Kelly Services, Inc. (NASDAQ:KELYA)
Q4 2016 Earnings Conference Call
February 2, 2017 09:00 A.M. ET
Carl Camden - President and Chief Executive Officer
Olivier Thirot - Chief Financial Officer
George Corona - Chief Operating Officer
John Healy - Northcoast Research
Ladies and gentlemen, good morning and welcome to Kelly Services Fourth Quarter 2016 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.
Thank you, John, and good morning everyone. Welcome to Kelly Services 2016 Q4 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.
As we walk through our results this morning, let me point out that our year-over-year comparisons are represented in constant currency, due the volatility of foreign currency exchange rates and as an additional resource to help you navigate our Q4 results, we published a slide deck on the Investor Relations page of our public website summarizing our key financial performance indicators.
All told, 2016 was a year of progress for Kelly. We grew gross profit delivered higher operating earnings, improved our conversion, added free cash flow, and delivered higher dividends to our shareholders. Our performance against these key indicators in 2016 confirms we are indeed operating as a more focused agile company committed to delivering growth.
Before we dive into the details of today's results, let me point out that our year-over-year comparisons, especially in the fourth quarter are significantly impacted by two factors. First, our 2015 reported results included a 53rd week of revenue in the fourth quarter that is absent from 2016’s fourth quarter. And second, Kelly finalized our APAC joint venture in July 2016 and thus had no reported APAC staffing revenue in the second half of the year. I’ll discuss these impacts in more detail as I cover the individual segment results, but for the sake of clarity, I’ll begin this morning by walking through the companywide results with and without the impact of the JV.
Included in the impact of the JV, Kelly's revenue for the fourth quarter was $1.3 billion, down 10% compared to last year and for the full year revenue was $5.3 billion, compared to $5.5 billion in 2015. For the quarter, we achieved earnings from operations of $22 million, compared to $27 million last year. And for the full-year, we reported operating earnings of $65 million, compared to $67 million for 2015.
Kelly's fourth quarter earnings from continuing operations for $0.55 per share compared to earnings of $0.88 per share for the same period last year and for the full-year earnings were $3.13 per share, compared to earnings of $1.39 per share for the same period last year.
Now, excluding the APAC business and the 53rd week from our 2015 results, revenue for both the fourth quarter and the full-year was essentially flat. And for the quarter, we achieved earnings from operations of $22 million compared to $25 million last year, and for the full-year adjusted earnings from operations totaled $68 million, excluding restructuring compared to $63 million last year, an increase of 9%.All told, though the economic environment did seem to soften a bit in the fourth quarter, 2016 was indeed a year of progress for Kelly.
Now let’s take a closer look at the performance in each of our business segments, starting with the Americas. As expected, the 53rd week in fiscal year 2015 had the largest impact in our Americas staffing segment. Americas 2016 fourth quarter revenue decreased 6%, compared to the same period last year. Excluding the impact of the 53rd week, Americas fourth quarter revenue was down 2% from a year ago, compared to the 1% decrease we reported in the third quarter.
In Americas commercial, revenue decreased 5% year-over-year for the quarter and decreased 1%, excluding the impact of the 53rd week consistent with the 1% revenue decrease reported last quarter. Americas PT revenue for the fourth quarter decreased 9% year-over-year and was down 4%, excluding the impact of the 53rd week, as compared to the 1% decline we reported in the third quarter.
As stated on previous calls, we service our staffing clients through two different delivery models and it’s helpful to look at our results for each of these models separately. Also to provide clearer context around sequential performance, the remainder of my Americas revenue comparisons will exclude the overall impact of the 53rd week. And accounts serviced through our local U.S. branch network commercial staffing increased 1% year-over-year in the fourth quarter an improvement from the 1% decrease we reported for Q3.
Excluding Kelly Educational Staffing, KES, local commercial revenue decreased 1% year-over-year, an improvement from the 5% decline reported last quarter. The increased demand in light industrial staffing that we started to see late in Q3 was the main driver of this improvement. KES reported revenue growth of 6% for the fourth quarter. Whereas Q3 revenue growth had spiked upwards, due to the timing of school breaks. In Q4, we experienced a negative impact on year-over-year revenue due to the timing of the school breaks.
