TechnoPro Holdings Inc

TSE:6028

Earnings Call Transcript 2021-Q1

[Toshihiro Hagiwara, executive]

[Interpreted] This is Hagiwara, CFO of TechnoPro Holdings. Thank you for your time today.

Since our previous full year earnings announcement, we've had numerous opportunities to talk with investors and received many suggestions that our first half guidance, particularly for second quarter, may be too conservative. The level of this guidance is not in the middle of our forecast range, but rather in the bottom range, which we could achieve for sure. And we have communicated that we will revise our first half guidance, if necessary, based on September renewal rates and first quarter results. And today, we are announcing an upward revision to our first half guidance.

In terms of the current KPIs, the utilization rate has rebounded to 93.9% at the end of September, and the contract renewal rate for September, this is when approximately 70% of the total engineers were up for renewal timing, actually landed at 92.5% compared to our initial assumption of 85%, resulting in roughly the same level as the previous year.

This has led to a higher headcount of engineers starting their assignments from October 1, and we are getting visibility into Q2. However, if you ask whether the whole tech human resource service industry has hit the bottom under this COVID impact, we are not yet optimistic.

Unit sales prices are weakening due to a decline in overtime hours, and customer requests for higher technical skills is increasing. So we feel that demand has not yet returned to the point where we can immediately assign even inexperienced engineers to a new position like we used to. Even if we are able to successfully renew our contracts in December, we still need to watch carefully, how much renewals we get in March as customers with their fiscal year ending in March will begin drawing up their new budgets starting January and that will affect our business.

So for your information, the proportion of renewals against the total number of contracts is 55% for December and 80% in March. So you can see how important the March renewal is for us. Nevertheless, there are some positive signs emerging in certain technology areas.

I will now provide an overview of the Q1 results, KPIs, future outlook and policies. First on Page 2. The Q1 sales were JPY 39.1 billion, flat versus last year, and operating income was JPY 4.3 billion, up 12.2%. And net income was JPY 2.9 billion, up 11.8% from the previous year. From this time and on, we are disclosing the core operating profit, which is calculated as gross profit minus SG&A. The purpose of this is to eliminate the effect from extraordinary items, such as foreign exchange profit and losses, impairment loss and others.

I assume many of you calculate the business core profits yourself. So please note that this fiscal year, we will also add in that government subsidy for employment adjustment, and this is unique to COVID. In Q1, we recorded about JPY 500 million in other income. And also, we expect the same amount in Q2, so the operating profit will also increase.

The year-on-year growth rate of this operating profit base was only 4.2%, and gross profit margins were 1.9 points lower than last year, again, due to higher standby costs, resulting from lower utilization rates and lower unit sales due to reduced over time. On the other hand, the SG&A decreased by approximately JPY 800 million versus last year. It comprises 12.9% of sales, and this is an improvement of 2.2 percentage points versus last year.

The largest reductions were seen in recruitment, advertising and travel expenses. The former is an upfront investment and will rise to pre-COVID levels as we revamped hiring going forward. We believe these costs can be fully absorbed by the high utilization rate and GP margins as we should be on recovery track by then. And we will continue to control travel expenses, keeping an eye on OP margins because traveling will continue in the post-COVID days.

On Page 3, we show quarterly net sales and operating income. Since our last presentation, we began to disclose domestic operating hours per day in addition to operating days in the R&D and construction management segments. While the number of working days is affected by the calendar alignment of holidays, overtime, paid leaves and non-billable furloughs, the working hours have recently been on a downtrend due to increased telework and customer budget controls.

In Q1, the operated hours per day was 8.44 hours. While this is a slight recovery from the 8.39 hours in Q4. It is still down 0.12 hours year-on-year. Or in other words, minus 2.43 hours per month in 20 working days, down 1.4% year-on-year, which is one of the reasons for the decline in unit sales. For Q2, we expect 8.41 hours per day, down 1.7% year-on-year.

On Page 4, we have the Q1 performance by segment. In the domestic R&D and Construction Management Outsourcing segments, which account for more than 90% of consolidated sales and operating profit, the year-on-year operating profit growth rate was greater than that of sales because of the government subsidy absorbed in the increase in standby costs, and also because the SG&A reductions took effect. The domestic others segment fell into the red despite the absence of extraordinary items such as impairments. However, we aim to catch up in Q2 so that we can avoid making a loss in the first half. The technical training business is on the road to recovery, but the staffing business is likely to take some time to recover due to customers' hiring restraints due to COVID. The overseas segment is still small in scale, accounting for only 6.2% of consolidated sales and 4% of operating income. So we were able to maintain profitability despite lower sales and profits year-on-year.

On Page 5, we have the balance sheet and cash flow statements. Since COVID was expected to have a serious impact on the economy, we secured financial reserves and diversified our funding options to prepare for emergencies by increasing our commitment line for working capital, and obtaining an external credit rating that allows us to issue corporate bonds in the market.

At the end of September, we newly raised JPY 10 billion through a new syndicated loan to extend the loan period and to equalize the principal repayment amount. At the end of June, we had a total of JPY 7.6 billion in debt outstanding and principal repayments of approximately JPY 3 billion per year over the next 2 years. The 5-year equal repayment loan, this new one, which is intended to refinance existing loans, helped to reduce the annual principal repayment to JPY 2 billion. And with a JPY 2.4 billion increase in the loan, we were able to slightly increase our liquidity on hand. The balance of the loan as of September end was JPY 12.7 billion, and we plan to repay the portion exceeding JPY 10 billion by the end of November as it is a part of the existing loans.

And on Slide 6 to 10, we have laid out the KPIs. On Page 6, the average utilization rate for the first quarter was 92.7% compared to 91.5% expected at the beginning of the fiscal year. The utilization rate is calculated by dividing the number of active engineers by the total number of engineers at the end of each month. But under a hiring freeze, the denominator becomes smaller due to retirement. So even if the numerator does not change, the utilization rate will improve.

