| Subject: Monday, 26 November 2001 4:46 PM--ERG |
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Date Posted: 23:11:41 11/25/01 Sun
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toucan (ID#: 381204) Monday, 26 November 2001 4:46 PM--ERG 11/26/01 02:06 4410725
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Monday, 26 November 2001 4:46 PM
Welcome to the latest edition of the ERG email subscription.
Addresses by the Chairman, CFO and CEO
Annual General Meeting of Shareholders
26 November 2001
Address by the Chairman - Mr Sandy Murdoch
The 2001 financial year has been an extremely busy one for your Company. We have continued to make excellent progress towards achieving our Group's vision.
We have recorded revenues of $299.9 million and a net profit after tax of $6.1 million. As you would be aware, the reduction in our revenue levels is largely due to the sale of the telecommunications and manufacturing businesses concluded in 2000. These sales have allowed the Group to focus on smart card related activities. Mr Slater will discuss the 2001 results in his address to you shortly.
We have declared a dividend of 1 cent per share which will be paid on 30 November 2001. Bearing in mind our share split in November 2000, this dividend represents a 50% increase over last year.
You will have recently received a Prospectus and other documentation related to our rights issue and acquisition of Proton World. This acquisition is a natural extension of our smart card strategy and provides us with an immediate presence in the banking and financial services sector of the market. Proton World accelerates our goals to participate in the adoption of smart cards in markets beyond the transit sector. Mr Fogarty will explain in more detail, the strategy behind this acquisition in his address to you.
As is often the case in this situation, the new ERG balance sheet will have an amount of goodwill attributed to the acquired company. Current Australian accounting standards require this amount to be amortised through the profit and loss statement. On a global stage, this treatment prejudices companies such as ours. Under US accounting standards, no such amortisation charge is required. US companies retain the goodwill on their balance sheet so long as the directors are satisfied as to the recoverable amount of the asset. Our auditors, PricewaterhouseCoopers, have made submissions to the standard setters on this point in an effort to align Australian standards with the US. We fully support their position on this matter.
The acquisition of Proton World will be funded by the rights issue announced on 31 October 2001. The rights issue gives you the opportunity to purchase 3 new shares at 50 cents each for every 10 you held as at the record date of 15 November 2001. If you wish to take up your rights, you must do so by
11 December 2001. The rights are renounceable giving shareholders the option of selling their rights on the Australian Stock Exchange. The rights are currently trading under the code ERGR, and will continue to do so until 4 December.
The past year has seen continued strong progress in our Automated Fare Collection (AFC) business. We have focused heavily on the implementation of systems in the major projects we have previously reported. New systems are now largely installed in Rome, San Francisco and Singapore, and all of these projects will have commenced operational use of our systems by early 2002. At an operational level, these projects have been our main focus over the year. They have required a significant cash investment which we expect to substantially recoup this financial year. Once operational, these projects will make a significant contribution to our ongoing recurring revenue.
I am very pleased to report we have once again exceeded our own targets for the rate of success in AFC tenders. We are working on finalising high profile contracts in Sydney by the end of the calendar year and in Seattle early next year. These tenders have been in progress for many years and our success underlines our standing in the transit industry. In addition, work has commenced on new projects in Bordeaux, Gothenburg and the Rhein-Ruhr region of Germany, reinforcing our strength in the European market.
In February this year, we purchased Motorola's stake in the ERG Motorola Alliance for $46 million. As evidenced by our successful Seattle tender, our independence has not impeded our ability to be successful in the US. ERG is now free to work alone, or partner with other organisations depending on the individual requirements of a project.
Despite this continued success, you will no doubt be aware that our share price has not performed well this year. We are conscious of the concerns of shareholders and are working hard to ensure the value of the Company is fully reflected in the share price. We acknowledge that we will have to clearly demonstrate sound cash flows and profitability for the market to re-rate our stock.
