22/11/22 Presentation to AGM 22 November 2022

Not much new from KME in their AGM update, a general update that revenue growth is "performing well" but noted with US expansion 1H/2H skew will be larger moving forward.

The update on the US/Tutorfly expansion was the most interesting, management saying that FY23 to date has already contracted as much work FY22 with 8 months remaining and now a preferred supplier in Alabama and Texas. I was initially sceptical on the US expansion which also used a different business model than KME traditionally uses (outsourced tutors). However the ability to sell into government contracts has greatly de-risked the expansion and it seems it could be material to FY23 numbers.

Increased government contracted work was a theme for the more established geographies as well with management calling out their ability to tutor at scale as a main reason why. While it may be a sugar hit for KME, I suspect governments funding to close the Covid caused learning gap will stay around for a few years.

23/8/22 Annual Report to Shareholders

At a headline level a nice result from KME, revenue and EBITDA exceeded recent guidance. Commentary was positive on the outlook for the business as the lingering effects of Covid slowly dissipate. Management also highlighted the support being provided globally from Governments where they are capturing additional revenue.

Beyond the headline numbers there was an area of concern which was the cashflow. KME has historically been a business that converts cash exceptionally well but this result bucked that trend with a large receivables balance (~$3m) at the reporting date. This is a question for management given the business model shouldn't run large receivables, my best guess is a timing issue around a large franchisee but need to find out more.

Looking to FY23, I will have to adjust my numbers with the cost base run-rating at higher levels than I expected. This is nothing untoward, I mentioned in my last update it would be hard to nail the cost base given spending for growth was highly discretionary on how hard KME wanted to chase the opportunities in corporate centres and the US.

22/2/22 (RIP Richie) Half Yearly Report and Accounts

Ever since buying KME on SM and RL, this meme sums up my experience:

This result only further entrenches my view, I think factoring in Covid impacts this was a brilliant result and lays the platform for stronger profits than I previously modelled in FY23 and beyond.

Headline numbers: 33% revenue growth and 46% EBITDA growth (removing JK) despite some Omicron impacts late in the year particularly in NSW and VIC. Management look at the UK experience (who are a few months ahead of Aus for Covid timelines) and see that once lockdown measures end growth resumes strongly. Management are targeting the 15-20% pre-Covid growth now restrictions are behind us.

The two main factors for me upgrading my FY23 expectations are a recent price rise in January from $62 to $68 per lessons. I asked Storm whether this was to recoup wage pressures and he answered that while they had seen wage pressures in the corporate office (primarily IT), they aren't seeing it at the tutor level meaning most of that price rise will fall straight through to margins. The second factor is that corporate revenue is clearly growing faster than I anticipated. KME acquired 5 more corporate centres and I asked Storm what sort of run rate the business is on and he answered ~3500 when the business enters it's busy period.

Previously I was modelling $5.5m NPAT for FY23, but when I punch in $68 lessons and higher corporate revenue that number becomes $7.5m. Admittedly nailing the cost base is difficult especially as the potential of US expansion through Tutorfly appears to becoming a reality but I have no doubt the earnings power of the core business is expanding dramatically.

16/11/21 AGM Presentation to Shareholders

No major surprises from the KME AGM held a couple of weeks ago. A few points I took out:

Management confirmed that after the investment in the executive team and head office in FY21 those costs will remain flat in FY22 meaning growth in Corporate centre revenues should scale nicely.

Corporate revenue currently run-rating about $8m more than 100% growth on $3.5m in FY21.

The Tutorfly office will be the launch pad for US expansion in FY23.

Covid continues to affect the business with 503 active centres compared to 537 at the end of FY21. Worth monitoring if these centres return when restrictions are lifted.

Despite that, lessons were up 8% and revenue up 21% (as Corporate revenue grows and captures a bigger percentage of the lesson fee). Management have five centres ready to purchase early next year.

24/8/21 Appendix 4E and 30 June 2021 Annual Report to Shareholders

A decent result from KME given on-going Covid disruptions with reported financials in line with guidance provided late in the financial year.

Revenue increased 13% to $19.3m while EBITDA and PBT fell 3% to $5.2m and $2.3m respectively. A lower tax rate meant NPAT rose 10% to $1.7m.

The increase in costs largely came at the employee line with an additional $1.6m costs from building out the executive team (new Chief Technology, Customer and Product Officers all added through the year) plus additional salaried tutors in corporate centres.

The other reason for increased costs was the accelerated development of their upgraded learning platform and administration sofware. The administration software has begun rolling out to franchisees globally with the learning platform to be released later in 2021 (note this has been delayed numerous times, so take with a grain of salt).

Total lessons provided through the year increased 1%, but revenue growth exceeded this as more lessons were performed by corporate centres where KME captures the full fee rather than a % of a franchisee.

