Trading Update

Nov 6, 2018

Earnings release

Wait for your name to be announced. I must advise you that this conference is being recorded today, on Tuesday the sixth of November, 2018. I would now like to turn the conference over to your first presenter today, Mark Dixon. Please go ahead, sir. Thank you, operator. Good morning, everyone. Thank you for joining us this morning to discuss our third quarter trading update. I'm joined on the call today by Eric Hageman, our interim CFO. Firstly, I'd like to take you through the key points from the update and then hand the call over to Eric to comment on the financial performance, and then, as usual, we'll be open for questions. I'm pleased to report that our improved sales activity has driven strong revenue performance in the third quarter. Total group revenues increased by 10% to GBP 637 million, GBP 638 million at constant currency. Revenue from total open centers, that excludes centers that have closed, have increased by 13% on a similar basis. This improvement has been broadly based with good performance coming from the Americas, EMEA, and Asia Pacific. These three together represent more than 80% of our business. They all delivered good double-digit growth in Q3. As indicated before, the U.K. remains disappointing. We have action plans in place to address the issues in this market. We've accelerated our program to close, replace, and refurbish specific locations. In mid-August, our new sales and operational structure has also been put in place. Whilst it's early days, we've already seen some of the benefits from this. In conclusion on the U.K., lots of actions being taken. Please remember, this is still a good, profitable business. It's not a bad business. It's still profitable. It's just not as profitable as it was. We think the actions we're putting in place will restore it to somewhere close to its previous performance. It just takes time to get these things done. We're absolutely focused on it. Importantly, looking at the whole business, we've seen further improvements in the mature revenue growth on the back of this improved sales activity previously mentioned. Revenue in the quarter increased by 3.9% on mature with high single-digit growth in Americas and EMEA. Combined, these two regions are approximately two-thirds of our mature revenue. Year to date, mature revenue is therefore up 2.9%, a sequential improvement on the 2.4% we saw in the first half. Mature revenue performance in the U.K. has stabilized at a rate similar to the first half, with Q3 showing some improvements on Q2 year-on-year. Mature occupancy has increased by 30 basis points to 74.3%. Here we see still plenty of room for growth in the mature estate. That's obviously a key strategy for us moving forward. We're very focused on trading the business, maximizing occupancy and revenues from the mature estate. Of course, all the estates. We remain focused equally on the returns we're making for our investments, on our investments, and on a 12-month rolling basis, the returns for all of those locations opened before 31st December 2013 were 17.5%, well above our cost of capital. This is after increased maintenance CapEx, which is written off of this number prior to calculating return. Also, just to remind you all, this is a post-tax number as well. Not a bad return even with the U.K. not performing as it should. We've continued to develop our network. 72 locations added in the quarter, taking total new openings to 204. Across all of our brands, we've added 76 new locations in our large format brand Spaces. These centers substantially higher size than a typical Regus location or the other brand locations. As of the 30th of September, we had a total of 154 locations open and a strong pipeline for the remainder of the year. Year to date, we've added 4.7 million sq ft of workspace. Our global network now stands at 55.8 million sq ft across 3,258 locations. With our network refurbishment program, together with the natural ending of certain leases, 25 locations were closed in the quarter, taking the total for the 9 months to 71. Our growth pipeline for the whole of 2018 remains broadly unchanged at approximately GBP 230 million of net growth investment, representing about 275 locations and an additional 6.7 million sq ft of space. This is over 20% more space than we added in 2017. In line with our strategy of lower risk and more capital-light growth, we are experiencing accelerating momentum in our franchising activities. Whilst the numbers are currently relatively modest compared with the total group, this will become an increasingly important part of the next generation IWG. Historically, we've done franchising in some of the more developing markets. We're now seeing growing interest in some of our developed markets. Overall, we have a really good pipeline in this area. We have substantially built the operating team to grow our franchise business. We think this is a very exciting further development in the way we grow the business into 2019 and beyond. In summary, the good sales activity we talked about before has translated into better sales momentum and occupancy. We've seen price increases in addition in the mature business. Our newer locations have continued to develop strongly. We believe that this will continue into the fourth quarter. We are continuing to explore a range of potential strategic opportunities. Some of these, you may have heard some of the noise in the press, that we are busy and at work looking at possibilities. We haven't got anything that we can talk to you about at this moment, but we do believe that there are things that we can do in addition to focusing on trading, which is the first order of the day, that will deliver