SThree PLC

LSE:STEM

Earnings Call Transcript 2019-Q4

[Operator]

Hello and welcome to the SThree Q4 Trading Update Call. [Operator Instructions] And just to remind you, this conference call is being recorded.Today, I am pleased to present Mark Dorman, CEO; and Alex Smith, CFO. Please go ahead with your meeting.

[Mark Dorman, CEO & Executive Director]

Okay. Thank you, Sandra. Welcome, everyone, to our 2019 full year trading update. With me is Alex, our CFO.It was great to see everyone last month when we did our Capital Markets Day. And just to reiterate: We are excited that we are truly a unique business as the only pure-play STEM specialist focusing on science, technology, engineering, mathematics roles in the marketplace.As far as performance in Q4. We've got continued good progress year-on-year and growth is materially ahead of the wider market. Q4 has delivered in line with expectations. And in terms of our financial composition, Q4 is our single biggest quarter. And in terms of performance, our net fees for full year were up by 5%, driven by our international markets which now represent 86% of the group. In terms of our profitability, we expect to report our adjusted profit before tax in line with market consensus at our full year results, representing all-time record profitability for the group.As discussed at our Capital Markets Day, we're excited about the future. And we think that our performance is reflective of where SThree is positioned, which is at the center of 2 long-term secular trends really driving our results. The first of those secular trends, as we entered into the Fourth Industrial Revolution, is SThree really is at the center of STEM and placing the best STEM talent. The second is the way in which we do that is we are focused very much on another long-term secular trend, which is around flexible working both for those candidates with STEM backgrounds entering into the workforce; and as companies look more and more towards contingent and flexible working as a solution for them, whether they are searching for growth or searching for survival in today's uncertain markets.But with that, I'll pass over to Alex, and we'll go through some detail on the financials. Alex?

[Alex Smith, CFO & Executive Director]

Thank you, Mark. Good morning.So in terms of the results, the fourth quarter has cemented a strong year of trading. The figures I will comment on are for year-on-year growth for the year to 30 November. And we will, of course, be providing more depth and color to the figures at our full year results on the 27th of January.As Mark said, group net fees were up 5%, with growth across all international markets which were up 8%. We saw strong growth in the U.S., Continental Europe and APAC & MENA. DACH again was the standout, delivering market-beating net fee growth. We made management changes in the U.K. in the fourth quarter to positively impact performance against a challenging macroeconomic backdrop. The U.K. represents a small proportion of the overall group, with international markets contributing 86% of group net fees. However, U.K. does remain a good opportunity for us.The overall performance is expected to deliver an adjusted profit before tax for the year in line with consensus and as Mark said, an all-time record for the group.Contract continued to be the engine for growth, in line with our strategic focus. Contract net fees were up 8% and now represents 74% of group net fees. We saw growth across all sectors in Contract, apart from Banking & Finance. The U.S. and Continental Europe, which together represent 81% of Contract net fees, were up 17% and 11%, respectively.Permanent net fees were down 3%, reflecting a mixed performance across our markets. We are a full-service provider, and perm has an important place as part of our full solution set. It represents the minority of the group at 26%; and possesses different characteristics to our Contract business, which we went into some detail on at our Capital Markets Day. Our largest perm region, DACH, continued to perform strongly, up 5%, while the broader Continental Europe region remained flat. Japan saw excellent growth, reflecting the structural nature of the market there and demonstrating why we are committed to providing the right solutions to the right market.Finally, the strong results of the group are supported by a healthy underlying financial position, with net cash at the period end of GBP 11 million from a net debt of GBP 4 million a year ago. This is ahead of market consensus and demonstrates the highly cash-generative nature of our business model.I'll now hand back to Mark to comment on the outlook.

[Mark Dorman, CEO & Executive Director]

Thanks, Alex.So as Alex said, we've got strong performance through Q4 for the full year, but we're now into the new year, and I'm pleased to say that we've begun well in our key growth markets. And as we look ahead, I think our performance will be underpinned by we are in the right STEM markets as well as being at the center of STEM, which sets us up for the future. As we explained in our Capital Markets Day, the opportunity for us in those markets is huge. We have a scalable operational platform that supports our global footprint for growth for the future, and all of this gives us confidence in our ability to deliver growth and continue to outperform the broader market.Of course, uncertainties persist in terms of the macroeconomic and political landscape and the uncertainties around. However, guided by our purpose of bringing skilled people together to build the future, over the long term, we believe that we are better positioned than ever to be the #1 STEM talent provider in the best STEM markets.And now we'd be delighted to take your questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Steve Woolf from Numis Securities.

