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Spherion Corporation (NYSE:SFN)

Q4 2008 Earnings Call

February 5, 2009 9:00 am ET

Executives

Roy G. Krause – President & Chief Executive Officer

Mark W. Smith – Executive Vice President & Chief Financial Officer

Analysts

Jeffrey Silber – BMO Capital Markets

Andrew Steinerman – JPMorgan

Operator

Good morning, and welcome to the Spherion Fourth Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator Instructions). Today’s conference is being recorded. If you have any objections you may disconnect at this time.

Now, I will turn the meeting over to Mr. Roy Krause, President and Chief Executive Officer. Sir, you may begin.

Roy G. Krause

Thank you, Stacy. Good morning, everyone. Welcome to Spherion’s fourth quarter call. Before we begin our prepared remarks, Mark Smith will read our Safe Harbor Statement.

Mark W. Smith

Thanks, Roy. This call may contain statements that are forward-looking in nature and accordingly are subject to risks and uncertainties. Factors that could cause future results to differ from current expectations include risks associated with the company’s ability to implement its business strategy, acquisitions, competition, changing market and economic conditions, currency fluctuations and additional factors discussed in this call and in our filings with the SEC.

The company’s actual results may differ materially from any projections discussed on this call. Additionally, we may make statements referencing certain non-GAAP financial measures. Management believes the non-GAAP measures are useful in evaluating operations, but should not be considered an isolation or as an alternative to financial measures or performance as determined by GAAP.

A reconciliation of non-GAAP measures to our GAAP results has been provided in our press release, which can be found in the Investor section of our website. We will make references throughout our presentation to organic revenue changes and have included calculations of organic revenue changes in our non-GAAP reconciliation. Roy?

Roy G. Krause

Thanks Mark. The fourth quarter was a period of well-publicized economic decline accelerating through the quarter and into January. Within that difficult context, I’m satisfied that our teams executed appropriately during the quarter, and believe that we continue to manage the company in a proactive manner by controlling the factors that we can.

The BLS reported that employment numbers declined at an accelerating pace throughout the quarter. But I know, we continued to deliver quality service even as we made significant adjustments to our cost structure in preparation for the challenges in 2009.

Although, the fourth quarter traditionally sees ramping demand in the staffing industry, our revenues did decline 6.4% sequentially, evidencing the accelerating economic downturn. To the credit of our organization, costs were quickly adjusted, but adjusted EBITDA margin declined to 1.8% due mainly to the swift falloff in December.

We continue to emphasize what we believe are the right areas to weather this difficult economic cycle, specifically developing our higher margin professional services, while carefully adjusting our cost structure to reflect current and anticipated revenue levels. We will continue to optimize cash flow, pay down debt and preserve adequate and flexible liquidity to maximize our options in the upcoming quarters.

For the fourth quarter, our loss from continuing operations was $2.45 per share, compared with earnings of $0.18 last year. This loss included a restructuring charge of $0.11, and an impairment charge against goodwill and other intangibles of $2.36. Adjusting for these items, earnings from continuing operations for the quarter were $0.02.

Revenues were down 12.8% from the prior year, and down organically 20%. Our revenues were generally down on an organic basis across all service lines and skills, reflecting the broadening decline in the overall economy. Our revenue mix between large accounts, and small and mid-sized accounts has grown in favor of large accounts, particularly on the staffing side, which again confirms the trend we’ve seen in the past quarters, our large accounts holding up a little better than our smaller customers in these tight economic conditions.

We’re still seeing opportunities for new accounts as clients consolidate their spends and look for better value and service, but we see no indication that the U.S. economy will materially change direction in the near term.

Consequently, we expect the sales cycle to continue to extend with continuing pricing pressure. But we expect to operate successfully through this downturn by delivering quality service, careful cost management and attention to cash flow. As we have done throughout 2008, we will balance the cost actions that we take into 2009 with an eye towards quickly participating in a future economic recovery. Our overall business strategy will continue to focus on professional services, account diversification and mid-sized deals in commercial staffing.

