IWG Plc

LSE:IWG

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen and thank you for standing by. Welcome to today's IWG Q1 Trading Update Analyst and Investor Conference Call. [Operator Instructions] I must also advise you that the conference is being recorded today, May 1, 2019.I would now like to hand the conference over to your first speaker today, the CEO, Mr. Mark Dixon. Thank you. Please go ahead, sir.

[Mark Dixon, CEO & Director]

Hello. Thank you, operator, and good morning, everyone. Thank you for joining us on this call this morning to discuss our first quarter trading update. As usual, I'm joined on today's call by Eric Hageman, our group CFO.Firstly, I'd like to make some brief remarks and then hand the call over to Eric to comment on the financial performance and then we'll be open for any questions.The momentum we saw building through 2018 has continued and we started 2019 strongly. And this is clearly reflected in our constant currency revenue growth. Revenue from our open centers increased over 15% with all regions contributing to this.Also continuing the positive trend is the group revenue, which is up by 10.6%. The revenue improvement has been driven by double-digit growth in 3 of our regions. That's the Americas, Asia Pacific and EMEA. I'm particularly pleased to report that we've seen strong performances from many of the larger countries within EMEA, including France, Germany and Spain. In the U.K., we saw improvement in our like-for-like open center revenues, which is encouraging.Looking at our pre-'18 performance, we can see a similarly pleasing development with strong performances from the U.S., our largest market, and also in Canada. And as I've said, a good EMEA performance. And overall, we delivered a 6.3% constant currency revenue growth in this group. Pre-2018 occupancy increased by 4.2 percentage points to 74 -- 75.4%.We also continue to grow our network. We added 55 new locations, taking our network at 31st of March to 3,311 centers. These additions added about 1.5 million square feet of space, taking the total to almost 58 million square feet of space. All of these new openings were organic and about 1/3 were various forms of partnering deals.With partnering and franchising increasingly a key element of our growth strategy, we're particularly pleased to announce in the 15th of April a landmark strategic partnership with TKP, which involved the divestment of our Japan business for GBP 320 million in cash and the simultaneous entering into an exclusive master franchise agreement. TKP, our great partner, and they're going to significantly help us develop our network in Japan.In return for the exclusive use of our brands and our support services, IWG receives an ongoing platform fee linked to the systemwide revenues in Japan. We see this as the first of more to come over time.And with that, I'll hand over to Eric to discuss the performance in more detail.

[Eric Hageman, CFO & Director]

Thank you, Mark, and good morning to everyone on today's call.Now looking to the performance in some more detail. With the tailwind from prevailing exchange rates, group revenues at actual rates increased 12.7% to GBP 658.3 million. As Mark already said, on a constant currency basis, revenue was up a pleasing 10.6%. A better indication of the health of the ongoing business is the 15.1% constant currency increase revenue from all open centers in the first quarter.Just coming back to group revenues, the waterfall of first quarter revenue development highlights the significant improvement in the underlying business performance. The pre-'18 revenue contributed a 6.3% increase to group constant currency revenue. The New 18 and New 19 centers added a further 8.7% to group constant currency revenue. The impact of our network rationalization reduced revenue by 4%. These movements, together, with a modest 1.7% ForEx tailwind already mentioned, delivered the reported 12.7% increase in group revenue at actual rates in our first quarter.During the first quarter, we invested GBP 43.3 million of net CapEx and opened 55 new locations. All of this is small locations than the 46 we opened in the comparable period in 2018. The amount of investment is lower than the GBP 63.4 million invested in Q1 '18. The main reason for this is the receipt of a higher level of partner contribution in the first quarter due to timing differences.Group net debt increased to GBP 534.1 million from an opening position as at the 31st of December of GBP 46.8 million. However, this does not take any account of the GBP 320 million cash proceeds anticipated this month from the divestment of a business in Japan. And just to remind you, we also have approximately GBP 150 million of freehold property investments on our balance sheet.Looking to the network development pipeline at the end of April, it stood at approximately GBP 230 million for 220 locations and 6 million square feet, slightly higher than we observed at the end of February.Now back to Mark for concluding remarks.

