SThree plc (STEM) Earnings Call Transcript & Summary

Welcome, everyone, to our half year results for the 6 months ended 31st of May 2021. Now today, I'm joined by Alex Smith, our CFO. And I'm also joined by Andrew Beach, our CFO, Designate. You will have all seen the announcement that Andrew has joined SThree in recent weeks as our CFO Designate and was formally appointed to the Board last Thursday. However, for the purpose of the call today for delivering the first half results, we're still in the highly capable and experienced hands of Mr. Alex Smith, my great partner as CFO. And so he will be taking you through the results today. And you can look forward to speaking to Andrew in the coming weeks and months, and he'll update you on our Q3 trading update and for the full year results in January 2022. So with that out of the way, why don't we get started with the presentation. So I think it's important just to remind everyone that our purpose drives everything we do at SThree. We bring skilled people together to build the future. And as we go through the results, our focus on our purpose and our focus and our ability to execute our strategy of being at the center of those 2 long-term secular trends, that being of STEM talent. So the great skilled people in life sciences, technology and engineering and as well as the long-term move to flexible working really has underpinned our performance. That, in combination with the great people we have at SThree, the resilience and their ability to adapt to the unprecedented conditions, certainly over the last 18 months really is the foundation and the ability for us to execute. But we are unique. We are the only global STEM staffing company, and that really helps us with our performance. So on our strong financial performance for the first half, you'll see that, importantly, our net fees grew against 2020, but even more importantly, we're up 3% versus 2019 in the same period. Our profit has increased against our 2020 base and by triple digits. But importantly, I think it's good to highlight that we're also up double digits versus 2019. That amounts to improved performance and real growth in our EPS to 14.4p, up 140% versus 2020, but importantly, again, up double digit in 2019. And so how have we done this? It's been with our clear strategic progress and our ability to move our strategy forward. And so if you'll recall, in previous updates, we shared the framework that we look to operate in within the current pandemic environment that laid out into 3 stages. One was our initial response. The second phase is the phase that we're still doing, which is ongoing management of the crisis. And ultimately, and hopefully, when everyone is vaccinated, we'll get to some version of the new normal and recovery. Right now, we're still in this ongoing management phase, and we've continued to execute against our strategy whilst inventing new ways of working. You'll remember that our position in terms of this ongoing management was that we would learn, adapt and adjust our business so that we could operate effectively regardless of the external conditions. And I'm pleased to say that our people, the backbone of our business and their ability to be resilient and perform really are helping us develop and improve assign our strategy regardless of the environment. That has led to our strong financial performance and our ability to really impact people's lives in the way that we do. You'll see in the top right there that we're continuing to deliver impactful work with over 16,500 people and their lives positively impacted, which includes replacement of over 10,300 people in new roles. And as we do that, we're very proud that we're making progress on our broader commitments to society, we'll be early adopters of TCFD disclosure. And very pleasingly, we were 69th of the top 300 companies in the FT's recent Climate Leaders list and the only company in our sector to make the list. So great work by our teams and their resilience and ability to perform regardless of the environment, aligned with our strategy and our ability to execute. And if I think about this delivering of impactful work, which is core to us bringing skilled people together to build the future, I thought it would be good to highlight 2 of these stories. And the types of real talent that we deliver into the market for our clients and the impact that they are having on the broader world. So on the left here, you have us building -- helping to build a sustainable world by placing 12 commissioning experts in helping to deliver an offshore wind farm as the entire energy complex is rethought and renewed towards renewables. And on the right, we delivered 12 -- sorry, 10 subject matter experts to help our clients navigate through in the pharma industry and through medical devices to be able to navigate through complex compliance requirements in order for us to deliver innovation into health care more generally. And as these individual stories told over and over again is the core of what we do at SThree is that we bring skilled people together to build the future. And it's that critical power that we place an ever-increasing flexible ways that help drive our performance. And so with that in driving our performance, I will hand over to Alex, who will take us through our financial performance. Alex?