For the quarter, professional service revenues were 32% of the total company revenues and generated about 42% of gross margin dollars. The economic slowdown is also certainly impacted our RPO business. Revenues declined both year-over-year and sequentially and this decline directly reflects the seemingly daily public announcements of hiring freezes and other cost cutting actions.

Fortune 500 customers make up the base in this business and hiring freezes and cut backs among that client base have had the effect of temporarily holding RPO growth.

However, the business is quickly scalable in response to economic downturns and upturns. And the deep loss of jobs among this customer base should result in an eventual steep recovery. We believe that the long-term growth prospects for recruitment outsourcing remain positive, and that trend towards outsourcing recruiting will accelerate driven by the need for flexibility and cost containment.

For example, we are currently talking to several companies who are concerned about their ability to respond quickly when the economy improves, as they’ve cut deeply into their HR recruiting basis.

Our balance sheet and liquidity are strong, net debt at the end of the quarter was approximately $32 million, compared with $93 million at the end of last year. During 2008, we made this debt reduction while also buying back $25 million of our stock. Cash flow has been good, and we continue to emphasize the acceleration of collections and we will minimize capital expenditures, especially until we get better visibility towards positive hiring trends. Even if current trends continue throughout 2009, we continue to believe that we can have most, if not all our debt repaid when the current working capital revolver is up for renewal in 2010.

Before I turn the call over to Mark to review our financial results in some more detail, I want to thank our entire team for their solid performance in the wake of a very difficult market last year, especially in cost containment and cash management. They understand the 2009 will be challenging, but are focused on increasing our customer base, diversifying risk and matching cost to gross profit trends. Mark?

Mark W. Smith

Thanks, Roy. Over the next few minutes, I'm going to give you more detail on our segments, and then talk about balance sheet and cash flow at the end of the year and for the quarter.

So, first with segments. On the professional side of the business, we reported fourth revenues of $165 million, which represented 32.4% of total company revenue. On an organic basis revenues were down 22.8%, and down across all major skill areas.

Of course, perm is being impacted due to the economic environment and was down organically 50% year-over-year, and accelerating from the third quarter year-over-year decline of about 23%.

Gross profit margins in Professional Services were 27% in the fourth quarter, down from 32% last year, and 29.3% in the third quarter of 2008. Changes year-over-year and sequentially are primarily due to changes in perm mix as the percentage of total professional services revenue, so, perm was 3.9% of revenue this quarter, 8.1% of revenue last year, and 6.4% of revenue in the third quarter of ’08. Temp staffing margins declined 200 basis points from the prior year, and 50 basis points from the third quarter.

SG&A in the professional segment decreased to 23.4% of revenue in the fourth quarter, compared with 26.7% of revenue in the fourth quarter of last year, a reduction reflects acquisition synergies, ongoing cost control and productivity improvements. Segment operating profit margin was 3.6% in the fourth, down from 5.2% last year and 4.5% in the prior quarter.

We now move onto Staffing Services, where we reported revenues of $343 million, which was 67.6% of total revenue. On an organic basis, Staffing Services revenues were down 19.1% for the quarter, which was above the same on a GAAP basis as on an organic basis.

On a monthly basis within the quarter, year-over-year revenue comparisons were as follows; down 14.7% in October; down 13.2% in November; and down 26.4% in December. And of course be a little bit careful with those November and December comparisons. There was an acceleration towards the end of the year-end declines, but the Thanksgiving holiday did flip months on a year-over-year comparable basis.

Gross profit margins in Staffing Services were 17.7%, compared with 19.9% last year and 18.1% last quarter. The year-over-year contraction and margin is consistent with the trends we've described over the past three quarters, and those items that impacted margin were higher, temporary staffing mix, lower managed services margins, lower pay bill spreads, and higher payroll burdens, primarily workers comp due to the declining interest rate environment that were in, and remember our workers comp reserves are discounted and impacted therefore by the declining interest rates.

