Kelly Services, Inc. (KELYA) Q1 2018 Earnings Report, Transcript and Summary

Good morning, 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. George Corona, President and CEO. You may now begin.

Thank you, Cynthia, and good morning. Welcome to Kelly Services 2018 First Quarter Conference Call. With me on today's call is Olivier Thirot, 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. As we walk through our results this morning, let me point out that my year-over-year comparisons are represented in nominal currency with the exception of our international segment, which is in constant currency. Turning to Kelly's first quarter results. Revenue was $1.4 billion, up 6.2% compared to the first quarter last year and in line with our expectations. Reported earnings from operations were $12 million in the first quarter compared to $16.4 million last year, and diluted earnings per share were $0.74 compared to the $0.31 per share last year. As we indicated on our fourth quarter call, while we continued to grow in Q1, it was at a slower pace. Our first quarter revenue growth rate and our results were mixed as slowing growth in our commercial staffing product was partially offset by professional and technical products in the U.S., along with growth in our outcome-based services. Now let's take a look at how Kelly's 3 operating segments performed in the first quarter, starting with Americas Staffing. Americas Staffing revenue increased 5% in the first quarter compared to the same period last year. Commercial staffing revenue increased 2% over prior year, a slower growth rate compared with the previous quarters, due mainly to slowing growth in light industrial, the decision to exit certain accounts due to pricing discipline and a challenging candidate market. Kelly Educational Staffing delivered revenue growth of 18% in the first quarter. This growth rate was favorably impacted by the September 2017 acquisition of Teachers On Call. Excluding Teachers On Call, KES revenue was flat to the prior year as first quarter results were impacted by weather-related school closures and the timing of this year's school vacation schedule. Revenue in our Professional and Technical specialties increased 8% in the first quarter compared to last year, with year-over-year growth in all specialties continuing the positive trend we saw last quarter. On a combined basis, total perm fees were up 23% year-over-year with growth in both Commercial and Professional and Technical specialties. A pickup in customer hiring of temporary employees in our commercial product contributed to the slowing growth rate in commercial staffing in the first quarter. The first quarter gross profit rate in Americas Staffing was 17.9%, down 50 basis points from a year ago due to changes in business mix, partially offset by higher perm fees. Expenses for the quarter were up in Americas Staffing by 9% year-over-year, primarily the result of additional sales and recruiting resources compared to the prior year and to the addition of Teachers On Call. All told, the Americas Staffing segment achieved an operating profit of $16.1 million in the quarter compared to $21.2 million last year. Let's now turn to our International Staffing operations outside of the Americas. Revenue in International Staffing increased 22% compared to the prior year in nominal U.S. dollars. On a constant currency basis, revenue increased 9% across the regions in Europe. For ease of reference, the remainder of my comments on International Staffing will be on a constant currency basis. Fee-based income for the quarter was up 11% year-over-year. The segment's reported GP rate was 13.7% for the first quarter. The year-over-year drop in GP rate was driven mainly by a onetime benefit, which lowered cost of services in the first quarter of 2017. Excluding the effects of that onetime benefit, increases in GP dollars and fee-based hours growth were offset by declines in customer mix in the first quarter. Expenses were 1% lower than prior year due to continued effective cost management across the region. In summary, International Staffing's reported operating profit was $5 million compared to $5.2 million a year ago. Now let's turn to results of our Global Talent Solutions, or GTS, reporting segment. The GTS reporting segment reflects the 2 primary ways that large clients in this segment are buying from us: talent fulfillment and outcome-based services. I'll discuss each business's results separately. But first, let's take a look at how GTS performed as a whole in the first quarter. GTS revenue was flat year-over-year, while gross profit increased 2% for the quarter. Revenue increased year-over-year in our KellyConnect, Business Process Outsourcing, Contingent Workforce Outsourcing and Recruitment Process Outsourcing products offset by declines in our centrally delivered staffing and Payroll Process Outsourcing products. Now let's look at the gross profit results in each of the 2 GTS businesses. Our talent fulfillment business is made up of our Contingent Workforce Outsourcing, Payroll Process Outsourcing, centrally delivered staffing and Recruitment Process Outsourcing products. Gross profit in the talent fulfillment business was down 3% year-over-year, due primarily to decreased revenue in our centrally delivered staffing and PPO products due to customer-specific declines in demand and to a lesser extent, the impact of our decision to exit some low-margin accounts. Gross profit in centrally delivered staffing was also negatively impacted this quarter by an increase in our employee-related benefit costs and the sale of our health care staffing specialty. These year-over-year GP decreases were partially offset by continued double-digit GP increases in our CWO product as well as double-digit GP growth this quarter in our RPO product. We are pleased with the continuing growth in our CWO and RPO products. Now turning to our outcome-based services. Business -- this business is comprised of our BPO, KellyConnect, Kelly legal managed services and advisory services products. Gross profit in our outcome-based services business increased 18% year-over-year, driven primarily by continued momentum and strong results in both our KellyConnect and BPO products as a result of program expansions and new BPO wins. Overall, the GTS segment gross profit rate was 18.9% for the quarter, up 30 basis points year-over-year. Expenses in GTS were up 1% year-over-year in the first quarter and up 4% when adjusted for last year's restructuring charges. The like-for-like increases were due to additional headcount and salary costs related to the addition of new programs in our outcome-based services business and our CWO product. These increases were partially offset by lower salary costs in centrally delivered staffing and in PPO as we aligned our resource levels to the lower volume in these products, coupled with continuing savings from last year's Q1 restructuring in our talent fulfillment business. All told, GTS first quarter operating profit was $16 million, up 5%, but down 7% when we exclude last year's Q1 restructuring charges. I'll now turn the call over to Olivier, who will cover our quarterly results for the entire company.

