Trading Update and Strategic Review
RM plc ("RM", "Company" or "Group") issued its Interim Management Statement on 22 July 2011 which highlighted the unpredictability of the current education market. As well documented, the RM business is highly seasonal and, in recent years (2008 - 2010), on average approximately 60% of the Group's revenue was generated during the second half of the year. However, whilst the Group has experienced some seasonal increase in the current year, this has been lower than the historic trend. As a result, for the 12 months to 30 September 2011, the Board anticipates operating results below current analyst forecasts. In addition, a number of material charges, a significant proportion of which are non-cash, will also be incurred in the current financial year associated with the actions resulting from the strategic and operational review of the Group.
Over the past few months, the Board has been undertaking a strategic review of the Group's operations. In parallel, the Board, together with its advisors, has considered strategic alternatives in order to determine the most attractive option to deliver value to shareholders. The Board has concluded that the business and its shareholders would be best served by a more focussed, restructured Group as explained in more detail below.
RM is a long established leading provider of products and services to the UK Education market, achieved through the strength and commitment of the Group's employees and its unrivalled expertise in the sector. The Group also benefits from its strong, well-established customer relationships and a diverse product offering. RM has established an international presence and, while the strategic review has identified some weaknesses in this area, it is also apparent that growth in international markets remains an opportunity for some businesses in the Group.
With its dependence on the UK Education sector and a significant share in this market, RM is subject to revenue, profit and cash flow seasonality. RM is, and will continue to be, dependent on the UK macro-economic environment and particularly public sector spending on Education. After a decade of increasing Education budgets, the current climate provides a sharp contrast. Recent reductions in UK public sector expenditure and the termination of the Building Schools for the Future ("BSF") programme have, and will continue to have, an impact on the Group in the next few years. However, the strategic review has highlighted a number of actions which can be taken to mitigate some of these effects, although the Board anticipates earnings volatility as the Group adapts to the changing environment.
In order to provide shareholders with a greater understanding of the RM Group, together with the future opportunities and challenges for the businesses within RM, the Board has provided detail on the Group's operations below. In setting the future strategy for the business, the Board is applying the following key themes:
1) Focus: To concentrate on the core business of RM where the Group has in depth market knowledge, a strong reputation with customers and proven ability to deliver earnings and cash flow, together with appropriate scale. Businesses that do not meet these criteria will be considered for exit or disposal.
2) Integrate: To integrate previously acquired companies more fully, obtaining cost synergies and sharing expertise more effectively by structuring each business around compatible product/service offerings.
3) Mitigate Seasonality: To rebalance profitability/cash flow and reduce the dependency/risk of the Group's financial performance on a few months of the year. Eliminating the market seasonality is not feasible but actions can be taken to moderate this effect.
4) De-risk International Strategy: The level of investment in international infrastructure exposes the Group to more risk than a strategy based around distribution through resellers. Consequently, the Group's international strategy will in future primarily be based on a distribution model, with direct sales activities where appropriate.
Organisation Structure and Divisional Strategy
The RM Group is currently structured in three operating divisions, namely Learning Technologies (72% of Group revenue in the year ended 30 September 2010 ("FY10")), Education Resources (22% of Group revenue in FY10) and Assessment & Data (6% of Group revenue in FY10). This structure has resulted in a disproportionate dependence on the Learning Technologies division and does not reflect the different business activities or operating models within the divisions. In order to address these issues, the core businesses of the Group will now be structured into four operating divisions and each division will comprise businesses operating similar business models. A table summarising the business activities within the old divisions and the new divisions, together with approximate divisional revenue contributions, is attached.
· Education Technology
The new Education Technology division will be a UK-focused business supplying IT infrastructure and third-party classroom equipment. In the period October 2010 to August 2011 ("FY11-YTD") the division accounted for approximately 40% of Group revenue, although this is anticipated to decline in FY12 as budget reductions impact negatively on IT expenditure in schools.
Revenue derived from hardware (RM-branded and third-party computing products, together with maintenance & warranty and other third-party classroom equipment) currently accounts for approximately 62% of the division's revenue. While the RM-branded computer product operations continue to provide a positive profit contribution due to the higher gross margin achieved compared to third-party products, the business model associated with RM-branded computer assembly has a high element of fixed costs and will be monitored closely should volumes decline. In the current market, both revenue and gross margins for hardware products are anticipated to come under pressure in the year ahead.
Network Solutions contributed approximately 26% of the division's revenue in FY11-YTD. Revenue is anticipated to decline in FY12 and, while reported gross margins in this business in FY12 should benefit from BSF projects coming on stream, underlying gross margins may experience some pressure. The Internet Hosting Group, where RM has a strong position as a service provider, is anticipated to be broadly flat in the year ahead but with pressure on margins consistent with market trends for internet services. The remaining revenue (approximately 12%) of the Education Technology division is derived from associated support services.