We spend a significant amount of management time communicating with the finance markets and will continue to do so. We are well aware of analysts' views that forecasting the earnings of our Company is a difficult practice. We continually face the difficult position of balancing the desires of analysts with protecting the competitive position of the Group. The margins we quote on tenders are commercially sensitive and we simply cannot afford to disclose such matters. None the less we have put significant effort into better communicating the structure and revenue streams of the Group in the 2001 Annual Review and the Prospectus for the rights issue. We have made a concerted effort to explain our present and future sources of income. I trust you have found these documents to be informative.
In closing I would like to acknowledge the ongoing efforts of our Chief Executive, Mr Peter Fogarty, my fellow Board members and all employees that are often required to spend large amounts of time away from their families.
I look forward to the challenges of the year ahead and the continued achievements of our goals.
A S Murdoch
Chairman
-----------------------
Address by the Chief Financial Officer ˇV Mr Michael Slater
Over the next few minutes I will cover a number of items, being:
"h a brief review of the June 2001 result;
"h current status of ERGˇ¦s cash flows;
"h an overview of the core earnings streams of the base ERG business; and
"h a brief overview of key short-term business focus.
The 2001 year revenues of $299 million were down against the prior year by some 28%. The primary reason for this fall was the effect of removing the telecoms business, sold in October 2000. With telecoms business revenues removed from both years, revenues would have been flat, with $240 million being achieved from the underlying transit business in both years.
EBITDA for the year at $36.5 million shows a fall on the prior year. The impact of removing the telecoms business, whilst still maintaining the existing corporate structure, has impacted this line. We continue to undertake significant effort in bidding for new city projects. All such bid costs are expensed, until such time that a project is won by ERG.
The resultant net profit of $6.1 million was below expectations. The final treatment adopted by ERG in respect of a licence fee to the German business card.etc AG was to not recognise the value of that fee at June 2001. Following discussions with our auditors, their view was that the business plan of card.etc was not sufficiently advanced to be able to form an opinion as to the value of the licence fee due to ERG of $31 million. Since closing out the June 2001 year-end, card.etc has been awarded Germanyˇ¦s first large-scale transit smart card project to supply smart card solutions to the Rhein-Ruhr region in Germany. This is anticipated to result ultimately in some 7 million smart cards being issued, which, in turn, represents approximately 35% of the smart card issuance envisaged in the card.etc business plan within Germany.
We will continue discussions with our auditors in order to assess whether this transaction will be booked in the current financial year. As we have stated on previous occasions, the revenue has not been lost or disallowed, but deferred until future events allow its recognition.
In balance sheet terms, total assets at $711 million have increased marginally on the prior year. Cash on hand reduced year on year by $113 million. This reflects the ongoing project build and development costs of the business, as well as investing in future earnings opportunities, most notably acquiring the 50% profit share arrangement from Motorola. This cash requirement was foreseen, as a result of which ERG raised $250 million via a convertible note issue in February 2000.
I have highlighted a proforma balance sheet, based on the June 2001 ERG balance sheet, incorporating the effect of the Rights Issue and the Proton World acquisition. A key outcome from this transaction is that the ERG balance sheet is strengthened. ERGˇ¦s debt to equity ratio, including the Listed Convertible Notes, improves from 110% as at 30 June 2001 to 80% based on the proforma position, with the Rights Issue and Proton World acquisition taken into account. When looking at the future opportunities available to ERG, increased balance sheet strength will be an important ingredient to being able to deliver on those opportunities.
In addition, we believe that having some 8.4% of ERGˇ¦s issued equity held by organisations such as American Express, Visa International, Banksys and Interpay is a positive attribute to our investor base.
As part of our year-end announcement in August of this year, ERG highlighted the future key cash inflows anticipated in 2002 being a target of $265 million. Our stated view at the time was that some $180-200 million of this $265 million target should be considered as conservatively attainable.
To date, $100 million has been brought in against these main areas. We will continue to provide updates as appropriate when further major inflows have been crystallised. The main inflows to date have been against the Singapore and San Francisco projects, as well as a number of corporate items.