increased shareholder value into 2019 and beyond. I've already talked about our increased franchising activities and the heightened level of interest that we've got from potential partners in new and existing geographies. You have to remember, the interest in co-working, the interest in flexible space, is very high at the moment. So we think it's a good time to be looking at these strategic possibilities. We'll continue to report on the initiatives we have as they become more concrete and as we start moving them into the execution phase. With that, I'll now hand over to Eric, who'll discuss the performance in more detail. Thank you, Mark, and good morning to everyone on today's call. Let's look at the financial performance in some more detail. With the headwind from prevailing exchange rate reducing in the third quarter, group revenues in Q3 increased 10.2% at constant currency and were up 8.9% at actual rates to GBP 637.9 million. As Mark said, group revenues for the nine months to 30th of September increased 8.1% to GBP 1.8 billion at constant currency. The waterfall of the first nine months revenue development highlights the strong development of our newer centers and the improved mature performance, but with ForEx and closures having a negative impact. Mature revenues contributed a 2.7% increase to group constant currency revenue. This, together with a 7.6% increase from the additions to the portfolio in 2017 and 2018, helped us offset the 2.4% closures impact and the ForEx headwind of 3%, to deliver a year-to-date 4.9% increase in group revenue at actual rates. The year-on-year 2.9% growth in mature revenues for the first nine months of the year reflects improving growth during that period from all those centers open on or before the 31st of December 2015, and the strong development of the 2016 year group additions. Our post-tax cash returns on that investment remain strong at 17.5%, clearly well above our cost of capital. This is achieved after the increased investment in maintenance CapEx over this period, which, to remind you, we expense in this calculation. Our underlying cash generation year to date was GBP 120.3 million. This is slightly down on the GBP 129.6 million reported for the same period in 2017. This reflects the slightly higher level of maintenance CapEx and cash tax paid. We have, year to date, invested GBP 204.9 million of net capital expenditure into growth. This compares to GBP 224.1 million in the corresponding period in 2017, which, again, to remind you, included investment of approximately GBP 110 million on property which we still own to date. Net debt has increased GBP 50.7 million to GBP 433.9 million, compared to GBP 383.2 million at the 30th of June 2018. This reflects the continued investment in growth and the share buyback program. During the third quarter, we also acquired some 8.8 million shares for a total consideration of almost GBP 21 million. Our balance sheet continues to remain strong, and we feel very supported by our lending banks. As indicated in the statement, the board remains confident that the group will deliver its full-year results in line with management expectations. Thank you. I will now hand back to Mark. Thank you, Eric. In conclusion, we remain confident of our position in this exciting growth market. We're encouraged by the sequential improvement in revenue growth from the improved levels of sales activity, we anticipate this continuing into Q4. We remain in a strong financial position with a prudent approach to risk. We will continue to strengthen our business with targeted approach to growth. We expect an increased franchising activity, we're in active discussions with a number of interested parties, we'll update you on this in at the full year results. We're also exploring a range of other potential strategic opportunities. We have a great business with this, by far, the most cost-efficient business model out there today in our industry. We are the market leader in every country we operate in. Others make claims, we actually are the market leader in all of these places. The sheer size of our networks really surpass anything else that's out there. We've got a unique suite also of multi-brand formats, so centers and products, to address different customer requirements. Again, a key number when differentiating against the competition is that nearly 30% of our revenues come from ancillary revenues. There is not a single other competitor that gets anywhere close to this. The best they're doing are in the 10s, possibly 15, the very best. We're double that. That, again, is a testament to the way we run the business and having a great model focusing on the basics that you build this business from. What's clear to us as well is that, it's becoming clear as we go along, is that the customers don't want the same thing. We're seeing also benefits from having multi-brand. Our ability to offer choice, both in prices, in formats, and in the services to supply to different work styles is working and it's working well. As before, we continue to win more and more corporate customers that increasingly are using the network. That, again, is a key strategy for us. It's winning more and more of these customers that want to use the network and not individual sites. With that, I'll hand back the call to the operator who will explain the procedure for asking questions. Thank you. Thank you. If you wish to ask a question, please press star and one on your telephone keypad and wait for your name to be announced. To cancel your request, please press the hash key. Once again, to ask a question, please press star and one on your telephone. Your first question comes from the line of Stephen Wolf. Please ask your