Kelly Services, Inc.
Q2 2008 Earnings Call Transcript

Published: 22 Jul 2008

[Operator:]

Good morning ladies and gentlemen, and welcome to Kelly Services’ Second Quarter Earnings 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, and if anyone has any objections you may disconnect at this time. I would now like to turn the meeting over to your host Mr. Carl Camden, President and CEO. Sir, you may begin.

[Carl Camden:]

Thank you, John and again good morning and welcome to Kelly Services’ 2008 Second Quarter conference call. Let me start by introducing Patricia Little, our newly appointed Executive Vice President and Chief Financial Officer. Patricia brings more than 20 years of corporate finance, treasury, planning and analysis to Kelly. She is coming to us from Ford Motor Company, where she served most recently as General Auditor. We're very pleased to have her on the team and glad that she's joining us this morning. We'll briefly review today's agenda

[Patricia Little:]

Thank you, Carl. First, I’d like to say how very happy I am to join the Kelly team. Before I get into the details, you may recall that we recorded a restructuring charge in the UK of $2.4 million or $0.07 per share in the second quarter of 2007. All of the comparisons referenced this morning are for continuing operations excluding the restructuring charge. For the quarter, total company revenue totaled $1.5 billion, an increase of 3% compared to last year. That’s consistent with the growth rate reported in the first quarter. On a constant currency basis, revenue decreased by 1% compared to last year, which is also consistent with the first quarter. But as we mentioned, Easter fell in the first quarter this year and in the second quarter last year. This shift improved our reported revenue growth by about one percentage point in the second quarter. Our gross profit rate was 17.7%, an increase of 20 basis points compared to last year. The increase is primarily due to improvements in growth in our higher margin OCG business as well as increases in fee-based income in EMEA. These increases are partially offset by the non-recurrence of the French payroll tax benefit, which added 40 basis points to our 2007 gross profit rate. Selling, General and Administrative expenses totaled $242 million, an increase of 9% year-over-year. Most of the growth in SG&A expense came from EMEA, APAC and OCG segments where we continue to make strategic investments. SG&A expense decreased by 2% in our Americas Commercial segment. The growth in SG&A expense was also impacted by currency rates. On a constant currency basis, SG&A expense grew by 4%. Earnings from operations totaled $15 million and were down compared to $24.7% million last year. Other income totaled to $149,000 compared to $930,000 last year. This decrease is primarily due to increase debt and lower average cash balances. The effective tax rate in the first quarter was 30.9%, which is consistent with a 30.7% rate in the prior year. This rate was lower than we had expected because of higher work opportunity credits. Diluted earnings per share from continuing operations totaled $0.30 per share, compared to an adjusted $0.48 in 2007. I’ll remind you that the second quarter of 2007 include $0.07 related to the French payroll tax credit. Turning to the balance sheet, I will provide a few highlights. Cash remained strong totaling $85 million; accounts receivable, totaled $953 million, an increase approximately $80 million compared to the prior year. Our receivables continued to increase faster than sales, due to the significant growth in our Vendor Management business. Under US, GAAP, Vendor Management service billings are not included in revenue but are included in accounts receivable. For the quarter, our global DSO was 51 days, unchanged from the prior year. Debt remained relatively unchanged at $96 million compared to $98 million at year-end. Turning to our cash flow, net cash provided by operating activities was $41 million compared to $30 million last year. Improvement was primarily related to improved working capital driven by the timing of payroll tax payments. As Carl discussed, as a result of the economic uncertainty that continues to impact our industry, we have decided to discontinue our quarterly guidance. So now I’ll turn it back to Carl for some concluding thoughts.

[Carl Camden:]

