Kelly Services, Inc. (KELYA) Q1 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to Kelly Services First Quarter Earnings Conference Call. [Operator Instructions] Today's call is being recorded at the request of Kelly Services. If anyone has any objections, you may disconnect at this time. I would now like to turn the meeting over to your host, Mr. Carl Camden, President and CEO. Sir, you may begin.

Thank you. Good morning, everyone, and welcome to Kelly Services' 2012 First Quarter Earnings Report and Conference Call. With me on today's call is Patricia Little, our CFO. Let me remind you that any comments made during this call, including the Q&A, may include forward-looking statements about our expectations for future performance. Actual results could differ materially from those suggested by our comments, and we have no obligation to update the statements made on this call. Please refer to our SEC filings for a description of the risk factors that could influence the company's actual future performance. Now let's move on to our first quarter results. First quarter is traditionally the weakest for the staffing industry, which feels the effects of seasonal and postholiday employment adjustments. Although January showed promise, the first quarter of 2012 did sputter and concluded with tepid job growth. The industry is definitely experiencing a slower than anticipated recovery. Nonetheless, we have positive news to report. Kelly's first quarter was a good one. As the first 3 months of the year played out, we leveraged our leaner cost structure, improved our gross profit margin and stayed focused on executing our strategy, and our first quarter results reflect those efforts. Revenue for the quarter was up 1%, at the low end of our internal projections. Kelly's earnings from continuing operations were $0.24 per share compared with last year's adjusted first quarter earnings of $0.14 per share. We achieved an operating profit of $14.7 million, a healthy improvement over the adjusted earnings of $5.6 million for the first quarter of 2011. Our gross profit rate increased to 16.5% during the quarter compared to 15.8% for the same period last year. Additionally, our quarterly performance was bolstered by steady progress we're making in our key strategic areas. Our higher margin OCG segment remains on track and was profitable again this quarter with earnings improving by $3 million year-over-year. Professional and Technical performed well with improved revenue and gross profits in all regions year-over-year. Our PT growth rates continue to outpace the growth rates seen in our commercial staffing businesses. We also saw a steady pickup in our perm fees with year-over-year growth of 15%. At the same time, we're holding costs in check. Our expenses were up slightly compared to the prior year by 1.6% adjusted for last year's restructuring, but down sequentially compared to the last quarter. These progress points reflect our team's strategic focus and a slowly improving economy. While we're cautious, we believe the U.S. recovery is taking a firm hold. Undoubtedly, high fuel prices and worries over economic conditions across Europe dampen the confidence of business and consumers alike. March's employment gains were the fewest in the preceding 5 months. But even with that, the U.S. labor market recorded its strongest first quarter performance in 6 years. Improvement may come at a gradual pace, but the U.S. economy has proven it's capable of producing a steady increase in jobs. Several broad economic indicators support our tempered optimism. The unemployment rate dropped to 8.1% in April, ticking downward from 8.2% in March and reflected in the growth in our fees. In the U.S., the temp penetration rate now stands at 1.88%. After steady gains, temporary job growth has moderated slightly, but remains at the highest level since August 2007. Among college graduates, the job picture remains bright with unemployment in that segment hovering around 4%, reflected in our revenue growth and the ongoing investments we're making in PT. Small- to medium-size companies appear to be responsible for the lion's share of job growth at this point in the recovery, and this has kept our commercial growth flat year-over-year. We expect hiring among large companies, which form the core of Kelly's client base, to pick up as we move further into the economic recovery. In contrast to the gradual improvement here in the U.S., Europe lost ground in the first quarter. After contracting during the fourth quarter, the eurozone economies continued to struggle during the first quarter, as weakness extends into the more resilient economies, such as Germany. Prolonged uncertainty is also contributing to rise in unemployment levels through the region. As such, our outlook for Europe calls for recessionary conditions to persist with only a modest recovery expected by the end of 2012. Nonetheless, we are encouraged by growth in PT and are making investments that take advantage of long-term business opportunities across that important region. With that, I'll provide some quarterly highlights beginning with the Americas. In the Americas, we felt the effects of the slow-moving recovery across both our Commercial and Professional and Technical segments. Combined revenue for the region grew by 3% year-over-year. On a sequential basis, revenue was flat for the quarter. Americas Commercial revenue increased 2% year-over-year due to the acquisition of Tradicao in Brazil. Without Tradicao, Commercial revenue would have been relatively flat for the quarter. We saw a slightly stronger revenue growth from our Americas PT, which grew 4% year-over-year, increasing 3% sequentially. Within PT, the strongest growth came from our IT and finance businesses, growing 9% and 7% year-over-year, respectively. For the Americas region, combined temp to perm, direct placement and other fees increased more than 24% year-over-year and were up 1% compared to the prior quarter. Americas gross profit rate for the quarter was 70 basis points higher than the same period last year. This increase was