Kelly Services, Inc. (NASDAQ:KELYA) Q2 2016 Earnings Conference Call August 10, 2016 9:00 AM ET
Carl T. Camden - President and CEO
Olivier Thirot - CFO
Good morning and welcome to Kelly Services Second Quarter Earnings Conference Call. All parties will be in a 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 T. Camden
Thank you, Brad. Good morning, everyone. Welcome to Kelly Services 2016 Q2 Conference Call. With me on the call today is Olivier Thirot, our CFO, and George Corona, our COO.
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.
Before we look at the second quarter results, I'm pleased to confirm that as of July 4, we have completed the APAC joint venture we told you about last quarter, forming TS Kelly Asia Pacific, one of the largest workforce solutions companies in Asia. Olivier will provide more details around this transaction in his commentary, but let me say that we are extremely pleased with this JV as well as our ongoing growth plans for Kelly OCG which remains wholly owned by Kelly in the region.
Now turning to our second quarter 2016 results, let me point out that our year-over-year comparisons are represented in constant currency due to ongoing fluctuations in foreign currency exchange rates, with the exception of our year-over-year earnings from operations and earnings per share comparisons which are represented in nominal currency. And as an additional resource to help you navigate our quarterly results, we've once again published a slide deck on the Investor Relations page of our public Web-site, summarizing our key financial performance indicators.
Turning to Kelly's second quarter results, I'm pleased to report we delivered solid GP growth on top of steady revenue and we demonstrated a quick and agile response to what appears to be a somewhat softening demand in the U.S. Revenue for the quarter was $1.4 billion, basically flat compared to last year.
We achieved earnings from operations of $9.9 million for the quarter, compared to $11.5 million delivered last year. This decline reflects restructuring charges that we incurred during the second quarter, which Olivier will review in more detail during his comments. Excluding restructuring, we delivered operating earnings growth of 16% for the quarter.
Kelly's second quarter earnings from continuing operations in nominal currency were $0.23 per share, compared to earnings of $0.18 per share for the same period last year, an increase of 28%. And again, these results reflect second quarter restructuring charges.
All told, we're pleased with Kelly's performance in the second quarter. We increased our gross profit rate by 70 basis points over last year and grew GP dollars faster than adjusted expenses, showing agility and delivering leverage that yielded strong adjusted operating earnings.
Now let's take a closer look at the performance in each of our business segments, starting with the Americas. The Americas delivered $26 million of operating profit, including restructuring charges, in the second quarter. Excluding restructuring, the region delivered $29 million of operating profit, a 12% increase over a year ago and strong leverage of more than 100% for the quarter. We are pleased with these bottom line results, given that America's second quarter staffing revenue decreased 1% year-over-year as we experienced softened demand in some areas during the quarter.
In Americas Commercial, Q2 revenue decreased 1% year-over-year, compared to the 3% growth we reported last quarter. Americas PT revenue for the second quarter was down 2% year-over-year, down from the 2% growth we had reported last quarter. We took swift action to align our cost structure with demand in our Americas segment, including consolidating branches in our U.S. network and eliminating positions in our field operations, centralized operations and support services functions. These actions resulted in a restructuring charge of $2.2 million in the second quarter and we expect to see the benefit of this revised cost structure in the second half of the year.
As has been our practice on our earnings call, we will separately review the results of the two service delivery models in our Americas staffing operations. In accounts serviced through our local U.S. branch network, commercial staffing revenue was up 1% year-over-year in the second quarter, compared to the 7% increase we reported last quarter.
Excluding Kelly Educational Staffing, local commercial revenue decreased 1% year-over-year, compared to the 4% growth we reported last quarter, primarily due to lower office services and decelerated growth in our light industrial business. KES reported revenue growth of 11% for the second quarter compared to 22% growth last quarter. The lower growth rate is due primarily to the impact of many schools closing earlier for the summer this year compared to prior years and we anticipate this shift in school calendars will have a positive impact on our KES revenues in the third quarter.
In our branch network PT business, revenue increased 1% year-over-year, compared to the 11% growth last quarter. This decline was due to project completions along with fluctuating demand, though we did see signs of improvement as the quarter progressed.
Looking at our centrally delivered large customer model, commercial revenue decreased 5% year-over-year in the second quarter, compared to the 3% decline we reported last quarter, primarily due to office services. In our centralized PT business, Q2 revenue was down 3% from a year ago, as compared to the flat revenue we reported last quarter, primarily due to the impact of vendor neutral accounts on our PT business.