Thank you, Patricia. When I talked to you all in April, I said that predicting the economic future was a bit like reading tea leaves. Unfortunately, the tea leaves didn’t foresee the downward inflection. The staffing industry is well as a cyclical business, trends in the demand for temporary staffing have tended the move in concert with economic growth. During this cycle, our U.S. commercial business has undergone a longer duration of decelerating growth compared to the last recession sessions in 2001. It has now lasted seven consecutive quarters. In 2001 and 2002 we experienced only six consecutive quarters of year-over-year declines. On the other hand, the rate of decline was much greater in the last recession than we’ve seen over the duration of the current cycle. Again, there’s no doubt the economy has worsened in the past three months and that difficulties experienced in the US and the UK are now being felt elsewhere. It wouldn’t be surprising if conditions continue to be difficult throughout 2008 and perhaps longer. Many economists predict only sluggish economy growth for the remainder of the year, and many analysts have lowered their expectations for the entire staffing industry. At Kelly, until we witness sustained temporary job creation, our focus will be on minimizing risk for the short-term and taking steps to ensure long-term value for our shareholders. We’re prudent; we are pushing ahead with geographic expansion to generate additional revenue and earnings growth. For example, Kelly recently announced an agreement to purchase 13 branch offices and 15 onsite locations from Randstad Holding, a transaction that establishes Kelly’s presence in Portugal. Now before we open our call to your questions, I’ll conclude by noting that I am personally disappointed in missing our earnings forecast for the quarter. The downward inflection we saw in the quarter was unexpected, but when I looked through it all despite the turbulent economic headwinds, we are making excellent progress. During the quarter we improved geographic diversity with our expansion in the Portugal and Dubai. We successfully expanded our fee-based services and OCG increasing revenue by 60%. Our professional and technical business segments in all three regions increased our earnings and in this most difficult environment, our GP was up 20 basis points in the quarter. Given the global market and economic conditions, we are going to continue to look for opportunities to reduce our cost structure and improve our cash position. Specifically, we are looking at consolidating some commercial branches in Europe, making further reductions in corporate expenses and considering various initiatives to reduce field costs in Americas Commercial operations. But let me add this; While I am committed to a lower cost, we cannot cut our way out of this cycle. We must maintain an adequate infrastructure and continue to invest for the future. The simple fact remains that temporary staffing is a cyclical industry, and currently the largest parts of Kelly's revenue mix are in the most cyclical parts of the industry. This will end our formal comments, Patricia. Mike and I will now be happy to answer your questions.

[Operator:]

Thank you. Ladies and gentlemen, as to allow as many callers as possible to participate, we ask that you please limit yourself to one question in a single follow up as needed and then return to the queue. (Operator Instructions). We will first go to the line of Jim Janesky with Stifel Nicolaus. Please go ahead.

[Carl Camden:]

Hi Jim.

[Jim Janesky:]

Yes, hi Carl. Thank you. Good morning. A question on your US based or Americas business; Some competitors have indicated that, while the US business was still on contracting, it had stabilized and in some cases expected it to stabilize as we moved into the third quarter. Do you think that is either too optimistic of an outlook or is there something unique to your business mix possibly with the auto related business that has your business contracting more? I would just like to hear your point of view, if I could?

[Carl Camden:]

Sure. For Kelly that would be an optimistic appraisal the one you are reciting by others. We don't see it that way. Our mix is different than other large staffing firms in the US. We are lighter, significantly lighter in the distribution and manufacturing, industrial side of the business. We are heavier on the office clerical side of the business and so there are going to be quarter-to-quarter differences in what we see on the commercial segment versus the opposition. But I just note, there is nothing and that would be based on our last numbers that would argue that stability has been obtained, and there is nothing yet in the Kelly numbers that would argue stability has been obtained. Hence our comment on visibility is significantly worse now than it's been.

[Jim Janesky:]

Okay and then as a follow up - first couple of weeks of July, how did that trend seem versus what you have experienced in June?

[Carl Camden:]

I do not have enough data there to make a comment or we would have. We were in a holiday period at that point which is always distorting. What do you see?

[Jim Janesky:]

Okay, thank you.

[Operator:]

And next in line with Tobey Sommer with Suntrust. Please go ahead.

[Carl Camden:]

Hi Tobey.

[Tobey Sommer:]

Hi good morning. I had a question for you about perm. I think you described the overall perm in the US. PT is kind of flattish. If you would look at monthly trends would you have seen kind of a progressive deterioration because some of the other monthly comparisons you gave whether it was EMEA or I think US commercial, it seems like June was a particularly bad month?

[Carl Camden:]

Yes in terms of PT, it was one of those where there was no clear trend established, there was a lot of volatility in the month-by-month numbers, so we didn't give a trend there. There wasn't one to be seen.

[Tobey Sommer:]

But on the perms specific side whether it’s...