due to favorable adjustments to prior year workers compensation cost in the Commercial segment, lower benefit cost in PT, and favorable customer mix and pricing in both Commercial and PT. On a sequential basis, the gross profit rate was 40 basis points higher than the fourth quarter, and I expect that about half of that 40 basis points will continue going forward. We remain committed to improving our margin and remain willing to walk away from business that we can't service profitably. Expenses were flat year-over-year and increased 3% compared to the fourth quarter. Excluding Tradicao, expenses were down slightly year-over-year. We continue to carefully manage expenses throughout the region. All in all, we're very pleased with the Americas earnings of $35 million for the quarter. This represents an increase of 40% over prior year and 3% over the fourth quarter, evidencing strong earnings leverage on 3% revenue growth. Let's now turn to our operations outside the Americas, beginning with EMEA. Reported revenue in EMEA was down 7% in the first quarter compared to last year. On a constant currency basis, revenue was down 4%. For the remainder of my EMEA discussion, all revenue results will be discussed in constant currency. Difficult economic conditions are prevalent throughout EMEA, and staffing markets are seeing revenue declines in the range of 5% to 10%. Eastern Europe was down 8% year-over-year while Western Europe fared better with a decline of just over 2%. The declines are attributable to a pullback in Commercial temp sales. PT, on the other hand, is still trending positive with growth of 5% for the quarter. We continue to see nice improvement in fees for the quarter. Fee revenue for Q1 was up 8% year-over-year and up 5% sequentially. Growth was seen in both our Commercial and PT segments. The GP rate for the first quarter was 17.6%, down slightly from the 17.7% for the same period last year. The GP rate decline was exclusively due to temp GP deceleration across most countries. We're seeing unfavorable customer mix between corporate and retail accounts within our EMEA Commercial segment. Temp GP and Professional and Technical remained stable for the quarter. At constant currency, expenses decreased by 1% year-over-year and nearly 4% sequentially, excluding restructuring. We're pleased with our ability to reduce our segment costs, more than offsetting targeted investments in PT. EMEA reported a profit of just over $300,000 for the first quarter. Given the headwinds in Europe, we expect results to continue to be below last year. Turning now to APAC. Combined revenue for the region, both Commercial and PT, declined 11% in constant currency. Commercial revenue was down 13%, due primarily to our decision to exit several large, low margin accounts in India and Australia. Excluding these accounts, revenue was up 3% for the quarter. We did see growth in PT, which grew by more than 10% year-over-year for the quarter. Fees across the region declined by 2% year-over-year. On a sequential basis, Professional and Technical fees rebounded nicely with a 27% improvement over the prior quarter. Our GP rate for the region increased by 150 basis points to 18.1% compared to the same period last year. This improvement was primarily due to strengthening temporary margins in Australia and India as we exited unprofitable accounts. We're also seeing fee improvement in the average fee for placement, resulting from our strategy to deliver higher level placements. Expenses were flat for the quarter or up by 1% on a constant currency basis. We continue to focus our investment on Greater China, where we've seen solid growth over the last 4 quarters. While we concluded the quarter with a loss of $1.4 million, we expect to see an improving profit picture in APAC. Our final segment is our Outsourcing and Consulting Group, and we're very pleased with the progress made by the OCG team. OCG revenue was up 27% in the first quarter compared to last year. The strong year-over-year growth is consistent with the 26% growth we reported in Q4 of 2011. Sequentially, revenue is down 8%; however, this decline is directly related to the seasonal nature of programs within our payroll processing outsourcing business. Fourth quarter is traditionally the strongest quarter in terms of both revenues and profits for PPO. Revenue growth and demand for our OCG services remains strong in many of our practice areas. Fee revenue was up 50% year-over-year in our CWO practice. Revenue in our business process outsourcing was up 32% year-over-year, driven primarily by high demand in our contact center solution. Our PPO practice also reported nice revenue growth of 27% in Q1 as compared to a year ago. And globally, in our RPO practice, revenue was up 18% versus a year ago due to strong revenue growth in our EMEA programs. Overall, OCG's gross profit rate of 26.7% is 170 basis points higher than a year ago. Improvement in GP continues to result from improved volume mix within higher margin practice areas. Expenses were up roughly $3 million or 17% year-over-year in OCG. Increases in expenses continue to be the result of servicing costs associated with the expansion of customer programs as well as costs associated with new customer programs being implemented. But all in all, we're realizing very nice operational leverage. For the quarter, OCG reported earnings of more than $500,000 compared to a loss of nearly $2.4 million a year ago. As a final note, our Q1 performance in OCG was especially gratifying given that the first quarter is traditionally our weakest quarter. This year, we experienced better-than-expected volume in our BPO and EMEA RPO business units, which help drive a stronger-than-expected first quarter. However, we expect Q2 to performance to follow more normal seasonal patterns, and we expect Q2 to be impacted by costs associated with the implementation of customer programs that are scheduled to come online in Q3. That said, 2012 should be a profitable year for OCG. I'll turn the call over to Patricia, who will cover our quarterly results for the entire company.