Thank you very much, Mark. Good morning, all. So a strong profit performance in the half despite the impact of COVID-19. Mark has actually touched on quite a lot of these numbers. And I suppose -- we are particularly proud that we have grown our net fees and our operating profit ahead of the same period in 2019. So in terms of overall net fees, net fees of GBP 164 million, up 3% versus '19, up 10% versus 2020. Operating profit up 18% versus 2019 or up 106% triple-digit growth, I like it, Mark, on 2020. Our conversion ratio, the ratio of operating profit to net fees 17.1%, up 8 percentage points year-on-year or up 2 percentage points versus '19, really driven by 3 main factors. Clearly, a very strong demand in the market and particularly for STEM talent, continued benefits that we're experiencing of the trend towards flexible working and some very good margin expansion across all the products that we sell. And then driving very strong productivity in the half, but I'll dig into that in a little bit more detail in a moment. So profit before tax of GBP 27.6 million, up 19%. And our effective tax rate that we're estimating to be 31%, down from where we were this time last year, which is more like 38%, 39%, giving a profit after tax of GBP 19.1 million, up 136%. So digging into those profit drivers a bit more. So strong market demand. We're clearly seeing a very strong demand in the STEM sectors that we are exclusively focus upon. So we're in the right sectors. And we're also benefiting, of course, from the broader improvement in the recruitment market. So demand a key. The benefits of continued trend towards flexible working, we're really seeing the benefit of that in the move towards the employed contractor model. contractor model. This is a secular trend that we've talked about before and where we see higher margins. And of course, as you all know, our contract lifetime values are also attractive and hard than permanent equivalents. So strong in terms of this flexible working trend, but also margin expansion across all product types, and I will get into that, too. And then productivity, so activity levels higher versus '19, head count lower driving a very attractive productivity increase, which we do expect to normalize to some extent but also intend to retain levels of productivity increase versus 2019 as we look forward. So in terms of the strong demand in the second quarter, Q2, we're up 8% versus 2019. More permanent than contracts as you expect at this time in the cycle, so permanent up 13%, contract up 6%. Our contractor order book, which is a snapshot of the value of contracts written up to the contractual end points up 13% versus 2019. So that's a good kind of exit rate indicator up 15% at the end of June, the calendar half year. And when you look back over the last 3 years, our CAGR in terms of the contract order book despite the pandemic, up 8% per annum. So this slide looks at the analysis of net fees by product type and really the striking call out here is the employed contractor model, which has grown from 22% of net fees in 2019 to 31% of net fees in 2021, that's up 24% year-on-year and up 38% versus 2019. And we've talked before about the margins that we see within ECM, which are roughly 40% higher than freelance. And this is the predominant model now in the U.S. and fast-growing in Europe. We've seen some very strong margin improvements in the half, I'm pleased to say. At a group level, our group net fee margin is up 1.5 percentage points year-on-year and up on 2019. When you look at contract, overall, contract net fee margin is up 1 percentage point year-on-year to 21.3%. And you're seeing positive growth in both employed contractor fee margin and freelancer fee margins. So both components of flexible working, we're seeing margin expansion. And on the permanent side, our permanent fee margin is also up both year-on-year by 0.4 percentage points versus 2019. So strong growth in margins across all our product types. And of course, with contract lifetime values, on average, still about 40% higher than perm equivalent. And some of the growth we've seen in our permanent margins, you can link back to what seems to be accelerating wage growth on the permanent side. So we saw 2.5% wage inflation in the half year-on-year for perm accelerating to 3% in Q2. And so bringing all together in terms of productivity in the half, we saw productivity per head increased by 32% year-on-year in the half, and this was driven by improved net fee margins, the growth in our employed contract model, and we benefited, of course, from increased contractor hours, 74% of net fees for SThree come from contract and largely there were paid essentially by the hour. We've seen roughly 5% more hours worked per average contractor than in the previous year. The operating profit conversion ratio, 17.1%, significantly driven by the productivity growth that we've talked about. and the other factors that we've covered. And we do expect this operating profit conversion ratio to partially normalize in the second half, and that's as a result of the previously flagged sequential headcount investments that we plan to make in the second half and increasing investments in technology and go-to-market strategies or to sustain the long-term growth of the business. So how does this look from a kind of overall operating profit bridge point of view. So here, we're bridging from H1 '20 to '21. You can see the permanent and the contract net fees dropping through. You can see the people costs, which are fractionally up year-on-year, and that's despite the fact that our average heads are down, and this is driven by a slightly higher average salary rate across our remaining people. LTIP costs have gone up to reflect the increased prospects for the group. And we've seen elevated levels of bonuses and commissions given the strength of the markets in which we're operating in. But when you take the net fees and the cost base kind of in the round, the incremental drop-through in the first half is high at 97%. Moving on to the balance sheet. We have a strong balance sheet with debt facilities undrawn. Working capital, a