[Carl Camden:]

I'm talking specifically about the perm.

[Tobey Sommer:]

Okay thank you.

[Carl Camden:]

Yeah.

[Tobey Sommer:]

And then I guess it’s a good thing that you were rationalizing some branches over the last several quarters. But if the slowdown in demand continues, to what extent can you continue to look at branches or are you comfortable now that you're at a level, and in terms of your footprint that you are going to stick to it?

[Carl Camden:]

Well you're never comfortable, you always examine branches, as things unfold and what we’ve said when we did the last restructuring was that if the fundamentals changed in the American economy and you saw declines in profitability in the commercial sector, we would again take a look at branches. If we had a plan to do something about it we would have said so. You noted that we talked about some consolidation of branches inside Europe, we didn't talk about the America segment but we are always looking at the branches there.

[Tobey Sommer:]

Okay and then, I'll sneak in one last question and get back in the queue. You generated significantly better cash flow from operations in the quarter versus a year ago. Could you just comment about how the changing economic conditions and lack of visibility may impact your thoughts on cash deployment and how you are going to use both the cash flow and the cash on your balance sheet. Thanks.

[Carl Camden:]

Although know Tobey, again, that a chunk of the cash flow improvement was due to the timing of payroll taxes here in the United States, so that’s was on, just a particular note. We’ve always said that we would use our cash and we look at our cash for both in continued dividend payments, looking at it for branch openings as well as acquisitions. Those kind of primary areas haven’t particularly changed, we always have more caution as we approach the downturn and look to maintain healthier cash balances so that we can cope with the uncertainty. That hasn’t changed at Kelly either, and we’re in a period of economic uncertainty and we will even more closely monitor our cash.

[Tobey Sommer:]

Thank you very much.

[Operator:]

And your next question from T. C. Robillard with Banc of America Securities. Please go ahead.

[Carl Camden:]

Hi Tom!

[T. C. Robillard:]

Thank you. Good morning Carl, I’m just struggling here. You guys always give us great details segment-by-segment, but what I’m still trying to get my arms around here is the revenue side actually did not look that bad for you guys in the quarter. (at least that would have kind of where expectation where in), If I look at that grossly related to what we saw in the first quarter was fairly similar but the margin deterioration was pretty significant. I’m just trying to get my arms around why you were able to see a slight operating margin or a slight deterioration,I guess, I should say in the first quarter, but you saw significant deterioration in the second quarter. Is there something specific that we were missing. I mean I know that things fell off late in the quarter particularly in Europe, but I’m just trying to reconcile that the de-leverage there would seem to be lot more severe than what the revenue base would indicate?

[Carl Camden:]

Yes, I think a couple of things worth noting again. If you listen to us talking about the deterioration first in the Americas Commercial side, we’ve talked about that in the last 15-16 months. As you begin to anniversary year-over-year comparisons, we had an expectation that, while you would necessarily see growth that anniversarying of the decline that we have seen in the prior year would be reflected in the numbers. It was until we continued the same rate of deterioration and at some point you do cross leveraging points and so you had a 6% revenue decline translating into a 21% profit decline in Americas. Over on the EMEA Commercial side which you were referencing, there was a sharpness of the decline which you’ve reference kind of paling off in the US in the last part of the quarter. Again we’ll look at a further rationalization of the EMEA Commercial branch network with these types of results.

[T. C. Robillard:]

Okay and then the follow up to that would be, you made some comments that you did see a growth in SG&A and EMEA and APAC as you are investing in branches. Can you tell us exactly where we are seeing some of these. I know you highlighted the Portugal acquisition that will come on and the Dubai office but are there any other areas where you are investing, where you are seeing growth opportunities?

[Carl Camden:]

No, there was no particular country that was over weighted with branches that would just fill in the holes and the distribution network over the specific customers who had a need.

[T. C. Robillard:]

Is that something where you are thinking to pull back the reigns as you are looking at the deterioration of some of your larger markets or is this just a function of the short-term pain for the long term gain?

