SThree PLC

LSE:STEM

Earnings Call Transcript 2018-Q3

[Operator]

Welcome to the SThree Trading Update Call. [Operator Instructions] Just to remind you, this conference call is being recorded.I'll now hand the floor to Gary Elden and Alex Smith. Gentlemen, please begin.

[Gary Elden, CEO & Executive Director]

Good morning, everyone, and welcome to the call. As usual, Alex Smith is here with me. I'll start with a quick summary, and then we'll take your questions.We're pleased to have delivered another strong quarter, with group GP ahead by 13%. This performance is driven by the combination of our STEM focus and international market exposure, with 84% of GP in Q3 coming from outside the U.K.Picking out some highlights. Our largest region, Continental Europe, continue to grow robustly with both DACH and Benelux posting record performances. Contract remained the driving force of our overall performance with GP ahead by 14%. Contract now represents 73% of the group's GP.The U.S.A. grew by 8% in the quarter against some strong prior year comparatives. And Permanent posted another improved performance, with GP ahead by 8% and productivity up by 11%.Once again, Continental Europe was the primary driver, but Japan also continue to grow strongly with GP more than doubled.So overall, we're pleased with our progress at this point. And we enter Q4, our biggest quarter, feeling confident about our full year prospects.We're now happy to take your questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Rory McKenzie of UBS.

[Rory Edward McKenzie, European Support Services Analyst]

Just one question on that really strong growth in Continental Europe. As you're looking to the next quarter, obviously, the comps get a lot tougher. Could you say by region, so DACH versus Benelux, where the comps are toughest? I think Benelux has been pulling really strongly for quite a while now. So is that the way you'd expect to see the sharpest slowing in the fourth quarter?

[Alex Smith, CFO & Executive Director]

Yes. Thank you, Rory. Yes, so we did have a very strong Q4. Benelux last year was up 28%, so that is one where we would expect to see the headline year-on-year growth rate in the fourth quarter. Still maintaining a double-digit sort of growth rate, but probably quite a lot down from what we saw in the third quarter yet. Germany, however, was, in terms of comps, a year ago, Q4 was up 9%, it's up 5% in Q3, so kind of comps really not too challenging there.

[Rory Edward McKenzie, European Support Services Analyst]

Okay. Okay, sure. And then I just want to ask about in the U.K. Obviously, that declined, yet you mentioned obviously the impacts of the Permanent restructure. Has there been any knock-over impact on the Contract business? Or has it all been very, very separate?

[Gary Elden, CEO & Executive Director]

Yes. We've got a separate management team on Contract. We made that separation a few years back. And fundamentally, the Contract businesses, it's still growth market for us, and we still believe there's an opportunity to continue that growth. And the headcount investment we're making now, we should really start to reap the benefit towards, well, Q4, but more likely Q1 of next year and thereafter. So the investment in Contract is still an opportunity for us. The perm, we -- the structure on perm, we're now in that we believe we're in the right places now. We're pleased with the improvement on productivity, and that's what will continue to drive on perm throughout this year and next year.

[Alex Smith, CFO & Executive Director]

Yes, just worth saying that our Contract headcount in the U.K. we've grown consequentially by 7% since the half year. And so that's a great investment for the performance latter half of Q4 and into 2019.

[Rory Edward McKenzie, European Support Services Analyst]

Okay. And just lastly, on the kind of drop-through implications for operating profit after this kind of good quarter. Historically, the U.K. would have been the kind of highest incremental margin region. But I guess given the productivity there, it's not one that would have particularly hurt. So how do you characterize the profits impacts of the growth this quarter?

[Gary Elden, CEO & Executive Director]

In the quarter just gone, it's strong profit growth underlying. So thinking about the U.K., there, we've reduced our average headcount on perm, and we can see the yield coming through ahead of that. So productivity growth across our U.K. business, particularly on the perm side there. So positive profit trends into the second half. As we expected and which was always required to achieve our consensus profits for the full year, but the incremental drop-through in H2 was always going to have to be 30-plus percent in the second half to get to where we need to get to, and we're confident in that.

[Operator]

Our next question comes from the line of Andy Grobler of Crédit Suisse.