slight increase there as we've seen a sharp increase in the number of contractors, strong cash performance. I'm very pleased to note that the days sale outstanding have decreased by 1 day sequentially versus the year-end and the proportion of aged receivables has improved. So good work there by the team. Moving on to cash and free cash flow conversion. Sorry, a lot going on, on this slide, but really, the operating cash conversion ratio, 91% adjusted for the reversal of certain VAT deferral benefits we had last year. We highlighted those in our analysis last year. So adjusting for those, 91% operating profit conversion ratio or on a reported basis, 74%. That operating cash flow then pays for our corporate taxes, our lease payments to generate a free cash flow of 31% on an adjusted basis of operating profit or 14% on a reported basis. So essentially, the cash conversion ratio impacted this year particularly by the working capital that's starting to be required to fund the growth of the business, the GBP 12.8 million outflow there and compare and contrast that to what we saw at the half year last year, which was a circa GBP 50 million outflow. And then moving on to dividends and earnings per share. So a strong profit after tax growth on a reported basis of 128%. And are one-off basic and fully diluted flat year-on-year, driving a basic and diluted earnings per share of 127%, 14.4p basic, 14.1p diluted. I'm really pleased to be announcing our interim dividend of 3p per share, which is consistent with the dividend cover target that we outlined at the trading update of between 2.5 and 3x. So now moving on to the business overview. And you'll be familiar broadly with this chart. There's a bit more going on this year because we were keen to show not just year-on-year, but versus 2019, too. So net fees, 10% up year-on-year, up 3% versus marketing. So you've seen that before. Average headcount, which is down 16% versus '20, down 15% versus '19. So you can see that we're performing in terms of ahead of 2019 in terms of fees and operating profit, but with 15% less heads on average. Net Promoter Score, this is client and contractor at a group level, pleased to see that this is, again, high and fractionally up. And looking at the sector analysis on the bottom right there, you can see where we've taken relative share, and it won't surprise you to see that technology now representing 47% of net fees up 2 percentage points and also a 2 percentage point growth in Life Sciences. So moving on to DACH. So really pleased, strong net fees in the half, up 15% versus 2019. I think interesting to call out here that our average headcount in the DACH region is flat on '19. So we have -- if you like been relatively more defensive in terms of our head count in this region, very pleased in terms of the Net Promoter Score, building on already a very strong number, up 4 points year-on-year. And interesting, again, when you look at the split of sectors, so tech in Germany or in the DACH region up 5%, Life Sciences up 1% as a proportion of the overall net fees. So this slide really highlights a couple of points that Germany represents the vast majority of the DACH region, circa 90%, but also again, charts, the contractor order book for the DACH region, up 33% versus '19 at the half year and a CAGR here of 18%. And as previously talked about at the trading update, the strength in Germany coming from growth in Life Sciences and Tech in particular. So moving on to EMEA, excluding DACH. So this has been a more challenging for us. It includes the Netherlands, which has had a robust performance, the U.K., France, Belgium, Luxembourg, Spain. So more challenging, as you can see from the stats. So net fees down 14% versus 2019. Average heads down 32%. So you can see that this is a region where we took more deliberate headcount reduction action. But of course, the positives are you seeing some strong productivity growth coming through, given the fact that net fees are down 2% year-on-year against average heads down. And there, you can see the relative sizes of the countries there within the region. So Netherlands actually did have a good performance, up 8%. U.K. has seen good progress and good productivity improvements with Q2 net fees now up 3%. And in terms of the contractor order book, whilst down on 2019, we are up 25% year-on-year. So again, the kind of the prospects look going forward for this region do look positive. But on a 2-year view, the contractor order book is still down. Moving on to the U.S. The U.S., we've seen high demand, and we've seen significant net fee growth both year-on-year and versus 2019, up 22% versus '19. And again, I'll just highlight the average headcount, so only down 2% versus 2019, a particular area of focus in terms of sequential headcount build. Again, a very pleasing client and candidate Net Promoter Score. And when you look at the net fee mix, again, you can see what is probably quite intuitive, Life Sciences, which is a big sector for us in the U.S. You can see that 48% of the overall net fees, up 3 percentage points and tech up 1 percentage point relatively. And so in terms of the contractor order book, that kind of exit rate, if you like, for contracts, up 36% versus 2019, a 3-year CAGR of 15%. And strong performance, as I've mentioned, in Life Sciences technology. But I'd like just to highlight also engineering, which in the U.S. is driven by our renewable energy-focused construction practice. And then finally, moving on to the APAC region. This represents 3% of net fees for the group. So it's small for us. If you look at the chart on the bottom left there, you can see that it's almost the reverse of the group in terms of perm contracts. So this is a permanent heavy region, 83% perm compared to the group, which is 74% contract. The region for SThree represents Japan and Singapore. Japan is roughly 3/4 of the net fees. And in the second quarter, Japan was up 14% versus 2019 and with a very good exit rate, driven by tech and life sciences. So I'd now like to hand back to Mark, who will talk us through the strategic -- the strategy and update and the outlook. Mark?

