TechnoPro Holdings Inc

TSE:6028

Earnings Call Transcript 2021-Q2

[Toshihiro Hagiwara, executive]

Hello. This is Hagiwara, CFO of TechnoPro Holdings. Thank you for your time today.

In Japan, the spread of the coronavirus infection has not been controlled, and the state of emergency has been declared for the second time this year. Although the outlook will continue to be unpredictable, we and our customers have become fairly accustomed to dealing with the COVID virus. And so far, there has been no major confusion like the last time when our sales activities and new allocations to work were severely restricted.

So the December contract last year, the renewal went well, and Q3 started with a normal utilization rate of 95%. This time, we are announcing our full year guidance based on our first half results and our outlook for the second half. As mentioned before, March is a major month of contract renewals, and so the Q4 forecast will be greatly affected by how many contracts we can properly get renewed.

So in the latter half of our briefings today, Mr. Nishio will confirm the current KPIs and touch on specifics, such as conditions for March new renewal rates and future hiring policies.

I will now explain the results and KPIs for the first half as well as the outlook for the second half. Please look at Page 2 of the deck.

First half revenues were JPY 79.4 billion, basically flat versus last year. And operating profit was JPY 9.7 billion, up 17.7% from the previous year, including JPY 1.33 billion of government subsidy for continuous employment. So if we exclude the subsidy and other extraordinary items, the operating profit was JPY 8.3 billion, which is up 2.2% versus last year.

Compared to the guidance we gave previously when we announced the Q1 results, there is an increase in the first half of about JPY 2 billion in net sales and JPY 1.2 billion in operating profit. This upside in sales can be explained by the fact that Q2 average utilization rate and monthly average unit sales prices were better than expected. And the upside in operating profit comes from the same reason and an additional JPY 300 million in employment subsidy recorded ahead of schedule.

We continue to cut back on travel expenses under the pandemic, and recruitment advertising expenses did not increase so much either due to the delay in starting our recruitment activities in Q2. So the run rate of SG&A is still kept at around JPY 1.7 billion per month.

Looking at Q2 or even looking at the entire first half, the fact is that the decline in gross margin was compensated by the SG&A improvement, and core operating margin was maintained on a year-on-year basis. And even under flat sales, core operating profit was maintained at about the same level as last year and operating profit has been increased with the employment subsidy. However, we cannot expect for year-on-year growth in operating profit because the year-on-year number of engineers at work will start to decline in Q3, and the sales unit price is not expected to rise for a while. So revenues and core operating profit in the second half will be less year-on-year.

In addition, the income from employment subsidy will taper from Q3 onwards as the utilization rate recovers. In addition, as mid-career hiring gradually starts to take off in the second half, SG&A expenses will increase due to upfront recruitment and advertising expenses, and so the operating margin will be lower than the first half. However, this means we are returning to growth, a positive sign from the perspective of mid- to long-term value creation.

On Page 3, we have the quarterly performance of revenues and operating profits. In Q2, although the number of operating days increased slightly year-on-year, the domestic operating hours per day decreased by 0.09 hours or 1%. Previously, when we announced our financial results, we had estimated that operating hours to fall to 8.41 hours per day. But instead, we came to 8.47 hours, slightly higher than the Q1 result of 8.44 hours. This may lead you to believe that the decline in overtime hours have bottomed out. But we actually see more tail work again under the second emergency declaration, and so we're not yet optimistic about Q3 and beyond.

At the bottom of each table for revenues and operating profit, we have here the year-on-year comparisons. And you will see the turn to negative in the second half of the year. Although the Q4 operating profit is up by 4.4%, we still expect negative growth on a business profit basis because last year's figure, JPY 2.7 billion, is the result after a goodwill impairment of JPY 900 million.

On Page 4, we have the results by segment for the first half of the fiscal year. In the Domestic R&D and Construction Management segment, which account for more than 90% of consolidated revenues and operating profit, the trend remains the same as in Q1 and that the year-on-year growth rate of operating profit is greater than that of revenue due to SG&A reductions and employment subsidy.

In the R&D segment, the number of engineers at the end of Q2 was still higher than a year ago due to the hiring of new grads in April last year. However, the number of foreign engineers living in Japan decreased due to the pandemic.

