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Edited Transcript of GEM.AX earnings conference call or presentation 25-Aug-19 11:00pm GMT

Half Year 2019 G8 Education Ltd Earnings Call

Bundall, Queensland Nov 26, 2019 (Thomson StreetEvents) -- Edited Transcript of G8 Education Ltd earnings conference call or presentation Sunday, August 25, 2019 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary G. Carroll

G8 Education Limited - CEO, MD & Executive Director

* Sharyn Williams

G8 Education Limited - CFO

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Conference Call Participants

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* Aaron Muller

Canaccord Genuity Corp., Research Division - Head of Research of Australia

* Gareth James

Morningstar Inc., Research Division - Senior Equity Analyst

* John Hynd

Wilsons Advisory and Stockbroking Limited, Research Division - Senior Equities Analyst

* Jules Cooper

Ord Minnett Limited, Research Division - Senior Research Analyst

* Peter Drew

* Shaun Weick

Macquarie Research - Analyst

* Tim Plumbe

UBS Investment Bank, Research Division - Director and Research Analyst

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the G8 Education Limited CY '19 Half Year Investor Call. (Operator Instructions) I would now like to hand the conference over to Mr. Gary Carroll, CEO. Please go ahead.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [2]

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Thank you, and good morning, everyone, and welcome to the 2019 half year results presentation for G8 Education Limited. My name is Gary Carroll, and I'm the CEO and Managing Director of G8 Education, and I'm joined today by the Group CFO, Sharyn Williams. We'll walk through the investor presentation that was posted on the ASX earlier this morning and then provide time at the end for any questions.

Slide 5 sets out the statutory results for the half year. I won't dwell on this slide other than to point out that the group's reported results have been materially impacted by the introduction of the new accounting standard for leases, and I'll refer people to the recent market presentation by Sharyn, which set out in detail the impact of the new accounting standards on the reported results for G8.

Turning to the CY '19 half 1 snapshot on Slide 6. The group achieved underlying EBIT of $51.6 million for the half, in line with consensus forecast. This result was driven by very good performance in our organic centers with EBIT for those centers up approximately 14% on the prior corresponding period driven by of 1.5 percentage point improvement in like-for-like occupancy. Partially offsetting this was a mixed performance from our acquisition centers with incremental earnings from prior year acquisitions being slightly below expectations.

As anyone that has followed G8 will know, cash flow generation is a real strength for the group. Cash conversion remained strong in the first half of 2019 with EBITDA to cash conversion of 108%.

During the half, G8 utilized its syndicated debt facilities to repay its $270 million Singapore bond facility at maturity. In addition to providing interest rate savings and increased tenor, the group's syndicated debt facilities now provide sufficient headroom to enable us to implement our strategic growth plans.

A fully franked half year dividend of $0.0475 per share has been declared, an increase of $0.25 per share compared to the prior corresponding period. The group continued to make solid progress in relation to implementing its strategic plan in first half of '19, including both the curriculum development and customer engagement center initiatives being executed and performing in line with expectations. All other strategic initiatives are broadly on track, and I'll provide an update on those later in the presentation.

Before I analyze the financial results for the year in detail, it's worth providing an overall view of the sector dynamics as well as current and projected demand and supply environment, and these are covered in Slides 7 and 8.

Firstly, on Slide 7, long-term sector conditions are very favorable from both the macro perspective and in terms of the specific opportunity available to G8. Long-term demand growth is positive with bipartisan government support, continued growth in workforce participation to augment population growth. The sector remains highly fragmented with the top 5 players accounting for around 20% of the market and approximately 70% of the centers being owned by small operators. As the largest listed for-profit operator with a market share that's around 3x more than its nearest relevant competitor, G8 is uniquely positioned to use its scale advantage to provide differentiated offers to both families and team members and play a leading role in industry consolidation.

From a supply perspective, as shown on Slide 8, at a macro level, net supply growth in the first half of 2019 was lower than the prior corresponding period, notwithstanding an increase in the second quarter that was driven by a lower number of closures. From a micro perspective, the level of new supply within 2 kilometers of an existing G8 center during the first half of 2019 was in line with prior period levels, and this trend is forecast to continue in the second half. While this level of increased competition at the trade area level is considered to be a headwind, our analysis of centers that was similarly impacted in 2017 has provided us with valuable insight. It demonstrated that 40% of our centers continue to grow occupancy in the face of increased supply with those centers being characterized by good asset quality and, more importantly, stable center managers and teams. For us, this provides strong evidence that the group's strategy of driving reduced turnover and improved asset quality can in fact generate occupancy growth, even if local supply increases.

