SThree PLC

LSE:STEM

Earnings Call Analysis

Earnings Call Transcript 2023-Q2

[Timo Lehne, executive]

Good morning, and welcome. Thank you for joining us today for our half year results briefing. I'm joined by Andrew Beach, our CFO.

[Andrew Beach, executive]

Good morning, everyone.

[Timo Lehne, executive]

Together, we will be walking you through the half year numbers, our strategic progress and talking a little on outlook. As a reminder of who we are. We are the only global STEM specialist talent partner, which is a unique offering in the market. We are purely focused on STEM talent, meaning those people with skills in science, technology, engineering or mathematics and have been for nearly 40 years. We place people into STEM roles every day, including engineers to build wind turbines and data scientists to help businesses harness technologies.

As many of you know, our well-established strategy is positioned at the center of 2 long-term trends, STEM and flexible challenge. You can see on the left chart, the distribution of our focus across STEM disciplines. The focus on these much needed skills is where we see our long-term opportunity underpinned by long-term megatrends.

The right-hand chart shows our conscious focus on flexible talent by which we mean short- to medium-term contracts that are particularly well suited to be filled by highly skilled STEM specialists. This focus is demonstrated by the growth of our contract business, which now represents 81% of the group total, up from 77% a year ago.

Our bias towards contract provides us with a predictable and visible revenue stream and is a powerful differentiator in the market. Before Andy talks through our performance in detail, we are pleased to have delivered a resilient net fee performance in the first half of the year against the backdrop of macroeconomic headwinds and an exceptional prior year performance.

Net fees were down 2% on a constant currency basis against exceptional growth of 25% in the same period last year or with the benefit of FX tailwinds up 3% overall on a reported basis. During this period, the macroeconomic climate has remained uncertain. However, the overarching theme is the desire of our clients to retain scarce talent in the face of continued skill shortages evidenced in our contract extension rates and the robust pricing.

Our resilient performance is underpinned by our distinct business model with contract net fees growing 3%. And the order book, giving 75% visibility over the full year consensus at the half year mark.

You wouldn't believe how excited we are all about the progress we have made with our technology improvement program, which will be key to driving our long-term value. While making this planned investment together with maintaining appropriate headcount to ensure we are well positioned for when the market conditions improve. The group delivered sector-leading margins, recording an operating profit of GBP 38.1 million. This progress we have made is a testament to the quality of our global teams. And I would like to thank everyone for their hard work and commitment.

We have made some great achievements in the first half, and we're very excited about the prospects ahead across a number of our strategic initiatives underpinned by a robust financial position.

I will now pass over to Andy to talk us through the numbers. Andy, over to you.

[Andrew Beach, executive]

Thank you very much. Timo. Now I thought I'd start by taking a quick look back over the last 4 years. FY '19 and indeed the first half in that financial year was at the time our record ever net fee and operating profit performance. Whilst FY '20 was hit by the pandemic, the impact on our top line performance was relatively shallow. We bounced back quickly in FY '21, helped by the market recovery and returned to year-on-year growth from Q2 in that year.

The first half of FY '22 was the post-COVID peak period when we experienced an exceptional though unsustainable conversion ratio before we started to see a softening of market conditions in the second half of that year. Despite market uncertainty continuing into FY '23, we are pleased to have achieved a resilient performance in the first half, with net fees broadly in line with last year's record-breaking period and an operating profit and conversion ratio that exceeds historical norms even after the investment in the technology improvement program.

Now we've indexed our calendar quarter net fee performance since 2019, which is the last full year before the pandemic to show more clearly our performance compared to other staffing businesses who will focus more on the permanent market.

As the chart shows, we are much less cyclical, which we believe is due to our strategic focus on flexible talent and on STEM. Through the pandemic, our quarterly net fees fell by no more than 14% compared to our record 2019 performance. And we also recovered quickly and to a higher peak performance achieving index growth of 33% in June '22 compared to an average of 20% peak performance to the other staffers in December that year.

Over the last 2 calendar quarters, we have again started to break away from the group. And this shows that we are less volatile through periods of market disruption, but also that we recover strongly and quickly as we come out of tough economic periods. And that confirms that we have the right strategy and our business is high quality through the cycle.