Looking more closely at our core PT specialties in the Americas, year-over-year revenues in Science, Engineering and IT fell in the second quarter due to softening demand and the project completions mentioned earlier, while Americas Finance specialty delivered revenue growth.
Perm fees in the Americas decreased 5% year-over-year in Q2, down from the 24% year-over-year growth we reported last quarter, primarily driven by fluctuations in PT which is typically more volatile than Commercial. Commercial fees were up 4% year-over-year, consistent with last quarter's reported growth. Second quarter fees in PT were down 11% year-over-year as we experienced significant fluctuations in volume throughout the quarter, though we did see higher growth at the end of the quarter.
Americas Q2 gross profit dollars increased 2% year-over-year and our GP rate was 16%, up a healthy 60 basis points from last year. The improved GP rate is due to effective management of our temporary employee payroll tax and benefits cost and lower worker compensation cost, offset somewhat by the impact of customer mix.
Americas total expenses for the quarter were up due to the previously mentioned restructuring charge of $2.2 million, offset somewhat by a reduction in incentive payments. Excluding restructuring, we basically held expenses flat year-over-year. Given the significance of our Americas segment, we will continue to monitor demand as the year progresses and make additional adjustments to our cost base as needed to enable continued leverage in this critical business.
Let's turn now to our staffing operations outside the Americas, starting with EMEA. EMEA had another solid quarter with year-over-year revenue growth of 3% compared to last year. Commercial revenue was up 3% and PT revenue was up 2%, both coming from growth in the majority of markets, and the growth was partially offset by lower volumes in Russia, the Nordics and the U.K.
Fee-based income for the quarter was up 12% year-over-year, as our focused strategy on selected markets is starting to pay off, notably in Western Europe. EMEA's GP rate for the second quarter was essentially flat to last year at 14.9%. We're pleased to see signs that our EMEA GP rate is stabilizing and that our focus on improving our perm fee business is beginning to offset the downward trend on temp staffing GP resulting from market pressure and change in customer mix.
Expenses were down slightly compared with the prior year, which includes $1.2 million of restructuring cost related to our Italy staffing operations. The Italy restructuring is designed to reposition our operating model to pursue growth in perm and specialized temp business. Excluding restructuring cost, expenses were down 4% year-over-year as we continue to see the benefits from effective cost control in headquarters expenses across the region.
Netting everything out, we're pleased with EMEA's operating profit of $2.6 million, or $3.8 million excluding restructuring, compared to the $1.7 million from last year. We expect growth in the European markets to remain stable, although the impact of Brexit on our operations in the U.K. and Mainland Europe is still uncertain.
Turning now to our staffing operations in APAC, revenue for the region grew by 1% in the second quarter compared to the prior year. Temporary staffing growth continues to be solid in our large account portfolio, while perm fees declined by 2%. The GP rate of 13.2% was 70 basis points lower than the prior year due to the lower year-over-year Singapore wage credits.
Total expenses were lower by 2% against the prior year as a result of continued cost control efforts on productivity improvements. The APAC region ended the quarter with an operating profit of $1.2 million, down by $400,000 compared to the same period last year.
Now we'll turn from our staffing results to the performance of our Outsourcing and Consulting segment. For the quarter, revenue grew by 6% compared to last year and gross profit increased by 21%. The gross profit increase was driven by growth in all three of our core businesses; business process outsourcing, BPO; contingent workforce outsourcing, CWO; and recruitment process outsourcing, RPO.
BPO gross profit increased by 38%, due mainly to strong results in our STEM business. In CWO, gross profit increased 7% year-over-year, reflecting double-digit growth in our program management fees, offset by slowing demand in our payroll process outsourcing business. And in our RPO practice, gross profit increased by 14%, primarily due to a shift in customer mix.
Overall, OCG's gross profit rate was 24.6% for the quarter, an increase over last year's rate of 21.6%, due largely to favorable customer mix. Expenses in OCG were up 19% year-over-year related to increased salaries and performance based compensation, as well as the hiring of additional sales resources. Leverage for the quarter was 18%. We are on track to improve leverage for the full year while continuing to invest in this growing segment.
All told, OCG's operating profit of $4.8 million for the second quarter is up 38% or $1.3 million from last year. We are pleased with the progress we are making in this important segment and its ongoing ability to deliver solid leverage.
