Kelly Services' CEO Discusses Q3 2013 Results - Earnings Call Transcript

Nov. 9.13 | About: Kelly Services, (KELYA)

Kelly Services, Inc. (NASDAQ:KELYA)

Q3 2013 Earnings Conference Call

November 6, 2013 09:00 ET

Executives

Carl Camden - President and Chief Executive Officer

Patricia Little - Chief Financial Officer

Analysts

Ty Govatos - TG Research

Tobey Summer - SunTrust

Operator

Good morning, ladies and gentlemen. Welcome to Kelly Services’ Third 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. (Operator Instructions)

I would now like to turn the meeting over to your host, Mr. Carl Camden, President and CEO. Sir, you may begin.

Carl Camden - President and Chief Executive Officer

Thank you, John and good morning. Welcome to Kelly Services 2013 Q3 conference call. With me on 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 future performance.

Turning to Kelly’s third quarter results. I am pleased to report that our performance was better than our expectations. Revenue was down 1% year-over-year. Expenses were down 2% year-over-year while continuing to make targeted investments for long-term growth and we achieved adjusted earnings from operations of $21 million. Our gross profit rate for the third quarter was 16.4%, up from the 16.1% delivered last quarter, but down from the 16.8% reported in Q3 of 2012. Kelly’s adjusted third quarter earnings from continuing operations were $0.51 per share, a nice jump compared to adjusted earnings of $0.43 per share for the same period last year.

Now, let’s take a closer look at our third quarter performance in each of our business segments beginning with the Americas. We experienced continued softening in revenue demand in the Americas, as improvement in the temporary employment markets in which we are engaged has remained modest. Combined revenue for the region was down roughly 4% year-over-year for the third quarter, down from the 2% year-over-year decline in the second quarter.

Americas commercial revenue was down 4% year-over-year for the third quarter. This compares to the 3% decrease we reported in Q2. Light industrial revenue was up 1% from a year ago and up slightly from the flat performance in the second quarter, while office clerical on the other hand was down 10% for the quarter compared to the 8% year-over-year reduction we reported in Q2. On a more upbeat note, we are seeing the positive impact of new customer wins in our Kelly Educational Staffing unit, which reported revenue growth of more 35% year-over-year in the quarter.

We also experienced a more pronounced softening in our Americas PT revenue during the quarter. PT revenue was down 5% from the prior year compared to the 1% decline we reported in the previous quarter. We continue to see more widespread softness and demand in the higher end PT markets stemming from many of our customers delaying new project implementations. Within PT, once again, we saw revenue declines in our IT and finance businesses.

Engineering revenue was down slightly for the third quarter year-over-year as compared to the 4% growth we reported last quarter. This decrease was the result of completion of long-term customer projects during the third quarter. We are pleased that we saw an uptick in fees during the third quarter as quarterly fee revenue grew 4% year-over-year. This is up substantially from the 4% year-over-year decrease we reported in the second quarter. Our PT fees were the primary driver of this improvement, up 17% year-over-year for the quarter.

Americas gross profit rate was down 40 basis points from the previous year due to lower adjustments to prior year’s workers’ compensation cost and higher employee benefit cost. Expenses in the Americas were flat year-over-year, while we continue to be prudent in making our planned investments on professional and technical and centralized operation staff to support our largest customers and in our technology infrastructure, a reduction in our incentive-based compensation in the third quarter helped to offset some of the investment dollars.

As stated previously, these targeted investments will continue throughout the balance of 2013. Americas achieved earnings of $26 million for the third quarter. While this is a decrease from the previous year, our performance was solid and in line with our expectations given our investment strategy and the lower volume we are experiencing.

Let’s turn now to our operations outside the Americas beginning with EMEA. Revenue in EMEA was up more than 5% in the third quarter compared to last year. On a constant currency basis revenue was up more than 2% with 5% revenue growth in our professional and technical businesses on a year-over-year basis. For the remainder of my EMEA discussion all revenue results will be discussed in constant currency. Revenue in Eastern Europe was up 4% year-over-year due primarily to the solid performance of Russia and Hungary. The performance of our operations in Switzerland and Portugal also fueled growth of 4% in Western Europe year-over-year, while the Nordics experienced a decline of 10%. Our U.K. operations are also showing signs of year-over-year improvement with the 6% increase for the quarter.