In the Other Businesses in Japan segment, which fell into the red in Q1, and we have been telling you that we hope to catch up in Q2, actually landed in the black ink with JPY 26 million in the first 6 months. However, the permanent placement business being a slow business still continues to face a difficult situation.

And in the Overseas segment, although sales declined slightly year-on-year, margins improved and achieved growth in operating profit. Details by country are explained on a separate slide.

On Page 5, we have the balance sheet and cash flow statement. We have completed the refinancing of existing debt with a syndicated loan of JPY 10 billion raised in September last year, and we have leveled out the schedules for the principal repayments. We have so far not used the commitment line for working capital that we prepared as a countermeasure against the COVID virus, and we perceive our financial base to be currently stable.

Even in the pandemic, we have been continuing our M&A sourcing activities, and we are starting to see some interesting deals that fit our growth strategy, which we are formulating in our new mid-term plan. We are currently in a net cash position of about JPY 18 billion and have JPY 10 billion line of credit ready for M&A. So we will actively pursue M&A as a means to accelerate our business transformation for sustainable growth.

Pages 6 to 10 show the major KPIs that we have been disclosing on an ongoing basis. Page 6, the average utilization rate for the first half of the year was 93.7%, finally returning to 95% at the end of November last year and 95.6% at the end of December.

In conjunction with the release of our guidance for the second half of the year, this graph also shows our forecast for the number of engineers and utilization rate in Japan. In the third quarter, the number of engineers is expected to decline less than in the first half due to an increase in mid-career recruitment, while the utilization is expected to remain above 95%. In the fourth quarter, we expect the utilization rate to drop temporarily in April as in other years due to approximately 9 -- 1,900 employees due to nonrenewal of the contract in March and 300 new graduates joining the company, but we do not expect the rate to drop below 90% as it did last year. We will aim to stop the decline in the number of engineers by hiring more than turnovers. A number of engineers as of July 1 this year will be the launch pad for next year's performance, and the key will be to steadily increase the number of mid-career hires every month through June.

Our stock-based sales are composed of a number of engineers, the utilization rate and the sales unit price. Against the backdrop of COVID-19, we have prioritized returning the utilization rate to the normal level. First, at the expense of giving up increasing the number of engineers and raising the sales unit price because maintaining the employment of existing engineers and securing the profit margins are the most important issues. Through these efforts, we have been able to overcome the issue of improving the utilization rate, and we will now enter the phase of renewed growth where we will increase the number of employees while maintaining the utilization rate. Of course, the speed and rate of the growth will depend on the balance between demand, such as customer needs and supply, such as the procurement of human resources. So we will reflect this in our plan for the next fiscal year, the first year of the new medium-term management plan based on the renewal of contracts in March and the progress of full scale mid-career hiring.

Page 7 shows the trend of recruitment and turnover. The number of mid-career hires in the 3 months of the first quarter was 59, while the number doubled to 117 in the second quarter. The number of employees by technology field has been disclosed in -- is part of the document.

In the previous announcement of the financial results, we said that the pace of mid-career hiring after the resumption of operations, which start at around 50 to 100 employees per month compared to the usual 250, but the ramp-up has been slower than expected with 30 employees joining in October, 39 in November and 48 in December. For your information, the number of employees we joined in January was 88, showing slight recovery. The delay is due to the delay in forming a population of applicants and that it takes some lead time for applicants who are still working to accept the job offer and actually join the company.

Although the turnover rate is usually relatively low in the second quarter, which includes December, the month of winter bonuses, there has been no decline in the turnover rate in terms of LTM. The number of turnovers for the current fiscal year, including both permanent and fixed-term employees, is progressing at the same pace as the previous fiscal year, an average of 200 per month. And the number of engineers in Japan has decreased by 1,075 on a net basis since the end of June last year.

Page 8 shows the distribution of engineers by technology, and Page 9 by customer industry. The trend is largely unchanged from the previous quarter, so please refer to it.

The average monthly sales price of this year, shown on Page 10, was JPY 628,000 for the first 6 months of the fiscal year, down 0.4% from the previous year, mainly due to a decrease in overtime hours and the dilution of unit prices caused by the completion of the assignment of more than 1,300 new grads. The contract unit price of existing engineers on assignment as of the end of December last year was 2.6% higher than a year ago. But after a successful charge-up at the time of contract renewal in March last year, it was difficult to raise the charge at subsequent contract renewals. The increase was smaller than 3.4% year-on-year increase at the end of September. We have not seen much of charge-downs at the time of contract renewal. We understand that the inability to raise unit price of contracts at any time is a result of business operations that prioritize utilization rate.