Thank you, Carl. Revenue totaled $1.4 billion, an increase of 1% compared to the first quarter last year. On a sequential basis, revenue was down 3% compared to the fourth quarter. Our acquisition of Tradicao in Brazil late last year added about 1% to our first quarter revenue, leaving organic revenue flat year-over-year. Seasonally, the first quarter is always our weakest, and the sequential decline was expected. Overall, first quarter revenue came in at the low range of our expectation due to weakness in Europe. Worldwide, our fees were up 15% year-over-year, 16% on a constant currency basis. On a sequential basis, our fees were up 8%. Our gross profit rate was 16.5%, up 70 basis points compared to the first quarter last year. The improvement was due to continued growth in fee-based income as well as improvements in our temp GP rate. The overall improvement in our temp GP rate was due to lower benefit and workers compensation costs, some of which won't repeat next quarter. Expenses were up 2% year-over-year, excluding the restructuring costs that we took in the first quarter of 2011. Again, without Tradicao, expenses would have been flat compared to the first quarter last year. And on a sequential basis, expenses were down 1%. As I've mentioned before, we continue to focus on controlling expenses. We believe this is even more important in the current slow to flat growth period that we are experiencing, but we are still protecting investments in key areas such as OCG and PT. In the first quarter, our earnings from operations were $14.7 million compared to adjusted 2011 earnings of $5.6 million. That's good leverage on a small increase in revenue. The income tax rate in the first quarter was 35%. The tax rate came in somewhat better than expected, primarily due to favorable adjustments related to work opportunity credits from last year. Diluted earnings per share from continuing operations for the first quarter of 2012 totaled $0.24 per share compared to an adjusted $0.14 in 2011. Looking ahead to the second quarter of 2012, we expect revenue growth to be flat to up slightly on a year-over-year basis. Up in the low single digits sequentially. We expect the gross profit margin to continue to be up year-over-year, although most likely not quite as much as we saw in Q1 due to the favorable adjustments Carl and I noted. We plan to stay the course on expense control in 2012 and deliver growth with only modest increases in SG&A. On a year-over-year basis, expenses will increase in the mid-single digits, and on a sequential basis, we expect expenses will only increase slightly. As I've mentioned before, our income tax rate will be much higher than in 2011. This is primarily due to the expiration of the work opportunity in HIRE Act retention credits, which provided $28 million of combined benefit in 2011. We don't anticipate the HIRE Act retention credit to be reinstated, but the work opportunity credit has expired and been reinstated several times, even retroactively. Given the current political environment, it is uncertain if or when the work opportunity credit will be reinstated. We estimate our annual tax rate to be 25% to 30% if WOC credits are reinstated and 35 to 40% if they aren't. The accounting model for taxes means that we will not book any 2012 work opportunity credits until legislation is enacted, and in fact, our second quarter rate will be higher than the first quarter due to work opportunity credit adjustments we recorded in the first quarter. I also want to point out how the change -- the change in how we present an account for our operating segments. As we've continued to refine our operating structure and combine the management of Commercial and PT in each of our regions, we have been required to allocate a significant amount of expense between Commercial and PT. Beginning in 2012, we've eliminated the expense allocation, which we do not perceive as much value. While we continue to report through the gross profit line for the 7 operating and reporting segments, our expense reporting has been reduced to the 4 regions: Americas, EMEA, APAC and OCG plus corporate. Turning to the balance sheet, I'll make a few comments. Cash totaled $88 million, up from $81 million at year-end 2011. Accounts receivable totaled $978 million and increased $33 million compared to year-end 2011. For the quarter, our global DSO was 54 days, up from 52 days last year. The increase is due primarily to expansion of terms for CWO and other customers. Accounts payable and accrued payroll and related taxes totaled $550 million and increased $41 million compared to year-end 2011. At the end of the first quarter, debt stood at $95 million, about the same as year-end 2011. Debt to total capital was 12%, down slightly from year-end 2011. In our cash flow, we generated $13 million of net cash from operating activities compared to a use of $5 million last year. The change primarily reflects improved operating results as well as lower working capital requirements in 2012. I'll turn it back over to Carl for his concluding thoughts.