The group's occupancy performance is outlined on Slides 9 and 10, and please note that the reference to occupancy is a reference to like-for-like occupancy. Half 1 occupancy performed in line -- well and in line with expectations, growing by 1.5 percentage points over the prior year. The result was driven by both the market environment in the form of the new government subsidy as well as group-specific initiatives. From a market perspective, the new subsidy has improved affordability with the impact being felt both in terms of new families entering the sector and existing families taking additional days. From a G8 perspective, the customer engagement center is performing well, in line with expectations and is driving inquiries for tourists. And our supply defense initiatives to drive asset quality and reduce team turnover in supply impacted centers are showing positive early signs.

From a geographic perspective, all states grew occupancy except South Australia, which was impacted by elevated supply levels in 2018.

Slide 10 provides a more detailed trend data in relation to occupancy, highlighting that occupancy has been consistently above prior year levels during the half, with the group also benefiting from an increase in childcare subsidy cap levels in the second quarter. The other key takeout from the graph is the higher growth rates in the second half 2018 following the introduction of the new child care subsidy, providing for some more challenging comparables in the second half. Maintaining the prior year trajectory for the remainder of the year will result in full year occupancy growth of circa 1.5 percentage points.

Slide 11 provides an overview of wage performance for the year. As with organic occupancy, wage performance was in line with expectations during the first half, with quarter 1 benefiting from prior year challenges in implementing regulatory changes. From a forecast perspective, the focus is on generating further wage efficiencies to absorb potential increases in wages flowing from the ECT regulatory changes that take effect from January 2020.

The quantum of any increases will depend on the number of existing G8 team members that will be undertaking study towards a degree qualification with these results being known over the next 3 to 4 months.

Turning to overall operating performance, which is contained on Slide 12. The impact of improved occupancy and wage momentum is clear to see. Organic center EBIT grew by 13.9%, absorbing increases in depreciation resulting from refurbishment activity, the cost of the customer engagement center and increased R&M costs. Support office cost increased by $4.5 million in the half driven by annualization of CY '18 costs and the spend necessary to support previously announced strategic initiatives. The support office is now rightsized for the business, and overall support costs are now at an appropriate level for the group.

Slide 13 to 15 set out the performance of the group's 2017 to 2019 acquisition portfolio. Starting with the 2017 cohort on Slide 13, the greenfield cohort is nearing occupancy maturity with a focus for these centers now on achieving EBIT maturity.

The 2017 brownfield acquisitions have continued to improve, both in terms of occupancy and wage efficiency with a target to continue to bring occupancy levels to the group average.

The 2018 greenfield cohort, which is set out on Slide 14, has been a bit slower in terms of ramping up occupancy. 7 of the 11 centers are meeting expectations with the remaining 4 centers being included in a turnaround focus group, which is showing encouraging signs so far in half 2. While we remain confident of the medium-term returns for this cohort, the slower ramp-up of these centers mean that contribution from the 2018 cohort will be around $3 million lower than previously forecast.

As a result, the incremental earnings from both the 2017 and 2018 cohort is expected to between -- be between $6 million and $7 million.

Turning to the 2019 greenfield cohort on Slide 15, the $3 million drag from current year greenfield centers in the first half was in line with guidance provided at the AGM.

While the majority of the centers opened to date are performing in line with expectations, 3 of our larger format centers have not met initial expectations. In addition, there've been delays in licensing a number of centers that were due to open in May and June. The impact of these issues is that the drag from 2019 greenfield centers is now expected to be $3 million in the second half as compared to the previous guidance of a $1 million contribution. As outlined in previous presentations, the group's network modeling indicates there is potential to grow the group's center network without cannibalization.

The current forecast of the group's network is contained in Slide 16. Clearly, the primary focus is on completing the existing committed greenfield pipeline and generating the forecast returns from those assets. As has been the case from the last 2 years, the group will continue to evaluate opportunities to rationalize underperforming centers with 8 centers being closed in the first half and a further 5 centers identified for closure at lease expiring in the second half 2019.

I'll now hand over to Sharyn to talk through the group's performance in relation to cash flows, balance sheet and capital management.

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Sharyn Williams, G8 Education Limited - CFO [3]

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Turning now to Slide 18, which outlines the cash conversion of the business measured on a lease-adjusted basis. The strength of the business continues to be the generation of strong operational cash flows with over 100% of this period's lease adjusted EBITDA converting to lease adjusted operating cash flows. The continued focus on efficient working capital is the driver of this conversion result, particularly after the implementation of the new childcare subsidy where additional account support was provided for both parents and our center-based teams in the initial 12 months of the subsidy.

