... as ERG warns costs will add to likely loss

Nearly three years ago, automated ticketing company ERG completed a major balance sheet restructuring and installed a new board of directors.

That was meant to be the start of a bright new future for the troubled company, which was acknowledged as a world leader for its technology but consistently failed to deliver profits.

Unfortunately for investors, particularly Duncan Saville’s Ingot group, which effectively rescued ERG three years ago and has since increased its stake to 35 per cent, ERG is still in the red.

The company lost $52.7 million in the year to June 2004, lost a further $11 million in the year to June 2005, and last week foreshadowed a further loss in the current financial year.

The latest projected loss reflects unexpected cost increases on its six major ticketing projects, in Sydney, San Francisco, Seattle, Washington DC, Stockholm and Gothenburg.

The company said costs had blown out by about $18 million. This followed disclosure of a $15 million cost blowout just seven months earlier.

In addition, the company said, it expected to write-down the value of its multi-application smartcard system by $19 million as a result of the cost increases.

Patersons Securities analyst Robert Gee said that would add up to an annual loss of nearly $40 million, prompting him to downgrade the stock from a speculative buy to a hold.

ERG’s chief financial officer James Carroll said the Sydney contract, valued at $339 million, was “the largest and most complex of our projects” but declined to elaborate on whether it was also the biggest contributor to ERG’s problems.

Ironically, Perth could have added, in a much smaller way, to ERG’s problems if the company had been successful in bidding for development of the city’s automated ticketing system.

The $30 million Perth contract was won by Downer EDI subsidiary Delairco Bartrol and its UK partner Wayfarer Transit Systems.

Their SmartRider system, which Planning and Infrastructure Minister Alannah MacTiernan says will be Australia’s “first, fully integrated, state-of-the-art smartcard public transport ticketing system”, was originally due to be launched by the end of 2004.

The full-scale launch has been repeatedly deferred, initially to January 2006, then to the end of April, and most recently to an indeterminate time in the future as a result of issues identified in a public trial of the system.

The deferral has allowed the contractors to introduce a range of software and hardware changes to improve the reliability of the system.

The ongoing problems with ERG’s big projects have overshadowed progress with the rest of its business.

Its operating companies division, which services installed fare collection systems in cities like Melbourne, Hong Kong and Singapore, is trading profitably and broadly in line with its budget.

Last year the division achieved an underlying profit of $26 million.

Its small projects division, which provides standardised fare collection systems in smaller cities, is also trading profitably.

Its underlying profit last year was $8.6 million and in recent months it has won new contracts in China, France and the US.

Mr Gee said chief executive Allan Sullivan, who has been in the role nearly two years, was aiming to focus growth on the small projects division.

He said contracts that were smaller in size, shorter in duration and less demanding technically were much easier to manage.

“The longer the duration of these contracts, the more likelihood something will go wrong,” Mr Gee said.

For investors looking for positives, the company said last week it had made significant operational progress on all of its major projects, with installation of the Sydney and San Francisco projects due to commence mid year. The company said it expected to achieve a break-even profit in the second half of the current financial year.

Mr Carroll noted that this year’s technology write-down would have a positive effect in future periods, by reducing the annual amortisation charge by about $3.8 million.

Looking further ahead, ERG expects to generate “significant free cash flow” in the year to June 2007.

This reflects the nature of its big projects, which require the company to invest more than $115 million in working capital in order to reach project milestones.

Once it has achieved the milestones, customers will commence repaying the working capital to the company. That offers some hope to investors, who pumped $97 million into the company last year through two separate rights issues pitched at 20 cents per share and 12.5 cents per share.

By comparison, ERG’s share price currently is languishing around 12 cents and shows little immediate sign of making a sustained recovery.