Kelly Services, Inc. (KELYA) Q3 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to Kelly Services Third Quarter Earnings Conference Call. [Operator Instructions] Today's call is being recorded at the request of Kelly Services.[Operator Instructions] I would now like to turn the meeting over to your host, Mr. Carl Camden, President and CEO. Sir, you may begin.

Thank you, Louise, and good morning, everyone, and welcome to Kelly Services 2012 Third Quarter Earnings Report and Conference Call. With me on the call today 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 talk about our third quarter results. The third quarter offered no relief from the global economic headwinds we have faced during the first half of the year. The U.S. recovery, already the slowest in 6 decades, softened further in response to Europe's ongoing crisis, anxiety over the fiscal cliff and uncertainty leading up to yesterday's presidential election. Kelly achieved better than anticipated results despite these conditions. Our GP and earnings from operations showed improvement both year-over-year and sequentially. And we continue to make progress in our targeted strategic focus areas. Revenue for the quarter was down 1% year-over-year in constant currency, a deceleration from the flat growth we saw on the second quarter. Despite revenue declines, we kept our control over expenses and improved our gross profit, which gave us leverage to deliver an operating profit of $24 million for the third quarter, compared to $22 million in the third quarter of 2011. Earnings from continuing operations were $0.43 per share, compared with last year's earnings of $0.52 per share. Our gross profit rate was 16. 8% for the quarter, a healthy increase of 80 basis points year-over-year and a 50 basis point improvement over last quarter. Overall, we're encouraged by our progress in a low growth economic environment where macro conditions remain unsettled and uncertainty persists. With that, I'll provide some quarterly highlights, beginning with the Americas region. As expected, we began experiencing the effects of a softened economy in the Americas as we ended the third quarter. Combined staffing revenue for the region was down 1% year-over-year, and down 3% sequentially. Americas Commercial revenue was down 3% year-over-year. Without Tradicao, Commercial revenue would've been down about 5% for the quarter, with light industrial trending 6% below prior year. We saw stronger revenue growth from Americas PT, which grew 4% year-over-year and was flat sequentially. Within PT, the strongest year-over-year growth came from engineering, finance, IT and health care. For the Americas region, combined temp-to-perm, direct placement and other fees increased 25% year-over-year. However, sequentially, fees were down 5% compared to the prior quarter. Americas gross profit rate for the quarter was 80 basis points higher than the same period last year. This increase was due to lower workers compensation cost, improved pricing and higher fees. We remain committed to improving our margins and we're seeing evidence of our efforts. Gross profit dollars were up 4%, in spite of the 1% decrease in our Americas revenue year-over-year. We are carefully managing expenses throughout the Americas region, expenses were up 4% year-over-year, however, excluding our Brazilian acquisition, expenses were up only 2% year-over-year. On a sequential basis, expenses increased nearly 3% from the previous quarter. The sequential increase was due to annual merit increases and increases in performance-based compensation. Americas achieved earnings of $36 million for the third quarter, a 6% improvement over the prior year. We're very pleased that given a tough economic environment, a yield at a 1% drop in revenue year-over-year, our Americas team was able to improve GP, control expenses and leverage our operations. I continue to be pleased with our efforts. Let's now turn to our operations outside the Americas beginning with EMEA. Reported revenue in EMEA was down 17% in the third quarter compared to last year. On a constant currency basis, revenue was down 7%. For the remainder of my EMEA discussion, all revenue results will be discussed in constant currency. Business conditions remained challenging throughout much of EMEA and staffing markets are experiencing revenue declines in the range of 10% to 15%. For Kelly specifically, Eastern Europe was down 8% year-over-year, while our operations in the Nordics and Western Europe fared a bit better with declines of just over 1% and 6%, respectively. The declines are attributable to softening Commercial Temp sales. PT growth also slowed over the course of this year, turning slightly negative during the quarter, with a nearly 1% decline compared to the same period last year. During the quarter, we also saw a decrease in our fees across the region. The revenue for Q3 was down 13% year-over-year and down 12%, sequentially. Fees within EMEA's PT segment have been the hardest hit. The Commercial segment fared a bit better with positive fee growth for the first half of the year, but experienced declines in the third quarter. EMEA's GP rate for the third quarter was 17.1% compared to 17.8% for the same period last year. The decline was due to margin erosion on the Commercial segment, as well as the decline in fees. In constant currency, expenses decreased by 5% year-over-year. This reduction was primarily due to decreases in variable costs in the Commercial segment in line with the level of activity, partially offset by targeted investments in the PT segment. Netting it all up, EMEA reported adjusted earnings of $3.9 million for the quarter, a decrease of roughly $3.6 million compared to last year. However, we're very proud that we remain profitable in such a difficult market. As we said on our last earnings call, conditions across Europe will remain a challenge for the staffing industry for the foreseeable future. Now let's turn to APAC. The macroeconomic headwinds continue to be felt across parts of the APAC region as well, impacting our operations there. Combined revenue for the region, both Commercial and PT, declined roughly 11% in constant currency, primarily as a result of exiting a number of low-margin customers in late 2011 in Australia and India. On a sequential basis, revenue for the region improved by 2% over the second quarter. Fees declined by 1.5% year-over-year. However, we are seeing