[Mark Dixon, CEO & Director]

Thank you, Eric. So in conclusion, we've started 2019 strongly. It's very much in line with our expectations. We've got strong sales activity and that's translated into improved occupancy, which in turn is driving good pre-'18 revenue growth and of course running through into the improved gross profit margin. The strategic partnership with TKP, a landmark development and an important aspect of our strategy to deliver capital-efficient growth. We anticipate further deals in the future that will continue to unlock further shareholder value.With that, I'll hand back to the operator who will explain the procedure for asking questions. Thank you.

[Operator]

[Operator Instructions] And we now have your first question from the line of Alexander Mees.

[Alexander Mees, Head of UK Small and Mid Cap Research]

Two questions please. Firstly, with regard to the franchise opportunity. I'm wondering if you can comment on the level of interest from potential franchise partners and what you've been looking for in a franchise partner for future deals. And secondly, with regard to the higher partner contributions in the quarter, Eric, you mentioned it had to do with timing differences. I just wondered if you could explain how that works and whether there's any reason we should expect a lower level of partner contribution going forward.

[Mark Dixon, CEO & Director]

Do you -- Eric, do you want to go first here?

[Eric Hageman, CFO & Director]

Yes. Perfect. So we saw a higher level of net growth CapEx at the end of last year, just over GBP 320 million. And at that time, we said a part of the partner contribution will come in the fourth and in Q1, and that's exactly what we have seen developing. What we see on the deals that we do, whether they are for Regus or for Spaces, a very good continuing relationship with all our partners. So there is no change whatsoever if we think about the openings that we've done, the 299 last year and the 220 that we expect this year, any change in the level of partner contribution. The only thing that you sometimes see quarter-to-quarter is a different change in the influx that you have. So you see some pluses and minuses when it comes to our quarterly cash inflows, if you will. But in absolute terms, there is no difference in how keen partners are to work with us and to contribute to the cash flow that we spend when we open new centers.

[Mark Dixon, CEO & Director]

I think just to add to that, so the -- just to emphasize this. So what actually happens here is the partner agrees to fund the CapEx. We've been successful in achieving that in more cases. There is a timing difference caused by the fact that we are generally paying, not always, but we are paying for the cash contribution ourselves. And then we receive either stage payments or bullet payments from our partner when the job or during the course of the job being done. So that's where this timing difference comes from. And I mean you can see it on the balance sheet, the only thing that you can see the balance sheet on the quarter, but you can see it on the full year and a half year. And Eric can go through with you where that turns up. But that is correct, isn't it, Eric?

[Eric Hageman, CFO & Director]

Absolutely. You can see the cash flow statement. It's very simple. And then I think the answer is clear is you open centers during the weeks, months and the year and sometimes the payment that you get related to an opening falls on a different quarter. That's exactly what happens here.

[Mark Dixon, CEO & Director]

I think the key thing, just to emphasize Eric's point, is we're getting more growth for less capital. That's the important takeaway, which over time -- and you can see in the first quarter, all of the centers were organically growing, so there were no acquisitions. Generally, when you get organic growth, you will make a higher return on capital than acquisitions, and -- but you do have a higher level of contribution and you do get this timing difference. All of which you don't sort of get when you do acquisitions. So that's the first question. I think the second question, the -- look, there's a very good level of interest. There's no question -- here, the timing is good. Some of you might have seen the news yesterday of our friends at WeWork, potentially, so I'm not sure, but potentially looking for an IPO. There's several other people around in the market looking to raise finance. But what's common in all of those people, all of these competitors is they have businesses that are vastly, either vastly underperforming where we are, where we have size of these numbers or they are valued at very, very high multiples compared to where we are. So -- but what is clear is there's a lot of interest in the sector. And so it is a good time for us to be going out ourselves to find high-quality partners to complete our endeavor here which is to get faster growth that is more capital-effective than we have been doing previously and to release value back to shareholders in the form of cash in the short to medium term.So timing is very good and is helped by conditions out in the market. We are -- so we're getting a good level of interest. Since we've done the Japan deal, we've got -- our problem is -- and I don't want you to think we're going to be doing deals like immediately, but we know from the level of interest it's our ability to engage on that interest that's more of an issue.So moving on to the second part of this question, which was what do we look for, well what we look for is a partner like TKP that will accelerate the growth. So what we're not looking for are partners that just have money and want a business. We want partners that have a real capability of accelerating growth. This business -- this industry, the -- in this industry, the winners will be the ones with the greatest coverage. It's -- this is the -- similar to the beginning of the mobile phone industry where those that got country coverage, the best coverage were the winners. It is not about being the biggest in a city or the biggest in a couple of cities. It's about full national multi-brand coverage.And so we're looking for partners that can help us achieve that, who have the capital to do it, who have the entrepreneurial skills to do it, who we can partner with and make it happen.And what I can tell you is we are most definitely having the right sort of discussions, and we're doing before Japan, we're doing it more afterwards. So I'm sure we'll have more questions on this, but hopefully, that gives you some overall picture.