During the quarter, we continued to see a decrease in our fees across the region. Fee revenue for the third quarter was down 7% year-over-year, but a sequential improvement compared to the 15% decline in the second quarter. The decrease can be seen across both our commercial and PT segments. EMEA’s GP rate for the third quarter was 16.6% compared to 17.1% for the same period last year, a 50 basis point decline. The overall GP decline is attributable to continued margin erosion in the commercial segment due to customer mix as well as the decline in perm fees partially offset by the benefit of the CICE tax credit in France which was worth about 50 basis points. The intent of CICE is to improve business competitiveness by reducing the cost of labor. Adjusted expenses decreased 2% year-over-year. This reduction was primarily due to bringing variable expenses in line with the level of activity. Netting it all out EMEA reported an adjusted profit of nearly $5 million for the third quarter, in line with our expectations and an increase of roughly $1 million compared to the same period last year excluding restructuring. We expect conditions across Europe to remain challenging for the staffing industry for the foreseeable future especially with regard to fee revenue.

Now, let’s turn to APAC. As a reminder, we are no longer consolidating our former subsidiaries in China, South Korea and Hong Kong as such year-over-year percentage changes are adjusted to exclude the impact of deconsolidating. Combined revenue for the APAC region both commercial and PT increased by more than 6% in constant currency year-over-year. This was driven by improved staffing volumes in Australia, Singapore and Indonesia. For the remainder of my APAC discussion our revenue results will be discussed in constant currency. Fees declined by nearly 10% compared to the prior year due to the challenging environment across the region.

Our gross profit rate was 16.7%, down 220 basis points compared to last year primarily due to the decline in fees. However, on a sequential basis GP was up slightly compared to the prior quarter. Temp GP rates remain flat compared to prior year. We continue to keep a tight control on our expenses across the APAC region. Expenses were down 6% in constant currency for the quarter. This was primarily driven by a combined 18% reduction in headcount in Australia and New Zealand as we consolidated our operations there. We also realized more than 13% reduction in all other headquarter expenses across the region during the quarter. We concluded the quarter by achieving adjusted earnings from operations of $1.6 million in APAC an improvement of $1.4 million year-over-year.

Now I will turn to our results for OCG, an important segment that continues to be a driver of our growth. OCG revenue was up 21% in the third 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 work force outsourcing. Revenue in our BPO business process outsourcing practice hit nearly $50 million and was up more than 30% year-over-year. This was primarily due to an increase in our traditional BPO solutions within the Americas, as well as increased demand in our KellyConnect or contact center solution.

Total fee revenue in our contingent work force outsourcing practice was $16 million for the quarter, up 41% year-over-year. We are pleased that we continue to experience strong double-digit growth rates in both BPO and CWO year-over-year. Overall, OCG’s gross profit rate was 25.8% compared to 27% a year ago. The year-over-year decline was primarily due to business and customer mix.

Expenses on an adjusted basis were up 10% year-over-year on a 21% revenue growth. This increase is the result of servicing cost associated with the expansion of customer programs and new customer program implementations. I am very pleased that we continue to realize significant operating leverage. OCG had an adjusted operating profit of $6 million for the third quarter, 47% higher than the same period last year. We continue to be pleased with the strategic progress we are making in this important segment.

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

Patricia Little - Chief Financial Officer

Thank you, Carl. Revenue totaled $1.3 billion, down 1% compared to the third quarter last year and down 2% sequentially. Worldwide, our fees were up 2% year-over-year and sequentially. Our gross profit rate was 16.4%, down 40 basis points compared to the third quarter last year. As Carl noted, we saw declines in all three regions and in OCG. On a sequential basis, our gross profit rate was up 30 basis points, primarily due to improvements in OCG.

During the third quarter, we recorded restructuring charges of $500,000 primarily related to our previously announced plans in Europe. At this point, we have substantially completed our restructuring in Europe although we do have a small amount of expense which has been delayed into the fourth quarter. Excluding restructuring, expenses were down 2% year-over-year and down 1% sequentially. As a result of our continued efforts in controlling expenses, we were able to continue to offset the investments we have been making in PT, centralization and technology. Excluding the restructuring charges, earnings from operations were $20.7 million compared to 2012 adjusted earnings of $24 million.

Income tax expense for the third quarter was $100,000 compared to expense of $6.7 million in 2012. So our tax rate was 0.3% for the quarter compared to a rate of 29% last year. U.S. work opportunity credits provided a significant reduction to income tax expense and delivered $5.8 million of benefit in the third quarter of 2013 compared to $1.8 million in the third quarter of 2012 when the credits were generally not available for new hires. 2013 also benefited from strong returns on tax-free investments and company-owned life insurance policies that are used to fund non-qualified retirement plans and on the mix of income between jurisdictions.