Page 11 summarizes our overseas subsidiaries, which are still small in scale, but are frequently asked about by investors. We have been updating the status of management at Helius, which recorded an impairment loss in the fiscal year ended June 2007 every 6 months. This time, in this report, we have included our subsidiaries in China and the U.K. The scale of the vertical access of all 3 companies is the same. So if you compare them horizontally, you can see the scale of each overseas segment.

First of all, our Chinese subsidiary is expected to grow significantly in the current fiscal year, in line with the economic recovery in China after the successful control of COVID-19. Most of our customers are Japanese companies, and we have secured a high profit margin mainly through offshoring from Japan and transactions with Japanese companies local subsidiaries in China. This is an ideal form of global collaboration that leverages our Japanese customer base.

The mainly IT-centric Helius has also seen some recovery amid COVID-19. And Helius' Indian subsidiary is growing rapidly this year, although it still accounts for about 10% of the group sales. Although the lockdown by COVID was severe in India, the impact on the business is limited due to the strong demand for IT personnel and telework support. I realize the importance and future potential of India as a center of excellence for offshoring and cutting-edge technologies based on its abundant human resources.

Lastly, Orion in the U.K. experienced a significant decline in the fourth quarter of last fiscal year, but has gradually recovered since the beginning of this fiscal year. Although the spread of COVID pandemic in the U.K. is a risk factor, we currently do not expect a significant deterioration in business performance from the third quarter.

TPRI, our Indian subsidiary established in September last year, is still small in scale. So it is omitted from this report.

Page 12 shows our guidance for the second half of the fiscal year, and the KPIs that form the premise of the guidance is also shown.

Page 13 shows the slide by segment. As in the previous guidance, the JPY 300 million in government subsidy for continuous employment adjustment, to be posted in the third quarter and thereafter, has been factored into operating income. And while the third quarter results are mostly predictable, the fourth quarter results will be greatly affected by the contract renewal rate in March this year. So we have disclosed the results separately. For your information, we have assumed that the contract renewal rate for March will be 87.8%, down 1.5% percentage points from the same month last year.

Our guidance for the full year based on the actual results for the first half of the year and our forecast for the second half is for net sales of JPY 156.5 billion, down 1.2% year-on-year and operating income, including JPY 1.63 billion in the employment subsidy, to increase 7.8% year-on-year to JPY 17 billion. Although the full year forecast for the net sales is not very conservative, I hope you understand that operating income is a figure that we must achieve as a management team.

Page 14 shows the trend of dividends. The interim dividend for this fiscal year will be JPY 50 per share, as usual, and the year-end dividend is expected to be JPY 111 per share or, in total, JPY 161 per share for the full year based on the assumption of the payout ratio of 50%, in line with the aforementioned guidance for the full year.

That is all for my explanation. Thank you very much for your attention.

[Yasuji Nishio, executive]

Yes, I am Nishio, representative of TechnoPro Group.

I would like to, first of all, begin by explaining our current thoughts and response to questions from our investors and financial institutions. So there are 3 main questions that we are receiving, and the first is the latest KPIs and the timing of business recovery. The second question, related to the first one, is the timing as to when we will return to full-scale hiring. And the third is about our resilience to external shocks in the engineering professional services.

So first of all, in regard to the current KPIs, please refer to Slide 3 of the PowerPoint presentation files we distributed in advance. It shows the number of active engineers at the end of each quarter since September 2018, and the number of engineers whose contracts are up for renewal in light gray and the number of those whose contracts were not renewed and returned to work in dark gray. Also, the blue line graph shows the renewal rate for March, June, September and December. Most of the staffing contracts cover a period of 3 months, and the largest number of contract renewals occur in March, which is the fiscal year-end for most of our clients with 70% to 80% of the total number of contracts coming up to an end. And the next largest renewal happens in September, followed by June and December. The results of these contract renewals every 3 months have a significant impact on the business performance in the next quarter.

