SThree PLC
LSE:STEM
Earnings Call Analysis
Q4-2023 Analysis
SThree PLC
In a year of economic challenges, SThree showed robustness with a consistent net fee performance. The contraction of net fees by 4%, on a constant currency basis, comes after a period of exceptional growth, underscoring the impact of a softening market. Nonetheless, the company's strategic focus on Contract offerings and STEM specializations appears to be a buffer against severe fluctuations, leading to a slight 1% growth in their Contract business. Emphasizing on stability, SThree retains a strong contractor extension rate and tight pricing control that have enhanced average contract lengths, contributing to the company's resilience.
SThree's significant investment in a transformative technology improvement program ensures sustainable competitive advantage. Through the rollout of an integrated end-to-end platform, initially in the U.S., the company is increasing efficiency and scalability across business operations. With more than 2,000 contractors onboarded and approximately $70 million revenue invoiced using the new system, SThree has both systematized ECM compliance management and improved client and candidate experiences. Invoice disputes and credit notes have significantly decreased, a testament to the success of SThree's digital transformation.
With a 2% decrease in average headcount and commendable cost management, SThree has maintained a sector-leading operating profit conversion ratio—even with investments in their technology program. The contract order book's slight 3% decline still translates to sector-leading forward visibility, with over four months of net fees booked. Ending the year, the company's cash position was up by 27% to GBP 83 million. Illustrating strong capital management, SThree is set on investing in talent, organic growth, selective acquisitions, and returning value to shareholders through dividends.
With an under 3% average market share in each operating region, SThree sees vast opportunities for scaling, propelled by an analytical approach to market coverage. As consolidation activity remains high within the industry, particularly in the U.S., SThree is poised for strategic acquisitions that leverage its digital advancements. Meanwhile, the digital-first ambition fuels the company's readiness for a future of enabled and optimized sales consultancy, unveiling a roadmap for productizing the technology benefits for scale and cost-effectiveness.
SThree is staking a claim as a future-leaning organization significantly through its newly articulated corporate values and strengthened sustainability targets. The company’s ambition to be a digital-first innovator is complemented by its achievement in doubling the global renewables business ahead of schedule and setting a science-based target for net zero before 2050. These moves signify a holistic approach to growth that considers environmental impact and nurtures a culture defined by limitless career opportunities and continuous learning.
The culmination of SThree’s diligence in a tough economic climate is a testament to its strong business model and strategic planning. As the rollout of the digital platform advances, SThree promises enhanced services and platforms that could attract mergers and acquisitions due to its innovation and high entry barriers. Despite softer new placement activities expected to persist, robust contract extensions and strategic positioning obviate the company's preparedness for future growth and its unwavering focus amid an uncertain macroeconomic landscape.
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Good morning, and welcome, and thank you for joining us today for full year results briefing. I'm joined as usual by our CFO, Andrew Beach.
Good morning, everyone.
And together, we will be walking you through the full year numbers, our strategic progress and talking a little bit on outlook. So let's get started. As a reminder of who we are for those who don't know us, SThree is a global STEM specialist talent partner, which is a unique offering in the market. We are purely focused on STEM talent. This means we place people with skills in science, technology, engineering and mathematics into roads across a diverse range of industries and geographies.
This means also that together with our candidates, we are empowering a smarter future and unlocking the full potential of our clients on a daily basis. As many of you know, the charts on this page show our well-established strategy is positioned at the center of 2 long-term growth trends, STEM on one side and flexible talent. This is where we see our opportunity. We know that there are multiple mega trends having a huge impact on the future world of work. And with that, we will see an increase in structural demand for STEM talent and the overall Contractor model.
As a result of this focus, our Contract business now represents 82% of group total, up from 78% a year ago. Our bias towards Contract provides us with a more profitable and predictable revenue stream and is a powerful differentiator in the market. Before Andy talks through our performance in detail, I would like to say how pleased we are to have delivered a consistently robust net fee performance this financial year. This was delivered within a challenging macroeconomic environment, as we all know, and against a record prior year performance.