Diluted earnings per share from continuing operations, excluding restructuring charges for the third quarter of 2013 totaled $0.51 per share compared to $0.43 in 2012. Looking ahead to the fourth quarter of 2013, we expect revenue to be down 1% to 3% on a year-over-year basis flat sequentially. We expect continued pressure on the gross profit rate down slightly year-over-year and on a sequential basis. We expect SG&A to be flat to up slightly year-over-year and up 2% to 4% sequentially. As I discussed last quarter, we will continue to invest in our PT and OCG businesses as well as front office systems and expansion of our large customer service delivery model. In addition, annual merit increases went into effect October 1.

Our 2013 annual income tax rate will be under 10%, including the retroactive work opportunity credits we have recorded in the first quarter. Excluded from this forecasted rate is a possible benefit for adjustments to deferred tax balances that may result from Mexico tax law changes. Our tax rate is highly dependent on the mix of businesses, especially the amount of U.S. lid business, which drives Work Opportunity credits, the geographic mix of business, earnings or losses from our deferred compensation plans, tax planning and tax law changes.

Turning to the balance sheet. I will make a few comments. Cash totaled $74 million, down slightly from $76 million at year end 2012. Accounts receivable totaled $1.1 billion and increased $58 million compared to year end 2012. For the quarter, our global DSO was 56 days, up two days compared to last year. Accounts payable and accrued payroll and related taxes totaled $610 million, up $15 million compared to year end 2012. At the end of the third quarter debt stood at $58 million, down $6 million from year end 2012. Debt to total capital was 7% down from 8% at year end.

In our cash flow, we generated $22 million of net cash from operating activities consistent with last year. However, included in that net cash from operating activities, is an increase of $5 million related to the correction of the balance sheet classification error from prior periods. Even with the weak revenue situation we had strong operational performance. So I will turn it over to Carl for his concluding thoughts.

Carl Camden - President and Chief Executive Officer

Thank you, Patricia. Our third quarter results confirmed that Kelly is on the right track in making solid strategic progress towards our long-term success. Our OCG segment continues to exceed expectations, delivering strong revenue fee and earning results, winning profitable new business and expanding the current relationships Kelly has with many of the world’s premier brands. We have pioneered the talent supply chain management approach that is gaining traction and recognition in the crowded outsourcing and consulting marketplace while bringing in high-margin business for Kelly. As competition intensifies for the limited supply of skilled talent around the world we also continue to sharpen our focus on higher margin profession and technical staffing solutions.

Though year-over-year PT revenue was down, the third showed healthy improvements in PT fees in the Americas. And we believe our success in key areas of OCG particularly our engineering and science oriented BPO is a heightening awareness of Kelly’s overall PT capabilities. Finally, we continue to keep a tight rein on expenses making targeted cuts and investments to support long-term growth while delivering an operating profit in the phase of relatively flat revenue. All told, Kelly’s progress confirms that our strategy is responding to what the modern labor market demands more holistic work force solutions, access to highly skilled talent and work force models that help companies achieve their short and long-term business goals.

We are especially pleased that the Americas region reversed the PT fee declines we saw on previous quarters, delivering solid double-digit year-over-year growth in PT fees despite an uncertain economic climate and sluggish hiring condition conditions. Still, while we are proud of our teams and pleased with Kelly’s third quarter results we are realistic about the current climate. There are larger forces at play that continue to impact our business 2013 has been beleaguered by the same slow and uneven growth trends we saw in 2012 and DC politics are shaking what little confidence U.S. businesses had going into the fourth quarter. In fact given that the WOC ruling was delayed in the – into the first quarter of this year the ACA employer mandate delay issued in the second quarter and the government shutdown initiated in the third, it appears we may have to accept that ongoing political instability is yet another unwelcome aspect of the new normal on which we operate.

Given the uncertain climate and unimpressive job growth thus far in 2013 staffing revenues remain constrained in the staffing markets in which we are engaged and there is still significant pressure on margins. Looking ahead we don’t expect any meaningful improvement in the U.S. labor market and we believe that most companies will continue to hold out making key investments in people and capital until economic confidence and stability are restored. In the meantime we’ll continue to focus on executing a solid strategy with increased speed and precision. That concludes today’s report Patricia and I will now be happy to answer your questions. John the call can now be opened.

Question-and-Answer Session

Operator

(Operator Instructions) And we will go to line of Ty Govatos with TG Research. Please go ahead.

Carl Camden

Hi Ty.

Ty Govatos - TG Research

How are you? Patricia I am sorry could you go through some of the guidance numbers again, my fingers just aren’t that fast?

Patricia Little

I have to talk slower. We expect revenue to be down 1% to 3% flat sequentially more pressure on GP down slightly year-over-year and sequentially, SG&A to be flat to up slightly year-over-year and up 2% to 4% sequentially and an under 10% tax rate for the full year.

