Transcription. Title: Interserve Analyst and Investor Update. Date: Speakers: Debbie White and Mark Whiteling

Transcription

1 Transcription Title: Interserve Analyst and Investor Update Date: Speakers: and Conference Ref. No: EV Duration: 33:35

2 Presentation Hello and welcome to the Interserve Analyst and Investor Update call. Throughout the call, all participants will be in listen-only mode, and afterwards there will be a question and answer session. Just to remind you, this conference call is being recorded. Today, I am pleased to present, Chief Executive, Interserve. Please go ahead with your meeting. Thank you, Sarah, and good morning everybody. This is. Thank you for joining the call. I am joined today by Mark Whiteling, our CFO. The reason for the announcement today was that we wanted to update the market following the statement that we made on 14 th September. Since that day, as you would expect, we ve conducted a more thorough forecast exercise, and the statement released this morning reflects the result of that exercise. I hope that you ve had a chance to read the statement. I plan to talk through the key points, adding a little more detail, and then Mark and I will be more than happy to take your questions. The things I want to cover today are: our latest view on trading for fiscal 17; an update on our Energy from Waste business; an update on the covenant position; and finally, an update on our plans to improve the Interserve business, both strategically and operationally. So, the latest view on trading for fiscal 17. As I have said, since Mark joined we ve been completing a review of both trading performance and expectations for fiscal 17 for all parts of the business. The upshot of this review is that we have not seen an improvement in performance that the Board anticipated at the time of the half-year results. And in fact, for UK support services and UK construction, we have seen performance deteriorate. This is disappointing. It reflects a number of factors, including those listed in the statement. And in summary, I would say we have not responded speedily enough to contract cost pressures and performance and, despite that, we have not controlled the associated overhead cost base. This trading statement also reflects a more realistic assessment of some of the key judgements taken in the past relating to the UK construction business. So overall, we now expect current-year half-two operating profit to be half of the 60 million that we reported last year, which did include a number of significant one-off items that have not recurred. Moving on to Energy from Waste. As I m sure you will realise, this is a complex area, and without wishing to make all of us experts, I am committed to being as transparent as possible with respect to the contracts that we have in our exited Energy from Waste business. It s for this reason that we have included a short summary table setting out exactly the nature of the contracts that we have within that business unit. Now, Energy from Waste continues to be an area with both significant assumptions around the timing of completing and commissioning of projects, as well as assumptions around contractual claims and insurance proceeds. As indicated in our announcement, we have seen a shift in the anticipated timing of a couple of the projects, and this has caused us to reassess our position re the cost to complete our part of these projects, as well as potential claims from our customers. The net impact of this is that we will now need to increase our provision in fiscal 17 by 35 million. This will also increase our overall cash cost by the same amount in the future. The update on the covenant position is: in September, we said at that time that we still anticipated that we would be able to operate within our financial covenants. Having now completed the financial review process and updated both our earnings and cash forecasts, we now think there is a realistic prospect that we will not meet the net debt to EBITDA test contained in our financial covenants on 31 st December We have engaged PwC as financial advisors, and we are now working with them as we engage with our lenders. The initial discussions have been constructive, and we will be seeking some relief with respect to the covenant position at 31 st December So, what are we doing to improve the Interserve business? Since arriving, I ve spent a lot of time with all of the different business units and strongly believe, following the time spent with them, that we have some great capability, some very good clients and contracts and a very strong base for future profitable growth. Our performance improvement plan now has three parts: immediate cost reduction, setting a decent run-rate for 2018 and developing a medium-term plan for the sectors we wish to be in, in the future. In summary, the plan is focused on where we will play to win, and focused in the short term on what is within our direct control. We will of course look to provide greater clarity over the coming months on the plan and in the New Year, as we finish the work we need to do. I m very happy now to open the call up for questions. Sarah, I ll pass it back to you. 2