Regarding the Education Technology international strategy, the Board has decided to dispose of the loss-making former Computrac business in the USA, which accounted for approximately 6% of Group revenue in FY10 but has significantly declined in the current year. Heads of Terms have been signed with a potential purchaser.
· Managed Services
The Managed Services division will comprise implementation, management and support of IT infrastructure within schools and colleges, including the BSF contracts. The Managed Services division currently accounts for approximately 18% of Group revenue in FY11-YTD. This division provides a higher margin, service-based revenue stream which, excluding BSF, should be less sensitive to market variability and seasonality than product-based businesses.
The division has 32 contracts, including BSF and PFI contracts, which consist of multi-year support arrangements with resources geographically aligned to the schools, often with permanent on-site staff. The BSF contracts provide milestone receipts for the implementation of capital equipment followed by typically 5 years of managed service fees with existing school staff transferring to RM on commencement of the service under TUPE. The PFI contracts also consist of capital investment in equipment and software typically combined with a 5 year managed service. The division also services a number of smaller contracts which vary in duration from single year extensions to contracts of 5 years or more.
BSF currently accounts for approximately 67% of the division's revenue and is therefore a material influence on near term performance. Due to the contract roll-out timetable, it is anticipated that BSF revenue will peak in FY12 but will decline significantly thereafter with only modest revenue from BSF implementations from FY15. In cash terms however, a cash inflow is anticipated in FY13 and FY14 as the working capital absorbed by the BSF implementations unwinds, although this is partially offset by contractual obligations for provision of technology refresh programmes.
There is no intention to expand the Managed Services business internationally due to the high cost of establishing the local infrastructure to support such services. However, within the UK, RM is well positioned to benefit from structural changes in the UK Education market due to the cost savings it can provide to schools which outsource their IT infrastructure support.
· Education Resources
Currently the Education Resources division comprises a diverse set of business activities and the Board has determined that the division would benefit from rationalisation and increased focus. As a result, the division will in future comprise TTS and SpaceKraft, which in total account for approximately 19% of Group FY11-YTD revenue. Both TTS and SpaceKraft operate profitably and have delivered good performances in the current year despite the difficult market conditions. Although both companies experience market seasonality, the management teams have already structured their businesses to deliver profitable contribution on a monthly basis for the majority of the year.
TTS is a value-added distribution business offering a wide range of curriculum products and materials to schools for both general and departmental use. TTS is the only retained Group business which will continue to lead with its own brand in the UK, although the RM brand will become more evident in all TTS marketing materials. A significant proportion of TTS revenue is derived from products created or assembled by TTS and the business currently offers approximately 13,000 different products. Undoubtedly TTS has been one of the successes of the RM Group with an extensive product range (often sourced from Asia) and admirably high customer service levels. However, these factors combined with a sub-optimal product end-of-life strategy and a focus on product margin rather than cash flow, have resulted in a higher than optimal inventory level with excessive stock holding positions in some products. The TTS management team are already addressing a rebalancing of the inventory holding level and the number of product offerings in the business in order to improve the return on capital, although an increased provision against slow-moving inventory is anticipated in the current year.
SpaceKraft is a modest business, providing products and installation services for the Special Educational Needs market, a sector that a major supplier to the Education market, like RM, should serve. SpaceKraft has historically operated under its own brand but in future will be branded RM SpaceKraft. The new management team appointed in 2010 has made good progress in improving the financial performance of the business, although, as a small operation with a diverse product range, inventory management is challenging and the Board is therefore exploring opportunities to improve working capital performance. Both TTS and SpaceKraft have established some international distribution networks and this strategy will continue. However, in international markets, both businesses will lead with the RM brand.
· Education Software
The Group's software solutions have historically been managed in different divisions across the Group, with uncoordinated product strategies. The new Education Software division will comprise Assessment, Data Solutions, School Management Systems ("SMS"), Learning Platforms, Easiteach and other software (excluding network-related software which will remain part of the Network Solutions group in the Education Technology division). In aggregate, the division would currently account for approximately 14% of Group revenue.
The largest contributor of revenue to the new division will be the Assessment business which provides e-marking and e-testing solutions and services to examining boards where RM has established a strong position in the UK. However with future growth in the UK likely to be limited, RM has been pursuing international opportunities and has recently achieved its first success, although it is anticipated that international opportunities will evolve more as a software rather than service-oriented activity. The Assessment business has declined slightly year-on-year.