Slide 19 outlines the cash flow statement of the group. As a reminder from the recent AASB 16 leases presentation earlier this month, the implementation of the standard changes the presentation of the cash flow statement, but has no impact on the net cash flows generated by G8. Due to the transition method adopted by G8, the prior comparative periods have not been restated. To assist investors, we have provided both the pre- and post-AASB 16 basis to allow comparability. The presentation impact of the standard to increase operating cash flows and outflows of financing activities can be seen on this slide. Effectively, the rental payments include a principal repayment on the lease liability, similar to a mortgage, where the regular repayment is comprised of interest and principal.

The principal portion during the half of $31 million can be seen in the table moving from operating to financing cash flows with net cash flows remaining unchanged. Investors familiar with G8 are aware the business has a strong seasonal element to it, with the first half being the seasonally lower period in terms of earnings and cash flows.

The first half cash flows increased by $1.5 million on a prior comparative period. This is in line with the EBITDA increase of 5% over the same period. During this first half of 2019, operating cash flows were sufficient to fund maintenance CapEx and the dividends, while borrowings of $35 million were drawn to fund the $32 million of acquisitions during the period, with these acquisitions comprising 2 brownfield centers and 5 greenfield centers in New South Wales and Victoria. In terms of financing cash flows, during the period, the lower cost syndicated facility was drawn to repay the $270 million of Singapore bonds. Dividends of $27 million were paid to shareholders relating to the final dividend for 2018.

Looking ahead for the remainder of the year, the greenfield funding requirement is expected to be $30 million for the remaining 12 centers, taking the entire spend to circa $155 million for 44 centers and concluding the committed development pipeline.

Outlined on Slide 20 is a breakdown of the capital investment made during the half and the expected CapEx investment for the full year.

$16 million was invested in maintenance capital during the first half. This investment supports a number of our target areas, including continuing to build the quality of centers. The center refresh and refurb program continued with $7 million invested during the period. This CapEx specifically relates to investment made in the physical centers, such as playground and yard upgrades, painting, flooring, air conditioning and kitchens. This investment is targeted at the physical appeal of our center network that plays a role in enhancing the experience of both families and our teams within the centers.

The remaining $9 million was invested in educational equipment to provide educators with the tools required to offer engaging learning environments for our children and continued investment in our foundational systems and infrastructure to ensure our platform is scalable and efficient, predominately the system investment related to further expansion of the child care management system to provide enhanced communication to families, and the commencement of the rostering and workforce management system.

The Wi-Fi infrastructure upgrade for centers continued this period and sets us up well for the customer element of our CCMS rolled out during the period and the workforce management project that is underway. The forecast 2019 CapEx remains between $35 million and $40 million, as we continue to strengthen the quality of our center portfolio through refurbishment and refreshment as well as investing educational resources and technology to deliver a differentiated offer for our families.

Turning now to our balance sheet on Slide 21, where the impact of AASB 16 can be seen with the addition of a lease liability, both current and noncurrent, and a corresponding right of use asset. These leases relate to our lease centers as well as our motor vehicle fleet. On the transition date of 1 January 2019, a lease liability of $708 million was taken onto the balance sheet with a $612 million right of use asset, a $30 million deferred tax asset and a $68 million adjustment to retained earnings.

During the period, there were movements in this asset and liability in the form of acquisitions, repayments, depreciation and variable lease payments reassessments. 7 acquisitions resulted in further right of use assets and lease liabilities being added to the balance sheet. Further details of the movements are in note 6 of the financial statement. During the period, the Singapore bonds were repaid at expiry by noncurrent debt facilities with a weighted average debt expiry of over 3 years. This new syndicated debt facility provides increased tenor and flexibility as well as generate circa 200 basis points rate reduction in comparison to the bonds.

The group grew the network in the period and completed the acquisition of 5 greenfield centers from the existing development pipeline and 2 brownfield centers. A further 7 centers were expected to open in the first half to capitalize on the seasonally significant July to September period.

As Gary outlined earlier, licensing delays have resulted in these centers being scheduled for the second half. This takes the development pipeline to 12 centers and an estimated $30 million in outflows in the second half, with 3 of these 12 centers already settled since 30 June. This will mark the conclusion of the greenfield development pipeline committed to in the 2016 year with an expected total of 44 centers acquired for circa $155 million.

Slide 22 outlines the group's gearing ratios, including the net debt to EBITDA leverage and return on capital employed. The net debt levels at end of June were $350 million, resulting in $150 million of available debt facilities in cash. The leverage of 2.2x was lower than the 2.4x anticipated in February due to the delay in the developer pipeline.