[Steven John Woolf, Analyst]

Just 2 for me. Firstly, in terms of Germany, and I'm thinking particularly on the Contract side, could you just give a bit more color into the industries that have performed well, bad, et cetera; maybe sort of a delta on thoughts on where they were sort of 6 months ago? And then secondly, just your thoughts post the Capital Markets Day on head count plans for the full year, sort of full year '20, if possible at this early stage.

[Mark Dorman, CEO & Executive Director]

Steve, thanks for those 2. So in terms of Germany -- and on the industry question, just so I'm clear on your question: It's about which industries and how they're performing generally in the market from our perspective. Is that the question?

[Steven John Woolf, Analyst]

Yes, that's right. And particularly, in Contract. I was sort of looking for sort of where you feel the changes were this -- sort of this trading period versus, say, 6 months ago. I'm trying to get a sight of the deltas.

[Mark Dorman, CEO & Executive Director]

Right. Okay. So look, I think, in general, just to remind everyone, in our German business, which has got strong growth, we're more exposed to Mittelstand, so the small-, medium-size enterprises, than we are to the large OEM industrial companies. And we've got strong performance in Germany, largely in Technology roles that are growing well in Contract. And in terms of the delta in Contract and the performance overall, I think it's more a function of tougher comps as we come into Q4. And maybe Alex is going to just pick that up in a minute on the specific numbers. So that's the dynamic that you're seeing there more than how we see the market in Germany in Contract. We still think it's a strong market for us, and it's performing well. And what's pleasing for us actually, it's outperforming the general market in Germany significantly.On the head count plan, again I'll give you kind of an overview, and maybe Alex can pick up some of the specific number there. We're obviously cognizant of aligning our head count growth plan relative to where we see the opportunity. I'd say, as we look towards 2020, the focus is really going to be in those key markets where we see growth, which is largely in DACH region and in the U.S. is where the focus is going to be; and more focus on productivity in some of the other markets as we manage the business appropriately for growth in 2020. So Alex, maybe you want to pick up on the Contract number in Germany.

[Alex Smith, CFO & Executive Director]

Yes, yes. So in terms of the Contract performance in Germany, it's actually what's really pleasing is that Germany grew across all sectors consistently throughout the year in terms of it was growth for even Banking & Finance which at a group level was negative for both Contract and in total. In Germany, it was positive all the way through. And it is a comp thing principally. So we did have tough comps in Q3, Q4 2018. So the comps for Contract were up 26%. And we grew 7% in the fourth quarter 2019 in Contract. That's -- so I think it's a good market for us. We're performing well. We've been investing in heads. And I think, in terms about head count investment, as we think forward, it's obviously early in 2020 to be sort of pointing to where we think the head count will be, but if the past is any guide to the future, if I just highlight where we've been investing in heads in the second half of 2019: In our DACH business, in the second half of the year, we've grown heads sequentially in the last 6 months by about 7%, 8%. We continued growing those heads in the fourth quarter. And in the U.S. we've grown our head count by 12% year-end versus where we were at the half year. So that's a significant H2 investment that you would expect to see maturing as we look forward, all other things being equal. And as Mark said, we're expecting to continue to invest in those high-growth, high-potential markets.

[Mark Dorman, CEO & Executive Director]

Yes.

[Operator]

Our next question comes from the line of Kean Marden from Jefferies.

[Kean Marden, Head of Business Services Equity Research]

Is your better net cash because organic revenue growth has slowed or because your debtor days have improved in the second half?

[Alex Smith, CFO & Executive Director]

It's a combination of the two. I think it's probably principally driven by our business model dynamics. We've made some progress on DSOs. We -- it continue to be a work in progress, but yes -- no, it's a function of the attractive countercyclical cash dynamics of the business and some effective control of our working capital.

[Kean Marden, Head of Business Services Equity Research]

Can you expand on the DSOs? So thinking about it, I seem to recall, first half there was it was sequentially flat. I think, Q3, you reduced it by 1 day, from memory. So how we looked into Q4.