We are conscious of the need to provide greater clarity as to the underlying earnings of ERG, whilst at the same time maintaining both commercial sensitivity and client confidentiality. In both the Annual Review and the rights issue Prospectus, we have set out ERGˇ¦s five core earnings streams.
Having divested the telecoms component of its operations, ERG is now going through a further development and rebuilding phase.
The headline focus of ERG is in building up the level of stable, recurring revenue that will produce future annuity type income as well as creating and building asset values. This comes either in the form of investment positions held by the business, such as PCL in the UK and card.etc in Germany, or in the operational asset structures developed to manage the outsourced customer smart card infrastructure solutions we have installed, such as on the west coast of North America.
In the short term, ERG revenues and earnings will be subject to movements as a result of the specific factors and risks that can affect each of the five earning streams.
In summary, the five earnings streams are:
"h Firstly, up-front fees from licensing ERG technology. Here we are seeking to exploit the investment made to date in our technology capability and gain a return on that earlier investment.
Such transactions will be struck by ERG when it is considered most appropriate to do so. The scale and timing of such transactions will vary both by individual transaction and year to year. The card.etc licence is an example of such a transaction type and so highlights the potential for timing movements.
"h Secondly, ERG recognises the equity share of the operating results in those joint ventures that we participate in. The results of such joint ventures will depend upon the extent of progress made in achieving the separate business plans of each entity and so will be subject to a wide range of specific local market issues.
"h Thirdly, ERG will sell down interests it holds in those joint ventures or subsidiary operations where appropriate. Such sales will be to strategic value add partners who can actually contribute to the further development of that specific entity because of their own particular market expertise. The sale of stakes in PCL is typical of our strategy in this regard.
"h The supply of integrated transit and smart card systems provides the fourth revenue stream. Large contracts such as Hong Kong, Singapore and San Francisco are examples of this revenue type, where ERG earns revenue from the supply and build process over a period of up to three years, depending on the scale of the individual project.
"h Finally, ERG generates income from the actual operation of the systems it builds, undertaken on behalf of the customer on an outsourced basis.
In Rome, ERG now manages the processing operations for the Rome transit authorities, earning a percentage fee based on the total transit revenues managed through that system under an initial eight-year contract. These operations will typically take anything between 18 and 30 months to become profitable, as revenues build up in the early stages, through the issuance of smart cards. Operational costs at the early part of this phase will be higher, as the rollout of smart cards to transit passengers is managed. Operating costs will reduce over time, once the main card base has been issued and operational efficiencies established.
The actual point that revenues become greater than operating costs will vary, depending on various factors which can include the speed of smart card take up by transit passengers and the level of fare changes controlled by the transit authorities. Incremental benefit can then be accessed by adding further value-added revenues ˇV such as from tolling, car parking and retail models ˇV to the base transit model established by ERG. These incremental revenues will utilise the established backend system.
One key opportunity that has struck me, is that as an organisation we do not fully reflect the potential value of creating annuity type revenue streams, based on strongly positioned, longer-term operating contracts that we have won.
During the next three years ERG will continue to exploit opportunities in each of these five earnings areas with the ultimate focus being to increase the level of recurring revenues earned from outsourced management of systems, over long-term contracts. By developing such recurring revenue streams, the actual asset or vehicle that creates that income will in turn, we believe, have a considerably enhanced value compared to the present carrying values reflected in our accounts.
In the short term, and going forward, strong focus is now placed on cash management, as well as considering the cost structures appropriate to our business needs. The future process for major project implementations will benefit significantly from the product development undertaken to date. Accordingly, the project build phase should benefit from reduced risk, given the expertise we now have as a group. To date, ERG has borne most of the cash flow cost in terms of project builds. Our focus is now to have a far more balanced approach, with ERG carrying reduced funding for individual projects.
We are looking at our cost structures to ensure these are at the most appropriate levels for the business, both now and for future needs. We will not, however, damage the future potential of the business by merely cutting costs for the sake of a very short-term gain. The opportunities available to ERG are not inconsiderable, and it is important that we structure the business to give the greatest chance of success of harnessing such opportunities.
M D Slater
Chief Financial Officer
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