The peak net debt and leverage is now expected in quarter 3 with end of year levels to return to the low 2x. The current leverage levels of above 2x reflect the current growth phase of the company, as we execute on the development pipeline and the earnings profile of greenfield centers having a ramp-up characteristic.

We continue to have sufficient headroom available relative to our covenant levels as well as having approximately $110 million in committed debt facilities and cash available at peak borrowing levels. Once the development pipeline is completed and earnings are realized, this ratio is forecast to reduce through 2020, as we progress towards our target leverage range of 1.5 to 1.7x. Fixed charge coverage ratio remained stable during the half, and the group remains conservatively geared.

From a returns perspective, return on capital employed has remained in line with 2018 levels, reflecting the increased EBIT and average borrowings during the period. Return on capital employed is expected to trend higher as the core portfolio delivers organic growth and the greenfield centers mature.

Turning to Page 23. In terms of capital management, the Singapore bond repayment completes the transition of the group to lower cost of debt, improved covenant levels and a staggered debt maturity profile.

The Board declared a fully franked dividend of $0.0475 per share and a slide in the lease presentation earlier this month have amended the dividend policy to be 70% to 80% of lease adjusted impact.

I will now hand back to Gary for the strategy update.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [4]

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Thanks, Sharyn. So we'll now turn to an update on implementation of the group strategic plan. Slide 25 contains the medium-term targets that were provided to the market as part of our investor day last November, with the targets covering occupancy growth, returns from acquisitions and overall returns on capital. Time frame for the delivery of these targets is 2022, so the group is still partway through its overall transformation program. Our strategic priority areas remain unchanged, firstly to build a great team, strengthen our quality foundation, create a sustainably different offer and experience for families and drive performance by network growth, new revenue streams and scale-led operating efficiencies.

Slides 26 and 27 provide an update on the group's progress against the strategic plan. Our people program remains on track with our turnover of center manager and Early Childhood Teacher, or ECT roles reducing in line with expectations. In terms of training programs, our induction and onboarding pilot for center managers has commenced. We've rolled out our work routines for area managers and built the center manager work routines for roll out in early 2020. Finally, our professional development course for ECTs, Teaching for Tomorrow, has been rolled out as planned and very well received.

The group continues to make good progress in improving the quality of our centers with rollout of our educational framework commencing in August.

From an asset quality perspective, we're on track to complete the refurbishment of 80 centers in 2019, which is lower than our previous target of 100 due to delays in obtaining landlord and council approvals in some areas.

From a customer perspective, as outlined on Slide 27, the customer engagement center was fully operational from April.

Performance to date has been good and in line with targets with around 85% of inquiries being converted into tours. The group has decided to expand the rollout of 2 of its products, Kinderling and iSandbox, while the literacy in allied health pilots didn't meet relevant hurdles and will not be rolled out further.

During the second quarter, we also launched the parent and educator apps for our Xplor child care management system, in line with expected timings. Our fourth strategic pillar is concerned with driving profitable growth for the group. During the half, we established a dedicated group to focus on turning around the performance of a selected cohort of centers with the scope covering team, asset quality and learning environments. We are on track to complete 25 turnarounds in 2019 with positive results forecast to be achieved in occupancy and EBIT in the months following the turnaround.

By improving asset quality and team capability and turnover, these centers are also forecast to maintain and grow their performance, even if supply conditions worsen in their local market.

The rollout of our new labor scheduling and rostering system is on track to be piloted in January 2020, while our greenfield pipeline is scheduled to be completed by the end of the year, as Sharyn outlined.

Turning to the outlook for 2019, which is set out on Slide 29. Organic center performance continues to track solidly. It's noted that the second half growth rate will not have the benefit of the CCS stimulus that commenced on the July 1, 2018. And although occupancy building initiatives are performing in line with expectations and gaining momentum, we do remain cautious about the impact of near-term supply.

For these reasons, CY '19 like-for-like occupancy growth is expected to be in the mid-1 percent. Wage performance year-to-date is tracking to expectations, and further efficiency gains are expected in half 2. While the success of the 2017 acquisitions gives cause for confidence in the medium-term potential of the greenfield portfolio, the ramp-up of the 2018 and 2019 centers is taking more time, resulting in an $8 million forecast reduction in 20 -- CY '19 EBIT contribution from these centers.

The balancing the performance of the organic centers, which is very good, with our caution in relation to the market environment, the forecast underlying EBIT range for CY '19 is $140 million to $145 million. The strategy of driving quality, capability and team engagement is on track and producing results even in the face of increased supply, and as you would've seen throughout good organic occupancy growth and EBIT growth from the first half. We're only partway through our transformation program and the focus remains on execution. The group looks forward to providing a further update on trading performance at the investor day in November 2019.