For the full-year, KES reported a solid growth rate of 16% year-over-year. In our branch network PT business, fourth quarter revenue was down 1% year-over-year compared to the 3% growth reported last quarter. This reduction is due to the completion of customer projects, coupled with softening demand in the quarter.
Looking at our centrally delivered staffing model, commercial revenue decreased 5% year-over-year in the fourth quarter, compared to the 3% decline we reported last quarter due primarily to softer demand and longer holiday furloughs, compared to a year ago. And our centralized PT business, fourth quarter revenue was down 5% from a year ago, compared to the 3% decline we reported last quarter, as with our U.S. branch based business we saw softening demand in this segment.
We also continue to see the impact to customers buying more PT talent through a competitively sourced model. Looking more closely, at our core PT specialties and the Americas overall, year-over-year revenue was lower in all product lines in the fourth quarter, due to softer demand and project completions.
Firm fees in the Americas were down 9% year-over-year in the fourth quarter, a decline from the 1% growth in the third quarter, and commercial fees were down 11% down from the 10% growth we reported in Q3 and PTPs were down 6%, compared to the 7% decline we reported last quarter.
These results reflect the ongoing choppiness of the current hiring environment. Americas fourth quarter gross profit rate was 16.3%, up 10 basis points from a year ago. The improved GP rate is due to effective management of our temporary employee payroll tax cost and customer mix, offset somewhat by increased employee benefits cost.
Americas total expenses for the quarter were down 2%, reflecting the continued impact of the structural adjustments we made earlier in the year as we run the business more tightly in-line with our GP growth expectations. All told, the Americas delivered nearly $31 million of operating profit in the quarter, a decrease from the $36 million we reported last year and again this drop is primarily due to the impact of the 53rd week.
For the full year, the Americas delivered $110 million in operating profit, excluding restructuring, up slightly from last year. Overall, we’re pleased with the improvement in our U.S. branch based commercial business.
Our PT results in both models reflect a bit of softening in the market, along with a growing tendency for customers to engage in project-based and vendor neutral PT arrangements. Our teams have done a good job of monitoring and controlling expenses in both models and will continue to assess the marketplace and respond appropriately in 2017.
Now let us turn to our staffing operations outside of the Americas. Revenue in EMEA increased nearly 1%, compared to prior year, commercial revenue was 2%, while PT revenue declined by 3%. Growth in Ireland, Portugal, and Russia was offset by lower volumes in France, Germany, and the UK. Excluding the 53rd week, EMEA revenue was up 6%. Fee-based income for the quarter was down by 2% year-over-year, primarily in the UK and Nordics, partially offset by Western and Eastern Europe.
EMEAs GP rate for the fourth quarter decreased the 14.5%, compared to 15% for the same period last year, due to unfavorable country mix, as well as change in customer and service mix. The lower GP rate on slightly increased revenue resulted in a 4% decline in gross profit dollars.
Expenses were 6% higher year-over-year, driven by targeted investments and recruiters in our branch network, partially offset by effective cost control of headquarters expenses across the region. Netting it all out, operating profit was $4.2 million, compared to $7.2 million a year ago. For the full year, EMEA delivered $13.2 million of earnings from operations or $14.4 million without restructuring cost, compared to the $14 million last year.
Now, we will turn from our staffing results to the performance of our outsourcing and consulting segment, OCG. OCG revenue in the fourth quarter was flat compared to last year and gross profit increased by 3%. The GP increase was driven by growth in business process outsourcing, BPO; and recruitment process outsourcing, RPO.
BPO gross profit increased by 7% year-over-year in the fourth quarter, and our traditional BPO solutions gross profit grew by 26% year-over-year, while the call centre outsourcing practice KellyConnect declined 14%, driven by an additional expense in response to an expansion of our largest program, which will yield revenue and GP growth in the first half of 2017.