improvements in fees within our APAC PT segment, resulting from our strategy to deliver higher level skill sets. Our GP rate for the region increased by 130 basis points to 18.9% 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. Expenses remained well controlled and we're down more than 2% on constant currency for the quarter, primarily due to a decrease in full-time salaries related to a reduction in headcount. We concluded the quarter slightly above breakeven, consistent with the same period last year. Turning to our OCG segment. We're very pleased to report that this quarter marks the fourth consecutive quarter of positive earnings for OCG. OCG revenue was up 30% in the third quarter compared to last year, and up 15%, sequentially, compared to Q2. Growth within our OCG segment is being driven by the 3 core elements of our talent supply chain strategy: Business Process Outsourcing, Contingent Workforce Outsourcing and Recruitment Process Outsourcing. Business in our Business Process Outsourcing practice was up 53% year-over-year, driven primarily by high demand in our KellyConnect, that's our contact center solution within that practice, as well as an increase in our more traditional BPO solutions within the Americas. The revenue was up 44% on our Contingent Workforce Outsourcing practice. And finally in our Recruitment Process Outsourcing practice, revenue was up 42% versus 1 year ago due to new client programs in the Americas, as well as continued revenue growth in our EMEA programs. Overall, OCG's gross profit rate was 27% as compared to 24.5% 1 year ago, due to growth in higher-margin practice areas. Expenses were up roughly $4 million or 21% year-over-year. This increase is the result of servicing costs associated with the expansion of customer programs and new customer program implementations. But all in all, we continue to realize significant operating leverage. For the quarter, OCG reported earnings of $4 million compared to a loss of $200,000 1 year ago. Strong growth in our BPO unit, the addition of new client programs in RPO practice and strong fee growth in CWO clearly helped to boost our third quarter earnings. While we expect to remain profitable in the fourth quarter, profits will decline from the levels seen in the third quarter due to the completion of 2 major projects. Overall, we're very pleased with the strategic progress we're making in this important segment. Now 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, a decrease of 4% compared to the third quarter last year, down 1% on a constant currency basis. On a sequential basis, revenue was also down 1% compared to the second quarter. Our acquisition of Tradicao in Brazil late last year added about 1% to our third quarter revenue. Worldwide, our fees were up 4% year-over-year, 8% on a constant currency basis. On a sequential basis, our fees were down 3%. Our gross profit rate was 16.8%, up 80 basis points compared to the third quarter last year. The increase was due to stronger performance in the OCG segment and improvements in our Temp gross profit rate in the Americas and APAC region. The Temp GP benefited from underlying strength, as well as adjustments to prior year's workers comp in the U.S. which was worth about 20 basis points of the GP rate increase. Expenses were flat year-over-year, up 3% on a constant currency basis. Again, without Tradicao, expenses would've been up 2% on a constant currency basis and on a sequential basis, they were also up 2%. In the third quarter, our earnings from operations were $24 million compared to 2011 earnings of $22.1 million. Given the decrease in the top line, it's good to be up compared to last year. The income tax rate in the third quarter was 29%, about where we expected, but significantly higher than the 15% tax rate last year. As I've noted before, the increase in the rate is due to the expiration of both the HIRE Act and work opportunity credits. Diluted earnings per share from continuing operations for the third quarter of 2012 totaled $0.43 per share compared to $0.52 in 2011. Again, the decrease is due to the income tax rate. Looking ahead to the fourth quarter of 2012, we expect revenue to be down, both on a year-over-year basis and sequentially. We expect the gross profit rate to continue to be up year-over-year, although down slightly sequentially, as we don't expect to repeat the favorable workers compensation adjustments, which were worth about 20 basis points. We expect modest increases in SG&A, due largely to merit increases and additional recruiters to continue to take advantage of our PT focus. We will also have a $3 million impairment for a PeopleSoft module we have decided not to deploy. We are on track to launch PeopleSoft payroll in the U.S. next year, but last month, we decided that the cost-benefit wasn't compelling for subsequent change to our billing system. As I've mentioned before, annual income tax rate will be much higher than in 2011. As we look forward on the tax rate, it will depend on the extenders bill being passed and signed before the end of the year and we'll just have to wait and see. If the extenders bill is signed before the end of our fiscal year, which is December 30, we will have a negative income tax rate in the fourth quarter. If it's signed after the end of our year, the benefit will fall in the first quarter of 2013. Turning to the balance sheet. I'll make a few comments. Cash totaled $70 million, down from $81 million at year-end 2011. Accounts receivable totaled $1 billion and increased $74 million compared to year-end 2011. For the quarter, our global DSO was 54 days, up from 52 days last year. The increase in DSO is mainly due to extending customer terms and circumstances where we were comfortable with credit risk and we're appropriately compensated. Accounts payable and accrued payroll and related taxes totaled $549 million and increased $40 million compared to year-end 2011. At the end of the third quarter, debt stood at $84 million, down $13 million from year-end 2011. Debt-to-total capital was 10%, down from 12% at year-end. In our cash flow, we generated $21 million of net cash from operating activities compared to $6 million last year. The change primarily reflects lower additional working capital requirements in 2012. With a weak revenue situation, it's still a strong operational performance this quarter. And now, I'll turn it back over to Carl for his concluding thoughts.