Now looking in more detail at the half year FY '23 performance. Net fees are down 2% on a like-for-like basis, though, with the benefit of FX tailwinds are up 3% year-on-year.

Operating profit for the half was GBP 38.1 million, which is down 22% and reflects both the normalization of productivity as we run hot in the first half of FY '22 and the strategic investments that we are making, particularly in a technology improvement program to secure future value.

Even after these investments, excluding last year's exceptional, this operating profit is a record first half performance for the group. Our conversion ratio, the ratio of operating profit to net fees is 18.3%, which the first half, excluding exceptional conversion achieved in the first half of '22 is the highest conversion achieved for the first half in 15 years. Now we expect this to decrease in the second half as our investment costs increase with the rollout of the new technologies into the regions and current consensus for the full year is around 17%.

Profit before tax is GBP 38.5 million, down 20% year-on-year, reflecting the lower operating profit, slightly offset by net interest income on our cash. Our effective tax rate is estimated at 28.1%, similar to the rate we forecast at the half year last year, and this gives a profit after tax of GBP 27.7 million, down 21% year-on-year.

I'm now going to talk about some of the key drivers behind this performance. Despite the more challenging macroeconomic environment that we experienced a year ago, we continue to benefit from our focus on scarce flexible STEM talent. Contract, which now represents 81% of net fees, saw a growth of 3% year-on-year as we delivered strong levels of extensions with continued demand for tech and good growth in engineering offset by weaker demand for Life Sciences.

Permanent represents just 19% of our net fees and was down 19%, of which roughly half can be attributed to the change in our headcount mix as we have prioritized headcount towards contracts with average permanent headcount down 10%. It's worth noting that the switch from permanent to contract headcount impacts on the timing of fees as a total fee on a permanent placement is recognized in 1 go, while contract net fees are recognized over the life of the contract.

Contract continues to deliver higher returns over the life of the placement and with the average length of contracts increasing 20% over the past year, we are confident that our strategic focus on flexible talent will continue to deliver the benefits that significantly outweigh the short-term impact on permanent fees.

Turning to the net fee margins on the right of the chart, you can see that we broadly maintained or improved net fee margins. Contract margin expressed as a percentage of revenue, has been maintained at 21.7%, which is up 1.8 percentage points from pre-COVID levels. Our permanent margin, which is expressed as a percentage of the candidate starting salary is up 1.5 percentage points year-on-year at 26.6% and up 2.1 percentage points compared to FY '19.

We continue to benefit from the ongoing trend towards flexible working. This slide looks at the analysis of net fees by product type. Our contract business can be split between independent contractors and employed contractors. The most notable shift over the last few years has been the trend towards the employed contractor model, or ECM which has grown from 22% of net fees in 2019 to 36% of net fees in the first half of '23.

Under the ECM model, contractors are directly employed by SThree for the duration of the contract, and we're able to offer this more complex service in a compliant way. It continues to be the predominant model in the U.S. and is fast growing across Europe, which is why the introduction of automation to ECM processes enabling scale is 1 of the key aspects of the technology improvement program.

Turning now to the regional and skill mix for the period. We have a well-balanced business, both geographically and by skill. On the 2 charts you see here, the outer ring represents half year '23, and the inner ring represents half year '22. The first chart shows the new regional structure we announced this year with DACH remaining the largest region in the group, representing 36% of net fees.

The second chart shows our strong and unique position in providing STEM skills. Technology continues to be our largest skill, and it represents 49% of net fees. The strength of engineering means it is now the second largest skill of the women in life sciences, demonstrating the diversity of the business. [ I can see that ] while DACH net fees were flat year-on-year, growth achieved in the Netherlands region and Middle East and Asia were offset by lower net fees in rest of Europe and the U.S.

And you can also see that while both technology and engineering grew year-on-year, this was offset by lower net fees across Life Sciences following a global slowdown across that sector. As expected, productivity has come down from the exceptional levels achieved in the first half of last year as headcount has increased and uncertain macroeconomic conditions have impacted net fees. However, pleasingly, the current levels of productivity remain 28% above those achieved before COVID, demonstrating the successful execution of our strategy and our new ways of working.