Great. Thank you, Alex. And a good update for the performance for the group overall as well as the individual regions. And as I think about how we're making progress as an organization, it's really against our strategic pillars that we laid out back in November 2019. It seems like a very long time ago. But really, we're focused on these pillars that are really driving our strategy moving forward. And it's really good that we're continuing to not just have good financial performance, but also good making progress against all of these pillars. So we're continuing to focus on being at the center of STEM to deliver sustainable value to our clients and candidates. And the work that we've done in terms of nurturing our specialist candidate communities these very scarce resources that are increasing demand and making SThree the place for them to work is really encouraging for us because that gives us differentiation in the marketplace. And we're working hard in terms of encouraging new entrants into the marketplace and expanding access as well as hosting remote educational events to continue to develop the talent that we place. We continue to work on creating a world-class operational platform. We've invested in our marketing and communications team to make sure that we can have the right people that are delivering the value in terms of our thought leadership and engaging with all of our stakeholders so that they understand who SThree is and the value that we can deliver in the marketplace and as well as improving the digital infrastructure to better network security and digital security. We continue to focus on how can we be a leader in the markets we choose, as Alex highlighted in the presentation part he gave as being discretionary about where we're focused and where we're not so that we choose to be in the right markets and where we are really executing well to improve our productivity and focus on taking market share and as well as ensuring that we're delivering value to both candidates and clients, we see a continuation of a very high and slightly improving Net Promoter Score to 53. And last, but certainly not least, we are a people business. and we're focused on making sure that we have the right environment for all of our people to be successful. And so we've learned a lot through the last 18 months in how we create and will continue to be a hybrid working environment for our people so that we can execute regardless of the external environment. And as well, we will continue to focus on creating an inclusive work environment through continued work of managing and supporting our people and whether it's their health and mental well-being as well as making sure that we are diverse, equitable and inclusive employer making it great for all talent, regardless of how they look, how they think and how they sound. And we continue to bolster our senior leadership team with additional expert skills that really complement the great organic talent that we've grown through the many years of our experience in the industry at SThree. An important part in the core of who we are as we think about being a purpose-led organization is empowering a sustainable future to STEM. And we've made good progress around making an impact across multiple lines in our ESG strategy. And as we set out in our impact report, we have our 2024 targets specifically aligned against the UN sustainable development goals. We're making good progress around impacting people's lives. And as I laid out, we've had over 16,500 people positively impacted, not just the 10,300 that we've accessed decent work through STEM placements. But over 1,600 that have accessed our career support program, the 1,700 that have accessed community programs and support and the over 2,700 people that have accessed career development opportunities posted and developed by SThree and all of our teams around the world. We've continued to focus on renewables, Alex mentioned in the U.S., great progress there. And our renewables business now compromises 6% of overall group net fees growing at 37%, which is incredibly important for us as we think about making sure that it's not only good for society, but it's good for us in terms of business as we help make a positive impact in the energy rethinking and decarbonization. We've also reduced our absolute carbon emissions by 56% in 2020 from 2019, and an important decline, although, obviously, it's impacted a lot by restrictions that continue