Thank you, Patricia. Although the U.S. employment rate finally dipped below 8% in September, overall job growth is tepid even in Professional and Technical areas and U.S. Temp job growth specifically also slowed in the third quarter. Looking ahead, we're now faced with new headwinds from the effects of Hurricane Sandy. Although it's too soon to specifically calculate the full extent of this economic repercussions, they will be noticeable. And in the Eurozone, we expect constrained hiring throughout the remainder of the year as prolonged uncertainty and economic contraction continue to take their toll on the labor market. However, Kelly's solid third quarter performance achieved despite declines in revenue gives me comfort in our ability to execute in this difficult market conditions. We continue to deliver sustained progress in our 3 strategic focus areas. Our OCG segment continues to deliver progressively stronger revenue, GP and earnings results. The gains in revenue confirmed the importance of the OCG's role in the marketplace as demand for workforce management programs continues to rise, while the gains in GP and earnings affirm the value of this segment to Kelly as we leverage higher-margin, fee-based businesses and build our talent supply chain capabilities. In Professional and Technical, our PT staffing growth rates outpaced our Commercial growth rates for the 6 consecutive quarter, reflecting our commitment to meeting our customer's growing demand for skilled workers. And we continue to hold costs in check, providing leverage and delivering earnings growth despite the decline in revenue. While we're pleased with Kelly's third quarter results, we're realistic about the cumulative impact of this anemic recovery. As we've stated before, reaching our goal of delivering 4% ROS will require more vigorous, sustained periods of economic growth and sharper increases in demand for labor than what is currently projected in 2012 and 2013. We remain committed to that goal. We're confident that long term, secular trend support a bright future for Kelly. The shift towards flexible labor models, heightened demand for highly skilled workers and the need for customized talent supply chain solutions will drive us forward. Our third quarter results show that we're leveraging these trends and staying true to our strategy of delivering a competitive profit from the right solutions for our customers, delivered by the world's best talents. That concludes today's report. Patricia and I will now be happy to answer your questions. And Louise, the call can now be opened.