Also, we do plan to deliver sustainable increased levels of productivity as we make our strategic investments in the digital infrastructure. As mentioned earlier, the first half operating profit now includes the technology improvement program, OpEx with GBP 2.6 million spent in the first half of the year. Spend on the project started in the second half of last year, so there is no cost in the comparative first half year.

Excluding expenditures so far this year, we achieved an underlying conversion ratio of 19.5%. As well as the OpEx in the first half, we've also incurred a further GBP 2 million of CapEx. We expect a higher run rate of expenditure on the program during the second half of the year as we roll out across the business and are forecasting spend to be comfortably within the ranges that we provided at the investor briefing in January, as shown here on the right.

Now whilst we could deliver a higher profit and conversion ratio this year, we're investing on both technology and strategically placed talent, this [indiscernible] growth.

Turning now to the year-on-year operating profit bridge. You can see the increase in contract net fees partly offset by the decline in permanent net fees. People costs are up year-on-year primarily due to the 5% average increase in headcount compared to the first half of last year, together with inflationary pay increases provided to staff during the year. Also included is the GBP 2.6 million of costs for the technology improvement program, as already discussed, and GBP 2.8 million of other operating costs, and this leaves profit for the half year at GBP 38.1 million.

Looking at our net cash position. We've seen an 11% increase in net cash since the year-end, benefiting from the anti-cyclical nature of our working capital, which gets released when growth slows. As such, we have seen a decrease in trade creditors and accrued income of nearly GBP 29 million, this is partly offset by the decrease in trade creditors, accruals and provisions of just over GBP 22 million.

The closing cash position also reflects the GBP 2 million of CapEx incurred on the technology improvement program and the purchase of GBP 10 million of shares to ensure that our EBT holds sufficient capacity to deliver on existing long-term incentive plans for our top talent.

Moving on to look at our dividends. To reflect our performance and confidence in the business, I'm pleased to confirm that we're maintaining our interim dividend at 5p per share. We plan to remain in line with our stated dividend policy for the full year being cover of 2.5 to 3x.

Looking now at the future visibility of our contract business, which constitutes 81% of our net fees. The contract order book represents the value of contracts written up to the contractual end date, assuming that all contracted hours are worked.

The book has remained flat as strong extensions have offset slower new placements. Pleasingly, as mentioned earlier, we have seen average contract length increased by 20% and this trend has continued into Q3 with a modest 1% year-on-year increase in the contract order book at the end of June. The order book continues to give us excellent forward visibility compared to permanent focused staffing businesses with over 75% of consensus net fees for FY '23 already recognized or booked.

So to sum up, we're reporting a resilient trading performance with net fees down just 2% in total and contracts up 3% against what was an exceptional sector-leading performance in the first half of '22, we demonstrate the benefit of our strategic focus on STEM and contract.

Operating profit remains at near record highs despite the increased investment in talent and our technology improvement program. The contract order book continues to give us good visibility of future net fees and we have a strong balance sheet with which to fund our dividends and our strategic investments.

With that, I'll hand back to Timo.

[Timo Lehne, executive]

Thank you, Andy. We were now trying to look at what we have achieved strategically over the first half.

Turning to our operational progress. We have made significant advancements in the line of our strategy as we prepare the business with the right people, structures and processes to support our next growth evolution. As a reminder, we set out these 4 strategic pillars so that we can consistently comment on our progress relatively to our places, platform, people and position.

I will now look at the progress we have made against each pillar in turn. The markets and disciplines we operate in are deliberate and strategic. And while there may be variances across these over time, we have chosen our focus areas based on where we see long-term structural opportunities and aligned to the biggest STEM markets. We concentrate assets on those niches with the highest demand for STEM specialists and limited supply and where we can generate the highest returns.

The focus that we have is demonstrated by the fact that we remain ahead of our peer group in all core geographies on a net fee growth basis versus FY 2019. In line with our market investment model, we saw scope to make our operating structure and regional presence less complex and more focused. This has included the restructuring of our position in Singapore, Ireland and Hong Kong, streamlining our focus further. Additionally, our contract focus in the strongest market has meant that we have been able to successfully maintain net fee margins, which are holding up well.