That concludes the formal part of the presentation, and I would now hand back to our host to start the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Tim Plumbe with UBS Investment Bank.

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Tim Plumbe, UBS Investment Bank, Research Division - Director and Research Analyst [2]

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Just a couple of questions from me, if possible, please. Gary, just firstly in terms of that additional supply coming in on -- or rather, some of the supply not coming out as quickly as expected, how are you guys looking at that supply-demand dynamic going forward? When do you see them being in line given the current trajectory? And what kind of gives you comfort around that given that it seems to be moving around a little bit?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [3]

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Yes. Thanks, Tim. So I think this is where we can separate the macro from the micro. Macro level supply-demand is on track to being balanced at the end of the year as we had forecast. The impact on G8 center by center -- and any operator center by center varies. What we're looking at is that we've had about the same level of supply increase year-on-year for the last 2 to 3 years. The positive is that 40% of our centers from 2017 grew occupancy really quite nicely, even in the face of that increased supply where we've had a stable engaged team and a decent asset quality. So we know what we need to do to grow occupancy. We've actually formed a dedicated team to get down center by center to start implementing those sorts of turnaround plans that were evident in the 2017 center, with the 25 this year, as we prove up the methodology and get it ticking along and then look to scale up that activity in future periods, and that gives us actually a great deal of confidence, Tim, that we can grow occupancy, regardless of what happens in the supply environment.

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Tim Plumbe, UBS Investment Bank, Research Division - Director and Research Analyst [4]

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Got it. And just the second question for me, I'll leave it to other people to ask a couple of other ones. Just in terms of the cohorts that are coming through, so the calendar year '17 cohort delivered $3.8 million of EBIT. Can you give us a sense of what you are expecting for the full year? And how does that compare to the original EBIT that you guys had acquired and in the brownfield EBIT? And I don't know if you are able to split it up between kind of brownfield and greenfield EBIT contribution from that.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [5]

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Yes. So probably, the easiest way to answer it is at a headline level, Tim. CY '17, we are on track. And each of the cohorts in broad terms, we're going to deliver somewhere between $8 million and $10 million of incremental EBIT. In CY '17, cohort is clearly on track to deliver that. The 2018 cohort is tracking behind. It was due to deliver around $5 million incremental this year. It's probably going to be around the $2 million mark. The medium term, we're still expected to deliver that circa $10 million of incremental. CY '19, if it follows the trend of our CY '17, it's more a 3-year journey than a 1- or 2-year journey. 22 centers should actually deliver a little bit more than $10 million over the coming periods, so that should deliver probably mid- to high teens in terms of incremental EBIT. And we think we will deliver that. It just takes a little bit longer.

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Operator [6]

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The next question comes from Jules Cooper with Ord Minnett.

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Jules Cooper, Ord Minnett Limited, Research Division - Senior Research Analyst [7]

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Well, just 2 from me. You'd previously said that the support costs were rightsized at the '18 result. And if I look at the second half, I think that had sort of implied about $17 million. And you're saying that it's rightsized now at $19 million. Do you sort of mean that the full year expectation for the support cost is $32 million? Or is it the sort of the first half annualized we should be thinking for the full year? Then there's one other.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [8]

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Yes. So there's couple of things here, Jules. The CY '18 result didn't have the full impact of the additional role, so what you're seeing in the first half of '19 is the annualization of roles that came in partway through '18, with the net result is you're looking -- the full year result will be effectively the run rate that was -- is in the first half of 2019.

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Jules Cooper, Ord Minnett Limited, Research Division - Senior Research Analyst [9]

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Right. Okay. And then I sort of just noticed that the refurbs are going to be lower this year than expected, but the CapEx guidance is unchanged, if you could just make a comment on that as well as the CY '19 openings delayed because of license approvals. If we could just sort of explore the drivers behind why that hasn't delivered as expected. It seems to have cost the business quite a lot.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [10]

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Yes. So the refurbs -- the major refurbs are the ones that are the 80, we have still retained a bit of capital during the year for -- our -- the turnaround projects that I've talked to, and some of those have aspects around minor CapEx and room resources to get learning environments up and running. So we wanted to maintain that capital envelope to drive those turnaround projects. We're happy with the overall spend.