[Operator Instructions] Our first question is from James Samford from Citigroup.

I just wanted to congratulate you on the OCG numbers. It's certainly better than we expected on the bottom line. I wonder if you could talk a little bit about your pipeline of opportunities there as you enter the fourth quarter. I know you said it will be down this quarter because of few projects that have rolled off. But what does the pipeline look like from the year and how much visibility do you have in OCG versus, let's say, your Commercial and PT?

Great. So if you talk about the silos inside the OCG, CWO, RPO and so on, staffing industry analysts show that it is still lightly penetrated in the large companies and still has strong growth prospects in the front of it and the silos will perform differentially. The RPO segment in particular, you don't see hiring picking up in North America and in Europe. It's always going to be constrained by a lack of the activity of companies seeking full-time employment. At a macro level, the blending together of solutions into supply chain capabilities is very lightly penetrated. We've been leading the way into that. And I would view, in general, the pipeline to still be rich. The sales cycle is long for the newer -- for this newer solutions that are being introduced to the companies. But I don't see a slowdown in the secular shift and a -- towards the solutions. So slowdowns, we see are where the particular solutions touch permanent hiring.

Great. And I guess in light of the election last night, I was wondering if you could talk about the likelihood of the extenders bill happening this quarter and/or just if you have any thoughts on what the tax rate might be with or without the extenders bill in 4Q and how should we think about the tax rate next year?

I was hoping that your analyst would tell you what the probability. Are we going to be interested? I don't know. There's a broad coalition of those of us who are in employment and also those who are in research heavy activities looking for the extenders. The research credits as well as the employment credits are critical to a large number of companies and enjoys a fair level of bipartisan support. But I have no expectations that I'm going to get rich by predicting what our government is going to do or not do. I'll let Patricia answer the question as to tax rates with and without and what is possible next year. I'm curious myself as to what she thinks is going to happen next year.

Work opportunity credits, our latest guess of where they would come in if the extenders bill was passed, whether in 2012 or 2013, it's about $8 million. That's down a little bit from what we've seen in prior years, primarily because the volume is down. So that number is also, I think, a pretty good guess for where they come in, in 2013 as well.

Our next question is from Tobey Sommer from SunTrust.

Carl, I'm interested in your perspective. We've had a challenging economy for a while, the growth rates have decelerated. Is there anything that you're seeing in your non-OCG fee businesses, temp-to-perm conversions in outright perm that lead you to believe that we're kind of turning a corner down economically in the U.S.?

Yes, the answer -- so visibility is of course limited to a few weeks at a time here, but the answer is no. So we tend to look at several technical lanes which I won't get into. But at the broadest level, we pay a lot of attention to the question our big customers beginning to ask us to lay in contingency plans for what might happen, not that we're planning to do anything, of course, if we were going to reduce our workforce by x or y. Those conversations aren't taking place. That's for me, the closest in tripwire indicator that things are about to go south in a big way. Technically, as we look at things like workers' compensation, unemployment claims, other technical aspects, I'm not seeing signs of a rock 'n roll recovery around the corner, but nor am I seeing signs of a sharp decline. And again, we're specifically talking about the U.S. here. I think when you move over to Europe, we're clearly in recession. In a large number of countries, I see little hope that we're going to come out of recession. I think that Europe is facing a very tough 3 to 5 years here in front of it.

I'm curious. In the OCG business, you said, I think you have a couple of projects ending. Are those projects -- did they -- are they ending on the timeline that was expected or is this kind of an unanticipated cessation of a project?

A very quick answer is that they are ending as planned. You have 2 styles of relationships in OCG. You have long ongoing projects where you're handling, as an example, the recruitment of all permanent staff for the foreseeable future. But you also have companies who are staffing up or dealing with a particular exigency, a particular need they have. They might need to be launching a new product and have x thousand new salespeople to be hired. Those projects, the types of projects that are coming to an end, they had a predictable begin and a predictable end. And they're following along that path.