3 Q&A Thank you. Ladies and gentlemen, if you do wish to ask a question please press 01 on your telephone keypad. If you wish to withdraw your question, you may do so by pressing 02 to cancel. There will be a brief pause whilst questions are being registered. Our first question comes from the line of Sam Bland from JP Morgan. Please go ahead, your line is open. Sam Bland Hi there. Morning. Actually, three questions if I may, please. On the first one, could I just get a sense of the updated guidance for the full year 17: in terms of the change there, how much of that s related to construction versus related to services? And wrapped in with that: if it s construction, will those problems roll off naturally as those contracts come to a conclusion, versus services, it s a bit more difficult to work through and solve the problems? Can I get a sense of what you re thinking for 2018 profitability? As a base, should we be looking at your updated guidance for the second half of 17 and multiplying it by two, and that s basically the starting point, go from there? And then the third question, obviously I think it s pretty clear that the balance sheet is not where it needs to be: have you got any sense at this point in time how you are looking at that and what you think might be the best way of solving that problem with disposals versus raising money? Thank you. Okay, Sam. Thanks for the questions. In the first order, in terms of the downgrade and in terms of what we ve seen, I think construction UK, the H1 year-on-year degradation, which was sort of, what, 4.5 down to two, I think we will see a similar level of degradation versus H2 last year. And then the balance of it really is in the support services sector. So, that s obviously been the more significant portion, and obviously Debbie s talked to why it is that we think that we ve seen that level of degradation at this point in time. I think on 2018, at the moment I don t think you can just take the second half number and double it crudely. There is an element, clearly, of us addressing issues, as Debbie said, which haven t been addressed we think in the past, or we ve taken a slightly different view in terms of judgement. And so, I think it would be misleading. And obviously, our view on 2018 which we haven t quantified yet, we ll see the benefit of the cost actions that we referenced which we haven t yet finished and quantified. And we ll also start to see the benefits of some of the other actions that we are working on as we look to improve the operational performance of the business. And I guess the last thing in terms of the question around disposals and improvement on the balance sheet: yes, we are looking at actions to improve short-term cash generation, such as small disposals of some of the investments and stuff. But fundamentally, we are engaging with all of our lenders, both the banks as well as the PPNs[?], as well as our other creditors in terms of who help us with our credit exposure. We re engaging with all of them, and then as we develop the plan for the business going forward, we ll obviously work that into what we think we need in terms of capital structure. Sam Bland Understood. Okay, thank you. You re welcome. Thank you. Our next question comes from the line of Stephen Rawlinson from Applied Value. Please go ahead, your line is open. 3

4 Stephen Rawlinson Good morning. Could you just please focus on three issues, if you don t mind? Firstly, with regard to the statement that you ve initiated a comprehensive contract review. So, do we take it from that, that actually what s happened since you joined, Debbie, on 1 st September is that you ve only conducted a partial review and come up with this conclusion? So, can you just help us out here with how much has yet to be done to understand what s going on with these contracts? And secondly, could you talk a little bit about the Fit for Growth and what your first thoughts are with regard to the pace of that, how much improvement you might be able to make and what it will cost to get that improvement? And thirdly, the support services FM business at Interserve is quite different from what you ve experienced at Sodexo, if as an outsider I can say that. What are your first thoughts in and around some of the vital issues with regard to the IT and FM and other elements of the ability of this business to compete in the future? So, if could you just sort of cover those three things please, if you don t mind. Firstly, how deep is the contract review to date and what s to be done; what the costs are to get it right and what you expect to achieve; and thirdly, the state of the current business in competitive terms compared to what you ve experienced at Sodexo. Thank you, Stephen. I m not sure how long you ve got, but I ll do my best to try and answer those three questions. Stephen Rawlinson Well, given the situation, I think it deserves some attention. Absolutely. In terms of the comprehensive contract review: of course, what we have captured in the update today is all of those contracts which are loss-making or poor-performing. I think in terms of the more comprehensive nature of it, what we want to do is ensure that we have complete transparency and visibility, as a leadership team, on all of those contracts which contain some issues. And they may not be just financial issues; they may be broader than that. So, that s really the reason for the comprehensive contract review; we want to make sure that as we enter 2018, the base is as strong as it possibly can be. So, whether it requires renegotiation; whether it requires exit; or indeed, whether it requires more fine-tuning of our performance. So, that will be an ongoing process. And in fact, this is a B2B contracting business, in every aspect across all of our different business units. So, it is something that should be regular management practice. As it relates to the Fit for Growth pace, it has started, in terms of cost reduction. Of course, we have gone and are going after low-hanging fruit, and that relates to all discretionary spend, it relates to parts of the business which are not core for the foreseeable future, including the potential disposal of small business units which are within the different business portfolios. Stephen Rawlinson So, what are you targeting in terms of cost reduction? How much will it cost to get there? Have you got any idea of that at this stage, please? No. So, obviously, we ve got some immediate quick wins which we can identify, but obviously part of the review process that we are going through is a restructuring and operational review as well. So, we are not just doing a financial review; we are doing the operational review. And as we finalise the plans on that, obviously we d look to conclude on what we think the opportunity is, as well as obviously the cost of achieving that opportunity. And so, we will update you at that point in time. I think it s very clear to say, Stephen, that the overhead cost base here is not where it should be from a market competitiveness perspective, and so that is of course our immediate area of attack, ensuring that the overhead cost base is fit for purpose for the medium term. So, that s where our initial work is focused. As it relates to your third question about Interserve versus its competitors, and of course the one I know best is Sodexo, but I m pretty au fait with all of the UK competitors: my perspective hasn t changed, actually, the perspective I had when I agreed to take 4