to impact our offices and therefore, our carbon emissions. But this is a target that we're focused on and that we laid out not just in our impact report, but as part of our Capital Markets Day. And indeed, by being an inclusive and diverse employer, we continue to focus on gender equality in having a move towards a 50-50 split at all leadership levels with SThree. And we're making good progress there as we are maintaining and increasing development and representation of female leadership across the organization. So that's enough about us. I thought it might be helpful about how we are seeing from our clients and candidates and really building on some of the market insights that we've shared before. No surprise that the broad framework that we laid out before and continues to be themes that are developing over the first half of 2021. Certainly not a surprise is all of our clients are looking to how do they think about management of a more flexible and resilient workforce and what does that mean for the future? And when we think of flexible working, we think of it in ways that talent are deployed, whether that's permanent, independent freelancers or employed contractors, but that's also about what is hybrid working mean and what's the working environment for our clients and how do they manage that talent of the future. And so we're working with them to understand what that means and how they can use both their permanent and contingent labor in different ways and working environment they need to develop for them. There's a continued focus on the rebuilding of the global supply chain with a real focus on resilience and sustainability. And that's not just for global companies that manage a global supply chain, but that's all companies as they think about building back better and where they're sourcing their materials and roll goods from as well as how do they develop and deliver their value to their stakeholders. And then last but not least, as you would imagine, a continued acceleration of digital transformation. If we take e-commerce as an example, there's been approximately 1 decades worth of progression in about 1.5 years. And we see that flowing into all areas of digital transformation, whether that be areas have been lagging in the past. So the digitization of health and tele-health similarly, acceleration of digitization and education and then specific areas of focus on mobile, artificial intelligence and, of course, the continued fight against cybersecurity. So all of those areas, we see the critical trends that really work in our favor as SThree as we sit at the center of those 2 secular trends of STEM talent and flexible working. Now how this has played out in the half, we continue to make progress against all 4 sectors of our 2024 ambitions throughout the period, and we're certainly very proud of the work we've done and through the last half year in achieving more progress against those. And as I look forward and ahead for the business, we certainly are tracking ahead of our full year 2021 expectations when we started into the year. But we obviously remain cautiously optimistic as there still remains a level of volatility. As we've previously talked about, there's a backlog of holidays and holidays to be taken, as we're seeing certainly where we are now -- where I am now in the U.K., increased case loads of infection. And so that's very dependent on what vaccine rollout looks like. And then there's obviously renewed concern about inflationary pressures that we may see in the back end of the year. But that being said, we continue to drive the group forward towards our long-term 2024 ambitions. The secular trends are certainly in our favor. And as we work with our people and as we've seen in the past, our ability to develop a hybrid working solution for our people and allowing our managers and our people to choose what works best for them within a function will really help our ability to attract diverse and top talent. All brought together, we continue to deliver against our strategy as we build our investments in our people as we continue to grow our sales capacity, our digital experience and tools to improve our productivity as well as investing in our go-to-market strategy to share the best of what SThree has to offer. We remain optimistic about the rest of the year. And so with that, we will hand it back to Thomson, who will open us up for questions, and we'd be delighted to take that. Thanks.

