Kelly Services' CEO Discusses Q1 2013 Results - Earnings Call Transcript

| About: Kelly Services, (KELYA)

Kelly Services, Inc (NASDAQ:KELYA)

Q1 2013 Earnings Conference Call

May 8, 2013, 9:00 am ET


Carl Camden - President & CEO

Patricia Little - CFO


John Healy - Northcoast Research

Tobey Sommer – SunTrust Robinson Humphrey


Good morning ladies and gentlemen and welcome to Kelly Services First Quarter Earnings Conference Call. All parties will be on listen-only until the question-and-answer portion of the presentation. 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.

Carl Camden

Thank you, John. Good morning everyone. Welcome to Kelly Services 2013 first quarter conference call. With me 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 performance.

Now let’s turn to Kelly’s first quarter results. I’m pleased to report that we exceeded our expectations in a tough economic environment. The revenue was down 3% year-over-year on constant currency, we held our expenses flat and made targeted investments on our long-term growth and achieved an operating profit of $7.1 million.

Our gross profit rate for the first quarter was 16.5% flat with the first quarter of 2012. Kelly’s first quarter operating earnings from continuing operations were $0.34 per share, compared to last year’s earnings of $0.24 per share for the same period. I will remind you that these earnings reflect a $0.26 per share impact resulting from the delayed reinstatement of the work opportunity credit which wasn’t passed until January 2013.

Now let’s take a closer look at our first quarter performance in each of our business segments beginning with the Americas.

We continued to experience softening revenue demand in the Americas that began in the third quarter of 2012. As customers remain cautious about the economic environment combined staffing revenue for the region was down 3% year-over-year. Americas commercial revenue was down 5% year-over-year for the first quarter, this compares to the 2% decrease we reported in Q4.

Light industrial was flat compared to the same period last year, while office clerical was down 10%. Kelly Educational staffing on the other hand had growth of 5% year-over-year as we continued to add new customers.

Americas PT revenue was basically flat year-over-year as compared to the 5% growth we reported in the previous quarter. We are now seeing a softening in the higher (NPT) market as many of our customers are completing the projects and then delaying new product implementations.

With (NPT) the strongest year-over-year growth came from healthcare and engineering, however, this growth was offset by year-over-year declines in science, IT and finance. On a more positive note, the Americas region combined temp to perm direct placement and other fees grew 13% in Q1 year-over-year are up 15% compared to the first quarter.

Americas gross profit rate for the quarter was 10 basis points higher in the same period last year. Expenses in the Americas were up 6% year-over-year nearly half of this increase is attributable to a one-time charge of $3 million relating to a state unclaimed property audit.

The remainder of the increase is due to planned investments we are making in professional and technical staffing and centralized operation staff to support our largest customers and in our technology infrastructure. These targeted investments will continue throughout 2013.

And as we mentioned on our last earnings call, though there maybe a drag on the regions earnings in the short-term. We expect these investments to deliver positive long-term impact as they enable us to execute our strategy with improved focus speed and efficiency. Also Americas achieved earnings at $25 million for the first quarter while this is a decrease from the previous year, our performance was solid and inline with our expectations given both the investment strategy we chosen to follow and the lower volume we are experiencing.

Let’s turn now to our operations outside the Americas beginning with EMEA. Revenue in EMEA was down 4% in the first quarter compared to last year on both the reported and constant currency basis. For the remainder of my EMEA discussion all revenue results will be discussed in constant currency.

As expected economic and business conditions remain challenging across Western Europe and staffing markets are continuing to decline at double-digit rates. For our EMEA operations in total, we saw a commercial revenue decline by 6% year-over-year for the quarter. But I’m happy to note that we saw a growth of 3% in professional and technical staffing.

For Kelly specifically Eastern Europe was up 6% year-over-year due primarily to the performance of Russia and Hungary, while the Nordics and Western Europe experienced declines of 9% and 6% respectively. The declines are primarily attributable to weak commercial temp sales.

During the quarter, we also saw a decrease in our fees across the region. The revenue for the first quarter was down 11% year-over-year, the decrease can be seen across both our commercial and PT segments.

EMEAs GP rate for the first quarter was 17.1% compared to 17.6% for the same period last year. Our GP performance during the quarter was positively impacted by the new CICE tax credit in France. The intent of the CICE is to improve business competitiveness by reducing the cost of labor. The benefit in the quarter was worth roughly 60 basis points. Aside from this benefit the overall GP decline in EMEA is attributable to continued margin erosion in the commercial segment due to customer mix as well as the decline in the perm fees.