Turning to our platform. Our key focus is the rollout of our technology improvement program. This is seeing us work with our partner, including Microsoft and that state-of-the-art technology across our global organization to systemize and standardize our SThree Blueprint, which has been the key ingredient in our success to date. We will shortly hear from Nick Folkes, our CTIO, who will talk us through the progress we are making with our technology improvement program. But first, I would like to point out that this remains key to our ambition of delivering sustainable higher margins.

Our underlying conversion ratio, both before and after costs associated with the technology improvement program continuously to considerably exceed our pre-COVID performance. While we expect current macroeconomic headwinds to dampen margin progression in the short term, we are confident that we're investing in the right infrastructure to build a world-class organization with a strong platform from which to scale.

Now over to Nick for a quick update.

[Presentation]

[Timo Lehne, executive]

So as you have heard, we are very pleased with the progress we are making and the team is so excited about the next phase of the rollout. With Phase 1, we're bringing in our technology copilot, which will speed up our time to productivity and bring important efficiency gains, but what we are also seeing is that the program is already [ despite ] a lot of innovative thinking about how we can leverage new technologies for additional benefits in the future.

Now turning to our people pillar. Of course, as the people-driven business, we are continuously reflecting on and enhancing our approach to attracting and retaining great people. Our commitment to creating an environment to support our people, whereby they can fulfill their potential is fundamental to the success of the business, and we are pleased to consistently achieve an eNPS score that places us in the top quartile of the professional service industry.

Bailing on achievements last year, we continue to focus our efforts on initiatives that will unite our global teams and ensure our culture moves forward with the evolution of the business, including initiatives centered on supporting hybrid working, tracking a performance culture and leadership training.

We have a number of initiatives planned into H2 and beyond, and we look forward to leveraging the collective input from our diverse workforce to activate and embed a new set of company values and evolve our culture to being 1 that has growth mindset combined with a high degree of collaboration.

Our thought leadership and our position at the center of STEM has always been fundamental to the success of our business. An example of this is the recent survey, which we published called How the STEM World Evolves, in which we surveyed 2,300 STEM professionals in our core markets to find out how they're adapting their expectations in a rapidly changing work environment.

To pick out 2 key takeaways, 80% said that choosing personal purpose at work was the main influence driving career choices. 63% said continuing to work flexible is a factor that will affect their career. The full survey is now available on our website. So connected to our purpose and strategy is a strong emphasis on our ESG commitments. We have made good progress against these with over 106,000 lives positively impacted since December 2019. 132% of constant currency growth in clean energy fees since FY '19 and 33% of leadership roles held by women.

For over a decade, we have taken action to reduce our environmental impact since setting our first climate science line target to reduce carbon emissions by 25% in 2019, we have made considerable progress reducing our carbon emissions by 44%. Last year, we made a decision to strengthen our vision and completed the process to set net zero targets verified by the science-based target initiatives.

Our approach to net zero involves planned targeted action that is left by data. It incorporates behavior change, operational adaptations and influencing our end-to-end value chain. As we place a crucial role in providing the STEM skills that will allow the world to invent, innovate and adapt to tackle climate change. Our commitment to net zero mirrors our commitment to finding and nurturing the talent needed to build a sustainable future for everyone.

So to sum up, we are perfectly positioned to help source and place the STEM talent the world needs. We're excited by our technology improvement program with the phased geographical rollout set to start in the coming months. [ We know we have ] to the opportunities available to us with optimism. Our specialism and STEM skills and the new ways of working provides a differentiated position to clients and candidates and the unique business model aligned to our long-term structural drivers.

As we enter the second half, market conditions continue to be varied with inflationary pressures remaining across a number of our markets. In June, we saw very early indications of easing caution from our customers as expansions remain robust while the rate of decline of new placements improved versus the prior month.

Supported by our robust contractor order book, we continue to invest in our people, infrastructure and systems to ensure we are well positioned when the market returns. So we are very, very positive, as we said about the upcoming future. We believe absolutely in our long-term trends and the position around STEM and flexible talent.

The technology improvement program guys, we hope we gave you today another good insight is really well on track. And it's not only bringing us excitement, but also a really great position for the future to drive the business up to a more sustainable, higher margins. And to overall what Andy said, maintain or potentially even increase at some point, the productivity levels.

So with that, we are well positioned. Thank you all for taking the time and see you soon.

[Andrew Beach, executive]

Thank you.