5 on the role, which is: Interserve has a very broad capability, and in fact broader probably than a lot of the competitors. That capability is well established, and performs reasonably well across all of the different sectors, most importantly in the public sector. I think what we need to do going forward is be a lot more focused with how we deploy that capability, and how we really get a return on investment from what the business has done. Stephen Rawlinson Thank you. Thank you. Our next question comes from the line of Andrew Nussey from Peel Hunt. Please go ahead, your line is open. Andrew Nussey Yeah, good morning, Debbie, morning, Mark. A couple of questions as well, if I may. Just turning onto the construction business, and the reference to market conditions, I wonder if you could just expand on that? Because I took it slightly different to what one or two others are saying. And also, the realistic judgements and some contracts within construction: have those been taken above the line, or should we be expecting some exceptional charges through the course of the rest of this year? And thirdly, if I may, just in terms of the 35 million increase in Energy from Waste: could you just give a feel of how much of that is increased costs or lowered assumptions in terms of recoveries moving forward? Thank you. Okay. Thanks for that, Andrew. I ll do them in reverse order, if that s okay, because the EFW one is relatively straightforward. There have not been any changes at the moment in the assumptions on the recoveries, although clearly, we are continuing to work the claims and actually are getting more secure in terms of the expectations of what will come from those claims. So, the actual claims themselves are continuing to develop, and so therefore we haven t changed any of the assumptions in that regard. It is around cost and the timing and the consequential impact of the delay which have caused the increase. On the construction above the line/below the line, and also the comment about market conditions, which was the first question: I think what we have seen is a combination of things, and I think that some of the contracts and the current-year contracts we have taken effectively into the numbers that we are reporting, and that is part of the reason why the deterioration has come through. So, we have tried to look at what is current year versus prior year, is the sort of split that we have tried to identify. And I think it s possible, coming out of the further contract review that Debbie has already referenced, that it is possible that there will be other costs, or other changes which we may well need to recognise, and I think we will form a judgement at that point in time of whether it s a current-year item or whether actually it s something which relates to a prior year, at which point in time we might and given that it s a one-off exercise, it is possible that there will be exceptionals in that regard, I guess. On market conditions, and obviously I don t know, Debbie, do you want to answer market conditions? I think it s clear that the businesses in this sector all have slightly different approaches. I think Interserve Construction has been a regionally based business, and that s been a core part of our capability within construction. I think the market conditions vary enormously by region in terms of availability of contracts, and to some degree profitability of contracts, and it is that in particular that we are looking at, at the moment, is around the regional dispersion of our business and, again, how we deploy our capability to the best possible effect. Andrew Nussey Okay, thank you. Thank you. Our next question comes from the line of Howard Seymour from Numis. Please go ahead, your line is open. 5