[Andrew Charles Grobler, Analyst]

Just another one on the U.K. It's been 3 years now since you've grown in the U.K. within any quarter. Why do you think now you're in the right place? And I suppose as an add-on to that, IR35, I'm not entirely sure whether that's going to come into force next year. But I mean, is there any update on that and any potential impact that you foresee?

[Gary Elden, CEO & Executive Director]

Well, from -- on the IR35 situation, the belief is that this will be rolled out next year, and that will have a short-term impact potentially. We saw that in public sector. But in the long run, the work that we've done around that, I think we now start to see the benefit in public sector a year on. So we believe that will have an impact, but we're prepared. We've got the team in place. We're advising on how Contractor's can work in this particular area. And we're pretty confident, as it becomes more complex, it just creates an opportunity. In relation to the growth factor, we think -- we look at perm now. The decisions that we've made is really not just driven by increasing GP. We're really pushing to increase profitability. And we've invested quite heavily into a low-cost delivery model in Glasgow, and we got a resource team based out there to deliver to clients in a more cost-effective way. So that should have a positive impact on our profitability. And so the GP, without a GP, won't necessarily see an increase year-on-year. We're pleased that the productivity will increase drop-through on profitability. While on Contracts, the feeling is it's been fairly flat for the year. But with the investments we're making now, and as you appreciate, it takes roughly 6 months to really see that coming through, we believe we're set up nicely to see some good growth coming out of Contract the next year. So overall, I think we're pleased where the U.K. is and we should now start to see some momentum coming through.

[Alex Smith, CFO & Executive Director]

I think it's worth making a couple of comments. Our U.K. business has, and you're right in terms of looking back over time, but it has been the talent hothouse for the rest of the group in terms of funding some of that overseas expansion, perhaps more so for us than for some of our peers. So we do continue to see talented U.K. staff looking to have exciting career opportunities with us overseas. So that is a factor. I think in terms of IR35, I do think we're in a really strong position. And why I say that is because, in terms of the public sector, we've been through that experience with our public sector contracts. It's not -- that was about 1/4 of our U.K. book. So we've been tested, if you like, in terms of the U.K. public sector. And we've got a -- we're already engaging with our top 20 clients, advising them in a kind of very strategic way on the potential changes to legislation, which, as Gary said, we do believe is likely -- more likely than not to come in from next year, to advise them to start to analyze their contract books. And we'll be able to really differentiate ourselves as an experienced trusted adviser, a compliant plc that can help them negotiate through these potential changes. So we welcome any regulation that builds barriers to entry, and we do think that this will -- a number of smaller competitors may just end up losing quite a lot of share with the share opportunity, albeit there may be some financial consequences in the short term.

[Andrew Charles Grobler, Analyst]

Okay. And just one other -- just a guidance point. With net debt at GBP 24 million at the end of Q3, what are your expectations for the end of the year, more or less?

[Alex Smith, CFO & Executive Director]

I would say, minus GBP 10 million, something like that, would be a reasonable estimate at this point.

[Andrew Charles Grobler, Analyst]

Sorry, minus GBP 10 million for the full year or minus GBP 10 million from where you ended?

[Alex Smith, CFO & Executive Director]

Sorry, at year-end, GBP 10 million [ net add ], approximately.

[Operator]

Our next question comes from the line of Srinivasa Sarikonda of HSBC.

[Srinivasa Raju Sarikonda, Analyst]

Srini from HSBC. A couple of questions from me. First, on wage inflation. Could you give us some color on wage inflation on each of the regions, like how much of this growth has come from that? And for U.K., now that the restructuring is done, the gross profit which we are standing at right now at the end of Q3, can we take that as a base? And your investment in headcount means like you are looking at some growth prospects in some of the sectors? And from here, it basically start growing up? Am I right in thinking like that?