When we look at just Temporary Staffing margins were 15.9% this quarter, compared to 17.1% last year, and 16.1% last quarter. Within our Managed Services, service line margins were 28.2% of revenue, compared with 31.9% last year, primarily they were, and down primarily a result of lower RPO volume. RPO has been impacted by slower client hiring, and client hiring freezes. We continue to make cost adjustments in this business, as Roy mentioned to adjust productivity levels.

SG&A in Staffing Services was 17.1% of revenue in both the fourth quarter of this year and last year. Segment margin was 0.6% down from 1.7% in the third quarter and 2.8% last year. Moving on the business lines, our unallocated corporate was $4.2 million in the quarter, and up $200,000 from the prior year.

Amortization of intangibles was $2 million, and we project that amortization will be about a $1.6 per quarter in 2009. Interest expense was $800,000 in the quarter and first quarter is expected to be about the same.

Let me make a couple of comments on our tax rates. The tax benefit rate in the quarter was 20.3%, compared with a 37.7% expense rate for the third quarter. The tax rate was substantially lower than the third quarter rate due to the amount of the goodwill impairment charge that was non-deductible, which resulted in less benefit against the recorded loss.

Just a comment about 2009, it is difficult to predict the tax rate for the first quarter of 2009 due to the volatility of the impact of permanent tax difference and earnings at low levels, but as you construct your models you can presume a 39% statutory tax rate and $3 million of annualized employment tax credits.

Again recorded a couple of charges during the fourth quarter. The first resulted from the company’s annual impairment testing of goodwill and other intangible assets and just as so many other within and outside our industry are having to do, we wrote our goodwill off. The non-cash charge of a $149.8 million was developed in accordance with the accounting rules and is simply a reflection of the current level of our market capitalization. The non-cash charge did not impact our credit facility availability.

The second charge related to about $25 million of annualized cost reductions that we undertook in December, and will begin realizing in first quarter 2009. Of the $9.5 million charge, $8.7 million has been or will be paid in cash, 800,000 was paid in the fourth quarter, $6.4 million will be paid in 2009 and then the remaining will be paid thereafter.

The company continues to adjust operating expenses based upon customer demand and may incur further restructuring charges in 2009.

Let me move onto the balance sheet and cash flow. Ending net debt was $31.7 million, compared with $92.9 at the start of the year. We did settle the remaining obligation related to the Technisource deferred purchase price, which was originally due in first quarter of 2009.

Cash flow from operations was $35.5 million, unused availability on our credit line was $65 million at the end of the year, and we continue to focus on paying down our debt in the coming months.

Let me make a few comments now about our primary revolving credit facility. The primary facility is our U.S. facility, and it has total capacity of $250 million. Availability is computed as eligible receivables up to the $250 million, which at year end was about $230 million less a 15% haircut of $35 million less facility borrowings of $30 million letters of credit for workers compensation collateral of $44 million, and a two-week payroll reserve of $56 million. So, the $230 minus the $35, minus the $30, minus the $44 and minus the $56 gives us our unused availability of $65 million.

Primary this revolver is up for renewal in July 2010. We did end the quarter with DSO of 49 days down four days from the end of the third quarter; our field and corporate service center teams did a great job of managing receivables in the fourth quarter. And of course in this environment, we continue to keep a close eye on credit quality and payment trends.

CapEx was $1.7 in the quarter and full year CapEx was $8.9 million. For 2009, we project that CapEx will be 30% to 40% below ‘08 levels.

Now finally, as a result of a deteriorating economy and very limited ability to predict revenue trends in this environment. We will again not give top line revenue or earnings guidance for the first quarter. However, revenue per billable day in the first four weeks of January, which of course included the New Year’s holiday has down from the fourth quarter average revenue per day by about a 11% to 12%, and may have been impacted by some lost time due to the Presidential Inauguration.