In CWO, gross profit declined 1% compared to last year, reflecting a 12% decline in our payroll process outsourcing business due to lower volume with several large customers offset by 4% growth in our program management fees, which were slightly lower than previous quarters as we anniversary several large wins from 2015. In our RPO practice, gross profit increased by 26% due to both revenue growth and a shift in customer mix as we expand our client portfolio in this practice area.
Overall, OCG's gross profit rate was 26.4% for the quarter, up 80 basis points, due largely to favorable practice in customer mix. Expenses in OCG were up 14% year-over-year, due to increased headcount and support both implementation of new programs and existing program expansions, as well as the higher reign of additional global sales resources to support the strategic growth of our talent supply chain management solutions.
All told, OCG's fourth quarter operating profit of $10.8 million is down 24% from last year and for the full year, OCG delivered earnings from operations of $28.7 million flat to prior year. Our full year OCG performance reflects our continual, intention, investment in this segment, we anticipate a return to double digit GP growth in the first half of 2017, as account expansions and new customer wins are implemented, and is our additional sales resources at their full stride.
Now, I’ll turn the call over to Olivier, who will cover our quarterly and full year results for the entire company.
Thank you, Carl. Revenue totaled $1.3 billion, down 10.8%, compared to the fourth quarter last year. Our reported revenue was impacted by several factors, including the deconsolidation of the APAC staffing business by 650 basis points. The inclusion of an additional week of revenue in Q4 2015, due to our 53-week year by 420 basis points, and finally by 70 basis points due to foreign exchange.
Without these impacts, revenue growth for the fourth quarter would have been essentially flat on a constant currency basis very similar to what we have experienced in the previous two quarters, reflecting an improving, but still slow growth environment. Now, consistent with Carl, the remainder of my year-over-year comments are represented in constant currency.
Staffing placement fees were down 22% year-over-year or down 7% after excluding the APAC staffing business from our 2015 results. We saw a 2% decline in EMEA and a 9% decline in fees in the Americas. This reflects the overall ongoing choppiness of the current environment.
In constant currency, overall gross profit was down $20 million or 8%. After excluding the APAC staffing business from our 2015 results, gross profit was down $7 million. This is due primarily to the impact of the excellent week in our 2015 results. Our gross profit rate for the quarter was 17.5, 40 basis points when compared to the fourth quarter of 2015.
Our GP rate improvement reflects the deconsolidation of our APAC staffing business, as well as an improving business mix and continued improvement of the GP rate for our OCG business, partially offset by lower perm fees. The overall pace of GP rate improvement is consistent with Q3 and has slowed as we have begun to anniversary the work started in 2015 to improve our U.S. staffing GP rate.
SG&A expenses were down 7% year-over-year. After excluding the results of the APAC staffing business from our 2015 results, SG&A expenses were down by 1.9%. Our year-over-year reduction in expenses reflects saving from reductions in our performance based compensation cost and lower corporate litigation expenses, partially offset by expense increases in our global OCG business, reflecting continued investment in that business unit.
Earnings from operations were $21.6 million in the fourth quarter, compared with 2015 earnings of $26.5 million. Excluding the APAC staffing business, 2015 earnings were $24.7 million. For the quarter, our conversation rate was 9.5%, compared to 10.6% in the same period of 2015.
On a full-year basis, earnings from operations was $65 million or $68.4 million, excluding restructuring compared to $66.7 million in 2015. Our conversion rate for the full year, excluding our structuring costs was 7.6%, up 40 basis points from a year ago, reflecting our results to produce improving earnings from a combination of gross profit growth in key areas of the business and continues expense control efforts.
Income tax expense for the fourth quarter was $1.8 million, compared to an income tax benefit of $8.4 million, reported in 2015. The higher year-over-year quarterly tax expenses is primarily driven by the work opportunity credit. The Work Opportunity Credit was not reinstated until the end of 2015. Q4 2015 income taxes reflect a full year impact of the Work Opportunity Credit. The Work Opportunity Credit has been reflected in the quarterly income tax expense in each quarter of 2016.