CY '19 licensing delays are predominantly in Queensland. And I know through my associations with other operators in the market, they're facing similar delays with a number -- the departments in particularly Queensland taking longer and being a little bit more onerous in terms of their licensing requirements, and that's flowing through in terms of openings. We see that as being a short-term one-off type thing, Jules. So once the centers are up and running, they will track okay. It's unfortunate that they didn't get it up and running in the first half of the year to enable us to take advantage of that key third quarter trading period.

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Operator [11]

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The next question comes from Aaron Muller with Canaccord.

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Aaron Muller, Canaccord Genuity Corp., Research Division - Head of Research of Australia [12]

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Just a couple of questions. Firstly on the -- just on the price increase you made, just confirmed what that price increase and the impact was on, yes, the first half revenue. And then also if you could just talk about the pricing strategy going forward. Should we expect another price increase in the first half of next year?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [13]

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So the price increase was 4%, as you know, Aaron. It had a roundabout of $3 million impact, and it was largely offset in the first half results through one less trading day and the washout of the license fees that were in last year's result.

In terms of pricing strategy, I might hold far on that. We might have a bit more of an update in November. But the key takeout is that we will commit to having only one price increase per year. We've made out that commitment to the families a couple of years, and we will continue to stick with that.

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Aaron Muller, Canaccord Genuity Corp., Research Division - Head of Research of Australia [14]

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Right. And just in terms of the guidance, the $140 million to $145 million, can you comment on what organic growth you've assumed in the second half? Trying to work off a bridge for the last year's number, adding in the '17 and '18 cohort and minusing the $3 million deficit from '19, it should end up at about $140 million and the $145 million at the top end, I guess, assumes less organic growth. Is that right? And $140 million implies a negative organic growth in the second half.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [15]

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So what we've talked to, Aaron, is that if we maintain the trajectory from the prior year, which was pretty strong given the introduction of the CCS subsidies in July, we'll end up around in the mid-1 -- circa 1.5 percentage point for occupancy for the year. Delivering that gets us solidly in that range that we provided. We think the combination of the G8 specific initiatives and continued benefits in terms of wage efficiency, we're feeling pretty confident with the earnings range that we've given.

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Aaron Muller, Canaccord Genuity Corp., Research Division - Head of Research of Australia [16]

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Yes. Okay. And then finally, just on the network growth strategy into calendar year '20, how are you thinking about the growth strategies? Is it going to be acquisitions or you're thinking about more developments?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [17]

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So for us, first hurdle to clear is that we've got sufficient capital to devote to acquisitions. And the pleasing thing is that we'll finish our greenfield pipeline and be in a good position to be out to invest in future growth. So that's a good thing. Our view is that, that growth is likely to be by via acquisition rather than greenfield development certainly in the short to medium term.

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Operator [18]

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The next question comes from Shaun Weick with Macquarie.

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Shaun Weick, Macquarie Research - Analyst [19]

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Just a few on for me. Just -- I guess, just an initial one. Trying to understand your thoughts around achieving the 600 bps occupancy improvement by calendar year '20, so I guess the medium-term target. Are you expecting kind of even profile from here or the benefits of that more back ended? And I guess, the question was in that, how do you see the quality of the portfolios as they currently stand in order to achieve that?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [20]

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Yes. So the pace at which we get there, Shaun, will be driven by 2 factors. One, the pace of the turnarounds that we've talked about that we're kick starting that. While we've got the broader strategic strategy around improved training, refurbishment, et cetera, what we've done in the last few months is set up a dedicated team to focus on turnarounds at a more specific level. And the faster we get through that work, the greater the impact on occupancy growth, as we are pretty confident that delivers the results. It's now getting through the scale of the network. The second key element, of course, to getting the occupancy growth is rolling out our differentiated offer. And we're certainly at a pretty advanced stage of building some potential new offers to take out to market. I won't be going to that in any great detail, but we certainly have plans to roll those out in 2020 and beyond, and they will help drive occupancy growth as well. So we're pretty confident that those 2 factors will help get us to the occupancy targets that we've talked about by 2022. The second element, the quality of the portfolio, we always evaluate, and we continue to evaluate the quality of the portfolio. If there's an opportunity to do something a little bit more significant than waiting until lease expiry, that's something that we won't rule out in the next 12 to 18 months.

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Shaun Weick, Macquarie Research - Analyst [21]

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Okay. Great. And then maybe just one more, just on the wage performance efficiencies. What are your expectations in terms of what you can deliver through the second half and the benefits to flow through from the roster targets, the labor scheduling and rostering system? I was under the impression that, that was going to be staying to flow through from the beginning of next year, has that been back ended slightly? Or...