[Operator]

And we now have your next question from the line of Andy Grobler.

[Andrew Charles Grobler, Analyst]

Just 3, if I may, just on operational performance for the quarter. In the U.K., you mentioned that the open centers grew revenues in Q1. Do you expect that to continue? And maybe a bit more granularity about what's going on in the U.K. at this point? Secondly, with the rising occupancy in mature, which is -- which was very sharp indeed, which is great, and you mentioned gross margins were going up, what is the drop-through of that incremental gross profit to EBIT? And then lastly, just on Spaces, with the new center openings during the quarter, how many of those were Spaces and what are your expectations for Spaces openings through 2019?

[Mark Dixon, CEO & Director]

Okay. Thanks, Andy. Look, I'll just hit this first one. On the U.K., again, I'll give you big picture without it being a forecast. We've -- we talked on several occasions about just repositioning the U.K. We did a lot of work last year. We continue that work this year. What we are doing is working. So you can see a good turnaround actually from a poor position to a better position. Overall, we would expect the second half -- second quarter better than the first quarter, third and all the way through the year to get this business back to its -- somewhere close to its former glory, if you like, notwithstanding what's happening with Brexit, economy and everything else. We continue to open centers and continue to just reposition it and get it so that it's very, very competitive. And the medicine is working is all I can say. Still more to do, but there's less to do now than 6 months ago. I think then, Eric, I don't know if you -- do you want to comment? I mean rising occupancy in mature dropping through?

[Eric Hageman, CFO & Director]

Yes. No, so listen, the real question is how it is impacting EBIT because of the comment on gross margin. I mean it is an interim quarter, so we don't mention anything other than in the P&L, then anything on top line, actual constant, et cetera. So I can't comment on it other than to say that we are very pleased to see this 420 basis points increase. Obviously, that will have a positive impact on the performance of the business. And so, directionally, I think that gives you a sense of what the impact is. But I think we should refrain to say more other than at the half year results, we give the usual details when it comes to P&L items.

[Mark Dixon, CEO & Director]

And I think then, just I think the -- I haven't gone -- just look -- I'm searching for the numbers here. Wayne, if you're there, you've got the more...

[Wayne Gerry, Group Investor Relations Director]

On Spaces?

[Mark Dixon, CEO & Director]

Yes.

[Wayne Gerry, Group Investor Relations Director]

Yes. No, so we did 55 openings in Q1. Of those, 27 are Spaces. And I think if you think about the guidance that we've given, which is 220 locations for the year, if you saw the play 27 as a percentage of 55 and you would do that, the same, on the 220, you get a good sense of what we plan to open in 2019 for Spaces.

[Andrew Charles Grobler, Analyst]

Okay. And you mentioned that the full year -- the year-end revenue run rate in Spaces was 281.5. Where would it be now with those extra 27 openings, more or less?

[Mark Dixon, CEO & Director]

Well, we can't break that out. But you've got 2 things happening here. So I mean maybe Wayne or Eric can come back to you on this if it's important. But the -- you've got a rapid ramp-up of revenue in the Spaces locations. So they will be -- because you've got sort of -- by the way, you would have the same on the new Regus locations. So the shape is you've got pretty fast fill times and then you've got more centers added that you -- so it's all about fill time with new centers of any kind. With the Spaces, it's slightly different because they're larger. The ramp ups look different. Regus will fill up quicker than Spaces simply because they're smaller. What number are you trying to get to, Andy? Just so as we can understand.

[Wayne Gerry, Group Investor Relations Director]

[ About ] revenue, I guess, Andy, right?

[Andrew Charles Grobler, Analyst]

Yes, yes.

[Wayne Gerry, Group Investor Relations Director]

If you feel comfortable, Mark, we can share it, because we have it.