In constant currency expenses decreased by 6% year-over-year. This reduction is primarily due to decreases in variable cost in the commercial segment inline with the level of activity. Netting that all out, EMEAs earnings were basically flat compared to the same period last year. Given the difficult economic and business conditions particularly in Western Europe, we are pleased with our performance during the quarter, we remain focused on efficiency and expense control as we expect conditions to remain challenging for the staffing industry for the foreseeable future.

Next we turn to APAC. We are continuing to optimize our operations across APAC, you may recall we completed a North Asia joint venture with Temp Holdings during the fourth quarter of last year and as a result. We are no longer consolidating our former subsidiaries in China, South Korea and Hong Kong. For comparison purposes year-over-year percentage changes do not include the impact of no longer consolidating these operations.

During the first quarter of 2013, we combined our business across Australia, New Zealand and to a single management structure to streamline our operations there and this resulted in a $200,000 restructuring charge.

Combined revenue for the APAC region declined by 7% in constant currency year-over-year. This is largely due to exiting a low – a number of low margin customers in India during the first half of 2012 and weaker economic conditions across Australia and New Zealand. These declined by 17% year-over-year due to softening demand across the region, the exception was India for fees grew by more than 30% during the quarter.

Our gross profit rate for the region was 16.3%, down 60 basis points compared to last year primarily the result of the decline in fees. Expenses remain well controlled and were down by 10% in constant currency for the quarter, we concluded the quarter by improving earnings slightly ahead of the same period last year.

Now, we’ll turn to our results for OCG an important segment that continues to be a driver of growth. OCG revenue was up 14% in the first quarter compared to last year, growth within OCG continues to be driven by two core elements of our talent supply chain management strategy, business process outsourcing and contingent workforce outsourcing. Revenue in our business process outsourcing, BPO practice was up 30% year-over-year. This is primarily due to an increase in our traditional BPO solutions within the Americas as well as increased demand in our Kelly Connect or Contact Center Solution. Fee revenue was up 42% year-over-year and our contingent workforce or CWO practice. We’re pleased that we continue to experience double-digit growth rates in both BPO and CWO year-over-year.

Overall OCGs gross profit rate was 27.3% compared to the 26.7% a year ago with the improvement due to growth in higher margin practice areas. Expenses were up roughly $3 million or 12% year-over-year, this increase is the result of servicing cost associated with the expansion of customer programs and new customer program implementations. But all in all, we are realizing significant operating leverage.

For the quarter OCG reported earnings of $1.7 million compared to earnings of $500,000 a year ago, strong growth in our BPO and CWO units clearly helped to boost our first quarter earnings. We’re very pleased with the strategic progress we’re making in this importance segment. As we look to the second quarter, we’re anticipating a small loss in OCG as we make planned investments during the quarter to support future growth in one of our strategic accounts.

Now, I’ll turn the call over to Patricia, who will cover our quarterly results for the entire company.

Patricia Little

Thank you, Carl.

Revenue totaled $1.3 billion, a decrease of 3% compared to the first quarter last year, worldwide our fees reflect year-over-year. Our gross profit rate was 16.5% flat compared to the first quarter last year. On a sequential basis, our gross profit rate was up 30 basis points due primarily to the improvement in fees. Expenses were flat year-over-year and on a sequential basis.

As Carl mentioned, we recently settled an unclaimed property audit with the state of Delaware and as a result recorded a $3 million charge in the first quarter. Absence this charge, expenses were down both year-over-year and sequentially. As a result of our continued efforts in controlling expenses, we were able to offset the investment fees we’re making with further expense cuts. Restructuring did not have the expected $500,000 impact in the first quarter; we now expect that impact to be incurred later in the year.

In the first quarter, earnings from operations were $7.1 million compared to 2012 earnings of $14.7 million. Income tax for the first quarter was a benefit of $6.8 million compared to expense of $4.9 million in 2012. Included in the tax benefit is $9.7 million of 2012 work opportunity credits which we recorded in the first quarter. Diluted earnings per share from continuing operations for the first quarter of 2013 totaled $0.34 per share compared to $0.24 in 2012. The increase was due to 2012 work opportunity credits.

Looking ahead to the second quarter of 2013, we expect revenue to be flat to down 2% on a year-over-year basis, up to 4% sequentially since the first quarter is always our weakest quarter. We expect continued pressure on the gross profit rate holding it flat on a year-over-year basis. We expect SG&A to be flat sequentially and to increase around 5% year-over-year.

