Kelly Services, Inc. (NASDAQ:KELYA) Q2 2023 Earnings Call Transcript

Kelly Services, Inc. (NASDAQ:KELYA) Q2 2023 Earnings Call Transcript August 10, 2023

Kelly Services, Inc. misses on earnings expectations. Reported EPS is $0.36 EPS, expectations were $0.39.

Operator: Good morning and welcome to Kelly Services’ Second Quarter Earnings Conference Call. All parties will be in a listen-only mode until the question-and-answer session of the call. Today’s call is being recorded at the request of Kelly Services. If anyone has any objections, you may disconnect at this time. A second quarter webcast presentation is also available on Kelly’s website for this morning’s call. I would now like to turn the meeting over to your host, Mr. Peter Quigley, President and CEO. Please, go ahead.

Peter Quigley: Thank you, Lois. Hello, everyone, and welcome to Kelly’s second quarter conference call. Before we begin, I’ll walk you through our safe harbor language, which can be found in our presentation materials. As a reminder, 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. In addition, during the call, certain data will be discussed on a reported and on an adjusted basis.

Discussion of items on an adjusted basis are non-GAAP financial measures designed to give insight into certain trends in our operations. References to organic growth in our discussion today exclude the impact of the 2022 sale of our Russian operations. Finally, the slide deck we are using on today’s call is available on our website. We have a lot to cover today. So, let’s get started. In a moment, I’ll invite Olivier Thirot, our Chief Financial Officer to provide details on our financial results for the second quarter. We’ll spend the rest of our time providing an update on the transformation initiative I announced in May that is designed to significantly improve Kelly’s EBITDA margin and accelerate profitable growth. Specifically, we will review the aggressive actions we’ve taken, their immediate impact on our EBITDA margin, and our expectations for margin improvement going forward.

With that, I will turn the call over to Olivier.

Olivier Thirot: Thank you, Peter, and good morning, everybody. For the second quarter of 2023, revenue totaled 1.2 billion, down 3.9% from the prior year including 60 basis points of favorable currency impact. So revenues for the quarter were down 4.5% in constant currency. Included in that decrease is a 230 basis points of unfavorable impact resulting from the 2022 sale of our operations in Russia. So our revenue overall was down 2.2% year-over-year on an organic constant currency basis. As we look at the second quarter revenue by segment, our education segment continues to report significant year-over-year growth, up 33% due to our net new customer wins, strong demand from existing customers, and improved fill rates. PTS also continues to perform well, as we anniversary the acquisition in the quarter.

Overall continued double-digit revenue growth demonstrates that our education business is a significant growth engine even as broader economic trends soften. In the SET segment, revenue was down by 7%. During the second quarter, we saw a continuation of the deterioration of demand for our specialty staffing, as well as a slower revenue growth in some outcome-based specialties. Permanent placement fees were also impacted by a continued deterioration in market demand and declined 48%. In our OCG segment, year-over-year revenue declined 9% on a reported basis and 8% in constant currency. The declines were primarily in RPO and PPO, while MSP revenues were nearly flat. Revenue in our Professional and Industrial segment declined 9% year-over-year in the quarter.

Revenue from our staffing product declined by 16%, reflecting the impact of economic headwinds, which are more noticeable in this segment. The segment’s outcome-based business delivered again solid revenue growth of 15% as the market continues to be strong for these value-added solutions. Placement fees declined 55% and was impacted by lower demand for full-time hiring. Revenue in our International segment declined 9% on a nominal currency basis and was down 13% on a constant currency basis. Excluding the impact of the sale of our Russian operations, revenue declined 1% on an organic constant currency basis. Performance varied depending on geography and product. For the quarter, we had good constant currency revenue growth in Mexico and Portugal, but that was more than offset by declines in the U.K., Switzerland, Italy, and France.

International’s permanent placement fees were up 5% on an organic constant currency basis. Overall gross profit was down 8.3% on a reported basis or 8.5% in constant currency. Our gross profit rate was 19.8% compared to 20.7% in the second quarter of last year. Our overall GP rate declined by 90 basis points. The primary driver was 70 basis point unfavorable impact from lower term fees and 40 basis point of higher employee-related costs. These impacts were partially offset by 20 basis point of continued improvement in structural business mix. SG&A expenses were down 3.4% year-over-year on a reported basis. Expenses for the second quarter of 2023 include 5.6 million of charges related to our ongoing transformation efforts. So on an adjusted constant currency basis, expenses declined by 6.2% in the quarter.