[Mark Dixon, CEO & Director]

We can share it.

[Eric Hageman, CFO & Director]

The figure based on March compared to what we were using based on January figures, up 16%. So the simplistic run rate is now getting close to GBP 330 million.

[Operator]

And we now have your next question from the line of Steve Woolf.

[Steven John Woolf, Analyst]

Just a couple for me. Just in terms of the closures we've seen and getting back to the net 331. I'm just wondering whether you could give a bit of color on where they are, if that's possible. And then, secondly, going back to the U.K. business and its repositioning. Does that sort of give an idea that the CapEx that's gone back into the reinvestment is now largely over?

[Mark Dixon, CEO & Director]

CapEx on the U.K. is not over, it's largely over. I'd say it may be -- best guess would be about 75%, 80% through. It's just a few more, even if it takes a long time to negotiate. But in terms of sort of refurbishment CapEx, let's say, 75%, 80%, there's not much left. And it's not -- I don't think -- Eric, correct me if I'm wrong here, but they're not significant sums here in the U.K.

[Eric Hageman, CFO & Director]

No, no.

[Mark Dixon, CEO & Director]

It's, generally, we're negotiating and we're already getting -- in many cases, we're getting paid by the building owner.

[Eric Hageman, CFO & Director]

Yes. So, on refurbs, it's not a massive sum.

[Mark Dixon, CEO & Director]

I think then on closures, we like to call it repositioning. I mean a lot of it is repositioning, overall, because this is just a cycling through. Basically, when you have an estate of 3,300 sites, there are always a percentage that sort of come to -- that come to end of life or your building owner makes it end of life simply because he wants to push the economics more than we feel is accepted but then we can do better. So some of these places are close to them, reopen near a building with better terms. Some -- there are very few sort of -- I can't really think of anywhere we'd have an outright market closure. They are pretty much all either consolidations or closed to open with better terms.In terms of your -- your question is what are we likely to see this year, you're going to have a continuing program, probably the majority in the first half, yes. And then a few in the third quarter because we're always -- we're looking ahead for opportunities to maximize performance. So -- but it's -- there was a period during which we did not do this in a way that we should have been and this would have been sort of the beginning of last year. And basically, we changed management and really got focused on maximizing profitability. And when you do, it just takes time, but we're well ahead of the program now so we know what the future holds, we're very focused on doing it. And so we -- that gives us some confidence that we can continue to maintain what sort of translates into better performance because your -- basically that -- those consolidations and/or repositioning of centers adds to performance. And you can see it actually coming through quite strongly in this first report of this year.

[Steven John Woolf, Analyst]

One follow-on then in terms of the improved occupancy. Is it possible then to -- there's obviously a small impact there from the closures themselves. But is there a sense from the different regions as to what's driving the demand for the fill-ups during that period, rather than just the timing issue on that year-to-year?

[Mark Dixon, CEO & Director]

What we've been saying for a while, I think since the middle of last year, we've been talking about that they're very happy with sales. Now -- so it takes time to build the forward order book. So I think I mentioned actually on one of these calls that our outlook, if we looked out, we had a -- we can -- normally, we'd look out and see a shape that was sort of downwards as the order book empties. But we started to see the line of the forward order book moving up and that has continued. So as the forward order book, we saw well third quarter, fourth quarter, first quarter order book filling, you're starting to move that forward line upwards. And that's now translating into much better occupancies, and it's as simple as that. We sold more, we retained more and we have better occupancy. I know it's basic, but that's our business. But it takes work, you can't turn it, you have to keep focusing every day to make that happen.

[Steven John Woolf, Analyst]

The second part of that was really in terms of those end customers, do you sense it's coming from any particular industry? Whether it's SME-led or whether there is the larger corporates that you've mentioned before in the sort of the enterprise accounts?

[Mark Dixon, CEO & Director]

It's most definitely enterprise-led. I mean the -- I would say that, if anything, SME has faded. The world of crazily financed startups, basically, the money turned off third quarter, fourth quarter last year. Sort of -- everyone was sort of at risk on -- people were much more careful. Therefore, less of that, much more corporates. I mean that's my view. I mean I haven't got that. My view is because I saw it happening. But in our numbers, what we've been doing is a lot more corporate business, I mean to a large degree. Now why am I confident that will continue? Well, we've ramped up what we call our enterprise sales force considerably during the third quarter, fourth quarter. But the biggest rise of numbers of people in the enterprise sales force for this quarter this year. So this is a question -- you have quite a lot of interest. You have to sort of try and picture the industry, if you like. Thanks to what's going on. There's a lot of publicity. A lot of larger companies have sort of accepted this is now mainstream. That, plus IFRS 16, has made companies that would have never looked at this, [ look at this. ] What we needed was more people to get -- to just simply get in front of customers and explain how it works and how it can benefit them. That we have been doing, and we continue to add more people as we go.