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [22]

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Yes. So second half of this year, given our hurdle is slightly more challenging, we expect some level of wage improvement, but it won't be massive in the second half of the year. The key step change will be the rollout of the new roster system. We'll do a pilot in January, finish the rollout of the pilot end of quarter 1, beginning of quarter 2 next year. So the benefits will flow more into the second half of next year. So we won't get a full year benefit in 2020. We'll get a substantial portion.

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Shaun Weick, Macquarie Research - Analyst [23]

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And in terms of forming the business case around implementing that system, like what kind of level of benefits are you targeting to deliver?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [24]

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So we are targeting to deliver that high single-digit millions, which on an investment cost of $5 million is a pretty compelling business case for us.

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Operator [25]

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(Operator Instructions) The next question comes from Gareth James with Morningstar Equity Research.

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Gareth James, Morningstar Inc., Research Division - Senior Equity Analyst [26]

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Just wanted to clarify the lease adjusted impact that's just backing out the AASB 16 impacts. And also that the EBIT guidance is -- has obviously backed out AASB 16 as well.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [27]

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Yes. Correct on both of those, Gareth, yes.

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Gareth James, Morningstar Inc., Research Division - Senior Equity Analyst [28]

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Yes. Okay. And just another one on the marketing strategy. I know at the investor day last year, there was talk about possible brand consolidation. I was just wondering if there have been any progress in that regard.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [29]

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There has, and what we'll look to do is provide a more detailed update in our investor day in November. But certainly, work is continuing on that. As I've flagged at that time, nothing in '19. '19 is more of a planning year. We'd look to roll out from 2020.

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Gareth James, Morningstar Inc., Research Division - Senior Equity Analyst [30]

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Sure. And just final one on the organic growth -- revenue growth figure. I think it was about 6%. Are you able to say roughly the split between occupancy and price growth there?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [31]

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Well, occupancy improvements there, 1.5%. Weighted average price would be the remainder. The only slight offset in terms of revenue growth was the one less trading day.

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Gareth James, Morningstar Inc., Research Division - Senior Equity Analyst [32]

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Sure. Okay. So of that 6% thereabout, most of it is price growth.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [33]

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Correct.

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Operator [34]

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The next question comes from Peter Drew with Carter Bar Securities.

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Peter Drew, [35]

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Just one question for me. Just in terms of the occupancy growth guidance for the full year of 1.5%, you sort of lowered the tone on that. It was going to be sort of approaching 2% previously. And I'm just -- it seems like the change has sort of occurred more recently. Maybe you could just provide a little bit more color about what you've seen more recently to sort of lower the tone on the guidance. And could you also maybe touch on just what percentage of the portfolio is in your sort of description supply impacted, please?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [36]

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Yes. Thanks for the question, Peter. So our tone is more caution based off the quarter 2 supply. We had anticipated more closures because that trend had been kicking in nicely. So the net growth wasn't as pronounced -- net reduction in growth wasn't as pronounced in quarter 2. And what we do is, I think, adopting an appropriate caution that if that trend continues, makes life a little bit harder in the second half of the year. So we thought we should reflect that in our outlook. We also wanted to give ourselves time to implement the turnarounds in relation to occupancy, the project that we've kicked off reasonably recently. We didn't want to be overly optimistic in terms of the time that would take to turn around. Clearly, if both of those -- if either of those things turn out better than forecast, we'll have a better result. Your second question was...

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Peter Drew, [37]

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Just in relation to the portfolio just what percentage of the portfolio is in your sort of description supply impacted?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [38]

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Yes. So in 2017, if we use the definition of opening up within 2 kilometers, it's about 110 centers were impacted over the year. 2018 was about 130. 2019, as you would have seen in the presentation, we're predicting about that level. So over the last 3 years, about 370 of our centers have had a competitor opening up within 2 kilometers. And the good thing about that, from our perspective is, this year, we're growing occupancy by 1.5 percentage points at a time when you would say, if you just look at the numbers, half of our network would have been impacted by supply, a bit more up until that point in time, which brings us back to, if we get the environment right, good asset quality, stable engaged team, you still grow occupancy.

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Operator [39]

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The next question comes from Tim Plumbe with UBS Investment Bank.

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Tim Plumbe, UBS Investment Bank, Research Division - Director and Research Analyst [40]

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So just one follow-up in terms of the labor rostering work, the project that is going on. You were saying high single-digit cost saves. Can you give us a sense for what you think net benefit? And I appreciate that you need to wait and see for those calendar year '20 uplifts in labor. But broadly, how much of those increased labor or potential labor cost increases could be offset -- could offset some of that savings that you'd be getting through on labor rostering system?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [41]

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Yes. If what you're getting at is, is there a wage rate increase coming that will help dampen the wage savings, Tim, the only 2 factors that could potentially offset that are increased ECT wages, and we haven't provided specific guidance on that to date because we have quite a cohort of deployment qualified G8 educators that have expressed interest in undertaking further study. If they do that, it really means that there's not material incremental cost from ECT wages for us.