As I discussed last quarter, we will continue to invest in our PT and OCT businesses as well as front office systems and expansion of our large customer service delivery model. Our 2013 annual income tax rate will be around 10% including the retroactive work opportunity credits. Our tax rate is highly depended on the mix of our business, especially the amount of U.S. lit business which drives the work opportunity credit, the geographic mix of business, earnings or losses from our deferred compensation plans and tax planning.

Turning to the balance sheet, I’ll make a few comments. Cash totaled $62 million down from $76 million at year-end 2012. Accounts receivable totaled $1 billion and decreased $14 million compared to year-end 2012. For the quarter, our global DSO was 54 days, flat with last year. Accounts payable and accrued payroll and related taxes totaled $562 million up slightly compared to year-end 2012.

At the end of the first quarter debt stood at $50 million down $14 million from the year-end 2012. Debt to total capital was 6% down from 8% at year-end. In our cash flow, we generated $6 million of net cash from operating activities compared to $13 million last year. The change primarily reflects higher additional working capital requirements in 2013. With a weak revenue situation still a strong operational performance this quarter, and I will turn it back over to Carl for his concluding thoughts.

Carl Camden

Thank you.

As our first quarter results demonstrate Kelly’s strategy continues to deliver progress in the three key strategic areas. First our OCG segment continues to deliver strong revenue, GP and earnings results as we leverage higher margin fee-based business and strengthen our talent supply chain capabilities.

Secondly, our professional and technical staffing solutions are driving a more profitable business mix as we meet increased market demand for higher skilled, higher margin talent. And finally, we continue to keep a close eye on expanses making strategic targeted investments that support our long-term growth of delivering and operating profits in the face of lower revenue.

This progress confirms that Kelly’s strategy is designed with the modern labor market in mind and is positioning us to take advantage of secular trends that favor higher end workforce solutions and highly skilled professional, technical talent. Still, while we are pleased with Kelly’s first quarter results we are realistic about the erosive impact of the sluggish recovery in which we are operating.

Reaching our 4% return on sales goal will require a stronger, more sustained economic growth and we are likely to see in the near term. The slow and uneven growth trends we saw on 2012 remained with us as the U.S. economy grew less than expected in the first quarter of 2013.

And as a side bar, the U.S. employment is below 8% and declining, one of the primary drivers has been a shrinking labor force rather than a growing demand for labor. So, even though modest job growth is occurring, we are not seeing the corresponding uplift in our industry that we have typically seen in previous recoveries. And while some indicators point toward improving temporary staffing levels, the economy has yet to shake the forces that are constraining hiring and applying pressure on staffing revenues direct higher fees and margins.

Commercial staffing in particular has helped to drag a weak GDP growth. Customers remain cautious about expanding their workforce and Kelly and many of our competitors continue to see declines in revenue.

Looking ahead, we expect the current pace of growth will continue as the U.S. labor market remains fragile and unpredictable with no clear signs of momentum. Add to that there is ongoing uncertainty above the effects of sequestration and rising anxieties surrounding the impending Affordable Care Act, which is one of the most significant issues facing our industry today that the clock ticking on ACA implementation, companies are now struggling in earnest to understand the whole scope of the impact. And several pieces have yet to be addressed by regulators, general consensus flow of that compliance will be extremely complex.

For our part, Kelly continues to work closely with staffing industry groups, explore our cost modeling scenarios in pursuit of more accurate financial impact, work with vendors to develop ACA compliant plans and refine training and tools to equip our account teams to discuss potential impact with customers.

Our preliminary estimates for the ACA costs were approximately 1% of U.S. costs of sales. Our release cost will be passed on to our clients consistent with our competitors and with other government mandated (inaudible). We will continue to provide ACA updates on future conference calls.

That concludes the day’s reports. Patricia and I will now be happy to answer your questions. John, the call now to be opened?

Question-and-Answer Session


(Operator Instructions). And we first go to Tobey Sommer with SunTrust. Please go ahead.

Tobey Sommer - SunTrust Robinson Humphrey

Good morning. At first I was wondering if you could segregate the work opportunity impact in the quarter related to last year and then the impact related to the first quarter specifically?

Patricia Little

Sure, Tobey. The impact related to 2012 is $9.7 million or $0.26 per share. The way we do the full year as we credit over the quarter so we will find out what that number (we will find in a minute).

Tobey Sommer - SunTrust Robinson Humphrey

Okay. And Carl, I think I caught in the beginning with the prepared remarks when you are discussing the U.S. softening of the high-end within professional, its indeed I heard accurately. Could you describe that a little bit more please?