[Operator]

[Operator Instructions] Your next question is from the line of Calum Battersby.

[Calum Battersby, Analyst]

Two questions for me, just kind of to follow up from the last discussion on occupancy. Wonder if you can touch on which region specifically you've seen occupancy growth. And if outside U.K. can get back towards the kind of 80% level you're at 3 or 4 years ago. If kind of the target like that could now be discussed. And then, secondly, on franchising. Hoping to understand how you think about valuation versus ability to expand by the franchisee. Is it a business deal that future deals are going to come at valuations at broadly similar levels to that achieved in Japan or is the focus, as Mark has already said, kind of more on ability and willingness to expand?

[Mark Dixon, CEO & Director]

Okay. I think -- Eric, how are we going to answer this first one about occupancy?

[Eric Hageman, CFO & Director]

Yes. On occupancy, all regions contributing. So if you look at the strong top line growth where we called out those 3 regions: Americas, which is mainly U.S. and Canada; EMEA; plus Asia Pacific. I think we can categorically say that, that is driven by all those regions.

[Mark Dixon, CEO & Director]

Yes. I think just secondly, I don't want to go too far here. On the occupancy sort of level, let me just explain about occupancies. One of these -- the chief effects actually on occupancy is growth. And so what you will find is -- I mean you're seeing here the average occupancy. What we would see is where we have cities with no growth, we would have higher occupancy than cities with more growth -- high growth, because of just simple cannibalization. Now in spite of that, because we're going to grow this year, and so we would expect certainly our internal target would be to -- 80% will be good to get to. But really, our occupancy should be higher than that. So if you were ever in a sort of 0 growth scenario, you would expect this is a business that really should operate in the sort of lower 80s, mid-80s of occupancy. So certainly, Eric would be disappointed if we weren't even with growth getting to the sort of number you mentioned.

[Eric Hageman, CFO & Director]

Absolutely. I think if you look at some of the regions where we are, we give that color typically only at full year and at a half year and for some of the big regions, the 3 that I just mentioned. You're not that far off if you look at where we are. On the U.K., there is a bit to go, but there's no reason why you wouldn't be able to get to such a percentage. If anything, Mark and I and the team spend a huge amount of time talking about this and driving this within the organization because, obviously, that's where the performance that will come from. For every 100 basis point more occupancy and certainly when you get to 80% levels is when the business really, really starts to throw off a lot of profit. That's obviously what we're working for in 2019.

[Mark Dixon, CEO & Director]

And it's a 2-sided thing, guys, as well, obviously. It's occupancy and price and services. Remember, big difference with us compared to anyone else, 29% service revenues. WeWork, as an example, 7% service revenues. And we see lots of other businesses, almost all of them have low service. So all the ancillaries then, they're just not getting them. So if you really want, you've got to have all 3 of those working to get the margin up and to remain super -- remain both competitive and get the right return on capital.In terms of franchise, look, we weigh it up. I mean it's a weighing up between the 2. Clearly, we need to get the best valuation for shareholders. Your question what are the prices going to be in the future, well we've got to make here 100 or so sales, and they're all going to be different. They all have different growth possibilities, they have different businesses and so on. But what is uniform is simply picking out the very best partner we can find. So we're running a process in every market to see who are the best people out there rather than just the first person that comes along. It's -- this is a process that will take time, but it's absolutely critical if we're serious about getting full global coverage well before anyone else.

[Operator]

And at this time, sir, there are no further questions.

[Mark Dixon, CEO & Director]

Okay. Well, if there are no more questions, I'd just like to thank you all once again for joining us this morning, and we look forward to updating you again in a few months' time. Thank you very much.

[Operator]

Thank you very much. And that does conclude our conference for today. Thank you for participating. You may all disconnect, and speakers, please stand by.