The renewal rate in March is usually slightly below 90%. And in other months, it is usually around 92%, give or take, 1 percentage point. This is the normal state. And the reason why the renewal rate in March is below 90% is mainly because many of our clients' development projects end as the fiscal year closes. And almost 2,000 temporary staff contracts end, so we assigned them to other clients intensively during the month of April and May. And with new employees joining in the month of April, Q4 is when the utilization rate becomes the lowest of all.

So the renewal rate in December last year was 92.8%, which was 0.9% better than the previous December. So we have good visibility into the profit and loss for Q3. The remaining key is how we estimate the Q4 profits, which will depend on how we view the renewal rate in March.

So as we've explained, when we prepared this year's annual guidance, we set the renewal rate for March at 87.8%, which is 1.5 percentage points lower than March a year ago. To terminate a contract, one month prior notice is required so we will have better visibility by the end of February. But unfortunately, as of today, we do not have the results yet.

Although we are under a state of emergency due to the pandemic, we believe that we can somehow mitigate the deterioration of the March-end contract renewal rates compared to last year.

There are several reasons for this. Firstly, the current recession has had a tremendous impact on the service industry and the transportation and tourism industries. But fortunately, the impact on our core customer base, which is manufacturing and construction industries, have been relatively small. Secondly, as a result of the bold fiscal stimulus measures taken by the government, financial concerns have been quickly removed. Thirdly, various measures to maintain employment, which were more generous than expected, including tangible and intangible pressure on large corporations, is prevented rash staffing cuts. So fortunately, this led to a prevention of our staffing cuts on our part. And fourth, there is a shortage of technical personnel in Japan, especially in IT. And lastly, we believe that there is a rapid spread of telework. So with all the reasons I just mentioned, we expect the March and renewal rate to be 87.8%, taking into account the hearings from customers last month in January.

On Page 4, we have a graph of the utilization rate by technology field since September 2018. Although we usually view 95% to 96% as the appropriate level of utilization rate, but as you can see on this graph, the utilization rate rapidly declined until June due to the large number of employees returning to the bench at the end of March last year and more than 1,300 new grads joining the company, coincided with the declaration of the state of emergency. And since July, the utilization rate has been improving in the construction field, IT, chemical and biotech fields, and gradual recovery in the machinery, electric and electronics field as well. So the average utilization rate for the group was 95% in November and 95.6% in December, returning to normal mode. Even the average utilization rate during Q3, 3-months average will be maintained at 95% assuming the December renewal rate I mentioned earlier. So the bottom line is that the utilization rate is back to normal.

On Slide 5, we have the graph showing the number of orders received by technology fields. So if you look at this, you can see that last year in Q4, the number of orders from all fields declined due in part to major restrictions on sales activities caused by the state of emergency. However, since then, the orders in the IT field, chemical and biotech fields and the construction field have recovered to almost the same level as before. Just one exception is the machinery, electric and electronic fields where the orders are not quite back. But when you pay attention to the details, you can see that the level of business experience and technology levels required by customers have become higher than before, not just in the machinery, electric and electronic field, but also in the IT and construction fields. So the customers are still quite prudent in terms of quality of our engineers. Therefore, we believe that it is still too early to fully implement our initiative of hiring, training and finding inexperienced workers, which used to be one of the pillars of our business that helped us grow in the past.

Next, on Slide 6, we have the trend in number of hires. We've probably been the most rigorous player in reducing the number of new employee hires in this industry, and you can see that the results are clear in the graph. Taking into account the recovery in the utilization rate and the orders, as I explained earlier, we have resumed selective hiring of experienced workers for the construction field from summer as well as for the IT and chemical biotech fields from early fall. However, the impact of the temporary hiring freeze we've done has been significant, and we are still in the process of creating a pool of applicants. The number of new grads is down to 300 coming in, which is a reduction of more than 1,000 compared to the previous year. So if the March-end renewal goes smoothly, we will undeniably be short of resources.

As for the future outlook, as I explained earlier, we are not yet in a situation where our customers are willing to take on even those with no experience. So for the time being, we will focus on those with experience. And as Mr. Hagiwara explained, we are aiming to hire 300 new employees in the third quarter, mainly in the IT and construction fields. Then including the 300 new graduates who will join the company in April, we expect the number of engineers in the company to return to the same level as the previous year by the end of June. Therefore, the resumption of full-scale recruitment, this is the second topic, which is a major issue in the first half of the next fiscal year.