Net fees were down 4% on a constant currency basis against an exceptional growth of 19% in FY 2022. Due to macroeconomic uncertainty, new drug activity softened as business navigated through the pressure of inflation and high interest rates. However, the overarching theme is the desire of our clients to retain scarce talent in the face of continued skill shortages, evidenced in our strong contract extension rates and robust pricing.
As a result, our Contract net fees grew 1% in the year. A highlight really of this year has been obviously the exciting progress of our technology improvement program. We are delighted that the first iteration of our new end-to-end integrated platform is now live and transacting business across all of our U.S. operations. This will be key to driving both scale and higher margins over the mid to long term. This is a game changer in the industry, and we are excited to share more with you on this later in the presentation.
While making this planned investment together with maintaining appropriate headcount to ensure we are really well positioned for when the market conditions improve, the group recorded an operating profit ahead of market expectations at GBP 76.4 million, partially reflecting the phasing of cost recognition associated with our technology program, but Andy will give you further details on this shortly.
The progress we have made is a testament to the quality of our global teams, and we're really proud of that. And I would like to thank everyone for their hard work and commitment. We have delivered some really great achievements this year. We have not only delivered a robust performance with sector-leading profitability. We also mobilized and implemented a complete new end-to-end technology platform while preparing our teams for the future. And with that, I will hand over to Andy to talk us through the financials.
Thank you very much, Timo. Now as I've done with recent presentations, I wanted to start with a quick look back over the last few years. FY '19 was, at the time, our record ever net fee and operating profit performance. Whilst FY '20 was impacted by the pandemic, the effect on our top line performance was relatively shallow. We recovered quickly in FY '21, helped by the market recovery and returned to year-on-year growth in that year.
FY '22 was the peak post-COVID bounce period where we delivered record net fees despite starting to see a softening of market conditions in the second half of that year. Despite market uncertainty continuing into FY '23, we are pleased to have delivered a consistently robust performance with net fees dipping modestly below last year's record-breaking achievement and a sector-leading operating profit conversion ratio even after the investment in the technology improvement program of 18.2%.
We continue to index calendar quarter net fee performance since 2019, the last full year before the pandemic to show more clearly our performance compared to other staffing businesses who all have greater exposure to the permanent market. As the chart shows, we are less cyclical, which we believe is due to the strategic focus on flexible talent and STEM. Through the pandemic, our quarterly net fees fell by no more than 14% compared to our record 2019 performance.
We also recovered quickly and to a higher peak performance, achieving index growth of 33% compared to an average of 20% for the others in 2022. Over the last year, we have sustained our outperformance. This shows that we are less volatile through periods of market disruption, but also that we recover strongly and quickly as we come out of tough economic periods, and that confirms that we have the right strategy and our business is high quality through the cycle.
Looking now in more detail at the FY '23 performance. Net fees are down only 4% on a like-for-like basis, though, with the benefit of FX tailwinds are down just 3% year-on-year. Contract, which now represents 82% of net fees, saw growth of 1% year-on-year as we delivered strong levels of extensions. Permanent declined 22% and was impacted by the change in our headcount mix with average permanent headcount down 17%.
Operating profit for the year was GBP 76.4 million, which is down 5% compared to the record performance achieved last year. This reflects continuing exceptional levels of productivity and tight cost control to mitigate our slightly lower net fee income. We also benefited from some timing and spend recognition on the technology improvement program into FY '24, though delivery remains firmly on track. This has enabled us to maintain a sector-leading conversion ratio, the ratio of operating profit to net fees of 18.2%, which we expect to temper next year, though still remain sector-leading as our productivity continues to normalize and we incur higher technology improvement program costs.