6 Howard Seymour Thank you very much. Good morning. I ve got two questions if I may, please; one specific, one more general. The specific really is on justice; I was wondering if you could flesh out any of the bones on that one, where you allude to contract performance in justice? And then second, Debbie, you allude to the Fit for Growth programme, improving industry performance through industry norms. Apologies, but I m going to ask the question: what do you perceive as industry norms? Because clearly, if we look back at the support services business and that s where I m focused, that question the business historically would do a margin of circa 5%. Do you think that is a sensible margin in the medium term for the business, or has the company historically over-traded at that margin? Thank you. Thank you, Howard. So, I ll take them in the order that you asked, just to buck the trend that Mark s set. Justice, it is well known, it s very well publicised that the transforming rehabilitation contracts the CRCs, as they are commonly referred to across the whole sector have had challenges, in fact since inception. There is an awful lot of press comment out there, I think as everybody on the call probably realises, so challenges with these contracts are not exclusive to Interserve; it is a sector problem. I think the contracts themselves are incredibly complicated, and assumptions regarding what can and cannot be taken as it relates to contract performance, and the conservativeness of those assumptions and so on and so forth, have led to all sorts of and I m not talking about Interserve now, I m talking generally within the sector all sorts of reported performance or profitability performance on these contracts. I think it s fair to say that within the Interserve Justice business, the interpretation of those contract clauses, particularly as it relates to performance by results, is an ongoing judgement area and, again, as interpretation starts and this is a new part of the contract again across the sector, for all participants as they engage with government on what are the implications of performance by results from a contract performance and profitability perspective, that s an ongoing exercise and that s really what we re referencing in this part of the statement. I have visited one of our CRCs in the last few weeks. What I can say is that we do some amazing things in this space, and it is really part of the values of Interserve that we seek to improve offenders lives and the communities in which they work. So, it is something that I feel very strongly about, and I think is a really important part of our business going forward. As it relates to industry norms, I would agree with you Howard, 5% is what you d expect to see in support services. The competitive space varies depending on to what degree they ve got one-offs or not in their you know, from three to possibly towards six. I d expect us to be within the norm. Now, it will take us a little bit of time to get back to the norm, but in terms of a stretch goal, I d like to see Interserve performing at the top end of the range in due course. Howard Seymour Excellent, thank you very much. Could I just ask one additional one as well? That s very clear on both of those, thank you very much. It s probably more to Mark, to tell the truth. Prior to the statement, there was quite a lot of discussion about the capability to drive the working cap towards the end of the year. Now, clearly the profitability has changed, but would you perceive that there s been a fundamental shift in the capability to try to improve that working cap inflow in the second half? So, I think it s not so much a question of capability in that regard. Obviously, historically we have talked about a year-end debt position or a mid-year debt position and an average debt position, and clearly, if you look at the performance of our management over that period of time, you can see that we have effectively pushed incredibly hard as we ve approached a period end around working capital in order to, in essence, make sure that we can continue to operate within the covenants. I think there is clearly a cumulative effect of the Energy for Waste cash outflow which, actually, clearly makes that more challenging. And the other comment I would make in the current environment is clearly, we are, as we said in the statement, actively engaged with the banks, and that is creating within our supplier base, obviously, some degree of nervousness. And so, I think as we look over the next three months, we are basically taking a view that it will be more difficult for us because we need to be much more sensitive with respect to that creditor base. Howard Seymour Yeah, that s great. Lovely, thank you very much. 6

7 Okay, thank you. Thank you. Once again, if you do have a question please press 01 on your telephone keypad now, or press 02 to cancel. And our next question comes from the line of from Cenkos. Please go ahead, your line is open. Yeah, thanks very much. I ve just got one question, but I m sure it falls into a number of parts, and I apologise in advance for that. But I just want to focus clearly on what at the end of the day, it s the short-term issues which are probably the most challenging for you around the balance sheet and the covenant. Can I ask: in terms of the negotiations you ve got with the lenders, are you focused on trying to achieve some sort of holiday or whatever, or are you actually seeking to semi-permanently increase the debt lines? The reason I ask that is because I just want an idea of how structural you think the increase in debt has become, or whether you fundamentally think it s a far bigger issue; that the lack of EBIT is actually more important than the level of the debt. I just, again, really just want to get a sense of what you feel the priorities are in that degree. And also, with regard the covenant issue, is there a well, no, it s not a question: there has to be a danger that some of the decisions, effectively, are taken out of your hands, and are driven more by the bankers. And to that extent, are there businesses within the structure of the Group which you just simply regard as sacrosanct? If, for example, the banks turned around and said, Well, 12 months ago you put equipment services on the block and that would pull in a very healthy sum of money to make a big difference to the debt, we therefore insist you do that again, is that something you re prepared to tolerate? Kevin, I ll start the answer, and Mark will complete it, so thank you for that. In terms of the latter part of your question around lack of EBIT and then businesses within the structure of the Group that are sacrosanct, I ll answer those two questions. I think the lack of EBIT is a key issue for the Group. I don t think we have delivered the returns that these different business units are capable of and, again, as we have said, our short-term focus is to ensure that these businesses do deliver the returns that they are clearly capable of delivering. So, that is a priority, alongside the issue around the debt structure of the organisation. In terms of what s sacrosanct and what s not sacrosanct, I m quite used to working within a business which has very different business lines, and it s clear that if a business line is a good profit and cash generator, it s a key asset. And my preference is to keep Interserve whole, because I think our equipment services business is a phenomenal business actually, both in terms of what it does but also in terms of its financial performance, and I see it as a key strategic part of the Group going forward. Okay, that s very clear. I guess the other point, just to add to that, Kevin, is obviously, the reason we ve engaged PwC and the reason we ve got support on the strategic and operational front as well is to make sure that we can come up with the plan for what this business is capable of. Inevitably, as part of that exercise, there will be options that we will need to choose about what we do and how we move forward. And obviously, getting to a credible plan in terms of the actions and the options that we have is, in the first instance, the most important thing. And then obviously our lenders, be it the private placement note holders or the banks or our surety bond providers, they are all interested in making sure that they, effectively, have a business which is supportable going forward. On the structural issue, in terms of structural debt: the reality, which I sort of referenced in an earlier question, was that fundamentally, so far to date, cumulatively, cash out the door on EFW, we ve put over 200 million out the door on EFW. And the reality is, although in the future we will get some money back from insurance, the net outflow we now see in total since 2015 is in the order of magnitude of it will be million. And the reality is we are not going to get that back, and so that is a structural change in the level of our debt, and fundamentally that is what s driving the position that we re now in, in terms of our covenants. 7