question. Morning, all. Just a couple from me. Firstly, I know you said you'll give us a bit more update on strategic opportunities that you mentioned as and when you can, but can you sort of speak more generally about the options you consider available, whether it's in terms of spinoffs, breakups, anything you can sort of outline more generally in terms of your thinking? Secondly, in terms of the disappointments you've experienced with the U.K. market in terms of how challenging that is, just in terms of sort of general market, whether that's competition, whether how much maybe the investment you're having to put back into that market. Thirdly, in terms of the franchise network. Firstly, in terms of the contribution, perhaps anything you can give us in terms of how much the franchisees at the minute contribute to revenues or profit, and whether that has actually now changed your view of how much capital spend you might be putting into your thinking for 2019, whether it would have been GBP 230 million previously or that might now change to take out GBP 10 million-GBP 15 million that you might save or not be spending now. Thanks. Okay. That's quite a lot. Look, some of these things I think we'll update in more detail at the full year. If I deal with this spinoffs. Spinoffs, if you want to call it that, but that is we now have discussions ongoing with various interested parties who are interested in doing more significant partnering deals. This is franchising deals where we're franchising whole countries. We have been doing it in a small way for quite some while, but they're not meaningful. We now have some meaningful ones that are ongoing. What does this mean? This means that we will partner or franchise a company who we think would grow the country in question, or the countries in question, much more quickly, but would also be buying our business, our operating business, that actually exists in that country as well. We think we get a double benefit if we are able to achieve this. One, we will be able to start to get incoming cash, if you like, from the sale of a business, and we get further annuity income. We have to work for it because we've got to provide the franchise services, et cetera. Income then from a more significantly sized business in one country or another. They continue to be very much part of the network. They continue to be an integral part of the overall business, but we're doing it with partners. As I say, we've been doing this for the last five, six, seven years, but in a small way. We're now doing it in a more meaningful way. What does this mean to shareholders? This means some capital coming back the other way as we sell these countries, and it means an annuity or a revenue going forward that's more significant than what we would get today. It's making use of the platform we already have, accelerating the growth, and there's a whole difference in terms of returns on capital, in cost of capital. There's taxation issues, taxation advantages if you're local. There's funds movement in some countries, quite difficult, much easier if local money's doing it, and so on. There's a whole range of benefits. It is an important part of our strategy going forward, and it's part of our strategy that we had universally about releasing the value in this business, which we think is not reflected in today's share price. We also are considering, clearly, does Spaces have a higher value than the value of the rest of the group? We're just investigating that, and if it does, then we'll consider what we do with that. Very early stages. I would say except for the franchise and partnering discussions, more significant ones, they are more advanced. Turning to this so-called U.K. challenge, I think some of the time, again, the way we're talking about it, U.K.'s disappointing, but it's still a profitable, very good business. What we have are problems around the edge of it that we're sorting out. It's not the fundamental core business that there is a problem with. New centers do well in the U.K. It's not a sort of an overall U.K., but it's not a competition problem. It's a problem with some of the old acquisitions that we did that need to be sorted out now, and that's what we're doing. We don't see anything in the U.K. that would say, okay, the U.K. is somehow different to our business in France, to our business in Germany, or to our business in the United States. It just needs some repair work. Some very good investments we made some years back, they were very good. We've had our cash back many times over, very happy with the investments. They need sorting out now. We're sorting them out, period. That's it. Obviously, the economy's weak because of the uncertainty surrounding Brexit, that's clear, and demand is slightly down. However, we are doing well. When the centers are in good shape, when they're at the right rents and so on, we do well. Not a problem. Okay. We would expect the U.K. to keep coming back to health during 2019. We can't see anything that's sort of making us feel that we're staring down the end of the cannon here. It's certainly not that. It's a bit of sorting out. It's disappointing, but we're getting on with it. Sure. If we look at your question about franchise contribution. At the moment, frankly, it's too small to worry about. Sitting together with Eric, we're now working on basically the forecast of what this will look like and when we're going to start. We'll start talking about it when it's more significant and it makes a difference. You don't want us talking about small numbers on this call. When the numbers get more meaningful, we'll start to talk about it. Capital spend, will it change? It is likely to change for a number of reasons. First of