The Q1 utilization rate gradually recovered from 91.5% in July, 92.6% in August and 93.9% in September. But it was not just the effect of a smaller denominator. The numerator for the number of engineers working also increased from July to September. Our sales reps and also our customers are gradually becoming more comfortable with a new with-COVID style of sales activities and contract negotiations, and thanks to this, new assignments moved faster than originally anticipated.

But on the other hand, many competitors fight for the same order, and the competitive environment is intensifying. And the length of time between assignments is becoming longer. So we do need to monitor this carefully. Even though our contract renewal rate in September was 92.5%, the number of engineers returning to the bench with an old renewal is still over 1,000 in head count.

Assuming that reassignment proceeds smoothly, we expect an average utilization rate of 93.9% in Q2. Now this is a significant improvement from our initial assumption of 86.5%, but it is still down 2 percentage points from 95.9% in Q2 last year. The utilization rate on the bench model is an important KPI for management because it directly affects gross profit margins to the standby cost.

And now this bar chart shows that temporary hiring freeze has reduced the number of engineers, which is a driver of sales growth. Although we have resumed mid-career hiring in some technological fields, the number at the end of September was 20,631, down by 633 or a 3% from 3 months ago.

At the end of December, the number is expected to drop to 20,200, meaning that the number will revert to the level it was at the end of March before the addition of 1,364 new graduates who joined in April. Although some of these 1,364 new graduates have been postponed until after October, almost all of them are likely to be allocated.

Page 7 explains the trends and recruitment and turnover. The number of mid-career hires in Q1 will be just 59, half of them for the R&D segment already hired before the hiring freeze. And the other half for the Construction Management Outsourcing segment, in which we have already resumed hiring.

In Q2, we have already resumed hiring, not only for the construction management field, but also IT and biotech engineers, too, from which resources have been depleted. For the past year pre-COVID, we have hired around 3,000 mid-career workers every year, and this is an average of about 250 per month, and we believe this displays our hiring power. As I mentioned in the beginning, the quality of skills required by orders is changing in these technical fields as well. So we will prioritize on hiring experienced people who can get onto their assignments immediately for now. Therefore, we expect to hire 50 to 100 mid-career workers per month over the next few months. And from the beginning of the year, we will flexibly determine when to accelerate hiring while keeping an eye on the utilization rate, the number of new assignments and the contract renewals in March.

As of now, we plan to hire approximately 300 new graduates who will join us in April next year. The number of retirements of full-time and contract employees will remain at the same level as last year, a monthly average of 200. But we had 692 retirements in Q1, and so we are pacing faster than expected. The number of contract employees who account for about 10% of our engineer base has risen slightly. But also the retirement rate for full-time employees is not improving, yet. So we will continue to work on this issue.

Page 8 shows the assigned engineers portfolio by technology, and Page 9 by industry. Over the past year or so, we've repeated the same explanations. But in terms of technology, mechanical and hardware engineers in the machine, electrical, electronics deals, we've seen a decline. And by industry, the demand for transportation equipment is slowing. On the other hand, we see recovery in semiconductor-related field.

On the other hand, we are aware that demand for IT engineers is strong, both in the midst of this COVID disaster and in anticipation of the post-COVID times. So in this economic environment, we plan to continue investing in education and training at the same level as in the previous years, with a focus on shifting skills from the hard technology domain and acquiring new fields for soft engineers. And on recruiting engineers with digital technologies such as data science, Cloud, ERP, IOT, security and 5G.

This investment in education and training and the variety of attractive project opportunities for our engineers will surely become the differentiating factor that will help us outpace the intensifying competition for IT engineers.

The monthly average unit sales price for Q1, shown on Page 10, was JPY 620,000, down 1% from a year ago. Although overtime continues to decline, the turns that we achieved at the timing of March contract renewals this year have been successful, and the unit price per contract for existing engineers as of the end of September this year was 3.4% higher than a year ago. And despite a decrease in number of working days and overtime hours and with the work-style reform, and also the dilution caused by the mass hiring of new graduates and younger career employees, so we recently have been able to increase base charges and maintain the average unit sales price at a certain level. However, we expect the monthly average unit sales to be down about 1% to 2% year-on-year due to COVID.

Page 11 shows the dividend forecast. We have left the interim dividend as TBD until now but we now forecast it to be JPY 50 per share and plan to maintain our annual dividend payout ratio of 50%. We plan to disclose our year-end dividend forecast when we release our full year guidance.

Page 12 is the part on future outlook and policy, but this will be a repetition of what I've already mentioned, so I will not go through the explanation.

Page 13 shows the first half revised guidance along with the KPIs on which it is based.

And Page 14 shows this by segment. Please note that unlike the previous guidance, the latest profit forecast includes the JPY 0.5 billion in the government subsidy, the employment adjustment subsidy, which is expected to be recorded in Q2, which makes a total of approximately JPY 1 billion in the first half. Sales are expected to fall 1.9% year-on-year for the first half. But operating income is expected to rise 3.4%. However, if you exclude the JPY 1 billion subsidy I mentioned earlier, the final figure will be JPY 7.5 billion. So the profit has actually decreased.

Our revised guidance is again based on a bottom case scenario, which we will expect to achieve for sure. So we will continue to manage our business prudently as we remain cautious about the economic outlook. Regarding the full year guidance, we hope to disclose it at the timing of the announcement of Q2 financial results, and this is when the contract renewal in December will be fixed, and we gain better visibility in the coming March contract renewal.

Finally, today's script will be posted on our website as soon as possible, so please refer to it later on.

And this concludes my presentation. Thank you for your attention.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]