And then my last question, I'll get back in the queue. Could you give us a little bit more color about the PeopleSoft decision and what you're thinking about doing and kind of the rationale for opting not to deploy a certain module?

Yes, I'd be happy to answer that. We had -- just to remind you, we had launched PeopleSoft in various guises, but the big one for us is to launch in the U.S., which of course is the vast amount of our volume. We put that project on hold for a little while. But with the strengthening economy and also, frankly, some really good talent that we have in IT area, we decided to go ahead with that, and on payroll, which is what we really needed to do. That project has gone extremely well and I'm really pleased. We should be -- we're absolutely on track to launch early next year. We had contemplated, as part of that, going ahead and also launching PeopleSoft in billing, which would just give us a nice integrated suite of PeopleSoft for the whole back-office. But when we refreshed the cost estimates that we've done in October, frankly, it was very, very expensive and we didn't see an immediate benefit to doing it because our legacy systems are fine. They need a little bit of tuning up, but they are fine. And so we decided that the money would be better spent, frankly, on some more customer facing and front office systems, where we prefer to invest as opposed to the back office. So we made that -- this capital decision as we went -- we did have a little bit of cost from the balance sheet, from when we originally acquired and then some work on the PeopleSoft billing system, so that's what we're going to write-off.

[Operator Instructions] Our next question is from John Healy from Northcoast Research.

I wanted to ask you about the impact of the hurricane a bit, maybe not quantifying the impact, but could you kind of describe what the relation -- what the conversations with customers have been like? Maybe, I imagine activity kind of came in to a halt, but are customers telling you to bring people back or kind of what's the commentary you're getting from the field?

So if you look at the impact of the hurricane, it kind of comes into tranches, right? So the first tranche is you have a large number of branches that shut down, an immediate reduction and need for those people on the facilities that have been shut down, our customer locations. You have a shifting of that over to your emergency centers. And so you kind of have a permanent loss of business during a time that customers facilities have been shut down. And then the question you're really asking is how rapidly will they reopen and how rapidly will the business get back to normal. And the answer, usually is there's about 2/3 of it comes back pretty quickly and another 1/3 of it has some timing sitting behind as the customers have to look at whether they can actually reopen their facilities and what has to be done. And then that somewhat offset by work that we have as an example of our insurance companies who we're manning the call centers and helping dealing with the claims processing. Too early for us to know what the longer impact is, but there are clearly customers who lost facilities and are uncertain when they're going to have them reopen. That's as -- has been the case in general, as a smaller portion of the amount of work, most of it will bounce back fairly, fairly quickly.

Okay. That's helpful. And question for you, Patricia. I think you mentioned when you kind of gave us some commentary on the fourth quarter expectation that SG&A will be up a bit sequential, a bit -- it would be moving up a little bit. Was that a reference to year-over-year increase? Because I thought last year in the fourth quarter, there was a big catch up on incentive comp and I wasn't sure if you are talking sequentially in the year-over-year and if you're also including the $3 million of the PeopleSoft write-down in that SG&A thought process?

I was thinking -- my point about the increases in SG&A are both -- or clearly year-over-year and probably a little bit sequentially. Because of the timing of our typical calendarization, we do have more incentive comp that hits us in the fourth quarter than earlier in the year and I expect that will continue. I did not include the impairment in that because it's technically a separate line item on our income statement. So my point about SG&A were the base SG&A, not driven by the impairment.

And at this time, there are no further questions. Thank you. Please continue.

Good. If there are no other questions, I assume you all want to get back to trying to figure out the impact of the election results on your financial models. Please forward that information onto us. We look forward to chatting with you all again. Thank you. Thank you, Louise.

Thank you, and ladies and gentlemen, this conference will be made available for replay after 11:30 today through December 7. You may access the AT&T replay system at any time by dialing 1 (800) 475-6701 and entering the access code 232002. International participants can dial (320) 365-3844. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.