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Contributing to the decline was lower performance-based incentive compensation related to our lower gross profit levels and we have also started to see the early positive impact of our transformation efforts. As we noted in our release in July, we have taken additional transformation-related actions in early Q3 and we will recognize additional restructuring costs in Q3. Peter will provide more information on the transformation activities shortly today. In conjunction with our comprehensive review of SG&A as part of our transformation efforts, we also recognized $2.4 million non-cash impairment charge related to an underutilized leased office space. On a reported basis, our earnings from operations for the second quarter was 6.2 million compared to 8.2 million in Q2 of 2022.

As noted, our 2023 Q2 results include the $8 million of charges related to our transformation activities. So adjusted earnings from operations in Q2 of 2023 were $14.2 million and adjusted EBITDA margin was 2% similar to Q1. And as a reminder, Kelly Q2 2022 earnings from operation also include the impact of the 2022 non-cash charge related to the impairment of our Russian operations prior to their sale in July of 2022 as well as a $4.4 million gain on the sale of some assets. Income tax benefit for the second quarter was $1.9 million compared with our 2022 income tax expense of $4.9 million. Our effective tax rate for the quarter was 32.4% benefit. And finally, reported earnings per share for the second quarter of 2023 was $0.20 per share compared to $0.06 per share in 2022.

Adjusted EPS for the second quarter of 2023, excluding the transformation related charges, net of tax was $0.36 and after adjusting for the 2022 asset impairment charges and the gain on sale of assets, net of tax, Q2 2022 EPS was $0.45. So on a like-for-like basis, EPS declined by 20%. Now moving to the balance sheet. As of the end of the second quarter, as of the end of Q2, cash totaled $125 million compared to $154 million at the end of 2022 and we ended the second quarter of 2023 with no debt. Consistent with substantially no debt at the end of 2022. With our $300 million in available capacity on our credit facilities and our cash balances, we continue to have ample capital available to deploy. As of the end of Q2, accounts receivable was $1.4 billion and decreased 5% year-over-year, reflecting a year-over-year decrease in DSO as well as a decrease in revenue.

Global DSO was 61 days on par with year-end 2022 and two days lower than the second quarter of 2022. For the second quarter of 2023, we generated $32 million of free cash flow and year-to-date free cash flow now totals $14 million. For the quarter, we have continued to maintain lower accounts receivable balances, primarily as a result of favorable DSO trends. A portion of those receivables are related to our MSP programs and are funded with supplier payables. So the lower net position has a limited impact on free cash flow generation. We have also continued to execute against the 50 million share repurchase program that we announced in November of last year. Buying approximately 980,000 of shares for $69.5 million in the quarter, bringing the total repurchases to $42.6 million program to date.

And now, back to you, Peter.

Peter Quigley: Thanks for those details, Olivier. In a moment, I’ll invite Olivier to provide our outlook for the second half of 2023. It’s important to note that our second-half expectations reflect the impact of aggressive actions we’ve taken to date as part of our transformation. These actions amount to more than a cost-out exercise and they differ fundamentally from the cost management actions we reported in the first quarter, which we implemented in response to near-term demand trends. The recent steps we’ve taken represent a structural shift to the work we do within Kelly and how we do it, marking a necessary step forward on our journey to accelerate profitable growth and they are already producing results. For more details on our expectations for the balance of the year, I’ll turn it back to Olivier.

Olivier Thirot: Thank you, Peter. Our expectations for the rest of 2023 for the second half of the current year, assume a continuation of current market conditions. For the second half of 2023, we expect nominal revenue to be flat to up 50 basis points year-over-year. We expect to maintain our GP rate above 20% because of the benefit of our structural business mix improvement, but continued softness in demand for full-time hiring, we will continue to compress permanent placement fees and ARPU. All in, we expect our second half 2023 GP rate to be down by about 30 basis points, 20.1%. We expect second-half adjusted SG&A to be down 5% to 6% lower than the same period of last year. This reflects the actions we have taken throughout the year to align expenses with topline trends, the impact of transformation-related workforce reduction actions taken in July, and additional cost optimization actions we expect to complete this year.

Given the timing of these actions, we expect adjusted EBITDA margin in the second half of the year to be 2.3% to 2.5%, reflecting a 2023 exit rate of about 3%. For additional perspective with the benefit of a full year of expected transformation-related savings and our Q1 topline expectations, we would expect to reach a normalized adjusted EBITDA margin on a full-year basis in the range of 3.3% to 3.5%. And I now turn it back over to Peter for additional comments.