Now I'll turn the call over to Olivier who will cover our quarterly results for the entire Company.
Thank you, Carl. Revenue totaled $1.4 billion, up 0.6% in constant currency, compared to the second quarter last year. During the second quarter, we saw moderation of the impact of foreign currency translation on our nominal revenue growth at about 130 basis points for the second quarter.
Now, consistent with Carl, the remainder of my year-over-year comments are represented in constant currency. Staffing placement fees were up 1% year-over-year as we continued to see solid fee growth in EMEA, partially offset by declines in the Americas and APAC.
In constant currency, overall gross profit was up $11 million, nearly 5%. Our gross profit rate was 16.8%, up 70 basis points when compared to the second quarter last year. Our GP rate reflects an improving GP rate in our U.S. staffing business as a result of effective management of Company employee payroll tax and benefit expenses and strong improvement in the GP rate for our OCG business.
SG&A expenses were up 5.7% year-over-year. Included in our second quarter expenses are $3.4 million of restructuring costs in our Americas and EMEA staffing businesses. In the Americas, we have taken quick action to react to a slowing in revenue growth we saw during the quarter. The restructuring will allow us to manage operating expenses while ensuring we are prepared for sustainable profitable growth moving forward. In EMEA, we are repositioning our Italy business to capitalize on opportunities in the perm placement and specialty staffing business. Excluding all structuring expenses, SG&A expenses were up 4.1% for the quarter.
Expenses were flat to down in all of our staffing businesses. Expenses were up in our global OCG business, reflecting our continued GP growth in that business unit. Growth in our corporate expenses reflect $3 million of additional cost related to certain benefit plans and litigation as well as $1.2 million of one-time expenses related to the expansion of the APAC staffing JV. We'll continue to remain vigilant about expense control and we will manage expenses in line with GP growth for the full year.
Earnings from operations were $9.9 million in the second quarter, compared with 2015 earnings of $11.5 million. Excluding the impact of restructuring costs, 2016 earnings were $13.3 million. While reported earnings were negatively impacted by restructuring expenses, earnings from operations excluding all structuring reflect a conversion rate or return on gross profit of 5.8%, compared to 5.2% for the second quarter of 2015, a solid improvement year-over-year.
Income tax expense for the second quarter was $0.8 million, compared to an income tax expense of $3.7 million reported in 2015. The overall lower reported year-over-year quarterly tax expense is primarily driven by the work opportunity credit which was reinstated at the end of 2015. As a result, quarterly 2015 income tax expenses did not reflect the impact of the work opportunity credit until the fourth quarter. Our second quarter earnings per share reflect a $0.06 improvement related to reinstatement of the work opportunity credit.
And finally, diluted earnings per share for the second quarter of 2016 totaled $0.23 per share, compared to $0.18 in 2015, an increase of 28%. Excluding all structuring expenses, diluted earnings per share for the second quarter was $0.29.
Now, as we look ahead to the rest of the year, as Carl mentioned, we finalized the expansion of our joint venture in APAC as of the beginning of the third quarter. As a result, our APAC staffing operations will not be included in Kelly's consolidated financial results beginning in the third quarter. We'll account for Kelly's 49% interest in TS Kelly Asia Pacific as an equity method investment and the related income from this investment will be reported on the income statement below 'earnings from operations'. We have updated our guidance to reflect the closing of the JV transaction.
In light of an uncertain economic environment in the U.S. and excluding the impact of the APAC JV formation, we expect revenue for the third quarter to be up 1.5% to 2.5% in constant currency. We expect the gross profit rate to be up 50 to 70 basis points year-over-year, with approximately 20 basis points due to the APAC JV formation, overall equivalent to a total gross profit dollar growth of 3.5% to 4.5%.
Finally, given cost reductions initiated at the end of the second quarter, we expect SG&A expense to be up only 1% to 1.5%. So we expect to continue to deliver solid operating leverage. In addition, because we will report the earnings from our equity method investment in the JV on a three-month's lag, there will be no equity method income reported in the 'other income and expense' line for the third quarter.
For the full year, we expect constant currency revenue growth to be up 1.5% to 2.5%. We expect the gross profit rate to be up 40 to 60 basis points on a year-over-year basis, with approximately 10 basis points due to the APAC JV formation, overall in total equivalent to a gross profit dollar growth of 4% to 5%.