[Operator Instructions] Steve Woolf from Numis. Steve, do you want to unmute yourself?

I'm just thinking of the sort of the magnitude of headcount you're thinking of for the second half. And to be honest with everybody looking quite actively of all your peers to throw bodies for the second half, where do you see your greatest source of those consultants to come from? And has there been any change to the thinking of maybe taking more senior consultants across maybe taking on board the page strategy of taking people with 2 years' experience when they hit the ground running? Just any thoughts around that, please?

Thanks, Steve. Why don't I take the last part of the question first, and then Alex can talk about the volume in the second half. So no surprise as we've learned through the pandemic, we have adjusted globally as to how we think about talent. And I think our approach is really about a blend. So traditionally, we would have taken only graduates on their first or second roll, and then we would have trained them, productivity over time. I think where we are now is we're thinking some of that work in some places, and that still is a really good strategy for us. So we're focused on partnership with education partners in universities and schools around the globe where that makes sense. But there's also an opportunity in some specific domains in some specific markets to actually take more tenured staff. And so we're very much focused on a blend appropriately for the market in domain that we're looking for. And one interesting in some very specific domains, we're also taking people not from the industry in terms of the recruitment industry with experience. But from the specific domain that our operators there that really understand the domain and the specialists that work in there in some isolated cases as well. So we have a pretty comprehensive view about thinking about talent acquisition to put into that sales bucket as we move forward. We think that's the best way of maintaining the productivity that we've seen. Alex, do you want to give a note on the volume we're trying to think about?

Yes, sure. So kind of really very much as we said at the trading update, we plan to grow our kind of sales heads by low double digit, so in H2 sequentially versus H1, we've made some good progress in the month of June sequentially, and we look forward to continuing that investment in the second half. So low double-digit growth sequentially H2 versus H1.

[Operator Instructions] But as I say, obviously, a very comprehensive presentation. Steve has come back within that with another question.

Not a pity question, don't worry. It was more of a question structurally on conversion ratios across the industry having seen some great highs and gradually come down with investment, just your thoughts on over the past 12, 18 months, everything you have learned, do you think this adds to the chance of conversion ratio is going structurally higher over the next sort of 3 to 4 years?

So if I think I understand the question, Steve. It's more about the shape of our overall business for the long term. And how are we tracking towards that 21% to 24% conversion ratio sustainably into the future. Is that the question?

Yes. I think sort of more broadly around holding on to levels that you perhaps might have been previously and then with investment, but actually do you think it's a 200 bps change or anything along those lines?

So look, I think what we've seen is 2 things. Number 1 is our strategy is clearly the right one. So being focused on that supply constrained specialist same talent and life sciences, technology and engineering. Clearly, I think everyone understands that, that talent is more valuable and more in demand than other sectors and is likely the demand for it is likely to grow faster than other sectors. And we really understand the niches within there that gives us a significant advantage on accessing those candidates and placing them. And then the second thing, as Alex highlighted, is the way in which we deliver that with permanent independent freelancers and more and more employed contractors that move towards flexible working in contract and then the move within contract towards employed contract, certainly, structurally, means that as we get more operational leverage and as we scale, we should be sensitive to margin improvement over time, and we've seen that happen as that's developed, and you can clearly see that in our numbers moving forward. So I think the net, Steve, is yes, we're confident that our strategy is right, and we've got to continue to execute on that strategy moving forward that we'll continue to see margin expansion over time as we scale.

And that's the end of questions. Mark, do you have any closing remarks?

Well, thank you for listening today. I am cognizant that this is Alex's last half year update for SThree. And so I just want to say on behalf of everyone at SThree, thank you very much for all of his great leadership efforts and guidance over the 13 years that he's been the CFO at SThree. And I'm sure all of you have been really welcome to his thoughts and disclosure and sharing his wise words as we shared our numbers over that time. And a personal thank you for me. It's been a terrific guide and partner since I've been CEO, SThree. So thank you. Thank you very much, Alex, for all of your hard work. And then it will be a welcome to Andy as he joins us and for our next update, which will be on the 13th of September for our Q3 trading update, and we'll see you on then. But for that, thank you, and good morning to everyone.

Many thanks, Mark. And Alex, thank you all for joining. This is the end of the webinar.