[Alex Smith, CFO & Executive Director]

No. I think, when we kind of look at the position at the end of the year, we're broadly a day better year-on-year at the year-end. But there's opportunities which we're planning to continue to work through, but I think, in terms of the broader shape of the cash, cash conversion, working capital as a percentage of revenue, a lot of the things we talked about at the Capital Markets Day, we'll be looking forward to taking you guys through that in more detail at our full year results.

[Kean Marden, Head of Business Services Equity Research]

Okay. What's the target to reduce DSO by in fiscal '20?

[Mark Dorman, CEO & Executive Director]

So look, Kean, I think we've got good control over our DSO. And if I think of us relative to the market generally and the customer and terms we have in terms of where DSO is, I think we've got good control over it. Obviously, there's always work to do there. And -- but we're marginally better by a day, and we continue to focus on that moving forward as an improvement. I think the other components of the cash and our cash conversion are things we also look to work hard and making sure we've got -- we're good stewards of our cash moving forward. As Alex said, we'll go into more detail when we do the full trading at full year update in January, on the 27th.

[Operator]

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

[Andrew Charles Grobler, Analyst]

Just a couple of slightly broader ones, if I may. Could you just talk us through the dynamics in terms of candidate shortages, particularly in places like the U.S. where I know there's lots of vacancies? But can you kind of chat through how you're dealing with the challenge of finding people to put into those vacancies? And then secondly and I guess, kind of related, Contract gross margin/pricing, how that has moved through the year in some of your bigger end markets.

[Mark Dorman, CEO & Executive Director]

Andy, so why don't I take the first one, and Alex maybe will talk about the outline on the second one. So look, I think, in terms of -- we actively choose to look for supply-constrained large niches. That is where we add most amount of value. So if you think about candidate shortage in those markets, there is significant value we add to the client but also to the candidate and making sure they get the right contract and place them. And that's the core of the value that we do in terms of training consultants, to understand the niche, understand the candidate pool and make sure we are the best place for them to come to so we can give them the best opportunities moving forward. And so that's really the core of what we did. As we explained at the Capital Markets Day, we spend a lot of time and energy making sure that we understand the distinction between what we call mainstream skills and niche specialist STEM skills so that we deal with those candidate pools slightly differently to manage those pools of candidates effectively and match them with the right opportunities in the marketplace. And that's true in all of our markets, but specifically, in the U.S. we focus a lot on picking the right niche and the right markets within the niche geographically in the U.S. as well to operate it. Alex, do you want to...

[Alex Smith, CFO & Executive Director]

Yes, yes. So Andy, we will kind of give you more detail at the full year, but in terms of the headline Contract gross margin, it's 20.3%, 20.4%; and it's up by 0.4% -- about 0.6% year-on-year, ish. So 20.3% is where we are. I think it came outside 19.8% last year [indiscernible].

[Andrew Charles Grobler, Analyst]

And a couple of follow-ups just on the gross margin. Is that improvement mainly mix, i.e., Germany doing better? Or is it like-for-like across the regions.

[Alex Smith, CFO & Executive Director]

So I think, again, we'll give regional breakdowns at the full year. I will be a mixture, I suspect. In terms of that granularity, I think we'll perhaps cover that in January.

[Mark Dorman, CEO & Executive Director]

Yes.

[Operator]

Our next question comes from the line of Alex deGroote from Radnor Capital.

[Alexander Christian deGroote, Consultant]

Yes. Just 1 question, please -- and oh sorry. Firstly, I should say congratulations on the all-time pretax profit number. That's brilliant. The question relates to paragraph two of Mark's outlook statement, where he talks about the new financial year having started well. I just wondered if we could have a few more comments on that outlook with specific reference to the fact that you're actually lapping pretty difficult comps year-on-year, specifically in Europe but more generally.

[Mark Dorman, CEO & Executive Director]

Yes. So look, I think we've got good underlying exit rates in some of our key markets. So our key growth markets is looking well. And then the other metric that we focus on a lot particularly at this time of year is our level of extension rate in contracts coming out of the year because obviously that's a big end driver of our performance. And year-over-year, we're up in a good way as we exit '19 and go into 2020. So we're feeling pretty good about that. And as we explained at the Capital Markets Day, it's a big focus on how we actually manage the overall service. So if you think of our business as a platform in terms of delivering service, that full-cycle service and managing that is something we focus on a lot. So pleasing to see that we're executing well there.