Profit before tax is GBP 77.9 million, down 2% year-on-year, reflecting a slightly lower operating profit, offset by net interest income on our cash. Our full year effective tax rate is 28.1%, which is 1.5 percentage points lower than in the prior year due to a change in profit mix and unrecognized tax losses in FY '22. This gives a profit after tax of GBP 56.1 million, which is flat year-on-year. I'll now go on to talk about some of the details behind this performance.
Looking at the regional and skill mix for the period, we have a well-balanced business, both geographically and by skill. The first chart shows the new regional structure we introduced in FY '23 with DACH remaining the largest region in the group, representing 36% of net fees. Looking at the table on the right, you can see that the growth achieved in the Netherlands region and Middle East and Asia was offset by lower net fees in DACH, rest of Europe and the U.S.
The second ring chart shows our strong and unique position in providing STEM skills. Technology continues to be our largest skill, and it represents 48% of net fees. The strength of engineering means it is now the second largest skill offsetting the weakness in life sciences and demonstrating the diversity of the mix within our business.
We continue to benefit from the ongoing trend towards flexible working. This slide looks at the analysis of net fees by product type. Our contract business can be split between independent contractors and employed contractors. The most notable shift over the last few years has been the trend towards the employed contractor model, or ECM, which has grown from 23% of net fees in 2019 to 37% of net fees in FY '23.
As expected, productivity has come down from the exceptional levels achieved in FY '22, but still remains at elevated levels, exceeding our expectations and was only down 2% year-on-year, with the impact of a strong prior year comparator on net fees, partially offset by the 2% reduction in average headcount. Near term, we expect productivity to continue to moderate until market conditions improve. But over the midterm, we do expect to deliver sustainable increased levels of productivity as our strategic investments in digital infrastructure start to deliver benefits.
The technology improvement program remains on budget and the first iteration of the end-to-end platform is now live across the U.S. business. OpEx this year of around GBP 4 million was broadly in line with FY '22 and a little below the expected range for the year due to timing of expense recognition. In addition to the OpEx, we incurred GBP 6 million of CapEx as the program moved into the development and deployment phase, again, a little below our expectations. We do, however, expect a higher level of expenditure on the program in the coming year as we roll out across the major markets.
Our forecast OpEx and CapEx for FY '24 has increased slightly due to the delayed spend from FY '23, and we retain a further GBP 3 million of contingency within the program budget envelope. We are, therefore, continuing to forecast spend to comfortably fit within the GBP 30 million to GBP 35 million range previously communicated.
Turning to the year-on-year operating profit bridge. You can see the decrease in permanent net fees is partly offset by the increase in Contract net fees. People costs are down primarily due to the 2% average decrease in head count compared to last year and lower bonus and commission costs due to net fees being down. After other movements, this leaves profit for the year at GBP 76.4 million.
Looking now at the future visibility of our Contract business. The contractor order book represents the value of contracts written up to the contractual end date, assuming that all contracted hours are worked. The book was down a modest 3% year-on-year as a strong extensions performance was only able to partially offset the slowdown in new placements from the prolonged market uncertainty. However, even with the decline, the order book continues to provide us with sector-leading forward visibility compared to permanent focused staffing businesses with over 4 months' worth of net fees already booked, giving us a robust platform for the year ahead.
The strength of the contract order book demonstrates that whilst new placement activity has been lower this year, all other underlying metrics around our contract business are strong. We've seen excellent extension rates over the last year, and this has resulted in average contract length increasing by 18% compared to the prior year to 49 weeks. To sustain contract margins at 21.7%, we've managed tight pricing control, especially with extensions and the average salary of the contract roles that we've placed is up around 4% year-on-year, now reaching GBP 100,000 for the first time.
Looking at our net cash position. We have benefited from strong cash generation from underlying operations, combined with the anti-cyclical nature of the working capital which gets released when growth slows. And after taking off other usual expenditure items, including the CapEx on the technology improvement program, we ended the year with cash of GBP 83 million, up 27%.