Thanks, Patricia. It's clear that 2012 will present its share of challenges. To be certain, the U.S. economy is recovering, but at a stubbornly slow pace. Weakening European economies have shaken confidence here in the U.S., business consumers and investors remain cautious, and large companies still aren't spending in adding jobs as quickly as would have been expected. Those are realities that can constrain our business. But they're balanced by the positive longer term trends that favor Kelly, among them shortages in a number of high skill disciplines and an aging workforce that will create opportunities, an ongoing secular shift towards flexible workforce models and a growing demand for the types of customized talent management solutions we provide through OCG. And so we see the glass is more than half full. Despite the economic headwinds and low revenue growth, we demonstrated our commitment to improved operational leverage, achieving solid first quarter results. We remain optimistic about 2012, but the second quarter will be tougher than originally expected given global economics. As we conclude this morning's report, let me affirm what we set out to do. We're committed to delivering competitive returns and increased value for our shareholders. Specifically, our sights remain on achieving a return on sales of 4% this cycle. To do that, we're focusing on growing PT, fee base and other higher margin offerings and maintaining our lower cost to service delivery, and we're making progress. But if we're going to achieve our goal, we need to see stronger economic growth and greater demand for labor. Regardless, we know that the strategy is sound and we'll continue to act with urgency as we execute our plan. We'll leverage our reputation for excellent service to capture new business, broaden customer relationships and generate profit. We'll respond to customers' needs for flexible, innovative solutions for managing their workforce, from traditional staffing to Professional and Technical specialties through outsourcing and consulting programs. And finally, we'll leverage our exceptional Kelly team to connect the world's top companies with talented, passionate free agents and suppliers equipping our clients with the flexible workforce that helps them execute their business goals in 2012 and beyond. That concludes today's report. Patricia and I will now be happy to answer your questions. John, the call can now be opened.

[Operator Instructions] First from the line of James Samford with Citigroup.

Just wanted to just get a sense for -- things seem to be deteriorating here in Europe, certainly at least on the rhetoric level. Just wondering what you're hearing or what you've been seeing in the quarter so far, and particularly in maybe the Western European side?

So I'm not seeing any signs of a miraculous recovery in Europe, if that's what we're hoping for. I think the rhetoric is hard. Speaking not necessarily of the hours we're seeing, but talking of the customer sets in general, I see customers in all of the European areas being very cautious about starting anything new, very cautious about investing inside the European markets. I think there's insufficient certainty. And until there is some understanding of how the euro crisis, the debt situation is going to play out, I'm not expecting there to be any resolution of the certainty crisis in Europe, and we are not counting on a return to strong growth in Europe this year.

Yes, one of the segments, I guess, in Switzerland, you're still seeing some pretty nice growth there. And I think from the data, it looks like even Switzerland's temp data has gone negative. Is there a share gain going on there, do you think? Or is something particular in Switzerland that's going on?

If we're growing market and the overall data shows that it's losing, then you would argue that there is a share shift. I haven't seen the objective report to that effect, but that would be the only way the 2 numbers could be reconciled.