[Operator]

[Operator Instructions] Our next question comes from the line of Sanjay Vidyarthi from Liberum.

[Sanjay Kumar Vidyarthi, Research Analyst]

Just a quick one on Continental Europe. Obviously, DACH very strong there, but can you talk a little bit about some of the other markets, what you've seen in other markets in Q4?

[Mark Dorman, CEO & Executive Director]

[ Sure ]...

[Alex Smith, CFO & Executive Director]

Yes. So other markets outside of Continental Europe, right? So...

[Sanjay Kumar Vidyarthi, Research Analyst]

Sorry, within Continental Europe, markets other than DACH.

[Alex Smith, CFO & Executive Director]

Okay. So shall I comment on Benelux then? So Benelux represents just over 1/5 of the group, so 21% of net fees. And within Benelux, Netherlands is 75% of that region. And the Netherlands has become a more challenging market throughout the year. There are monthly stats that have indicated for the last 3 months that the technical temp volumes in that market are down 6% year-on-year, for the last 3 months. We're seeing a performance actually which is market beating. We are the biggest player in the Netherlands market from a STEM perspective, and what's pleasing is that our Q4 performance in the Netherlands is plus 4% against a quite significant kind of a negative backdrop. That performance has been -- that year-on-year growth has been reducing throughout the year, which is not surprising given that market dynamic. So I think, look, it's that Dutch market and the Benelux region more broadly is experiencing tougher market conditions, but we're performing well against that market opportunity. And that was about 95% of Continental Europe between those two.

[Mark Dorman, CEO & Executive Director]

Yes.

[Operator]

Our next question comes from the line of [ Julian Guddart ], who is a shareholder.

[Unknown Shareholder]

Firstly, congratulations on a good set of results. I've got a couple of questions for you. The first one just relates to valuation issues. Just a bit of disclosure: I am a former owner of one of your larger U.K.-based competitors. And so I well understand the benefits of the contract model over the more perm-based approach of companies which you might be compared to like Page or Robert Walters. And it seems, though, that the lower margins that you see at kind of an operating margin level are pulling down your valuation. That's my interpretation, at least. And I'm wondering whether either there are measures afoot to increase the margin that you're charging on the Contract side; and secondly, whether there will be efforts in terms of kind of education of the market relating to the more defensive growth aspects of running the contract model, which would, if you were to view it less cyclically, produce a much bigger multiple.

[Mark Dorman, CEO & Executive Director]

Well, [ Julian ], thanks for the question. So look, there's a bit to unpack there, so why don't I take it step by step? So you're absolutely right. The dynamics of contract as a business model, so the economics around it are very different than the transactional nature of Permanent. And so there's a level of prefunding or investment into Contract, and then it pays back over time. So it's got very recurring revenue-type characteristics which is both highly cash generative and more stable and we -- gives us much more resilience and visibility into the future, which we like. And so we're very focused on making sure we understand the dynamics of that economic model. And we build our operations and our platforms around that because the focus for us really is how do we scale in the best markets because obviously, a recurring revenue-type business, the host platform characteristics is very sensitive in terms of margin expansion as you scale. And so we're very focused on doing that. And so those are the plans afoot in terms of how we drive our performance for the business, and we've got to continue to grow. We've got to scale in the right kind of markets. And of course, we get a premium, as a result of that, of about 40% on the lifetime value of contract versus the equivalent permanent placement.

[Alex Smith, CFO & Executive Director]

And [ Julian ], in terms of educating the market, we had a Capital Markets Day in November where -- which was well attended by analysts and investors, where we, well, I think, put our best foot forward in terms of talking through the business model, the attractions of a contract business, as Mark sort of outlined; comparing it to the more transactional nature of permanent; explaining the economics, the working capital dynamics; and setting out some ambitious targets or ambitions for 2024 in terms of revenue, conversion ratios of net fees to operating profits, cash metrics and then some people and some carbon targets as well. So I think, in terms of that education, there's a lot more to go, but I think we've started to make quite an impact and quite a focused effort in that area.

[Mark Dorman, CEO & Executive Director]

Yes. And I would certainly encourage you, [ Julian ], to go to our sthree.com website, on the investor page, and the webcast of the Capital Markets Day as well if you haven't done it. And you'll see what we're doing there. And we can -- happy to pick it up after this in terms of a discussion on where we are.