And now turning to our capital allocation policy, which following a periodic review by the Board, has been updated to reflect investments in business improvement as a key aspect of our strategy. Our overarching intention is to always maximize value for our shareholders. We aim to achieve this by maintaining a strong balance sheet to provide flexibility at all times, whilst also providing shareholders with a sustainable through-the-cycle dividend with long-term earnings growth.
We then prioritize our deployment of capital towards organic growth by investing in talent and ensuring there is sufficient funds to support our growth. Our next priority is the investment in business improvement. As we are demonstrating with our TIP, we believe digitalizing is key to driving both scale and higher margins over the mid- to long term as well as enabling our people to operate at their best.
Next, we will look to accelerate our growth through acquisitions. Our focus would be on complementary and value-enhancing opportunities with strict discipline. Finally, we will return excess capital to shareholders through special dividends or share buybacks in the event of them not being suitable organic or inorganic opportunities within a reasonable time horizon. We are confident that this refreshed policy strongly supports SThree strategy.
So now let's quickly look at what this means in practice for several of these areas. For organic growth, this means investing strategically in headcount where we can generate the highest returns and maintaining sufficient working capital to prefund the onboarding of new contractors as the market recovers. Over time, we expect this capital deployment to transition from investments in headcount to investments in business opportunities, driven by technology and data.
For business improvement, we are currently investing up to GBP 35 million in the technology improvement program, and we expect to continually invest, albeit at lower levels once the program completes to sustain the advantages our end-to-end platform will provide.
Looking at acquisitions. Through our TIP, we are creating a highly differentiated, scalable platform that positions us as an attractive home for potential acquisitions. We know this is an analog industry, and there is huge scope to leverage our digital platform.
Moving on to look at EPS and dividends. Earnings per share increased by 4% to 42.4p. In line with our higher EPS, I'm very pleased to announce that our final dividend will be 11.6p per share, resulting in a full year dividend of 16.6p. This is an increase of 4% versus the FY '22 dividend and is in line with our dividend policy.
So to sum up, we are reporting a robust trading performance with net fees down just 4% in total and Contract up 1% against what was an exceptional performance in FY '22, which demonstrated the benefit of our strategic focus on STEM and Contract.
Operating profit remains near record highs despite our significant investment in technology, the contract order book continues to give us good visibility of future net fees, and we have a strong balance sheet, which will fund our dividends and our future plans. Thank you. I'll now hand back to Timo.
Thank you, Andy. We will now turn to look at what we have achieved throughout the year. Turning to operational progress. We have our 4 strategic pillars, which we consistently report against being our places, platform, people and position. I will now touch on each plan turn with an emphasis on our platform pillar this time around given the focus on our technology program rolling out during the year.
Our analytical and data-driven approach informs the regional and vertical mix we choose to operate in. Over the year, we intensively analyzed and validated our footprint, and we are confident in our active market coverage with 11 countries strategically focused in the biggest STEM markets. With an average share of under 3%, we believe there's a substantial scope to scale, both organically and given the highly fragmented and niche landscape through select acquisitions.
We continue to see high levels of consolidation activity, where we can see up to 100 transactions a quarter across our markets within our industry with the highest volumes being in the U.S., where there are tens of thousands of industry players.
Turning to our platform. Our key focus over the year has been the rollout of our technology improvement program. We are delighted with the progress we have made. And in order to give you an update on the program, I will hand over to our COO, Nick.
Good morning, ladies and gentlemen. I'm Nick Folkes, the Chief Operating Officer at SThree, and I oversee the implementation of the group's technology improvement program. Looking at the staffing sector, it is evident that it has stagnated somewhat over the past 2 decades, remaining largely [ analog ]. This stasis, however, presents a significant opportunity for SThree.
