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Spherion Corp. (NYSE:SFN)

Q2 2009 Earnings Call

July 30 2009; 9:00 am ET

Executives

Roy Krause - President & Chief Executive Officer

Mark Smith - Chief Financial Officer

Analysts

Jeff Silber - BMO Capital Markets

Jeff Meuler - Robert W. Baird

Operator

Good morning, and welcome to the Spherion second quarter earnings call. (Operator Instructions)

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

Roy Krause

Thank you. Good morning, everyone and welcome to our second quarter conference call. Before we begin our prepared remarks Mark Smith, our CFO, will read the Safe Harbor Statements.

Mark 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 evaluation our operations but should not be considered in isolation or as an alternative to financial measures of performance as determined by GAAP. A reconciliation of non-GAAP measures to our GAAP financial results has been provided in the press release, which can be found in the Investors section of our website. Roy.

Roy Krause

Thanks Mark. As we stated last quarter, during March, we began to see signs of stability in our weekly revenue trends, and I’m pleased to be able to report that this stability generally continued throughout the second quarter. While there was some variability in our weekly numbers, it was much less than we have seen in previous quarters. With this revenue stability and our success in cost management, we exceeded our EBITDA target for the quarter and were profitable on a net earnings basis.

Additionally, we are essentially debt-free and have refreshed our credit facility, and it will carry us through the next four years. While this has been a difficult period, I believe that our teams executed exceptionally well in the second quarter and that we’re in a great place to go forward. I’m also encouraged by our discussions with several of our clients who are beginning to prepare for future hiring needs in a recovering economy. Although jobs numbers are not yet improving, at least we’re seeing some deceleration in the decline.

For the second quarter, total Spherion revenues declined 3.9% sequentially, evidence that we cannot yet predict that we’ve reached the bottom of this employment recession. However, revenues per day were only about 1% less in June than in March. On the staffing services side, revenues per day were higher in June than in March.

From past recessions we know that commercial staffing; especially industrial staffing is the first to begin growing. Therefore, our 4.4% sequential growth in industrial staffing this quarter is very encouraging. Our cost cutting actions over the past two previous quarters firmly took hold in the second quarter and allowed us to exceed our EBITDA threshold. Adjusted EBITDA in the quarter was 2.3%, a clear indication of our success in cost management.

As I said last quarter, I believe that our cost structure is reasonably aligned with current levels of business. If current revenue per day trends are maintained, we should continue at approximately our 2% EBIT target for the remainder of 2009. We’ll continue to optimize cash flow and build our liquidity in order to maximize our options in this uncertain environment.

Our second quarter earnings from continuing operations were $0.01 per share compared with earnings of $0.10 last year. Year-over-year revenues were down 27%, reflecting the broad decline in the overall economy. However, on a positive note, both our F&A and light industrial business improved sequentially.

We believe that sequential improvement in these areas may be early signs of economic recovery, but pricing continues to be a challenge. Our customers continue to look for concessions or exercise termination rights to rebid contracts. Pricing pressure is intense, but we’ll continue to remain disciplined. We expect this pricing and competitive pressure to continue over at least the next six months, which may lead us to withdraw from some accounts if we cannot adjust cost and service levels to acceptable returns.

However, sequentially, our Q2 margins improved in both our segments. The improvement was very much a function of meeting SUTA caps during the quarter, as pay bill spreads sequentially decreased 15 basis points in staffing and 10 basis points in professional services. We’ll continue to be very focused in this area, and we’ll make every effort to pass the inevitable future statutory payroll increases through to our customers.

To offset this pricing pressure, we continue to identify and go after market segments where we expect to see both short and longer-term growth and higher-value services. Our initiatives targeting the TARP and stimulus funding programs are opening a lot of doors, and we are working to close on these opportunities.

We are also increasing our investment in the RPO space, developing our brand and positioning that business for what we believe will be an early growth area in the recovery. We believe many companies have cut too deep during this downturn and that our RPO business is well positioned to benefit. Our margins in that business remain very good and we are able to offer a good value to companies that have greatly reduced their HR recruiting capabilities.