[Unknown Shareholder]

Would that -- that might be very helpful. I will check out the video that you've got on the web page. I wasn't aware it was there. And I think, well, we all understand the industry. And I know actually how powerful the Contract revenue stream operates in an almost countercyclical fashion, certainly bridging short dips in confidence. Second question was more around strategy and whether you have plans. I've seen, Mark, your CV's, very impressive. And you've got some great organizations but in the industries outside the just kind of pure recruitment sector, and I wondered if you had any plans for SThree to expand its markets.

[Mark Dorman, CEO & Executive Director]

So we -- [ Julian ], again, we laid out our strategy pretty clearly at the Capital Markets Day, that our focus really is on how do we scale our business and become leader in the markets we choose to operate in. We're very focused on the key markets we operate in right now, being at the center of STEM, which is a long-term secular trend that we're engaged in right now as well as being at the center of flexible working. We called it Contract, but it manifests itself very differently in the 70 jurisdictions we operate in. And so it's really about how do we make sure we grow our business within that context of those 2 long-term secular trends using our global footprint as a platform for us to grow.

[Unknown Shareholder]

So there's no plans -- sorry to interrupt. So there are no plans to move into associated areas like online lending and so on at the moment.

[Mark Dorman, CEO & Executive Director]

Not at the moment, [ Julian ], but we're always looking at new dynamics in the marketplace and new opportunities.

[Unknown Shareholder]

Actually, I'm hear -- I'm glad to hear that. I'm quite a believer in sticking to [indiscernible], so I'm very happy with your answer to the question.

[Mark Dorman, CEO & Executive Director]

Thank you.

[Operator]

Our next question comes from the line of Matthew Lloyd from HSBC.

[Matthew Lloyd, Head of United Kingdom Small and Mid]

What -- I just wanted to -- there have been a number of questions on this, but take it down a sort of notch. If I'm a salesman at SThree, what incentives, KPIs, encouragements do I have to try and get a slightly fatter markup or gross margin on a contractor? And is there any plans to tweak that, further encourage it?

[Mark Dorman, CEO & Executive Director]

Yes. So Matthew, happy to answer that question. Our incentive plans relative to our sales consultants really are aligned with how do we get the best place in the marketplace as well as how do we drive net fees. So it's not just about top line. It's also about margin, and so we have a balanced approach in terms of what that variable compensation is and the piece of the sale that the salesperson gets. Now that's different country by country, as you would imagine, because of different structures in the markets that we operate in, but we align very much pricing control as well as net fee growth to our compensation.

[Matthew Lloyd, Head of United Kingdom Small and Mid]

And any sort of attempts to tweak that so it's a little bit more aggressive? And are there any countries where volume KPIs are a larger proportion...

[Mark Dorman, CEO & Executive Director]

Well, so it varies -- it very much varies market to market, and that's largely driven by a couple of factors. A, what's the norm within that employment market? Because we've got to attract talent and make it an attractive place for people to work. So we're competing with other employers in the marketplace. And then also, what's the makeup of the structure of the market we operate in? So we've talked a little bit today about Netherlands and Germany. And those are 2 very different structural markets. So if you imagine Germany: We are more focused on Mittelstand, small- and medium-size enterprise. And in Netherlands, just because of the makeup of the economy, we're more in global corporates. And so you can imagine the compensation scheme to incentivize people to engage with those 2 very different types of clients are structured differently to get the right kind of behavior.

[Matthew Lloyd, Head of United Kingdom Small and Mid]

And you've been there 6 months. Is it all as good as it should be, or do you think there is room for improvement in how you incentivize staff?

[Mark Dorman, CEO & Executive Director]

Well, the great news about sales forces, Matthew, as I find in my entire career, is they can never be truly -- there is always opportunity to optimize them, and they will never be fully optimized.

[Matthew Lloyd, Head of United Kingdom Small and Mid]

I'll grant you that. Very well.

[Operator]

Thank you. And as there are no further questions registered, I will hand the word back to Mark and Alex for closing comments.

[Mark Dorman, CEO & Executive Director]

Well, thank you, everyone, for a good Q&A session today.So very pleased with our results, and thank you for joining us this morning. We look forward to updating you at the time of our analyst update, which is on the 27th of January next year. So do have a good, festive period and a good new year. And we'll see you in January. Thanks, everyone.

[Operator]

This now concludes our conference call. Thank you all for attending, and you may now disconnect your lines.