Carl Camden

So, in context we talk about a decline in a startup of new projects and implementations of new projects and professional and technical that has been braining with it a (consummate) decline in demand for upper NPT professionals. For the longest time with the declines that we were seeing we’re primarily on the lower ends of the PT marketplace. That’s now spread as new projects aren’t been started and companies themselves are cutting back on spending while they wait to see where the economy is going into demand some of the higher end professionals, particularly in the science and IT areas.

Patricia Little

And Tobey, the first quarter, our work opportunity credit related to 2013 is $1.4 million.

Tobey Sommer - SunTrust Robinson Humphrey

Which in EPS, is that pretax or after?

Patricia Little

That’s a tax number, so it’s an after tax.

Tobey Sommer - SunTrust Robinson Humphrey

Oh, that’s an after tax number. Okay, in the OCG segments, the small loss that you expect in the second quarter, or what kind of investments is related to new client signings or anything else you can give us color there, huh?

Carl Camden

There is always new client signings required in investment stand. We are ramping up a particular customer that has a higher demand for various types of workers who come online prior to the revenue coming online for them and you will see that in the second quarter.

Tobey Sommer - SunTrust Robinson Humphrey

Okay. In the education business in the U.S. showed some growth. What sort of factors do you think may enable that growth to continue in the face of kind of uncertain demand across the overall business?

Carl Camden

School districts have always been looking for better ability to manage their need for substitute workers primarily teachers but others also. We have a management team that has been effective at pushing those solutions, now selling the solution in the school districts who don’t have a history of using us or others for that type of service. So it is not from any particular increase in demand and existing clients has primarily been driven Tobey by the team’s success in expanding the acceptance of the concept through other parts of the country.

Tobey Sommer - SunTrust Robinson Humphrey

Thanks. And my last question Carl relates to kind of your broader caution on the trajectory of growth in BLS Statistics? How do to reconcile the growth in temporary labor according to BLS Statistics with what yourselves and other companies are reporting in actual dollars and cents?

Carl Camden

So I have spent a lot of time on that issue in a variety of role for that play. Once before we had a significant divergence and I don’t think you are following us then but that turned out to be divergence in the sampling models being used by BLS and Reality, that’s not the case this time. We like other companies are showing 20 some percent of growth in things like healthcare, and so if you are – and healthcare is a large component of the U.S. economy but a small component of Kelly manpower and other company sales mix. And so, one of the strongest growing segments with strong demand for temporary employment is underrepresented in the large companies.

Secondly, construction has been doing well and is also chewing up temporary workers but as you probably would guess, there is not a Kelly Construction staffing services and we don't have carpenters and others blazing through the ranks companies that are construction heavy are again showing strong double-digit growth. But again, the major staffing firms would be underrepresented in that.

I suspect that those trends continue. I can see those numbers, I suspect that the trend would also be apparent and companies that were hospitality industry heavy and agriculture heavy but I don't have that same visibility. So it appears that we’re going through a period of time Tobey. I’m guessing the BLS numbers are correct and I’m real certain up the numbers being reported by the major staffing firms are correct. So, assuming that is not sampling error and I don't think there is this time is because the growth is for a moment occurring primarily in the economy and sectors that are way underrepresented in the major staffing firms.

Tobey Sommer

Thank you very much.


Our next question is from John Healy with Northcoast Research. Please go ahead.

John Healy - Northcoast Research

Hi, good morning. Carl, I want to ask about the OCG business, you guys continue to do a fantastic there and I know you kind of caution some things in terms of how large customers are or maybe planning a business going forward. And first to get your thoughts maybe on the business process outsourcing part, are you getting a little nervous there, would you expect the cadence and trajectory of the business that maybe kind of plateau a bit, curious to get any thoughts on those items?

Carl Camden

That was more mature, the answer would be, yes. So, it’d begin to rise and fall with general level of business activity. But on the supply chain parts of the BPO which is where we’re really focused sense of the concept that is still under adopted yet in the marketplace and it’s kind of in the fast adoption, fast growing side. I think that declines in demand in anyone particular accounts are being offset by the acquisition of new accounts in a big way.

John Healy - Northcoast Research

Okay. And along those lines, I know everyone continues to kind of focus on the healthcare reform angles relates to your business. But, do you think that maybe we’re looking at it wrong and thinking about it as a driver to penetration rate to temp demand or is it likely do you feel that parts of your business maybe on the consulting in the (modest) service side. Is that what you think you might see the demand created, I’m curious to get your thoughts that if you’re starting to develop more comfort regarding what this will do to different parts of demand for your business?