In 2023, we embarked on our technology improvement program or TIP, a transformation initiative to implement a cutting-edge end-to-end integrated platform. This platform is designed to reengineer, simplify and digitalize our most manual and complex processes. Our ultimate goal is to cultivate a platform of operational excellence that will optimize the experience and outcomes for our candidates and clients while simultaneously driving growth and higher margins for SThree.
In essence, we are transforming to become a genuinely digital-first enterprise. We are confident that this pioneering technology strategy, replacing our entire legacy technology infrastructure with a single integrated platform powered by Microsoft and both transform the way we operate and also position SThree as the game changer in the industry. For a more comprehensive understanding of the program, I encourage you to check out the investor briefing in the Investor Center on the SThree website.
Reflecting on 2023, I'm delighted by the progress we've achieved. We successfully designed and launched the first iteration of the new platform across all our U.S. markets, delivering a program of this magnitude at such a pace on schedule and within budget is a remarkable achievement. This accomplishment is a testament to our dedicated delivery teams, partners and colleagues across the U.S. who worked and collaborated tirelessly to surmount the inevitable challenges inherent in the changes of this scale.
As of today, we have onboarded over 2,000 employed and independent contractors who are utilizing the system daily. We have issued approximately 15,000 invoices amounting to over $70 million of revenue. This milestone indicates that we have successfully systematized the complexities of the ECM compliance management, a critical success metric we have been diligently monitoring and we are delighted by the results.
In a significant stride forward, we now offer our candidates an intuitive and user-friendly portal for self-serve onboarding. They now have a comprehensive dashboard where all necessary onboarding tasks are collated. The system intelligently determines what is required based on the local regulations of the placement, therefore, avoiding any unnecessary administration. This significantly improved user experience has already received positive feedback from our candidates.
Once their contracts have started, our proprietary time, expense, pay, bill system takes the lead. Like the candidate portal, the system ensures time sheets are automatically compliant with the relevant regulations for the placement. Our clients are also reaping the benefits of the new technology with smoother time sheet approvals, especially when managing multiple contractors.
Significantly, the improved data collection and automated processes are already yielding efficiency rewards for us and our clients with invoice disputes and credit notes, both down over 90%. This marks a significant milestone in our digital transformation journey, enhancing our operations and the experiences of our candidates and clients.
The agile methodology we have adopted to implement this program has been a vital part of its success. More than just mitigating delivery risk, it fosters a culture of continuous learning and iterative improvement impacting both the system itself and our delivery approach. The inherent flexibility of an agile approach allows us to adapt swiftly to changes, an essential trait in today's dynamic business environment. Coupled with regular feedback loops involving all colleagues and partners, it has cultivated a collaborative environment where everyone has a stake in shaping the system.
This participatory approach ensures the solution is tailored fit to our business needs and deepens the sense of ownership and engagement among our teams. Needless to say, a transformation of this magnitude requires providing substantial support to our teams throughout the implementation. This has been a crucial element of our program success to date, and we remain committed to constantly enhancing the transition experience for our consultants.
Although we have not yet activated all functionalities and enablers. As [ Stefan ] has highlighted, we are already witnessing efficiencies and identifying the potential these advancements hold for boosting productivity and scale. Over the coming months, we will roll out the enablers design to drive further productivity improvements. I'd like to introduce Matt McManus now, a respected SThree veteran of nearly 3 decades, who spearheads our U.S. business.
With over 27 years under my belt at SThree, I can confidently say I know the inner workings of this organization intimately. The remarkable success of SThree over the past 40 years can be attributed to our exceptional team. I'm convinced that our new technology platform will revolutionize our exceptional team and how it operates and how the business delivers. By ensuring systematic compliance with all regulatory requirements and introducing AI-enabled contract management, we are automating processes that have historically constrained the scalability of our contract business and in particular, our rapidly growing ECM business.