Thank you, George. Revenue totaled $1.4 billion, up 6.2% compared to the first quarter last year. Our total company reported results were favorably impacted by 270 basis points due to foreign exchange. So on a constant currency basis, our revenue growth for the first quarter was 3.5%. Our Q1 performance also includes the results of Teachers On Call, which added 150 basis points to our total revenue growth rate. Overall, the Q1 revenue growth rate reflects continued, although slowing, growth in Americas Staffing and continued strong performance in International Staffing. Permanent placement fees were up 23% year-over-year from continued positive momentum in both Americas and International Staffing. Excluding the impact of currency, fees were up 17%. Overall gross profit was up $7 million or $1 million excluding currency impact. Our gross profit rate was 17.4%, down 60 basis points when compared to the first quarter last year. As George mentioned in his discussions on International Staffing, our GP rate decline was driven in part by last year's onetime benefit, which was related to French payroll taxes. In addition, we have experienced declines in our Americas Staffing GP rate due to business mix and in our International Staffing business due to customer mix. SG&A expenses were up 5.1% year-over-year or 2.9% excluding the impact of currency fluctuations. Included in SG&A in the first quarter of 2017 were restructuring expenses of $2.4 million related primarily to optimizing our GTS service delivery model. Excluding the restructuring costs and currency impacts, expenses were up 4.1%. The increase in expense relates primarily to the investments in Americas Staffing that were made beginning in Q2 2017 as well as additional resources for new customer wins in GTS. We are committed to generating returns from our investments in our service delivery infrastructure and will continue to manage expenses across all our operations in line with GP growth for the full year. Earnings from operations were $12 million in the first quarter compared with 2017 earnings of $16.4 million. If we exclude the restructuring charges, adjusted earnings from operations for 2017 was $18.8 million. On an adjusted basis, these results reflect a conversion rate or return of -- on gross profit of 5% compared to 8.1% for Q1 2017. While these results reflect the challenges we faced in the first quarter, we are committed to continued execution of our strategy and to delivering an improved conversion rate for the full year. As we mentioned in our Q4 call, Kelly adopted a required accounting standard related to the treatment of unrealized gains and losses on our equity investment in PERSOL Holdings. As a result of that change, we recognized a $23.7 million pretax gain on our PERSOL common stock in the quarter as a result of increases in the market price of PERSOL stock. That gain is recognized below earnings from operations as a separate line item with other income and expense. Income tax expense for the first quarter was $6.4 million compared with our 2017 income tax expense of $2.7 million. The effective tax rate in 2018 was 18.8% compared to 18.4% in 2017. The 2018 effective tax reflects the lower U.S. tax rate as a result of the Tax Cut (sic) [ Cuts ] and Jobs Act, which is offset by taxes on the PERSOL stock gain, which is taxed at a higher Japanese statutory tax rate. Q1 2018 income tax expense includes $7.3 million related to tax expense on the gain on PERSOL stock. And finally, diluted earnings per share for the first quarter of 2018 totaled $0.74 per share compared to $0.31 in 2017. Included in 2018 EPS is approximately $0.42 related to our gain on PERSOL stock net of tax. Now as we look