8 And to the question around, how have we managed through now: the answer is, we ve managed our working capital to get through the testing points, but managing working capital doesn t make it go away; fundamentally, we ve still put out that amount of cash. Sure. Okay, so back to the original observation, then, is the priority to increase the total level of facility commitment you have, or is it, in your eyes, more a case of having some sort of temporary appeasement which gives you time for the plan to work in terms of getting the EBIT higher? No, so I think it s we re looking at all options, obviously, but clearly we aren t the only party in this discussion, are we? No. So, we re obviously engaging with them, and they clearly have a view, and they will have a view, on what they think. So, to your question. Where is that balance of the discussion: we are in the early stages in terms of negotiations. They have been very supportive at the moment, so far, to say, Yes, we want to give you the time to get to that position where we ve got a plan and you ve got a plan, and then I think that s when you enter negotiations around which option is preferable from their standpoint versus which option might be preferable from ours, and that s the negotiation we ll need to have. And obviously, the shareholders are a key part of that discussion as well, and so it s making sure that we have those conversations with all of the stakeholders in the business, and then come up with a solution that is optimal. And we recognise that it may involve some compromises. Yeah, okay, understood. Thank you very much. Thank you. Thank you. And once again, ladies and gentlemen, if you do have any questions please press 01 on your telephone keypad now, or press 02 to cancel. And our next question comes from the line of Thomas Musson from Liberum. Please go ahead, your line is open. Thomas Musson Hi there, good morning. Just a follow-up on that one quickly. As the business is today, do you therefore guide specifically to an average debt number for the year end this year, and spot as well? And a second question, if I may, on the retention of your contracts: do you give numbers to those, on what the retention level is? So, on the issue of average and net, we deliberately, this time, haven t given a target number, because obviously we are very sensitive to that in the conversations we re having with the banks, as well as responses from creditors and where we re going to end up. So, we are actively managing cash, as you would expect, just as intensely if we were pushing working capital. We re doing it, obviously, on a daily basis, receipts and payments and looking forward for the next three and six months to get us all the way through the end of March about what the shape of the cash profile looks like over the time. On the contract renewals: I ve not yet got to that number, Debbie, so I m going to look at you and say, Have you got to that number, yet? 8

9 No, I think the only thing I d say on business development and contract renewals: our retention, particularly in UK support services, is at one of the highest points in recent years; we have had quite a lot of contracts renewed with our clients and, as you can see from the statement, we have had a number of significant big wins in the course of the last quarter. Of course, all of that creates additional activity and cost as we mobilise, successfully, some very significant contracts. So, I think from a business development and platform-for-growth perspective, I think we re in a good position. Thomas Musson Great, thanks very much. Thank you. Thank you. And as there are no further questions, I will return the conference back to you, speakers. Thank you very much, Sarah, and thank you all for taking the time with us this morning, it s much appreciated. If you do have any other questions you ve not had an opportunity to ask, please do feel free to contact Mark or myself directly. And we do look forward to meeting you in person at some point in the near future. Thank you very much. Thank you. This now concludes our conference call. Thank you all for attending, you may now disconnect your lines. 9