And finally, diluted earnings per share for the fourth quarter of 2016 totaled $0.65 per share, compared to $0.88 in 2015. Our 2016 earnings per share include $0.15 per share for Work Opportunity Credit compared to $0.40 in our 2015 earnings per share related to the reinstatement of the Work Opportunity Credit in late 2016.
Now, looking ahead to 2017, we finalized the expansion of our joint venture in APAC as of the beginning of the third quarter of 2016. As a result, our APAC session operations are no longer consolidated and are no longer included in earnings from operations beginning in the third quarter.
We now account for Kelly's 49% interest in Kelly Asia-Pacific as an equity method investment and the related income from these investments is reported on the income statement below earnings from operations. Consistent with last quarter, our expectations reflect the completion of the JV transaction and the growth rates reflect no APAC operations in either year.
For the full-year, we anticipate revenue to be up 3% to 4%. We expect that the impact of FX on revenue will be minor, and do anticipate that revenue growth will prove progressively as we move through the year. We expect the gross profit rate to continue to improve on a year-over-year basis based on continuous improvement in our business mix.
We anticipate SG&A expenses to be up 3% to 4%. This includes year-over-year increases in compensation expenses, which will only be paid upon achievement of performance objectives. So, for the full year, we expect to deliver double-digit growth in earnings from operations on a like-for-like basis and expect to continue to improve our conversion rate.
In addition, we will be reporting the earnings from equity method investment in the JV below earnings from operations. 2017 will be a year of investment for the JV with the expectation that the JV will be positioned to produce faster growth in 2018 and beyond. As a result, we don't expect our earnings from our equity method investment to be material in 2017.
Our 2017 annual income tax rate is expected to be in the low-to-mid 20% range, including the impact of the Work Opportunity Credits. Another item to note as we look forward, the completion of the JV transaction, and the results of our annual strategic review will also likely result in a change in how we allocate resources and analyze performance. This may result in the change to our segment reporting as we enter into 2017.
Now, moving to the balance sheet, cash totaled $30 million, compared to $42 million at year-end 2015. In our cash flow year-to-date, we generated $25 million of free cash flow compared to $7 million of free cash flow in 2015. The change was mainly due to lower growth in trade accounts receivable. Global DSO was 64 days, consistent with the fourth quarter of 2015, and down two days versus the third quarter of 2016.
And finally, we ended the year with no debt, down $66 million from year-end 2015. We are pleased with our continued progress in generating sustainable free cash flow, as well as the cash proceeds from the APAC JV transaction. For more information on our performance, please review the fourth quarter slide deck, which is available on our website.
I’ll turn it back over to Carl for his concluding results.
Thank you, Olivier. Kelly entered 2016 with a firm commitment to increasing growth and profitability, and we exited the year having made progress on both of those fronts, even in uncertain environment. These financial results were complicated by a number of factors. The 53rd week, the APAC JV, restructuring charges, foreign exchange rates, and so on.
Let me attempt to cut through the complexity and give you my perspective as the CEO. It was a good year in a tough time. When I look back, three key takeaways emerge. First, our growth strategy is yielding results. Even in the phase of the lower revenue, we delivered against key performance indicators in 2016.
Our gross profit rate improved. We delivered higher year-over-year earnings from operations, and we improved our conversion rate of those gross profit dollars into operating earnings and we have demonstrated our focus to continued improving profitability. In addition, we maintained a strong balance sheet and we improved our free cash flow, while still increasing our quarterly dividend and ending the year debt free.
Second, Kelly's U.S. staffing operations continues to deliver solid execution. We are seeing the benefit of increased focus on good cost control as we run this business more tightly and in line with growth expectations, and although we are keeping a watchful eye on soften demand in PT, we're ready to adapt as conditions change in the year ahead.