Ty Govatos - TG Research

There you go, and a question this one is for Carl or yourself Patricia do you notice over the last 18 months that most of the growth in the U.S. market is coming from small accounts and large accounts tend to have been pulling back?

Carl Camden

All starts, large accounts have been pulling back but primarily as we said in the script because we are not engaging in investment projects, launching new products, building out new production capabilities and so on. We have been putting a different and focused effort in the marketplace against large accounts and small accounts. So I am not certain that what we see would be particularly indicative of the market, the marketplace in general. We are trying to produce some outsized growth in both segments.

Ty Govatos - TG Research

Fair enough. Thanks an awful lot.

Carl Camden

Thanks Ty.

Operator

(Operator Instructions) We’ll go to the line of Tobey Summer with SunTrust. Please go ahead.

Carl Camden

Hi Tobey.

Tobey Summer - SunTrust

Hi, good morning.

Carl Camden

Good morning.

Tobey Summer - SunTrust

Carl, what are your thoughts about the internal capability you have to expand operating margins if the economy and job growth don’t change?

Carl Camden

So partly the strategic initiatives focusing on higher end PT movement and OCG are designed both to take advantage of where the marketplace is going and have a corollary effect of expanding operating margins as they gain traction. You are seeing that in particular right now in the OCG space as we are achieving leverage and gaining some good momentum on the sales side, not seeing as much it on the PT side although the fees in the America as well as a good hopeful indicator of what could be done. The question I think you are really asking though is what type of expense you know management can be done in the future. And a lot of it will depend upon where growth happens and where growth doesn’t happen and what we succeed and the third strategic initiative that we didn’t talk in depth about, but you heard Patricia and I both mentioned which was the centralization of our service delivery system is designed to ultimately reduce expense cost and has been doing so, where we do more and more of our service delivery out of centralized hubs rather than a distributed branch network, which we hope also has the effect, Tobey, of freeing up the distributed branch network to pursue the local business when I talked about we are trying to make focusing on both in two different ways with two different delivery systems.

Tobey Summer - SunTrust

So is that to say that you think you can expand margins in a static economic and job growth environment?

Carl Camden

Yes, primarily from mix right, if PT and PT related fees continue to expand and OCG does what it’s supposed to do, then well we should be able to expand margins.

Tobey Summer - SunTrust

Okay. Within OCG, were there differences in kind of geographic growth rates or is it primarily end markets and skill sets, because I think you highlighted your engineering and scientific capability?

Carl Camden

Yes. So I think we are at the phase now, Tobey. As you know, where lots of companies are shifting the procurement model and shifting the talent management model to the supply chain approach. So right now we are seeing growth around the world. We are seeing growth across the U.S. marketplaces and we are seeing growth in almost every industry segment that you could – that you can think of. In particular, you see a lot of growth in those that are IT heavy, but that’s because in a lot of companies IT represents 40%, 50% of the external work for us, but we are seeing growth and demand whether it’s healthcare or whether they are healthcare professional, heavy finance professional or engineering heavy. Right now, this is a grow everywhere, grow everything stage supply chain management.

Tobey Summer - SunTrust

Carl, in the BPO spaces that are you taking away work from other providers or is the growth that you called out primarily new work to the market?

Carl Camden

Partly, you have an adoption curve taking place where there are aspects of work that companies are moving to do in inside of BPO solution. So we see – you see kind of new BPO opportunities emerging, particularly in those that are using professional and technical workers, because kind of the first stage of BPO was often pretty heavy in the use of commercial type of workers and now it’s moving up the skill sets, but we are seeing growth and everything from the most basic fundamental of our BPO, traditional products now to the newer ones better engineering and science driven.

Tobey Summer - SunTrust

Thanks and my last question has to do with commercial staffing gross margins that it seems you are providing a bit of a headwind in what do you think are the triggers we should look for the stabilization or expansion of those margins?

Patricia Little

In this quarter I would say that the fundamentals are reasonably stable. We saw impacts from things like prior year adjustment to workers comp which I wouldn’t view as a real driver or a signal. I will say going forward that the real impact will start hitting and the interesting question will be once we have all rolled out ACA and how that will impact our gross margins. And we strongly believe that we can recover the ACA costs that we have, but that is probably the biggest unknown we have for Americas commercial gross margins.

Tobey Summer - SunTrust

Thank you very much

Carl Camden

Thank you

Operator

And Mr. Camden, there are no further questions in queue.

Carl Camden - President and Chief Executive Officer

Great. Thank you, John and thank you all for joining in on the call.

Operator

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

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