Additionally, international contracts in this area are increasingly including the management of contingent vendors and independent contractor compliance. This combination of services is more typical internationally but there’s no reason to believe that it won’t expand in North America. We’re well positioned to offer these integrated services.

Our balance sheet and liquidity remain strong. Free cash flow has allowed us to pay down most all of our debt, and our revolving credit facility is now in place into 2013. The renewal and extension of this facility was a significant accomplishment in the second quarter, given the difficult credit environment. Our ability to get this done further demonstrates the confidence that our lenders have in our business.

We will continue to emphasize receivable collections and will maintain capital expenditures at minimum levels until we can see improvements in revenue trends. Our overall business strategy will continue to emphasize professional services, account diversification and midsize deals in commercial staffing.

Professional service revenues are 42% of total company revenues and, in the quarter, generated 57% of gross margin dollars, despite firm placement being down 71%. As I said, we have and expect to continue to invest in sales resources and product development to further diversify our services and benefit from improving economic conditions.

Now let me turn the call over to Mark.

Mark Smith

Thanks, Roy. I’ll take the next few minutes to give you some more information on our segment results, talk a little bit about our balance sheet, cash flow and then wrap up with some July trends.

So let me start with our professional services segment where we reported second quarter revenues of $171 million, which represented 41.8% of total company revenue. The segment revenue was down year-over-year 30.3% and down sequentially 5.8%.

Compared with the first quarter, our F&A temp revenues were up 1.5%, IT temp revenues were down 3.5%, and total temp revenues, excluding RPO, were down 4.8%. Of course, perm is being impacted due to the economic environment and was down 7.9% sequentially. On an intra-quarter basis, professional revenues were down year-over-year about the same in each month of the quarter as for the quarter in total on a year-over-year basis.

Gross profit margins in professional services were 27.6% during the second quarter, up from 26.6% in the first quarter. Sequential margin improvement of 100 basis points resulted primarily from a 110 basis point improvement from lower SUTA costs, a 35 basis point improvement due to lower billable expenses and those two improvements were offset by a 10 basis point decline in pay bill spreads and a 25 basis point impact from a mix change as RPO was a smaller part of total revenues.

Sequentially perm revenues as a percentage of segment revenues were flat at 2.8% and therefore did not impact the overall gross profit rate comparisons quarter-to-quarter. SG&A in the professional segment declined 36% year-over-year and 14% sequentially, bringing segment operating profit margin to 4.6% in the quarter, down from 5.6% last year but up from 1.5% in the first quarter of this year.

Let me move on now to staffing services where we reported revenues of $238 million, which represented 58.2% of total revenue. Revenues were down 25.1% year-over-year but just 2.5% sequentially. Compared with the first quarter, our industrial temp revenues were up 4.4%, clerical temp revenues were down 5.5%, and perm placement was down 25.8%.

On a monthly basis, within the quarter, year-over-year revenue comparisons improved through the months and were as follows; down 27.6% in April, down 24.3% in May, and down 23.7% in June. Moving on to gross profit margins in staffing services, we reported 15.1% in the quarter compared with 14.2% in the first quarter of the year.

The sequential improvement of 90 basis points is due to a 95 basis point improvement in SUTA costs, 25 basis point improvement in other burdens and those two items were offset by a 15 basis point reduction in pay bill spreads and a 15 basis point decline due to lower perm placement revenue mix.

Looking at just temp staffing, margins were up 100 basis points to 14.6% this quarter compared to 13.6% last quarter. SG&A in staffing declined 31.6% year-over-year and 5.8% sequentially. Segment margin was negative 0.3% compared to positive 0.5% last year and negative 1.7% last quarter.

Moving on, our unallocated corporate costs were $3 million and relatively unchanged from the first quarter, and we expect full-year unallocated corporate to be in the $12 million to $14 million range. Amortization of intangibles was $1.6 million and should be about the same in both the third and the fourth.