all, there's a probability that we will have incoming cash as we start to sell countries. Clearly for shareholders, we will start to get money coming back into the treasury from sales of countries. Secondly, the rate of organic full-fat, we take all the liability growth will be likely to be less in 2019 for many reasons. The main reason is we're putting much more of our efforts into franchising and partnering than we've ever done before, and we're taking a slightly more cautious view with the backdrop of a more uncertain economy. Overall, that's just a general thing. It's not country specific. It's a general feeling, a general view. Capital spend will still be there, but it will be, I think the numbers you use, without going into those, we may update you more, or we'll update you more when we next speak. Will be highly likely to be less, and we'll give firm up on that when we next speak. Thank you. On that question, Steve, which I'm not sure if anyone else has any new questions, go ahead. Wonderful. Cheers, guys. Thank you. The next question comes from the line of Calum Battersby. Please ask your question. Hi. Morning, guys. Two questions from me. Firstly, just to follow up slightly on the franchising question, hoping you could give more color on the likely economics of this model or how it works at the moment. Say, is it that you get a percentage of the revenues of the franchisee? They take up all of the upfront CapEx costs themselves? Secondly, on Spaces, you're now up to 170 centers or so. Just wondering the contribution of Spaces as a proportion of overall revenues at this point, how large is it of the overall group now? As well, is that business profitable in and of itself? I'd imagine it's not, just because of the timeline of most of these sites have been open since the start of 2017. Just wondering if there's any more color you can give us there. Thanks. Okay. First of all, franchises, you had it. The franchisee puts the CapEx in and pays us, basically, makes a contribution to overhead and effectively pays a royalty fee, which is about 4%, 5% for the use of the IP and everything else. Pays a small upfront and opening fee and so on, all of which are just contributing to overhead. Overall, it's a different model. It's not a 17% return on capital invested. What we're most disappointed about is the fact that this year we're only opening 250 centers, whatever the number. We should be opening in the thousands of centers. Clearly, doing that with our own capital is not going to work. We need franchising and other forms of partnership that rapidly get the number of centers up. We are a believer, as a board, and certainly myself, network wins the day. This is about coverage. It's always been about coverage. It's not about having load of sites in London. You've got to be everywhere, every single part of the country, then you win. That's it. With franchising going much more quickly, we expect that we can both create a better business for ourselves and, at the same time, a great business for franchisees. The ones we've got already, we've done quite a few, are doing well, and it can work for both sides. Clearly, in an IFRS 16 world, there is a big additional benefit that it's not coming onto our balance sheet. Turning to your question on Spaces. Is it profitable? Well, actually, all the first ones are doing very well. They're not more profitable than Regus, just to be clear. Everyone's got this idea that co-working somehow is a recipe to mint gold coins every day. It's the same business. That's not different. We make very good margins out of the centers, the early ones that were done, and the first ones opened about 10 years ago. The growth has been in recent years. Even those, the first ones, nicely profitable. Good profitable model, helped by, obviously, we're very economical on overhead, very tight on managing them. They are good. What was the other question? Sorry, I rambled. That was it. Economics- Economics, yeah. Spaces. Yeah. No, that was clear. It was just, if you could say as well, how large Spaces is a proportion of overall group revenues now? I don't know the number, but I know what the number will be when they're all mature. Yeah. Listen, if I may, this is Eric. If we want to say something more clearly about Spaces and the size and the contribution, whether it's revenue or profit, we would do so. Personally, I would then favor to do something like that at the full-year results. We're not doing it today. Okay. Yeah. Listen, if at the end of the year, we are at 157 location, which is the exact number, out of 3,500 that we will have more or less as a total group, it's a meaningful number. It's a meaningful number because they're, generally speaking, two, maybe even three times the size. Actually more, maybe four times the size, each one. We will update you with those numbers. It will be a significant number because of the size. The economics are different, the margins are the same. Okay. More questions. Sure. Thanks. Your next question comes from the line of Andy Grobler. Please ask your question. Hi. Good morning. Just a couple from me. Firstly, on the balance sheet. Net debt was a bit higher than I had thought. Back in August, the guidance for the full year was around GBP 330, and it seems like it is going to be a fair bit more than that from this point. Could you just walk us through the bridge of how we get to that number? Secondly, kind of a similar theme. You mentioned IFRS 16 earlier. Have you got any updates on what impact you think that will have on your balance sheet and P&L if you were to report under IFRS 16 right now? Lastly, just back to franchising. You've talked a fair amount about it, but I just wondered why now? What's changed to make you