[Carl Camden:]

Oh, the answer is always in between those two alternatives right -you never cut back to zero and you don’t go full pace ahead of this point. We will until we see some sustained growth and temporary employment, more closely monitor than even before, how much we invest, where we invest, but there's going to be some branch openings even as you shut down other branches if probable, and if you recall in Europe when we shut down a portion of the UK network, we also opened a significant number of professional and technical branches while closing some commercial branches. Again, missing in all of the confusion of the numbers is the fact that I hit at the end, but want to continue to hit, is that all three of the PT segments and all parts of the world managed to improve earnings. You don't want to stop feeding where you are growing earnings. So rather than look at it geographically, as you were, I would say that is a segment where you might see more investment.

[T. C. Robillard:]

Okay, thanks for the insights Carl. Appreciate it.

[Carl Camden:]

No problem.

[Operator:]

And next in the line of Michel Morin with Merrill Lynch. Please go ahead.

[Carl Camden:]

Hi, Michel.

[Michel Morin:]

Hi. Good morning.

[Carl Camden:]

Good morning.

[Michel Morin:]

I just wanted to clarify, Carl, the numbers you gave us for Americas Commercial on the monthly trends, where those just for perm? Or was that the temp numbers? April down 2, May down 10, and June down 16?

[Carl Camden:]

Those numbers were perm numbers.

[Michel Morin:]

Would you happen to have the temp numbers?

[Carl Camden:]

We didn't give the temp numbers, I don’t recall giving those. Again, non-holiday adjusted -6, -6, -7.

[Michel Morin:]

Okay, alright. Then specific to the gross profit, gross margin numbers, specific to the Americas Commercial - Could you elaborate a little bit on what the puts and takes are to the gross margin? Specifically, are you in terms of bill pay rates spreads, workers comp, how are those things evolving?

[Carl Camden:]

There were no significant changes compared to the second quarter of last year.

[Michel Morin:]

Okay. Great. Then if I am not mistaken, I think that, on the PeopleSoft implementation, you had put a few things on hold there. Could you give us a little bit of an update of where you stand there?

[Patricia Little:]

Yes. I’ll first reference you to our queue because I have a nice complete explanation of what specific deployments we are pushing off until 2010. That plan remains the same to push us off until 2010 and we’re still looking at the total cost of implementation.

[Michel Morin:]

Okay. Great. Will look out for the queue and then just finally, Carl I think on the earlier question regarding July. You said it was a little bit too early and the holiday has distorted the data. But in Europe, I don't think there is too much by way of holiday and your EMEA Commercial was down more significantly in June and if you continue to see that specific to the EMEA Commercial segment in July?

[Carl Camden:]

I am prepared to comment on any of July's numbers. I’m really against the whole notation of no guidance by the way. But in any case, two weeks of data is just insufficient at this point for us to call a trend in anywhere that we are seeing. If there had been something significantly noteworthy, we would have talked about it.

[Michel Morin:]

Alright. I thought I’d try. Thanks.

[Carl Camden:]

You tried. Thanks Michel.

[Operator:]

In your line David Feinberg with Goldman Sachs. Please go ahead.

[David Feinberg:]

Hi. Good morning.

[Carl Camden:]

Hi David

[David Feinberg:]

Hi, how are you? To Patricia and although, a question hopefully a housekeeping question for Patricia. CapEx in the quarter and CapEx budget for the year, as well as I didn't see any share repurchases. I just wanted to confirm that and see if anything had changed there.

[Patricia Little:]

We didn't make share repurchases in the quarter. We remain with about $7 million available. We don't have any active plans right now and CapEx was inline with what we expected and will continue to be.

[David Feinberg:]

Yes! I think that was like $45 million last year?

[Mike Debs:]

Yes, we spent $45 million last year. We spent a little bit less year-to-date than we did last year because of the KCP project so far this year.

[David Feinberg:]

I’m sure, and then given all the negative news, maybe try to take a glass half full approach this. So sometimes in a downturn there is an opportunity to take share, not some as you highlighted Carl, that you can’t cut your way out of this downturn but maybe there are more opportunities like the Randstad acquisition in Portugal. What are you seeing on the M&A front in terms of trying to gain share and/or diversify your business? Are the businesses just for sale and there are opportunities or is that just not the case where folks are not willing to sell given what’s happened with the marketplace?

[Carl Camden:]

That’s slightly too early in the cycle for the distressed sales that hit. But if you see the downturn continuing in another quarter or two, I wouldn’t be surprised to see more distressed sales emerge, but not yet. While it’s been a long downturn, it’s been a shallower downturn without the sharp inflexion down that crushed lot of firms the last time. So we haven’t seen the abundance of the business closings or distressed sales in this cycle that we’ve seen in the past.

