Grafenia plc – Final Results

Grafenia plc (AIM: GRA) announces its full year audited results for the year ended 31 March 2019.  

Operational Highlights

• Nettl of America successfully launched
• Over 220 Nettl partner locations now operating in 8 countries
• Second Nettl Superstore open in Exeter
• Revenues increased at company-owned stores
• Upgrade of Manchester production hub completed
• Relocation of Image Group to Manchester production hub completed in July 2019
• Post year end placing completed to support sign roll-up strategy

 Financial Overview                                                                                          

Chairman’s Statement

 Jan-Hendrik Mohr, Chairman of Grafenia plc today gave the following results statement.

I re-read my past Chairman’s statements when preparing this letter. Spoiler alert: a lot of what you will be reading in this year’s statement is consistent with what I talked about in the last two years. When we embarked on our journey two years ago to build, buy and licence Nettl, we didn’t know whether we were on the right path. Of course, certainty is an unrealistic state in any business, but we have gained confidence over the last months and years that we are on the right path.

So how did we do?

Operational Performance

In the recent fiscal year, our turnover increased by 9% to £15.96m (2018: £14.63m) and gross profit increased by 2.5% to £8.55m(2018: £8.34m). The year showed a decrease in EBITDA, which is operating loss before interest, tax, depreciation and amortisation, to (£1.11m) (2018: profit £0.75m). Our loss for the year came in at £2.82m versus £0.95m last year. We finished the year with a cash position of £1.35m (2018: £0.17m) and net debt (including deferred consideration) of £3.12m (2018: £3.04m). We invested £2.46mon capex (2018: £1.09m) – mainly for our new litho printing press strategy that Peter will discuss later – and capitalised £0.74m in R&D (2018: £0.84m). 

Importantly, these results include several cost items that are either one-time in nature, or constitute up-front costs, rather than ongoing operating costs. An example of a one-time cost is the improvement program in our finance function. As we have discussed on previous occasions, we decided to improve our financial capabilities to support our strategy. To that end, we have hired new team members and have had to part with others. The entire process was overseen very well by Simon, our Interim FD, and we are now seeing significant progress. Such restructuring does increase costs in the short-term, but we strongly believe it’s a worthwhile investment, given the planning and reporting requirements of our journey. 

An example for an ‘up-front cost’ is our start-up US business. Here, we have invested heavily in legal expenses, travel and salaries for the launch of Nettl of America.  

While it is not easy to put a precise number on both examples, it’s safe to assume they each cost us substantial amounts each in the last fiscal year.  

Some firms decide to back-out many costs from their profit and loss statement to arrive at some ‘adjusted’ figure. I find that a slippery slope, as it opens the door to mark every cost as ‘extraordinary’ or ‘non-recurring’. Such accounting doesn’t help with cost discipline internally. Also, communicating what ends up being a ‘profit before cost’ doesn’t help external readers either.

One pragmatic way to measure our progress is to consider our like-for-like (i.e. excluding acquisitions) development of gross profit. In the last fiscal year, that figure declined by 3.2% This decline has been significantly more severe in the past and we believe we are getting close to the point where declines from litho print are offset by increases in our other product lines. We are determined to grow our gross profit consistently and I encourage you to measure our progress by how we drive gross profits in the future.

People at Grafenia & Priorities in the last year

This past year has been the year of getting processes right. Especially in finance, we increased our capabilities in areas such as reporting speed, debtor collection, planning and expense management. This is the boring part of the business, but it can make a team’s life easy when these processes work well. Given that we are looking to grow the Group significantly – in part by acquisitions which always adds complexity – we had to get our finance foundation right before continuing to build. I’d like to express my thanks to all the people at Grafenia who were involved in the continuing improvement of our finance capabilities- your work will pay off!

In past letters, I wrote that there were three areas where my fellow non-executive director Conrad and I can impact the Grafenia organisation. Firstly, get governance right. Secondly, set the right incentives. Thirdly, make rational capital allocation decisions. The first we announced to be well on track last year. I still believe this to be true but encourage feedback from shareholders if they see ways where we can improve our governance. The second aspect, incentives, I’ll discuss in the next paragraph, as this is a priority for the on-going fiscal year. 

That leaves us with capital allocation – of which we had quite some news in the recent past! During the last 18 months prior to publishing of this report, we raised (or announced to raise) equity capital three times. We announced that we had raised £3.5m at 12p per share in April 2018, £1.1m at 13.5p per share in March 2019 and £4.01m at 14p share in July 2019. Why did we do this and how did we come up with valuation and amounts?