And finally, we expect SG&A expense to be up 1.5% to 2.5% before restructuring charges. The SG&A expense increase is in line with our expectation to deliver operating leverage in all segments. Please refer to our slide deck for more detailed information.
Our 2016 annual income tax rate is expected to be in the low 20% range, including the impact of the work opportunity credit. This excludes the impact of the expected material capital gain resulting from the expansion of the TS Kelly Asia Pacific JV.
And one other item of note as we look forward, the completion of the JV transaction will also likely result in a change in how we allocate resources and analyze performance, and may result in a change to our segments' reporting in the future.
Now moving to the balance sheet, although the closing of the APAC JV transaction did not take place until the third quarter, the assets and liabilities that were subsequently contributed to the JV have been accounted for as held-for-sale as of the second quarter balance sheet date.
Cash totaled $33 million compared to $42 million at year end 2015. Our reported cash balance at the end of the quarter does not reflect the $18 million of cash held in our APAC staffing operations as a result of the held-for-sale reclassification I just mentioned.
In our cash flow, year-to-date we generated $37 million of free cash flow, compared to using $33 million of free cash flow last year. The change was due mainly to lower growth in trade accounts receivable, due in part to improved DSO as well as improving net earnings. Global DSO was 53 days, three days better than the same quarter last year and one day better than the fourth quarter of 2015. This steady reduction in DSO reflects our continued focus on maximizing free cash flow generation.
At quarter end, debt stood at $27 million, down $29 million from year-end 2015 and down $63 million from a year ago. As there was no debt in our APAC staffing business, there is no impact from the APAC JV transaction. We are pleased with our continued progress in generating sustainable free cash flow.
In addition, we received $37 million in early Q3 from the closing of the TS Kelly Asia Pacific JV. As a result, we are reviewing our capital allocation strategy going forward. For more information on our performance, please review the second quarter slide deck available on our Web-site.
I'll now turn it back over to Carl for his concluding thoughts.
Carl T. Camden
Thank you, Olivier. We entered 2016 with a firm commitment to becoming a more competitive consultative and profitable company, and I believe today's quarterly report demonstrates that we are holding fast to that commitment and are actively reshaping our business to make that vision a reality.
If you sort through all of the information that Olivier and I have provided you, I think three key takeaways emerge. First, we are acting with increasing speed and agility. When we saw signs of the softening demand in the U.S., we acted quickly to align our cost structure with demand. And secondly, although quarterly revenue was basically flat, GP dollars grew by 5% and the GP rate increased faster than adjusted expenses. And third, this leverage enabled us to grow operating earnings 16% in the second quarter, excluding restructuring charges.
In addition to operating more efficiently, we're making progress strategically. We completed our joint venture in Asia, taking a significant step forward in that region, and we plan to capture the growth opportunities that will result. OCG remains wholly owned by Kelly in APAC and we will accelerate our investments in OCG's capability there to advance its leadership in the outsourcing and consulting space. Around the world, our OCG segment continues to deliver solid performance as more clients adopt the talent supply chain management approach, and we expect to see continued double-digit GP growth in OCG as existing accounts expand and our new customers enter the portfolio.
In our staffing business, our U.S. branch network continues to focus on capturing growth in our PT specialties as our sales and recruiting teams connect U.S. customers with specialized talent. Our centrally delivered account portfolio faces headwinds in our current slow growth environment, particularly as more large growth customers transfer their PT business to a competitive source model, but we are responding quickly to the trends and we'll continue to adjust our centralized account structure as needed. And in EMEA, we continue to deliver effective cost control while driving solid revenue growth, which yield strong improvements in operating earnings.
Overall, very pleased with Kelly's second quarter performance and our ability to deliver solid leverage and strategic growth. We are keeping a cautious eye on the U.S. market, though it's still unclear whether the current slowdown is a temporary pause or a longer-term trend. But regardless, Kelly is prepared. We are moving with more agility than ever, we have created a more balanced portfolio by growing our GP generating businesses, controlling expenses and delivering leverage across the board. We're responding to the new market trends and we're moving forward with confidence and a relentless commitment to improve profitability.
Olivier and I will now be happy to answer your questions along with George Corona, our COO. Brad, the call can now be opened.
Carl T. Camden
Very good and thank you, Brad.
No problem, sir.
Carl T. Camden
You can end the call.
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