Carl Camden

I’ve never been happy with the rhetoric about the driving penetration rate this company is seek to avoid employment model. I’m much more comfortable with the fact that there is a longer term correlation between growth in the industry and complexity of employment. And ACAS complexity to employment and company’s outsource complexity. So you’ve seen over the years John, you’re seeing the growth of benefits administration, payroll administration as company’s outsource complex parts of the employment process. And I think that in the longer run not in a short burst but in a longer run, the more complexity you add to employment relationships the better it is for employment services companies like Kelly. It’s just the amount of reporting and so on if you’re a company that has 40 to 60 employees is huge and your infrastructure to deal with that reporting is less developed than it is than in larger companies.

I think on the professional and technical side, access to healthcare has always been the number one psychological and reality impediment to people choosing to be a various forms of (pre-agent) labor and I think that in spite of some of its flaws, ACA makes coverage more available especially for higher paid workers and I think that you’ll see again a shift because of the easier availability of access to healthcare to greater use of that employment model by the talent choosing to do it, not because companies are trying to avoid cost but because talent has lost one of the bearers to choosing the work in a way that they want to work.

Do I believe that there will be companies that will pitch schemes to avoid ACA obligations absolutely I’ve seen them in the mail already. Do I believe that the government is committed to stopping the abuse and fraud around this on ACA, I have seen those activities already. I think it will play out just like (pseudo dumping dead) which is that will lead to small burst of activity delayed but ultimately effective government response.

John Healy - Northcoast Research

Great. And then just a final question Patricia, I think you mentioned 10% tax rate for the year and are we right in thinking that maybe in 2Q, we probably do something in the low 20s, is that kind of a decent proxy to think about for 2Q?

Patricia Little

Hang on, I think it will be, yeah somewhere in that range…

John Healy - Northcoast Research


Patricia Little

Well, it’s 20s.

John Healy - Northcoast Research

Perfect, thank you so much.


(Operator Instructions). And we do have a follow up from Tobey Sommer. Please go ahead.

Tobey Sommer – SunTrust Robinson Humphrey

Thanks, Carl and Patricia, where do you think you’re taking share and where do you think you’re losing share? Thanks.

Carl Camden

Fine question. There is not – so let me work my way through segments. There is not yet great objective data that I trust in the OCG space let me start there. It’s a messy category that companies put in different lumps. There is not a great – just not great industry ratings and even SIA is dealing with self report surveys and so on. So, if you’re asking me to guess and on the OCG space, we’re doing better than our opponents but it’s messy. That’s messy numbers.

The cleaner numbers are on the staffing side because most companies report staffing in the same way. And again the publicly traded companies, we’re either doing as well as they are and then all the commercial space as well in North America or but in the PT space we’re probably doing slightly better. In Europe we’re probably doing and in Western Europe is a mess. Everybody is in decline and I can’t tell you how that’s going on. The PT side we’re gaining share there I would say and in Asia, I forgot Russia, Patricia was whispering to me here. Russia, we’re doing great in gaining share.

Tobey Sommer – SunTrust Robinson Humphrey

And Carl, given that your comments about the demand picture kind of being uncertain and probably not showing a lot of improvement for the foreseeable future. Do you have significant levers you can pull on the cost structure in new methods of service delivery or are we really talking about changes around the margin and changes to variable costs?

Carl Camden

A lot is changing around the margin. We have been talking about for several quarters they changed to a service delivery model with centralized staffing. And we’ve also been pretty clear that every time you move an account then, you get a burst of expense that then works itself off as you both feel (back still behind) and what used to be in some of the branches as well as in offset that expense base.

So, we are continuing to move more of our business into centralized service centers but that doesn’t lead to any short-term improvements on the expense side, I feel it puts a little more pressure and but then it works its way off. We always look around the margins for ways. And I think you heard us talking about in several of the operating units, a reduction expenses as we reduced variable cost associated. And we’ve tried to over our restructuring efforts to get as much of our cost variable. You can only bring in so much evident to the variable category but yes. So, I would say continued improvement in centralized process and then focus on the variable cost.

Patricia Little

The other thing I would add to that is, as we sit here today; we made a small sort of normal course restructurings but they don't since doing anything larger than that. We’re pretty comfortable with our footprint and our resource. Frankly, our conversations revolve around those – to the continuous improvement in our cost structure. But also around where we want to invest for growth. So, that’s the offer that you see in the bottom line. So far, we’ve done a very good job of offsetting that investment for growth with incremental cost reductions. So, that’s, I would use that model as going forward.

Tobey Sommer – SunTrust Robinson Humphrey

Okay. Thank you very much.

Carl Camden

Thank you.


And Mr. Camden, no additional questions in queue.

Carl Camden

Very good and thank you John and I thank you all for listening.


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

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