Online lessons grew strongly given Covid restrictions in most geographies, up 220% on last year to 654k lessons. This compares to online only peer CLU who performed 251k lessons. For KME, 40% of lessons were online in FY21 but fluctuated heavily with Covid restrictions. Moving forward, management believe a blended model works best (and interestingly CLU's recent acquisition moves them into face to face learning as well) and expect online lessons to make up 20-40% of lessons.

Interestingly, KME broke out their customer acquisition costs for the first time which was $200, again this compares to CLU who reported $563. It will be interesting to track these over time, CLU currently has the market's support to chase revenue growth at the expense of heavy operating losses, but I suspect that enthusiasm will wane at some point.

Management didn't provide guidance other than they expect corporate revenues to grow over 100% in FY22 from $3.7m in FY21. An additional ~$4m revenue gives a good base of growth for the business to work off, somewhere in the range of 20%.

17/8/21 Scotland Area Developer Buy Back

KME announced they had bought back the franchisee servicing hub for Scotland which would provide a positive impact to EBITDA this year of $100k.

They also announced some smaller franchisee purchases in Perth and the UK to begin establishing corporate centre footprints in those regions. 

However, keeping in line with a terrible habit KME management have had for some time they also included a trading update as a footnote to what was essentially a non-market sensitive announcement.

Light on details, unaudited numbers for FY21 are expected to be 10% revenue growth and flat EBITDA/NPAT. Looking at my expectations, this is slightly better than expected revenue but I had started to factor in some margin improvement from Covid impacts. That said, my valuation was always based on FY22 profits given impact on FY21 was always hard to forecast.

When the results come out it will be interesting to see the breakdown of expenses but I expect the elevated cost base of building out the executive team and pull forward of the learning management system upgrade due to the massive shift to online lessons from Covid are the likely culprits.

Pre-Covid KME was growing their revenues around 25% and recorded $16.2m in 2019. Management were in the process of accelerating investment in the Kip Online system which hit their profit margins a little, but net profits still grew around 17% to $2.7m. At the current market value of ~$71m, KME trades on roughly 27x their pre-Covid earnings which seems fully valued, but Covid has accelerated the value drivers outlined in the Business Model/Strategy straw and I believe will drive a step change in profits over the next few years. I’ve attached a screenshot below of a rough model I have created for KME to demonstrate how I believe the business will change over the next few years.

With only three months left in FY21, the market will turn its attention to the post-Covid recovery in FY22 and if KME can report the ~$3.7m profit I am hoping for I expect the share price to perform well, particularly as the drivers of that recovery (online lessons and corporate centres) will continue into the future.

The business is currently undergoing a shift in their business model from the historical franchisee face-to-face tutor lessons. There are two key shifts occurring, both of which will drive increased revenue and profits for KME in the future:

• A shift to a hybrid online and face-to-face tutoring model. KME launched their proprietary Kip Online system four years ago but traction was slow as parents were wary of the quality of online learning (especially as KME price face-to-face and online lessons the same at ~$63). Pre-Covid about 1.4% of lessons were online, but lockdowns accelerated the shift with 42% of lessons now online in the latest update. Speaking with management, they expect more students to transition back to face-to-face when it is safe to do so, and target between 20-40% online penetration over time.

• A shift to a blended franchisee and corporate-owned centre network. KME has strategically identified that certain centres in highly populated areas are more profitable if they are run by the corporate office rather than a franchisee. Management are approaching these franchisees and offering a guaranteed buyer for their franchise at a fixed valuation, preferably a mix of cash and shares. This has the added benefit that salaried tutors in corporate centres can service students online who fall outside of a KME centre catchment. Like online penetration, management are hoping to achieve a corporate/franchisee balance of 20-40% over time.

KME is a leading provider of tutoring services to K-12 students, primarily in Maths and English. The business was founded by Kip McGrath in 1976 and has expanded from one tutoring centre in Maitland to 524 centres in 11 countries largely through a franchise business model. It is currently managed by Kip’s son Storm, with the father and son duo still owning ~30% of the business between them.

The core business model is charging franchisees a percentage of revenue which is collected per student, per lesson. KME offers two levels of franchise fees, Silver and Gold. Silver franchisees pay 10% of their revenue and receive access to the KME brand, learning materials and basic administration support. Gold franchisees pay 20% of their revenue and in return outsource more back office functions to KME such as accounting, human resources and marketing which frees time to focus on students and on average Gold franchisees generate more lessons and revenue than Silver franchisees.

In a few paragraphs, I expect KME can sharply grow lessons over the next few years with pent up demand as parents look to ensure their children have not fallen behind in their learning with the disruptions from Covid.

As online lessons maintain their penetration between 20-40%, more franchisees shift to Gold status as they become more confident in the future.

A conservative and aligned management team continue to make strategic purchases of franchisee centres and grow the corporate network over time, which also allows for further penetration of online lessons into new regions previously not serviced with more salaried tutors available.

Finally, margins should grow strongly on increased revenue from higher margin sources and general scale over fixed corporate costs. With large investment in Kip Online brought forward by Covid and an expanded executive team now in place, this should happen quickly.