IGNITE LIMITED — Call Transcript 2013

Aug 20, 2013

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21 August 2013
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MD on Outlook

Open Briefing interview with MD Kym Quick

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Clarius Group Limited Level 3, Suite 302 70 Pitt Street Sydney NSW 2000

In this Open Briefing[®] , Kym discusses:

• Restructuring to bring cost savings, efficiencies in FY2014

• Positioning of the business for recovery in demand

• Improved cash flow, balance sheet strength

Record of interview:

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Clarius Group (ASX: CND) today reported an underlying net loss after tax of $0.9 million (excluding non-cash goodwill impairment and de-recognition of tax losses) for the year ended 30 June 2013, compared with underlying profit of $2.1 million in the previous year. The result, which was in line with your guidance of early June, reflected reduced demand and ongoing pressure on margins. How did your client retention trend over the recent year and how are you positioned if conditions don’t improve?

MD Kym Quick

Our client retention over the year was good. We managed to not only retain all of the major clients we’ve had longer term relationships with, but also to win significant new accounts. We believe this means the opportunities for us are a little better than they’ve been over the last couple of years. Having said that, the bigger organisations we’re working with aren’t actively hiring extensively at the moment, however once conditions improve, our growth will escalate alongside that.

Client retention has been a significant issue over the last two years, where we’ve had a lot of renegotiation and renewal of significant accounts, and I can confidently say we’ve retained 100 percent of those accounts.

We’ve done a substantial amount of restructuring of the business which has allowed us to take significant costs out, particularly salary costs, and this will stand us in good stead if conditions don’t improve. Over the last couple of years, we’ve also managed to build a model that allows us to deliver to lower margin accounts far more profitably than we were able to do historically and that ensures we can continue to be competitive when we’re working with bigger clients.

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Including one-off restructuring costs of $0.5 million after tax and a goodwill impairment charge of $40.9 million after tax, the reported net loss after tax was $42.2 million, versus a loss of $9.4 million in the previous year. The impairment charge reduces the goodwill on Clarius’s balance sheet to zero. What was the rationale for completely writing off this goodwill and what are the implications for the value of your brands?

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MD Kym Quick

The goodwill arose from acquisitions made at the peak of the market. Over the past few years we have been revising our forecasts down on what these businesses are now worth. With the continuing challenging market conditions we have now taken a very conservative view on the timing of any improvement in economic activity and this has been reflected in our impairment models.

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Restructuring undertaken during FY2013 is expected to generate annualised savings of $6.5 million. To what extent will the full benefits be available in the current year if conditions remain subdued and what scope is there for further cost cutting if there is no improvement in the market?

MD Kym Quick

We’ve delivered a big chunk of those annualised savings in the latter part of FY2013 given a lot of that restructuring was done in November 2012. We’ll see the remainder of the benefits in the current financial year. However, offsetting that we’ve invested $3 million over the year in increasing our headcount in China. That’s an important investment for us in terms of our future growth strategy.

Being a people driven business, it’s very hard to continue to cut costs when the real issue is around revenue. But certainly there is some leverage in the business whereby if conditions improve we have capacity to maximise that opportunity without increased salary costs. On the reverse side, if conditions deteriorate then there are further costs we can take out of the business.

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In recent years Clarius has implemented new service delivery models in parts of its business, including Major Accounts and on-demand IT resource delivery models. To what extent have these been responses to structural change in the industry? Do you believe further such changes will be necessary for Clarius to remain competitive?

MD Kym Quick

Certainly the new delivery models and new services are being driven by structural change within our industry, particularly in relation to the IT industry, where we’ve seen significant margin pressure and a real change in the way clients, particularly larger clients, want us to deliver our services.

The structural changes we implemented in our Major Accounts servicing model several years ago have brought benefits in terms of making us more efficient and able to provide more cost effective delivery. Also, as a bi-product of taking our Major Accounts business out of the Candle brand and placing it under the Clarius brand, we’ve managed to separate the low margin business from the specialist Candle brand. This has allowed us to better differentiate the Candle value proposition as a “high touch” service provider, which has actually allowed us to increase Candle’s gross margin percentage.

The on-demand IT resource delivery model is still in its early stages of evolution but we’re certainly seeing increased demand and growing understanding among our clients about the benefits they can get from working with those types of models.

We’re in a fast changing market and need to be continually looking at our services and delivery structure to remain competitive and remain relevant.

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During FY2013 you began rolling out a new payroll system across some of your brands. When is the roll-out expected to be completed and will any of the benefits of the system be available prior to the completion of the roll-out?

MD Kym Quick

The roll-out is expected to be completed in the latter part of calendar year 2014, and at this point we’re on track to deliver by that date. We’re staging the roll-out by brand and as we do, we’re seeing efficiencies created, for example in back-office head count, and those benefits will be ongoing until the completion of the roll-out.

However, the greatest savings we’ll get from the system will be realised when the contracting market picks up as the system will give us a lot more scalability. Currently we would need to increase our head count if we added 200 or so contractors. Under the new system we could increase contractor numbers by 800 to 1,000 before we’d need to increase head count to manage them.

