand. Last one for me is you've made a comment about the contract extensions for salary packaging in the materials. And I think you've said that -- I just want to get this clear. So I mean you had 8 of the top 20 that needed to be renewed this year. Is it right that you've already completed those? Is that correct?

Yes, that's correct. All done.