Data Solutions provides database-oriented consultancy solutions and services to public sector organisations primarily but not exclusively in the Education sector. Data Solutions has experienced a difficult year compared to FY10 when the business benefited from some large data migration projects. The business is also very dependent on one public sector customer and the renewal of this contract in 2012 is critical to the future of this activity.
The other major products within the division and the future strategies for these products are:
o School Management Systems: Whilst RM is the second largest provider of School Management Systems in the UK, its market share is modest. In recent years RM has migrated the SMS software to a software-as-a-service ("SaaS") model. This SaaS approach offers schools a cost-effective operating model with the ability for new customers to be operational in a very short period of time. While currently a mature market sector, structural changes in the UK Education market may provide an opportunity for growth.
o Learning Platforms: These products provide an on-line teaching and learning environment for a school or educational authority. With tightening of education budgets the revenue per user is anticipated to come under significant pressure and a major existing customer (Glow) has indicated that it will not reprocure the existing service after the end of the current contract in September 2012.
o RM Easiteach: The Easiteach products are typically bundled with interactive whiteboards or similar devices such as projectors. Since the UK education sector has a high penetration of interactive whiteboards in schools, the primary market opportunity for Easiteach is for distribution on a licensed model through other third-party suppliers of interactive hardware in the international market. The timing and revenue recognition of such licence contracts has historically exacerbated the seasonality of the Group's profitability. Therefore the Board is exploring alternative future contract structures and is also reviewing the collectability of revenues from some licensees.
Distribution for the Education Software division's offerings will be through direct and indirect sales channels and also via the Group's other divisional sales operations. The Education market for software is anticipated to be challenging in the year ahead.
Disposals and Goodwill
As noted above, the Board has decided to dispose of the former Computrac business in the USA and progress is being made. In addition, the Board has reviewed the Group's other international sales subsidiary in Australia, which currently supports some of the Group's products in this market, together with Maze (Caz Software), a local software product. The Australian operations have been only a modest contributor to Group results and therefore due to the geographical distance and the strategy focus objective, the Board has decided to dispose of this subsidiary including Maze software and has signed Heads of Terms with a potential purchaser. In FY10, the Australian business accounted for approximately 1.5% of Group revenue.
The Board has also reviewed the Group's smaller UK operations:
· ISIS: The acquisition of ISIS, which provides classroom furniture, in 2009 was undertaken to support the Group's BSF tendering programme. With the termination of BSF and, since a significant proportion of ISIS revenue is derived from third parties, there is little strategic justification for retaining this highly seasonal business as part of the Group. The Board has therefore initiated a sale process although RM intends to continue distribution of ISIS products in the UK.
· Easytrace: The 'access control and cashless catering systems' part of the AMI business which was a component of the Group's BSF offering is now unlikely to achieve the necessary scale to be a self-funding product line. The Board has therefore decided to seek to dispose of this business.
· DACTA: Following the establishment of the Lego Education Europe joint venture, DACTA has been marketing and distributing a number of other third-party branded products through dealer/retail channels. With modest revenues and minimal RM operating relationship, the Board has decided to exit or dispose of DACTA.
· Minority Shareholdings: The Group has a number of minority shareholdings, which do not operate under the RM brand. The Board will continue to consider opportunities to realise these investments in order to focus on RM-branded activities and will minimise further investment in these ventures.
The above UK businesses, none of which operate under the RM brand, together with the US former Computrac business and the Australia operations, account for approximately 9% of Group revenue in the current year. As a result of the strategic review, including the decisions to exit and/or dispose of the above business operations, the Board will be reviewing the holding value of goodwill, intangible assets and investments and anticipates incurring a significant non-cash impairment charge in the current year.
The Group's operation in Trivandrum, India, RM Education Solutions India ("RMESI"), was established in 2003 and now has approximately 500 employees at a total operational cost of approximately £5 million per annum. RMESI provides services solely to RM Group companies with approximately 80% of staff devoted to software development, customer and operational support with the remainder providing back office shared service support (e.g. customer order entry, IT, finance and HR). The Group intends to optimise resource allocation between the UK and RMESI although it is anticipated that around three-quarters of RM Group employees will continue to be located in the UK in the future.
Proposed Redundancy Programme
Some of the businesses proposed to be sold or exited are loss-making and such actions will have a positive effect on the Group's medium term profitability. However, regrettably, in order to establish RM on a sound platform for the future, the Board has concluded that it also needs to engage in a consultation process with employees regarding proposed redundancies. The proposal is to reduce permanent headcount in the continuing operations by approximately 13% from the July 2011 level. Including the businesses to be exited, and the actions taken in March 2011, the proposal would reduce Group permanent headcount by approximately 23% from the September 2010 level.