The core reason for raising capital has been that we see attractive capital deployment opportunities within our business. Some are truly arising from day-to-day business (including launching Nettl in the US, our new litho printing press remodelling, combining Image Group’s production in Trafford Park and the like). Other opportunities arise when we bring in other businesses into the Group; our focus is on complementary sign businesses as Peter will explain later.

For each of these investments we prepare an investment case which sketches out the expected cash-flows under different scenarios. When deciding, we try not to lose ourselves in detail, but rather only pursue investments that are clearly attractive. 

We’ve made great strides over the last year to improve our budgeting and forecasting. In fact, we now have a pretty decent idea of how many sign businesses we can sensibly buy, what steps we need to take in our existing business to improve performance and where that would bring us in terms of revenue and profitability. I’d like to reaffirm our guidance from the July 3^rd trading update: our current business should be able to generate 10-15% EBITDA margins in the mid-term and we think we can continue to bring complementary sign businesses into the group at sub-5x EBIT multiples.  

With the placing of £4.01m announced in July 2019, we should now have enough funds to add a few more regional sign hubs to our network. Peter will elaborate later on exactly how we plan to do this and why we think it’s attractive.

In terms of valuation, we have tried to strike a sensible balance between offering an attractive investment to incoming shareholders, whilst not diluting existing shareholders. In the context of our base case forecast, we derived an implicit valuation of what Grafenia stock is worth if we achieve our plan. That value is significantly above where the stock has been trading and the valuations at which we raised funds seem to strike a balance between current trading and what we think the shares are worth.  

I’d like to note that we received a mix of astonishment and confusion when we planned to raise new capital at a price above the prevailing trading level. Several observers found this to be very ‘unusual’, as most firms tend to raise new capital at a discount to trading. However, given the magnitude of our equity raises vs the existing share capital, this would have caused tremendous dilution to shareholders who didn’t participate in the placings. This is frankly not the way we treat our shareholder partners – many who are employees, family of employees or local small investors – as most cannot pro-rata increase their shareholdings.  

The entire team would like to thank all shareholders who have participated in our three placing rounds for their support of our funding strategy – even if it’s slightly weirder than usual – we feel energised by the trust shareholders put in our work! 

Apart from lots of work with numbers, we had some (quite literally) heavy-lifting to do in our business. Very notably was the complete overhaul of our production logic. We replaced three old printing presses with one new press and have been moving the operations of Image Group into our existing hub at Trafford Park. There were potential risks involved in the entire operation and multiple different timelines had to be managed in parallel. The mastermind and terrific manager of our production overhaul is John Prior, Grafenia’s Production Director. I’d like to express my thanks to him this year. We put a lot of trust in his managerial skills during the last year and he truly delivered. Thanks again John and team!

Outlook and Current Priorities

Our clear priority for the ongoing fiscal year and beyond is to execute on the strategy that we have previously communicated. Over the past year, a lot of energy has gone into improving internal processes and it’s exciting to now focus on getting things done.  

I still owe you the “setting incentives” item on Conrad and my score card! It is important to remember, we do have several plans in place already. First and foremost, our SAYE scheme is taken up by 41% of the team. This plan makes shareholders out of employees and is structured in a tax-friendly way. Employees save a portion of their monthly salary which they can convert into shares after three years at a pre-set price. In past rounds, the subscription price was fixed at 7.8p and 11.5p per share. I’m pleased to know that some employee-owners of Grafenia have nice paper increases in their investment so far. Well deserved fruits for hard work indeed. 

We have applied a similar logic to structure our new management incentive plan. The idea is to give team members the option to buy shares at the price of the last financing round (i.e. 14p) with their own money. Grafenia will then issue a number of options for each share purchased which will vest after a period of time and upon achieving key parts of the aforementioned business forecast. Indeed, if management meets or exceeds targets, a nice payoff is due. But if targets are missed, their hard-earned own money is at risk (like that of our shareholders). We think this is the way incentives should be structured and have received positive feedback when sounding this among key shareholders. Please review our AGM invitation for specifics of the plan and do get back to me if you have input or questions. 

On a final note, I announce the sad news that my predecessor as Chairman, Les Wheatley, has recently passed after a long illness. Les has done great service to Grafenia and chaired the board for many years. Our thoughts are with his family.  

I look forward to seeing you at the Annual General Meeting on 25 September 2019 at our Nettl of Birmingham Business Store.

grafenia