Though, we assumed 18 billable days when computing the sequential change. I can report that Temp Staffing revenue trends throughout the month of January were stable from week-to-week after the first week of the year. We should see a contraction in gross margins in the first quarter by about a 100 basis points due to state unemployment tax rate resets, which is historically consistent.

SG&A should be down due to cost actions taken at the end of the year, which I previously talked about. Additional actions we are taking in the first quarter, combined with the natural SG&A reduction resulting from lower compensation associated with lower gross profit dollars. I would expect adjusted first quarter EBITDA to be less than our 2% annualized target due to the normally heavy suited costs in the first quarter. Roy, back to you.

Roy G. Krause

Thank you, Mark. Our sales teams are focused on creating sales activity to mitigate the economic contraction we are seeing. And other teams will continue working on improving our operating efficiency while carefully managing costs. I expect that these efforts will continue throughout 2009 based on early January trends, it’s likely we’ll have to make additional hard decisions.

Our strategies have not changed, but we are cognizant that the first order of business in this environment is to protect and preserve our future operating flexibility.

Now, I’d like to open it up for your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Jeff Silber of BMO Capital Markets.

Jeffrey Silber – BMO Capital Markets

I'm sorry. Can you hear me?

Mark W. Smith

Yes, Jeff.

Jeffrey Silber – BMO Capital Markets

Okay, great. Mark in your remarks, when you were talking about the tax rate, you said the first quarter tax rate is difficult to predict, because of a low level of earnings. Should we infer from that, I know you’re not giving specific guidance that you are expecting to generate at least some operating profit in the first quarter?

Roy G. Krause

Jeff, this is Roy. Yeah, we’re not going to predict exactly where we are going to be. We showed you that first couple of weeks indicated 10% to 12% pullback, which is a little higher than historically that we usually see. So it’s going to be tough for us. We’ve taken good cost actions; it’s always the lowest quarter of the year. So, I’m not going to make any prediction, and whether we lose $0.02, make $0.02 or whatever. Right now we’re all concentrating on cash flow and paying down debt, and trying to balance cost because nobody knows where the bottom of this is.

Jeffrey Silber – BMO Capital Markets

Okay, that’s fair enough. Getting back to the discussion about the environment out there. You talked about a little bit of difference between large accounts and small accounts and the large accounts are holding up a little bit better? Are you seeing any difference in terms of pricing, we’ve heard some other companies talking about a little bit more price pressure with their large accounts versus smaller accounts?

Roy G. Krause

Well, certainly there is a lot of price pressure, and there is a lot of renewal price pressure. I don’t really think large accounts want to change in this environment, but they are certainly taking the opportunity to put us all through the ringer of rebidding proposals et cetera. And obviously, we don’t want to lose an account that we’ve had for a significant amount of time, and we clearly haven’t. So, I’ve been very pleased that over this last couple of years, we haven’t – I think only last one of the accounts that we consider strategic, and that was our choice to walk away from that. So, I’ve been pleased with that, but we’re going to be faced with more of that the clients and procurement are continuing to test everybody. And it’s obviously expensive to go find a big account, or any account for that matter. And so, I would expect that we’re going to sharpen our pencil on renewals and have to.

Jeffrey Silber – BMO Capital Markets

Okay. You had given us monthly trends for the Staffing Services division. Can you give the same for the Professional Services?

Roy G. Krause

Yeah, I didn’t give those, because they are basically the same as the full quarter trend.

Jeffrey Silber – BMO Capital Markets

Yeah.

Roy G. Krause

It’s pretty flat.

Mark W. Smith

Pretty flat.

Roy G. Krause

Just as the same trend that we saw for the whole quarter.

Jeffrey Silber – BMO Capital Markets

And any meaningful difference between professional and staffing in January versus in December?

Roy G. Krause

Yeah. I mean, a little bit of a difference. So we saw a pullback on the staffing side, probably higher than the average, somewhere probably more in a 13% range and professional was lower. So 8%, 9% range.