think that this is the time to push that forward? Let me do the franchising first. Then I will pass over to Eric on the other question. What's changed, we painfully have restructured the business over the last two years, nearly three years now, to make it franchisable. Now, to make a business franchisable, you have to make it very easy for the franchisees. Our business three years ago was not easy. You need to be a rocket scientist to actually work it out at center level. The whole business has been restructured in such a way that it is relatively easy to run each operating unit, and the business therefore becomes franchisable in a much more significant way than before, because all of the difficult stuff is done centrally in our three global hubs and in our big operation center that sits behind them. There is very little that occurs at center level. It is much easier for someone to develop a business locally and get it done. Of course, it is much more efficient for them. They need less people, their returns on capital are significantly enhanced by the business being franchise-ready. That is number one. Number two, I think is maybe we should have put more resource into franchise earlier. We have been doing it during 2018 that we will go into 2019 with a much more significant franchise team. Again, you can pick up noise about this. I am seeing in the newspapers, but pretty much globally, we are putting in franchise teams, getting some markets are regulated. We have done all the regulation work, and we are ready to go and ready to sell it, and are selling. Number two. Number three, we think it is the only way to get into the deep countryside and suburbs and smaller towns of a country. If you believe in national coverage, if you believe in that is what is key, then what we know from our own experience is it is difficult for us to run very remote places, very remote businesses. There will be a difference in performance when we are running Fargo, I am not sure if it is North or South Dakota, to us running something in Chicago. We believe that local business people will make a much better job of it. The people we franchise so far, there has been tremendous momentum in the second half of this year once we really got going. People are not buying individual franchises. They are buying them in groups of 10, possibly groups of 20. They are very experienced business people that generally, so far, almost universally, I think, have other franchise businesses where they'll have a group of Pizza Hut, a group of McDonald's. They have quite a few other businesses. That's what they do. The right time, we were a bit slow in resourcing up. We've now done that and we believe in national networks. That's it. All right. Let me take the other two, and let me start with the net debt. The guidance, I think, was given at the half-year results. Why it's a bit high was your question. That's right. Let's start to break it down in buckets, which is basically, at the beginning of the summer, end of spring, we signed a new revolver, which basically meant that rather than having 550 as capacity, went up to GBP 750 million. The reason why you do that is because you want to use that capacity. On the one hand, part of it is used for guarantees, and part of it is obviously being deployed. What we deployed for that is as per this statement today, one is in growth CapEx, of which we've done GBP 75 million and GBP 40 million of maintenance CapEx. Equally important is obviously we started with a share buyback program, which was also announced at that time, of which we have done just over GBP 31.5 million year to date. We've also seen a bit of an increase in our cash back of around GBP 10 million, which together with in one or two other small individual balances, explains the delta that you have seen. Two more points to make, is one that we also still hold GBP 140 million of property on our balance sheet, which we are able to sell. Lastly, maybe just to put the context of the third quarter net debt increase versus the June one, what do we actually expect for the end of the year? What we are expecting is a net debt to EBITDA, that will be just a little bit higher than what we saw at the half year. A bit higher than the 1.1 times net debt to EBITDA. With that, we think that we still have a very solid balance sheet. Your other question, which was on our IFRS 16, there is nothing more that we can add or say other than what we've done at our half year results. Maybe just a bit of color. As you can imagine, this is a big part of what the central finance team is working on and have been working on for a long time. This has been flagged, we talked about it in the annual reports at length in the last two years. The organization is making sure it's ready to do what it has to do with its reporting obligations. People have been working on it. Systems are in place. We feel as a company, and this is my seventh week, I feel that we're doing, putting everything in place for it. Just on IFRS 16, at what point will you start reporting under that standard? Will it be for the full year so we have comparables or Exactly. Yeah. Full year 2018 will be comp. No. The idea is what you're going to see, you're going to have a parallel. You're going to have both. People will be able to see comparables. You can see what 2018 would have looked like under both standards. Needless to say, as you would expect from us, Wayne and myself, together with the central finance team, will make sure that well ahead of our full year results, we will have teach-ins so we can take everyone through it, which would give you ample time to be able to update your models in time for publishing results when the results come out the beginning of next year