Fair enough. I guess switching to the U.S. really quickly, just any comment on trends you're seeing there between sort of your larger clients versus smaller client mix?

Well, there was more growth than -- as we talked about, there was more employment being created in the smaller customer set. But not -- the dynamics aren't such that it would've caused any appreciable shift in our overall balance yet. What I tend to look for as my signs that doom and gloom is coming is our customers talking about contingency plans for what happens if they need 10% less staff -- that's not really taking place. On the other hand, there's not a whole lot of conversations taking place about how we would ramp up rapidly, to add even 10% more. It's kind of a stable set of expectation. That's why we talk about very low single-digit type of growth for a bit here in the U.S.

Next question is from Tobey Sommer with SunTrust.

This is actually Frank here for Tobey. I wanted to ask about the expense control and SG&A. You talked about continued improvement there throughout 2012. You've done a good job so far. Can you give us any color on, additionally, where that's coming from?

Yes, we're basically keeping the same tight rein on what I'll call sort of staff and discretionary costs. In addition to that, we really are focused on making sure our field is as efficient as it can be. Where it's appropriate, we're centralizing functions, which also give us some efficiency. I'll also say that to a certain extent, we're -- the only negative in the whole picture is that we do have a fair amount of turnover in the U.S. as well as in Asia, so sometimes we wish we had a little bit more expense to have a few more recruiters to deck against our business. But that said, that's not a big worry, it's just one of the pieces that we need to keep managing.

Okay. Great. That's helpful. And can you talk a little bit about pricing in APAC Commercial? What are the trends you're seeing there?

Well, what you're seeing inside our own data is not a reflection per se of pricing, it was a reflection of restructuring our portfolio of business and removing the lower price points. Clearly, there are parts of the business that have been more than commoditized. They have been -- brought down to gross profit rates that are razor thin, and we're not going to play in those areas. At the upper end, we seem to be capable of moving up the skill sets both in Professional and Technical temp staffing as well as in the placement fees. The question as to the more macro pricing environment, I'm not really set to answer.

Okay. Great. And then in EMEA, I guess, France is a particularly large exposure there. We've had some, I guess, political results lately. Any thoughts about either regulatory changes or shifts that could occur in that region?

It's hard to imagine more regulation on this temporary staffing industry than already exists in France. It's a very regulated market, and it is a -- it has been a long and core part of the French approach to the labor markets. I suspect over time we might see various legislative initiatives that might impact the market in France, but I'm not expecting any -- it's not high on the legislative agenda. I'm not expecting any significant policy change within the next 18 months.

Okay. Great. And finally, in kind of looking at cash flow and balance sheet, can you talk a little bit about your view of acquisitions? What you see out there versus your balancing of repurchases and perhaps dividend?

There's never an end to the possible uses of cash. And we still have a tad more debt than I would like, and so that's obviously an area I keep focus on. There are, as we have now come out of the postrecession environment, there are people now beginning to place more staffing properties on the market. And we, like everybody else, would take a look at those. And if we've found one particularly interesting and useful to our strategy, we would probably participate. But it is not an explicit strategy to go purchase just for the sake of purchasing.

[Operator Instructions] We'll go next to Ty Govatos with CL King.

Sorry about making you go back over what you said, but I've missed some of the guidance points. Patricia, could you go through them again?

Sure. Well, we talked about revenue growth being flat, maybe up slightly on a year-over-year basis. It will grow a little bit sequentially. We said that we would expect the gross margin -- the gross profit margin to be up year-over-year in the second quarter, but not quite as much as you saw in the first. We would only have mid-single digits year-over-year expense growth. And then I talked about taxes, which I revised the numbers that I gave last quarter, where if we do have work opportunity credits, we'd be in the range of 25% to 30%, and if we don't we'd be in the range of 35% to 40%. Is that helpful?

To the tax rate, you said second Q would be higher than the first Q.

Yes, I did. We had work opportunity credit adjustments in the first quarter, which is typical. You know, those things take years to move their way through the state system and so we were -- we made some adjustments.

So we're talking a higher rate probably for the year then.

Yes, this was the low side. I should say that was the low side, assuming no work opportunity credits. Obviously, if we got work opportunity credits, our fourth quarter rate would be very low.

And, Mr. Camden, no additional questions in queue.

Great. Thank you all and look forward to talking with you over the next quarter. Bye.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.