Jeffrey Silber – BMO Capital Markets

Okay, great I’ll jump back to the queue. Thanks.

Roy G. Krause

Okay.

Operator

Our next question comes from Andrew Steinerman of JPMorgan.

Andrew Steinerman – JPMorgan

Hi there, and good morning.

Roy G. Krause

Good morning.

Andrew Steinerman – JPMorgan

My question is about commercial temp gross margins and I did hear your comments just now about how the procurement officers are trying to take it advantage. My opinion kind of tracking the industry for 13 years pretty much of the vendors over that period of time have said that, they’ve gotten more disciplined on price, they become more EVA-oriented and obviously recession is kind of a test to that meadow. My question is do you feel like your peer group is more professionally managed more kind of smart about returns when it comes to commercial staffing than it was a decade ago?

Roy G. Krause

I do think that’s true Andrew. I think all of us, the large national players are doing a better job of resisting the changes. But there is probably as much pressure as I’ve been only in this 13 years, but I’ve never seen anymore pressure than this on renewals. And resistance to accept even passthrough costs like unemployment insurance where that’s really, they are paying that for their own employees as states reset their rates. So, it’s a battle, I mean every procurement officer out there is I am sure charged with saving money. And so, we’ve got to continue to show value. What I feel good about is, when we continue to survey those large accounts and we do it all the time and we surveyed on an over 250,000 just client incidents last year. We still come up with a great, would you recommend Spherion based on a 5-point scale, we come up 4.23. So, our clients like us, they respect us and I think we’re delivering good service. But it’s tough man.

Andrew Steinerman – JPMorgan

Great. The way, when I look at Spherion’s Commercial Staffing gross margins, back before last recession it was like 19% and then it came down, it was like 16%. And then last few years we’ve worked hard to get it up to 17% and sort of here we are back at 16 and I know how hard it is to kind of get commercial gross margins up in a recovery and so my concern is how low will commercial gross margins go.

Roy G. Krause

Well, I don’t know that Andrew. I mean I am not going to try to predict where they would go. I mean we’re trying to, I think we’re doing a better job of adjusting our costs than we did in 2000 and 2002 recession area. Our goal is to try to maintain this 2% EBITDA area in this recessionary period, and we won’t do that as Mark said in the first quarter, or I wouldn't expect that we would. But we were down as low as 0.8 in 2002 last year, I mean in last recession. And we want to be better than that. We think we can be better than that. And this is a variable business that you have to move on, and you're right we’re worked hard for three years to try to get them back up. I’ve been a little surprised honestly. That we’ve seen the smaller businesses run off as fast as they had.

Andrew Steinerman – JPMorgan

Right.

Roy G. Krause

That’s helped us to get, when we shifted our mix towards smaller businesses.

Andrew Steinerman – JPMorgan

Right.

Roy G. Krause

It moved our margins up. And Andrew just to balance the conversation about commercial staffing, temp staffing margins at that 15.9%, 16%. One thing to keep in mind is, and it is material to us – is this workers comp discounting thing, okay. So, during the year if you just go from year-end to year-end, we had to drop our discount rate and workers comp from by 200 basis points from 3.7% to 1.8%. And we probably took $2 million of additional charges very fourth quarter back-end loaded to adjust our reserves to this new lower discount rate. So it was material, of the year-over-year fourth quarter impact. It was probably 60 basis points of what we saw.

Andrew Steinerman – JPMorgan

Right, and just to round out the conversation. The 2% EBITDA annual target is still on the table as a goal for this year.

Mark W. Smith

Yes, it is.

Andrew Steinerman – JPMorgan

Okay. Thank you so much.

Mark W. Smith

Thanks Andrew.

Operator

(Operator Instructions). At this time I show no additional questions.

Roy G. Krause

Okay. Well, thank you everyone for attending. I appreciate it. And we’ll talk to you soon.

Operator

Thank you for participating in today’s conference call. And have a great day.

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