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Your recruitment services business, which accounts for 83 percent of your revenue in Australia, showed a decline of 15%. Given the business’s major exposure to IT and administrative staff recruitment, can you comment on how demand is tracking currently, particularly in Queensland where government cut-backs had an impact earlier in the year? Is there any sign that margin pressure is easing?

MD Kym Quick

Demand remains fairly flat. We’ve had six months of low level of demand as particularly larger institutions have delayed projects or suspended spending on infrastructure. We believe that will continue for at least the next three to six months.

Obviously we were significantly impacted in Queensland by the change in government which led to a significant reduction in contractor usage in that region. Recovery in Queensland is still very slow and we’re not seeing any significant turnaround in demand there.

Margin pressure varies across our client base and tends to reflect an organisation’s size and buying power. In our Major Accounts area there continues to be pressure on margins, albeit there’s not much more we can offer these clients in terms of margin reduction. In the small to medium size space, clients are still trying to reduce costs as much as they possibly can, but tend to understand better that getting the best talent comes with a higher cost. It’s smaller companies that feel more acutely the impact of bad hires, so if you can provide a high quality service, they are generally willing to pay.

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The IT services business, which accounts for four percent of your revenue in Australia, is down in revenue marginally. How are your key IT services brands, Ignite and JAV IT group responding to the continuing fall in revenue and what is the outlook for demand?

MD Kym Quick

We’ve diversified our IT services’ revenue stream over the past two years – whereas previously it was purely a contractor management business, now we’re offering more diverse service lines, including resource process outsourcing, human resources advisory, outplacement and psychometric evaluation.

Last year’s negative revenue growth was largely off the back of us walking away from a contractor management services contract because the margins weren’t sustainable. That will have a positive impact on the business going forward, particularly in terms working capital, as we reduce the funding cost of managing those contractors. Even though the revenue has seen some decline due to this, the overall impact on profitability will see an improvement.

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Your New Zealand and Asia businesses remained in loss for the year, which seems disappointing given recent restructuring efforts and investment, particularly in China. What further work needs to be done to ensure the businesses achieve and maintain profitability?

MD Kym Quick

We’ve invested significantly in our China business in the last 12 months and it was profitable in the second half and close to break even for the full year. We’re happy with that result in that we were trying to ramp up the business as quickly as we could to give us a really solid platform for growth in the current financial year. We’ve now completed the majority of our investment in the cost structure of the China business, and now we’re focused on productivity and returns, which are on track to where we need them to be.

We closed down our Hong Kong business in October 2012 given we weren’t getting traction in the market and given our belief that investment in the region would be better spent in China. We remain in Singapore, where we expect the business to break even and move into profit this financial year after incurring a loss in FY2013. Last year was our first year of operation in Singapore, which we feel is a strategically important market for us: it’s a stepping stone between Australia and China, and many multinational firms have their Asia-Pacific decision makers based there.

In New Zealand, we’ve restructured our business and now have a country manager overseeing both the Auckland and Wellington offices, which previously had general managers in each location. We expect New Zealand to deliver a far better result this year off the back of a reduced cost base and the newly rebuilt team in the Auckland office, where we sustained some significant losses over the last couple of years.

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Cash flow from operations was $4.4 million for the year, compared with outflow of $2.0 million in the previous year, partly reflecting improved debtor management. How much of the increased working capital discipline represents a permanent change to the way Clarius operates and can it be maintained in a time of higher demand?

MD Kym Quick

On the positive side, we had a lot more focus on improved debtor management and that’s been manifested in tighter controls and closer management at head office level. We’ve also talked with clients and provided incentives for them to pay faster, which has been particularly effective for our larger clients where our cash outlay is significant and payment terms have been slow.

On the negative side, our working capital needs have been reduced by the lower contractor demand.

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As at 30 June Clarius had net cash on hand of $0.2million and gearing (net debt/equity) of negative 0.6 percent, an improvement of $1.8 million and 2.8 percent respectively a year earlier. In spite of the relatively strong balance sheet, you’ve elected not to pay a dividend for the year, with no dividend having been paid since last year’s interim payment. What are Clarius’ capital management priorities heading into FY2014?

MD Kym Quick

We’ve made it clear that once we see sustained profitability ahead, we’ll be in a much better position to pay dividends. Hopefully that’s not far away. We’ve also been very conscious of our cash position and of not putting too much burden on the business during a particularly turbulent period when there hasn’t been a lot of visibility on the short to medium term outlook.

Also given the changes that are happening in the marketplace, we still want to be in a position where, if good strategic acquisition opportunities come along, we’re in a position to take advantage of them without burdening the business with too much debt.

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Thank you Kym.

For more information about Clarius Group, visit www.clarius.com.au or call Kym Quick on +61 2 9250 8100.

For previous Open Briefings by Clarius Group, or to receive future Open Briefings by email, visit openbriefing.com

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