ahead to the rest of the year, our current full year outlook is generally in line with the discussion on our Q4 call in February. And as I mentioned in February, the outlook provided does not reflect any future gains or losses on PERSOL stock, although we do believe that future unrealized gains and losses resulting from changes in market price could be material. For the full year, we expect revenue growth to be up 5.5% to 6.5%, including the impact of FX on revenue of approximately 150 basis points. We expect the gross profit rate to be flat on a year-over-year basis. And finally, we expect SG&A expense to be up 4.5% to 5.5%, which includes additional spending on our technology and efficiency initiatives. Our 2018 annual income tax rate is expected to be in the low teens, reflecting the ongoing impact of U.S. tax reform. For the second quarter, we expect revenue to be up 5% to 6%, including 200 basis points of FX impact. We expect the gross profit rate to be up year-over-year and up slightly sequentially. And finally, we expect SG&A expense to be up 7% to 8%, mainly driven by the investment in Americas Staffing resources, which began in Q2 of last year. We expect to begin leveraging in Americas Staffing in Q3. We'll continue to evaluate our resources and adjust accordingly. Now moving to the balance sheet. Cash totaled $37 million compared to $33 million at year-end 2017. Accounts receivable totaled $1.3 billion and was flat with year-end 2017. Global DSO was 57 days, up 2 days from the same quarter last year and up 2 days from Q4 2017. At quarter end, we had debt of $33 million compared to $10 million at year-end 2017 and no debt a year ago. In our free cash flow for the quarter, free cash flow was negative $9 million compared to generating $22 million of free cash flow last year. For more information on our performance, please review the first quarter slide deck available on our website. I'll turn it back over to George for his concluding thoughts.

Thank you, Olivier. While the first quarter presented some challenges, we remain confident and committed to our strategy for growth. We will continue to channel our efforts to grow where we know we can win, and we will take decisive action to protect and accelerate that growth. Our Americas International Staffing operations are executing with energy and focus. While we experienced a slowing growth rate in the commercial products in the Americas segment, we are pleased with the continued upward trend in our Professional and Technical specialties, where we entered the second quarter with good momentum. We will keep a close eye on market dynamics in the Americas, and we will adjust our resources accordingly. In Global Talent Solutions, we continue to manage our business in line with market demand, and we are committed to investing in higher-margin products and adding resources as we win new business. We fully expect GTS will improve its GP growth rate throughout the year as companies continue to adopt a more holistic approach to talent fulfillment and outsource their noncore functions through outcome-based solutions. As we proactively manage the company's short-term performance, we are also strategically leading Kelly's long-term future. We are focusing on our strengths, making strategic investments and leveraging technology to connect with talent like never before as we move forward with confidence, committed to our pursuit of profitable growth. Olivier and I will now be happy to answer your questions.

[Operator Instructions] And allowing a few moments, I'm showing no questions in queue at this time.

Okay, Cynthia. Thank you, and thank everyone on the call.

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