In our business, if we stop growing, as was mentioned by Hagiwara, we will be able to reduce our expenses significantly, especially recruitment and training costs. And for the time being, our profit will look higher than they actually are. On the other hand, when we resume growth, hiring costs and training costs will be brought forward. So we will need to carefully assess the balance between growth and securing profit as well as the content of customer orders. As I said, they were rather cautious in order to determine the turning point for business operations, including development and hiring. We believe that we will probably not see a full-scale resumption of hiring, including development, until the beginning of autumn when vaccination will have been administered throughout Japan and the spread of infection will be controlled.

Next, I'd like to move on to the third most frequently asked questions, which is the degree of resilience to external shocks. Please see the slide on Page 7. This slide shows the increase or decrease in the number of new job openings by occupation 6 months after the occurrence of an external shock using statistics from the Ministry of Health, Labor and Welfare during the Lehman shock and the COVID. As you can clearly see, during the Lehman shock, production process workers and the engineers were greatly affected. But this time, other fields were also severely affected, and as a result, the impact on any year was relatively small. This is because, as I explained earlier, from the standpoint of competitiveness, from the standpoint of digital transformation, which has suddenly increased due to the pandemic, and from the standpoint of a shortage of human resources in the first phase, I assume that priority is being given to technical personnel. Although it may not be in line with your expectation of growth, I believe that the degree of resilience of our business to external shocks is increasing, indicating that our business foundation itself is becoming stronger.

Today, I would like to talk about ESG initiatives, our own digital transformation initiatives and the progress of our new medium-term management plan. First is about our ESG initiatives. Please refer to Page 9. The group has selected 4 things as the group's materiality, which are related to the 17 goals of SAG, and have set a total of 20 specific achievement targets for each theme, which have been disclosed as KPI since we announced the integrated report 2 years ago. For details, please read the latest integrated report issued in December last year. Through the initiatives set out here, we aim to achieve sustainable growth by contributing to the resolution of social issues through our business.

In addition, on the right side of this slide, you can see the changes in our ESG score according to MSCI. And I'd like to take this opportunity to inform you that we scored AA last year. We have been asked by the Public Relations and Investor Relations department to emphasize this point today. And I hope you will remember that we are included in the MSCI ESG Fund Index.

The next topic is the company's own digital transformation. As you can see on Page 10 of the slide, our group employs about 10,000 IT-related engineers. And we have been hiring and training so-called DX personnel, such as data scientists and people who can utilize cloud technology. We have been hiring and also working on the development of these people. In the future, we will, of course, further strengthen our business development in this field, but we would also like to review our business promotion system from the perspective of DX to improve the efficiency of our operations and to reform our business process.

For this reason, as shown on Slide 11, I became the director in charge of the group's Systems division 2 years ago and have been constructing a talent management system and promoting the development of a core business system in order to reform our business processes. For the replacement of the company's core business system, we have completed the requirement definition and studied the development in January this year, which is scheduled to be completed in 2 years' time, in January 2023.

As shown on Slide 12, several subsystems of the talent management system are now in operation. And on the sales front, we have almost established a system for receiving information from engineers using IT, which has been very effective, especially in the face of restrictions on sales activities due to the COVID. It has proven to be quite effective. In addition, we have been using the sales management system of Salesforce, Inc. for a long time, but we have decided to replace it drastically along with the replacement of the core business system.

In 2023, we are planning to merge the talent management system with the AI engine and the new sales management system to achieve total optimization tallies, optimal matching and the assignment for engineers, customers and the company. That's how we are looking at it.

The last topic of today's presentation is a concept behind the formulation of the new medium-term management plan, which is shown on Page 13. Due to the COVID pandemic, we had to suspend the formulation of the plan in February last year, but we resumed discussions in October last year. What is unique about this year's plan is that it involves all of the outside directors and auditors and it envisions what we want to be in the next 10 years.

In addition to the changes caused by COVID, I would like to present the direction to the group's evolution based on the assumption of various changes, including technology innovation and changes in the industry map to achieve carbon neutrality. So various changes to be taken into account, and we try to show the direction of evolution of the group as a whole. We have already spent a total of more than 40 hours discussing this matter with all of our directors, including independent directors. And we were able to listen to a very objective way of thinking about things from the independent directors. So we'd like to publish this report in conjunction with the announcement of this year's financial results in -- before that fully incorporates objective opinions. So we will announce that in July.

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