Interest expense was $700,000 and will be higher in both third and fourth quarters due to our amended ABL facility. At the current level of business volume, interest expense in the third quarter should approximate $1.5 million, 300 of which will represent amortization of the approximate $4.9 million paid at the beginning of the third quarter to secure and document the amended ABL.

Our tax rate in the quarter was 75.3%, reflecting the fact that earnings were very close to breakeven. As you build your models, you can again assume a 39% statutory tax rate plus about $500,000 quarterly from non-deductable expenses and fixed state taxes.

We did record in the quarter a small restructuring charge of about $400,000. As a result of the actions in the second quarter, as well as those taken in 2008 and in the first quarter of 2009, we expect that at the current level of business volume we should have total 2009 SG&A expenses of about $330 million or about 27% lower than we reported in ‘08. We would expect third quarter SG&A to be about flat with the second quarter level and are not currently planning any significant further restructuring activities.

A couple comments now on balance sheet and cash flow, we ended the quarter with about $700,000 of net debt compared to $31.7 million at the start of the year and $24 million at the end of the first quarter; second quarter cash flow from operations was strong at $26.5 million, bringing year-to-date cash flow from operations to $38.4 million.

Unused availability on our ABL facility at the date it was amended was $110 million, which is about $39 million higher than availability would’ve been under the terms of the previous credit facility.

DSO at the end of the quarter was 51 days, down two days from the end of the first quarter. Credit quality remains good, and we continue to monitor receivables, quality, collections and activity very closely. CapEx was $700,000 in the quarter and should be about the same in the third.

Let me wrap up here by making a couple comments regarding July. Revenues per billable day in the first three weeks of July are flat with the second quarter average of $6,443,000 per day, with professional being down about 5% and staffing being up about 3%. We’re assuming 63 billing days in the third quarter. We would expect gross margins to be down slightly in the third compared with the second due to mix changes between staffing and professional and some additional customer pricing pressures.

SG&A and depreciation should be about the same as in the second quarter, and I’ve already given you guidance on amortization and interest. I would expect adjusted third quarter EBITDA to again be about 2%.

Roy, back to you.

Roy Krause

Thanks Mark. While the results this quarter are more encouraging, the overall employment market remains weak, and most clients have not begun significant rehiring. Our industry continues to face difficult market conditions with very limited forward visibility, but we remain committed to an operating structure delivering cash flow with the ability to quickly benefit from positive economic or client activity.

We’ll continue to invest to promote our TARP and stimulus initiatives and develop more bundled solutions to provide customers more efficiency and value. Our teams performed well this quarter, and we expect to take advantage of future improving market conditions.

At this point, I’d like to open it for your questions.

Questions-and-Answers Session

Operator

(Operator Instructions) Your first question comes from Jeff Silber - BMO Capital Markets.

Jeff Silber - BMO Capital Markets

Mark, I know you guys typically don’t give specific margin guidance by vertical, but if you can just tell us trend-wise what we should be expecting in the third quarter that would be great.

Mark Smith

Jeff, starting out with kind of overall, you heard me talk about the revenue trend into July, so I would expect some margin decline because we’ll have a mix change between the two segments. So that’s a starting comment.

Roy mentioned comments about pricing from customers, and we saw a slight pay bill contraction from the first to the second. I would not expect to see the pay bill change in the third to be any worse than what we saw in the second. So I think if you take that kind of guidance that should help you kind of understand what’ll happen to margins in the third quarter.

We do expect to be down slightly because of the mix and because of the pricing activity.

Jeff Silber - BMO Capital Markets

In terms of that translating down to the operating margin line, just kind of a proportional change from what we see on the gross margin side, just kind of drop that down to the operating margin line?

Mark Smith

Yes, I think with the cost reductions that we’ve done and the consistency, our goal is to be at that 2% level or slightly above like we were in the second quarter. That’s what we’ll work toward achieving in the third quarter.

Jeff Silber - BMO Capital Markets

You mentioned the cost cuts, and maybe this is a longer-term question, but when, and hopefully soon, business starts to pick up again, what kind of investments do you think the company has to make to take that business? Maybe asking it another way, what would be the incremental margins on a new piece of business going forward? Thanks.