And the second is any award-based increases or any significant movement in the awards, the IEU case is ongoing. We expect an answer on that in February. And initial indications are that there will be an increase higher than the standard 3%, but people are unwilling to nominate a quantum at this point in time. Our early planning is that we would expect net-net of all of those $2 million to $3 million impact. With our projected wage saving, that still takes us to the mid- to high single digits on a net basis. And before you go, I like your new surname, too. That's a really good thinking.

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Operator [42]

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The next question comes from John Hynd with Wilsons Advisory.

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John Hynd, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Equities Analyst [43]

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If I could just ask on some detail around perhaps the 2016 cohort, how that -- I think it's dropped off to at least how that performed first half of '19 and whether you expect that to still do sort of $12.8 million of EBITs in '19. And also if I could just get some final clarity on maybe mid-cycle, from those 4 years of cohort, how many centers are actually -- how many center will be coming through? And what's the mid-cycle EBIT you're expecting from it, please?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [44]

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So the 2016 cohort, we haven't included, John, because this really is part of our organic portfolio and that's been a while. Their EBIT performance largely tracks the performance of the rest of the group, so that would have been around that $13 million touch higher mark in terms of EBIT. Mid-cycle, we've called out that we're expecting 25% return on capital. So $155 million, you're talking mid-$40s million at maturity of all of those portfolios.

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John Hynd, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Equities Analyst [45]

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Great. And just a final question. I might not be understanding it correctly, but you have some new teams that are working on occupancy improvements. And I think you're targeting, is it 25 centers this year? What are the area managers and the regional managers doing in that regard? How -- is there a crossover between the roles? Are they part of the teams that are helping with this? I'm just wondering about how this is reflected in the wage cost, please.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [46]

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Yes. No, good question. So for the first portfolio, we selected a portfolio of 12 centers. We took our area manager of the year last year who is based in New South Wales because a fair chunk of those centers were in New South Wales. And we said, "Can we take you out of your day job and you work on turning around these centers?" We actually just reallocated her centers amongst the existing area managers, while we entered pilot phase. We did a similar thing with our key HR business partner. We took them out of the business, and that's all they worked on. And the rest of the team took up the slack. And we did that to prove up the methodology and see if we started to get some results. Results have been pretty good at an early stage, so we expanded the group. We still adopted the kind of reallocation, so the cost of the group to date has been immaterial in terms of that team's activity. When we start scaling up, we will take people out and backfill. We still don't expect it to be a material number in terms of the group, particularly relative to the EBIT impact that we get from improving those centers.

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John Hynd, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Equities Analyst [47]

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Okay. And just last one for me. Maybe if you could talk about 1 or 2 of the key issues on why the ramp-up of the centers is taking longer. Is it purely a supply thing? Is it executing the teams correctly? Are you still working out pricing in the areas. Maybe just something along that line, please.

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [48]

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Yes. You cannot -- you guys track the results of our competitors as we do. I don't think we're the only ones feeling the slower ramp-up of greenfield centers. When we review the results of other listed, we're seeing the same thing. That tells us it's a lot about the supply in the market that we're coming into. People have more choices than to convince them to leave centers for our center, particularly if that recent supply is new and in pretty good condition, takes a little bit longer. You do get there in the end, and Sharyn and I were talking this morning, there was a center at Notting Hill, Great Beginnings at Notting Hill that started slower. We were tracking that one with interest first 12 months in. That center in year 3 is actually performing really well for us now. It took a while, but once it hit a tipping point in terms of getting acceptance in the local market, they do start to track along quite nicely.

The other factor is some of the centers we're talking about are reasonably large. You're talking 130, 150-plus licensed places. They do take longer to fill as a general rule than a 80 to 90 play center. Once they do, their EBIT contribution is very significant. But the ramp-up as a percentage of occupancy takes a little bit longer.

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John Hynd, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Equities Analyst [49]

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Sure. Maybe just one more for me. The -- I think you alluded to it earlier that you're looking at -- always looking at some form of portfolio reconstruction with the centers. Is there anything on the agenda at the moment in terms of acquisitions or divestments of underperforming centers, please?

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Gary G. Carroll, G8 Education Limited - CEO, MD & Executive Director [50]

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Nothing specific, but we will continue to evaluate both acquisitions and divestments.

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Operator [51]

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There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.