And third, our expanded joint venture in APAC is now complete, establishing a dominant presence in the Asian staffing sector, while enabling us to focus on accelerated growth and our wholly-owned OCG segment in the region's outsourcing and consulting space. These progress points confirm that Kelly is operating as a more focused, adaptable, growth oriented organization, one that’s aligned with market trends and well positioned as a leader in the workforce solutions industry.
Our OCG segment continues to respond the client’s complex demands for a more holistic talent supply chain management approach, and while our investments softened our growth rates a bit in the second half of 2016, we fully expect to see a return to double digit GP growth in the first half of 2017. As we reap the benefits of expanded large account relationships and significant new wins our sales teams secured last year.
We remain confident in OCG's strategic direction and in the intentional investments we're making to increase top and bottom line growth in this segment. We believe Kelly is poised for continued progress in the year ahead. We move forward with confidence. We remain focused on profitable growth. We are proud to deliver that growth by connecting companies and talented people with excellence and integrity throughout the world. And again, I’d like to personally thank Kelly's teams for all their good work in 2016. And Olivier and I will now be happy to answer your questions, along with George Corona, our Chief Operating Officer.
John, the call can now be open for questions.
[Operator Instructions] And we will go to the line of John Healy with Northcoast Research. Please go ahead.
Thank you. Carl I wanted to ask your expectations for the Asia JV in 2017, can you give us some color in terms of how you expect that to contribute to income and maybe the cadence in terms of how you’d expect that business to kind of flow as we move through 2017?
Yes, I think is Olivier said, the JV contribution to our earnings in 2017 we don't expect to be material. They are focused on growth and expansion of the services to stay a dominant HR services company in the APAC region; that is the strategic plan for the JV. It is what we expect, significant growth, significant activity to expand, but not significant or material improvement to earnings in 2017.
Yes, we see that as a growth engine and they need to continue to size market opportunities because it’s a high growth market. So, most of their GP increase is going to be invested in expanding further the business.
If you look at where talent markets are going, most rapidly around the world, lots of the fastest growing markets are in the APAC region for both commercial talent, but also for professional and technical talent, as well as outsourcing and project work. It’s a market that the JV is looking very hard to stay dominant in.
Great. That’s helpful. And I wanted to ask about two geographies, the U.S. market and the UK market. When you look at the U.S., could you help us think about how headcount and wage inflation is kind of contributing to numbers in the fourth quarter and maybe how you think that kind of fares in 2017, and then the UK business was a little bit weaker than I would have expected. Any thoughts there in terms of the Brexit impact, is that a customer just kind of going the other way, just hope to get some color there?
Going to your first question, which is - and this is George, the U.S. market, you know we started to see wage increases to start throughout the year, but they are not huge, they are in the 2% range in terms of what we're seeing, in terms of wage increases, but it is a return to wage increases that we hadn't had for several years and it appears to be continuing. When you look at overall headcount, overall headcount in the fourth quarter was down a bit particularly in PT as we have seen softer demand. So that’s kind of how it works out. From a UK perspective, we are not huge in the UK, and so we're not going to move with the market. There are some particular account fluctuations as we go through that market, but we don't see anything that particularly concerns us at this point. I wouldn't say Brexit had much to do with it, it’s just ongoing business.
Great. And then just last question, when you think about the free cash flow generation of the company, I feel like you generated probably close to about $1 per share this year when you isolated a few things, is that a reasonable expectation for 2017, do you think?
Well I mean - I think John you have seen, you know that we have started really focus on working capital and in our business, I mean working capital is all about DSO and we have made progress year after year, just if you look at 2016 average DSO we are down by about two days versus 2014 and that’s a driver, we're going to continue that, we're going to continue to keep an eye on our cash, and we plan to continue to improve our free cash flow generation, as you might have seen from 2014 to 2015, 2015 to 2016. That’s an area of focus. That’s one of the key indicators we look at carefully during the year.
Okay, thank you.
Thank you, John
[Operator Instructions] And allowing a few moments, Mr. Camden there no further questions coming in.
Very good, John. Thank you and thank you all who attended the call. Appreciate it.
Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.
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