Roy Krause

Well this is Roy. We certainly hope they would be positive, very positive, okay? We think we’ve got a lot of capacity. We’ve reduced cost significantly, but we still have the infrastructure to carry the volume.

So we believe that, if we can see some growth and, again, encouraged by F&A being up and industrial staffing being up, we think we can drive some pretty good returns to the margin base. We have the infrastructure. We haven’t destroyed our infrastructure in any stretch of the imagination, so we believe we can move there.

We look at it is as a percentage of gross profit basis. Clearly the next couple of dollars of revenue, positive revenue, is going to generate significant returns. Variable costs are somewhere around 25% of gross margin. Then you start getting into a step-function where we would not expect to exceed 50% of gross margins for a while to be able to drive EBITDA margins up to a more acceptable level.

A long answer, but we would think we’d get some pretty good leverage quickly if we can get some revenue growth.

Operator

(Operator Instructions) Your next question comes from Jeff Meuler - Robert W. Baird.

Jeff Meuler - Robert W. Baird

Thanks for all the color on the year-over-year trends for professional and staffing services by month. Can you provide a little bit more detail, just broadly speaking, about which sub-segments are starting to see improvements in the rate of year-over-year decline versus which sub-segments are still worsening?

Roy Krause

Well I don’t think we’re seeing worsening in anything except maybe perm. It was down 70% in total. Hopefully, we’ve hit some stability there on that number, and we don’t see that number going up just from a general economic conditions point of view very quickly, but we will expect to see temps starting to come up as people begin to hire.

We talked about industrial. We were very pleased with the accounting stuff. I think IT has a shot to continue to improve. It certainly has decreased its sequential year-over-year negatives. So I don’t feel bad about any particular segment at all. Our RPO business has substantially contracted on a year-over-year basis, just because of the economy. But again, we’ve had some real positive discussions with people about preparing.

Now whether that preparation to hire is going to be done in the third quarter or the fourth quarter or the first quarter of next year, I think the jury’s still out on that one. But there are people talking about it, where 60 to 90 days ago no one was talking about it.

Jeff Meuler - Robert W. Baird

Then good job on the expense controls. Can you just talk a little bit about your philosophy? It sounds like if revenue is stable in this level you’re going to kind of continue to maintain the SG&A around where it is. Can you talk about what would lead to further reductions or, as you look out to next year, how you envision the trajectory of SG&A expenses depending on revenue trends?

Roy Krause

What we did is we set ourselves up a target. We looked back to the recession in early 2001, 2002, and we felt we had a much better and much more flexible cost structure than we did back then, and so we doubled our bottom point. So we used the 2% EBITDA target as the way we’d balance our situation.

That gives us positive cash flow. It gives us about a breakeven on an earnings per share and as long as we’re not borrowing money and we’re creating liquidity, I think our cost structure’s pretty good for this flat level of revenue. When you consider billing days being a little bit a higher in the second quarter than we calculate them in the third quarter, the revenue trends that Mark gave you are basically flat revenue. So we would expect pretty flat SG&A.

So that’s the philosophy. If we get increased revenue, as the previous question, we would expect to see increased leverage. If revenue trends get worse, if the economy starts worsening, then we’re going to have to do some SG&A adjustment. Mark?

Mark Smith

Yes, let me add one of the things that we’ve done to create longer-term SG&A savings during this time is that our focus has been on automating processes and making a lot of our infrastructure more streamlined.

So we’ve done a lot of work with our customers on electronic payroll and billing and collections and all that, and we’ve gotten a lot of our cost savings from more back office administrative type improvements so that we can stay more flexible on the recruiter and salesperson front and have ourselves well positioned for when this thing starts to move forward.

Operator

(Operator Instructions) We have no further questions, and that concludes our conference for today. Thank you for participating in today’s call and have a great day.

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Source: Spherion Corp. Q2 2009 Earnings Call Transcript
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