[Gary Elden, CEO & Executive Director]

Yes. So with your fee question first. So in terms of -- so wage inflation, so we obviously -- well, we look at a number of things. We look at salary inflation. We look at fee inflation. So in terms of overall Permanent fees in the quarter, they were up 4% across the group. Average perm salaries across the group were up 1%. So we managed to get a slightly greater fee growth than salary growth. In terms of that fee growth, we were seeing it. Overall, looking at a sector view of the world, our average IT Permanent fees across the group were up 5%; Banking, up 4%; Energy, up 6%; Life Sciences, up 11%; with a small decline in Engineering across the group. And that blends to the 3.5%, 4% that I talked about there. In terms of -- on the Contract side, we saw a 3% increase in terms of the average salary equivalent of the contractors we placed in the quarter. And we saw a 3% increase in the average run or weekly GP, so the average gross profit that we make on each of those 2. And in terms of how that lands, in IT, we saw an average 2% increase in the contracts that we placed in terms of their salary equivalent; 7% on Banking; 5% on Energy; 2%, Life Sciences. So that's the kind of blend across the 3% there. So in terms of the fee inflation, 4% on Perm, 3% on Contract. In terms of salary inflation, we saw a greater salary inflation on contractors than on perms. But there's a lot of regional mix stuff going on there and other things, but that gives you a flavor, hopefully, Srini.

[Alex Smith, CFO & Executive Director]

In terms of the U.K., so we have -- as we've talked about, we've rebased that Permanent business now into 4 regional hubs in the start of Q2. We further declined our headcount in Q3 on perm, so we're down 33% in the last 6 months on our perm headcount in the U.K. But from here, we believe we got the hub teams with critical mass. We got the dedicated management. We got the belief. So we absolutely hope to be driving that forwards from where we are now. On the Contract side of the business, we grew our Contract heads in the U.K. sequentially by 7% quarter 3 versus quarter 2. Now that takes a bit of time, as Gary mentioned, to kick into GP, which we didn't see in the third quarter, but we would expect to start to see in the fourth quarter and into early 2019. So I would -- we would definitely expect to see an improving U.K. performance, both year-on-year and sequentially.

[Gary Elden, CEO & Executive Director]

There will be a factor about the unknown around, obviously, Brexit, what impact that can have. But once again, if there's further uncertainty on, we don't come to any agreement, we don't know what impact that could have, but your guess is good as ours on that.

[Operator]

Our next question comes from the line of Rahim Karim of Liberum.

[Rahim Nizar Karim, Research Analyst]

But just very quickly. I mean, obviously, Energy is very strong in the quarter and has been for a few. [ Just ] a bit more color on the drivers there, both kind of business and regions, and how sustainable that growth is. And then perhaps a little bit more on Japan, if you could, because that's also seen some similar characteristics.

[Alex Smith, CFO & Executive Director]

Yes. So I mean, Energy overall was up 32% in the quarter. It's had a strong run really if we look back really to kind of quarter 2 2017. Since then, it's been growing 20%, 30%, 50%, 30%, 30%, 30% sorts of growth rates. I mean, where we're seeing the particular growth is U.S.A. So in the U.S., we're up 33% in the quarter; Continental Europe, 43%. So Continental Europe is about 1/3 of our Energy business, U.S. is probably 40%. And that's across -- in terms of the sectors within Energy, you will find that, obviously, we've seen a benefit of the stronger oil price. So we're seeing some benefit of the upstream market. But a lot of our growth is now the investment we made 2, 3 years ago around renewable and power markets as well. So again, with the -- it takes a while for that to kick through, as you appreciate, and we're now starting to reap the benefits of that now. So if that's sustainable, I think we're still looking to invest in the U.S. in these areas. We've opened up new offices in Chicago, the West Coast or in San Diego, obviously, Houston. So it's one of the core investments for us in the U.S. We've got a very strong business in Holland, and it's a very strong market for us. So I think we're seeing some good growth coming out of the power and renewable markets as well. And obviously, we're benefiting from the oil price. But still, the U.K. is still -- we're not -- the upstream market is not where it needs to be currently, so the U.K. is still a relatively small part of that. But any confidence around that, then we can see some benefit in there potentially in the long run as well. So overall, we should see some consistent growth coming through that sector.