While the creation of four operating divisions provides greater strategic focus, the restructuring actions include a number of office closures and departmental consolidations in order to improve efficiency and maximise the benefits of scale. This significant restructuring means that redundancies are proposed at all levels of the organisation, although the Board is seeking to minimise the effects on front-line staff in order to maintain the high levels of service to the Group's customers.
In light of the proposed redundancy programme, the Executive Directors have agreed to waive any bonus entitlements in the current financial year. Subject to review by the Remuneration Committee, modest bonuses to other employees may be paid in accordance with the rules of the current bonus schemes. In addition, the Chairman has elected to waive all remuneration for the current financial year from the date of his appointment in June.
Defined Benefit Pension
The RM Defined Benefit Pension Scheme ("DB Scheme") was closed to new entrants in 2003 and a number of actions have been taken in the interim period to mitigate the Group's exposure to the liabilities, including increasing member contributions and introducing a pensionable salary cap.
While defined benefit pension schemes are inherently complex, the relative immaturity of the DB Scheme, in terms of the age of the participants, makes the DB Scheme less predictable than typical schemes. Following a review with its pension advisors, and in order to mitigate the growth in future liabilities and to manage the risk associated with the scheme, the Board has entered into discussions with the DB Scheme Trustees regarding the potential closure of the DB Scheme to future accrual.
A separate announcement has been made today regarding the phased restructuring of the Board following completion of the strategic review. The constructive contribution of all Board directors through this period of transition has been appreciated.
Summary & Outlook
RM has recently undertaken primary market research into the outlook for the UK Education market, specifically the expenditure expectations of head teachers in primary and secondary schools in the coming year. In both primary and secondary categories approximately 70% of schools are anticipating reductions in capital expenditure, although with regard to revenue expenditure primary schools are less pessimistic with 20-25% anticipating reductions compared to approximately 50% of secondary schools. In terms of IT spend approximately 40% of both primary and secondary schools are expecting a reduction in the year ahead.
While this challenging market will inevitably have a negative impact on the Group's businesses, RM is adapting to the changing environment and taking the necessary actions to mitigate the market effects. With FY12 being the peak of BSF deployments, the full impact of the market environment will not be felt until FY13 and FY14.
The Group-wide restructuring of the continuing operations is anticipated, subject to the outcome of the consultation with employees, to cost around £5 million in the current financial year with annualised remuneration-based cost savings in excess of £12 million. Together with the businesses to be exited, which in aggregate accounted for approximately 9% of Group revenue in FY11-YTD, the anticipated annualised cost reductions are in excess of £20 million. Furthermore, through the strategic review process, the Board is increasing the level of integration of the retained operations, prioritising the RM brand and increasing the use of shared service centres (including RM's India operation) to realise the benefits of scale. As a result, in order to establish a foundation for the future, shareholders should anticipate one-off charges in the current financial year related to:
· The proposed redundancy programme, subject to the outcome of the consultation with employees;
· The proposed closure/consolidation of a number of office locations, including provision for ongoing lease obligations and dilapidations, associated with the reduced space requirements;
· A review of the provisions related to overdue debtors, work-in-progress and slow-moving inventory as a result of the strategic changes and market factors noted above; and
· Impairment of goodwill, intangible assets and investments.
These charges, which are subject to further review and audit, are currently anticipated to total in the order of £35 million, with a significant proportion related to the goodwill impairment (which will have no impact on cash) and property provisions.
The Board also recognises that there are opportunities to improve cash flow and working capital management and this is an area which will receive greater focus in the future. Furthermore, the working capital invested in BSF should unwind in FY13 and FY14, although some BSF contracts do require technology refresh, with short-term funding provided by RM. To ensure adequate banking facilities, the company has renewed the on demand sterling dealing line of £25m with HSBC, which is next scheduled for review on 30 September 2012 and therefore does not anticipate the need for additional funding from shareholders. Nevertheless, in the current climate, it would be imprudent for the Board not to review the dividend policy and shareholders should anticipate a material reduction in the dividend for the current year. The Board will keep the dividend policy under review if/when the market environment stabilises.
In summary, as a major supplier to the UK Education sector, RM is directly affected by the adverse public sector market environment and the Board anticipates a challenging period ahead for shareholders and employees. Actions are being taken to mitigate the effects of these external factors and to structure the Group accordingly. However, the Group's established customer relationships and strong market position provide a platform for realising the Group's potential for all RM stakeholders.
Appendix : Translation between Old and New Divisions
Martyn Ratcliffe, Chairman 08450 700300
Terry Sweeney, Chief Executive Officer
Iain McIntosh, Chief Financial Officer
FTI Consulting 020-7831-3113