[David Feinberg:]

Now, please remind me, I wasn’t following the stock during the last downturn. Was Kelly a net acquirer during '01 and would you expect to be one, if you saw those types of sales now?

[Carl Camden:]

We were a not a net acquirer in '01 and we always look at all opportunities in front of us.

[David Feinberg:]

Thank you very much.

[Operator:]

And we have a question from the line of Ashwin Shirvaikar with Citigroup. Please go ahead.

[Carl Camden:]

Hi Ashwin.

[Ashwin Shirvaikar:]

Hi Carl. How are you?

[Carl Camden:]

Doing well.

[Ashwin Shirvaikar:]

Good, thanks and welcome Patricia.

[Patricia Little:]

Thank you.

[Ashwin Shirvaikar:]

As I look at sort of the topic of negative operating leverage, it seems quite drastic quarter-over-quarter. It’s not as bad as the last cycle. I’m trying to think about what’s different this time. Is it just the pace, pricing, are there other factors?

[Carl Camden:]

Good question. And obviously we are not experiencing anywhere near the operating earnings declines that we did in the last cycle, so several things are different first for the industry, what's different is more rational behavior, within the industry and then secondly significant changes permanently and workers compensation cost, at a state level and again very healthy, still very healthy reserves on the unemployment’s upon the many states. While the unemployment rate has moved up to 5.5%, that still is significantly lower unemployment rate than it was on the last downturn, not causing as much hits on the funds. Within, Kelly again we have broader geographic diversity, broader business line diversity in this cycle, as we been working there with the last decade, than we did on the last one. As noted before you still, you have positive results coming out of professional, technical on OCG, even as this downturn is unfolding. An addition at Kelly, in this cycle we have already as an earlier question noted, began rationalizing the branch network. We've responded early in the cycle too, and that's been a significant contributor here.

[Ashwin Shirvaikar:]

Okay. So, the follow-up question becomes, what steps can you take further to continue to take cost out given you already had some restructuring and should we expect a specific charge?

[Carl Camden:]

I don't know the answer to the last question. There is nothing at the moment that would say that you should. While that we noted in my final comments, in the prepared section was that we are looking at reduction and corporate expenses, we are looking at some consolidation inside Europe and as always looking at overall branch expense inside the America zone. As we've talked about other regions in the Q&A section, we've talked about reigning in a bit in some sectors, some of the investment that we’ve been doing.

[Ashwin Shirvaikar:]

Okay, thank you.

[Carl Camden:]

Thank you Ashwin.

[Operator:]

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

[Tobey Sommer:]

Thank you. Carl, I was wondering if you could comment about IT. I think you said you are doing a little bit better internally but I was wondering if you are in a position to access how the market is doing in addition to accessing Kelly’s specific performance within that market?

[Carl Camden:]

I am not yet, but I will be soon after all the earnings announcements are out. When we talked about our IT segment is smaller than other segments, that we are not representative of what’s taking place nationally and if you recall two to three quarters ago, we said that we had gotten behind in the addition of some IT recruiters that we needed to add. It was a Kelly specific problem that we had fixed and I’ve seen improving results, but in this particular case I wouldn’t view us as an indictor for what you or you may not be seeing in the IT segment in general.

[Tobey Sommer:]

Okay then are there specific verticals with some strength and perhaps anything you may expect to be more resilient for non cyclical reasons over the next couple of quarters?

[Carl Camden:]

Yes, again in prior years I have talked about part of the strategic plan mixing out in the US was to have a better investment in less cyclical parts, not certainly, and is never truly immune but less cyclical part of the economy. The US government is an important segment for us, and so far I haven’t seen there be a less report showing US government hiring down. Education has been an important segment for us and while not free of all cyclicality has been doing very well in total BOS numbers. In particular, the petrochem industry and its engineering components especially, have all been in high demand in the overall economy and have done very well for Kelly.

[Tobey Sommer:]

Thank you very much.

[Operator:]

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

[Carl Camden:]

Great. Thank you, John. Thank you all for participating, look forward to follow on conversation from certain. Good bye.

[Operator:]

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