[Gary Elden, CEO & Executive Director]

And in terms of Japan, so again, it's a very strong performance in Japan, so more than doubled in the third quarter. In terms of the sectors that we offer in Japan, the investments we're making there is in IT and Life Sciences primarily. And what we see in the benefit in those particular markets is the skill shortage, which is -- works for our strength. It's difficult to find candidates, so you can create a premium for that. And we've also now got a solid base in that office now, so we're able to scale it at a greater rate than we have previously. So it's a relatively new office for us. We've now got strong management there, so we're able to grow the headcount.

[Rahim Nizar Karim, Research Analyst]

Can you just remind me, is that -- are you operating in the local market or is it just in the bilingual in the market there?

[Gary Elden, CEO & Executive Director]

The international market, yes, it's the international clients, so no, we're not in the local market. I think it's difficult unless you're a Japanese company to work in the local market. So our whole strategy is around the international market -- international companies.

[Operator]

Our next question comes from the line of Steve Woolf of Numis.

[Steven John Woolf, Analyst]

A minor one, just on the U.S. mainly. I know you've sort of flagged the tougher comps, et cetera. But I just wonder if you can give me an idea of the headcount year-on-year, and then against that, the sort of a bit more detail on some of the areas. I know you've just mentioned where Energy is, sort of the business, 33%. But if I look back to my comment -- the commentary you gave at the Q2 numbers in terms of the pickups there, in terms of the banking, the hedge funds and the asset management and also with Life Sciences, I'm just trying to sort of reconcile that against the 8%. So any more color you can give on the U.S., if that's possible.

[Alex Smith, CFO & Executive Director]

Yes, sure. So I'm just pulling out the headcount information. So just on the U.S., so I think there are some challenges of the uncertainty around some of the clients in the banking still. We saw some pickup with our key accounts in the second quarter. And then we've seen some impact of that of recruitment freezes or slowdown in Q3. So that's the effect of a perm business, you get that uncertainty. While on Contract, I think we've seen some positive in most of the sectors now. We had a record performance in last month on Contract new deals, and so we're investing the headcount on the Contract. As I mentioned, the Energy is a strong growth market for us as well. We're now starting to get some momentum on IT, which is our smallest sector. And so our feeling on the Contract market across the U.S. is continuing to invest headcount and see the benefit of that coming through on new deals, which will start to flow through in Q4 and Q1 of next year. On the headcount front?

[Gary Elden, CEO & Executive Director]

Yes. So on the headcount front in the U.S., we -- overall, sequentially, our U.S. headcount was up 13% Q3 versus Q2. So there was a strong focus since the half year to build across both perm and Contract. So we saw a 12% sequential growth in Permanent, and we saw a 13% sequential growth in Contract in the last 3 months. So it's been a big focus there to drive that headcount forward. That headcount, certainly, on the Permanent side, it's declined somewhat in the first half sequentially. And so we were very pleased to start to move that forward, and that points to productive contributions really Q4, Q1 next year.

[Steven John Woolf, Analyst]

So that's on the quarter-on-quarter side. I was just thinking more on the...

[Gary Elden, CEO & Executive Director]

That's right, yes.

[Steven John Woolf, Analyst]

If I look at it on a year-on-year basis, just trying to get back to that 8%, the contribution of the perm side.

[Gary Elden, CEO & Executive Director]

Okay, yes. So you're thinking more about the yields, Steve, in that U.S. business in the quarter?

[Steven John Woolf, Analyst]

Yes, indeed.

[Gary Elden, CEO & Executive Director]

So yes, so in terms of that, we saw a average headcount in the U.S. in the quarter then, up 8%. And we saw -- therefore, GP was up 8%, so the yields were basically flat in the quarter, and that was our average sales headcount growth year-on-year in the quarter. And if you're interested in seeing that between perm and Contract, actually, it was, in terms of yields, pretty similar. So our Contract yields were down 1%, our perm yields were flat in the U.S. in that quarter.

[Operator]

[Operator Instructions] Okay, there seems to be no further questions at this time, so I'll hand back to our speakers for the closing comments.

[Gary Elden, CEO & Executive Director]

Okay. Thank you all for joining us this morning. And we look forward to updating you again at the full year trading update on the 14th of December. Thank you.

[Operator]

This now concludes the conference. Thank you all very much for attending. You may now disconnect.