The enhanced access to quality data, combined with the power of Microsoft technology will empower us to optimize the market investment model. This will enable us to identify early market trends and make data-driven decisions. Furthermore, the system will utilize AI to continuously evaluate and optimize the enablers, learning from the actions that are most likely to lead to the success of our teams and individuals. Our priority in 2023 was to align this major initiative, accustom our teams to the new processes that ensure data accuracy from the outset and optimize the transition experience for our candidates and clients.
In 2024, the new enablers in development, I look forward to realizing the amazing potential of our investment. I'm extremely proud of what the teams have achieved this year. Navigating through a transformation of this scale hasn't been easy, but the anticipation of the promising opportunities ahead has us all truly excited.
The successful rollout in the U.S., one of our most complex regions, bolsters our confidence as we proceed. However, we are not resting on our laurels. We are now embarking on the next phase of the program in Germany. Thereafter, we will proceed with the remaining major markets in 2024. We do, of course, have contingencies in our budget to extend into 2025, if necessary. As we roll out further enablers across more regions over the next 12 months, we can provide further clarity around how the system is accelerating the productivity of our sales consultants and reducing the cost to serve.
We anticipate these proof points will start to materialize, and we plan to report on them towards the end of this year. In the meantime, we look forward to keeping you abreast of the progress throughout 2024.
As you've heard from Nick, we have been busy and have made strong progress. Of course, we have had challenges along the way, but this was expected. And it is important to underline that the program remains on track with our initial time lines and on track with budget. We are confident we have taken a good amount of learnings with us. And with that, we feel well prepared for upcoming rollout in Germany.
From Nick's update, it is clear that this end-to-end platform is working, and we're seeing several early benefits from our first deployment, including the systemizing of best practices and processes, helping to improve both employee and client experiences. We have bold ambitions to be digital first innovator in our industry, and we see huge scope to leverage the power of modern technology to drive scale and margin.
Now turning to our people pillar, the engine of our business. During the year, we soft launched our newly redefined values, which you can see here. These values shape the environment we want to promote and define the organization we want to be. We strive to be an organization that offers careers with no limits, a business where everyone contributes to our success, an employer where the learning path never stops and a great place to work with a clear purpose. Embedding these values across the group in the year ahead will help us to evolve the culture of the company accordingly.
In terms of our position through analysis and benchmarking, we have a good understanding of the strong brand value we have with our go-to-market brands. We are proud of this. And during the year, have invested in reinforcing our brand proposition in specific vertical skills and elevating our thought leadership through new research. We also established a group commercial function under a new Chief Commercial Officer position to coordinate our commercial strategy going forward.
We are pleased to have not only made continued progress against the clear ESG targets we have set ourselves, but to have also strengthened our environmental ambitions during the year with a new science-based target of net zero before 2050. A highlight has been achieving our target of doubling the share of our global renewables business ahead of the target date of FY 2024. More detail on our specific progress will be available in our 2023 impact report.
To sum up, I'm proud of the work we have achieved over the past year against a challenging economic backdrop. The group's performance demonstrates the resilience of our business model and strength of our strategy. Through this, we have invested in our people, our product offering and made excellent progress in the positioning of our business for long-term growth.
Following the successful rollout of the first iteration of our technology improvement program in one of our most complex regions and the positive feedback from candidates, clients and our teams, we look forward to the next phase of the implementation. We are creating a scalable platform to deliver unrivaled employee and customer experiences and in particular, streamline and power the complex but fast-growing ECM model.
In doing so, we're also creating a pretty unique platform for potential M&A opportunities, both in terms of synergies it delivers and the high barriers to entry or exit. As we enter the new year, prolonged market conditions means new placement activities remain softer for longer than we anticipated. However, contract extensions continue to be robust. We have been consciously investing in and positioning the business for the future. And whilst we continue to operate in a challenging macro environment, this doesn't change our focus.
We are delivering on so many fronts, have a resilient business, a talented team and are building a market-leading technology suite. And with our investments and innovations, we continue to power on executing our strategy.