Peter Quigley: Thanks for those insights, Olivier. To put our expectations into context, consider that Kelly’s average EBITDA margin has been approximately 2% for a very long time and adjusted EBITDA margin improvement of 130 to 150 basis points at between 3.3% and 3.5% will mark a significant improvement in our ability to convert revenue and gross profit to earnings. And as Olivier mentioned, our expectations assume no change to the current macroeconomic environment. They are driven entirely by the substantial progress we’ve made on multiple initiatives to drive sustained efficiency and accelerate profitable growth. In July, we announced strategic restructuring actions that further optimize the company’s operating model to enhance organizational efficiency and effectiveness.

These actions follow the comprehensive review of our business and functional operations, led by our transformation management office with support from a world-class transformation consultant. As part of the restructuring, we streamlined our organizational structure to reduce complexity and increase agility. We renegotiated supplier agreements and real estate contracts to secure terms that match our needs going forward. We revamped our performance management process to drive behaviors that will sustain these structural improvements, and we made the difficult decision to implement a workforce reduction plan to align our resources with our new ways of working. These actions among others are on track to deliver a 3% EBITDA margin exit rate in 2023.

We’re committed to sustaining these efficiencies having established rigorous controls that provide clear visibility into resources and expenses across the enterprise. These measures are designed to ensure the longevity of the structural changes we’ve made and serve as the foundation for further EBITDA margin expansion going forward. With our efficiency actions creating the necessary financial headroom to invest in our future, we are quickly switching gears to the next phase of our transformation driving growth. To that end, we have undertaken several initiatives that will accelerate profitable growth over the long term. The scope of these initiatives encompasses our go-to-market strategy, the technology and systems that underpin our operations as well as organic and inorganic growth opportunities.

Some examples include developing a comprehensive go-to-market strategy with innovative offerings to capture a greater share of wallet with large enterprise accounts. Committing to our inorganic investments and identifying additional high-margin, high-growth targets. Aligning incentive programs to these initiatives and their expected outcomes and sharpening our focus on DSO to drive free cash flow. The growth initiatives we are undertaking will be additive to the structural changes we’ve made to drive efficiency, which are the basis for our expectations for EBITDA margin improvement. Together, they will unlock the potential of our specialty strategy and accelerate both top and bottom line growth. I will share more details with you about our growth initiatives on our third-quarter earnings conference call in November.

Reflecting on the past several months of work, I can say with confidence that this transformation is fundamentally different than any other effort during the more than 20 years I’ve been with the company. Different in terms of the depth of our analysis, the speed and precision with which we’re executing, and most importantly impact. The change we set out to create within Kelly is no longer hypothetical. This transformation is delivering results. And while I’m pleased with the progress we’ve achieved thus far, our success will be determined by our ability to deliver on the important work that lies ahead. I have every confidence that the collective strength and resilience of team Kelly will continue to propel us forward on our journey as it has over the last few months, indeed the past 76 years.

As we navigate this period of change together, our commitment to our talent and customers remains steadfast. I’m grateful to them and to our Board of Directors and shareholders for recognizing the value-creating potential of this company. Lois, you can now open the call to questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is from Kartik Mehta from Northcoast Research. Please go ahead.

Kartik Mehta: Just trying on the transformation side. I’d be interested in just timing of normalized EBITDA margins. When you do expect to achieve that? I know you said the exit rate coming out at the end of this year will be 3. So are you assuming that you can achieve your normalized EBITDA margins by sometime in 2024?

Olivier Thirot: Yes, I mean it’s early 2024. And again to make it clear the improvement we have laid out especially on a full-year basis 3.3 to 3.5 is assuming the current top-line trends based on the current economic environment. The GP rate we are in now and the full-year impact of this transformation. So – and it does not include anything about the Phase 2 of this transformation, which is about growth, right? It’s really the pure impact of the efficiency initiatives that Peter was talking about and that should be basically our starting point for 2024.

Kartik Mehta: Yes. Obviously, you’ve talked about businesses that you’d like to accelerate growth. But are there any businesses that you might de-emphasize as a result of all these initiatives?

Peter Quigley: Well, we are continuously reviewing our portfolio to ensure that were – have opportunity to create value. There is no specific business line that we’ve identified as a result of the transformation activities. But we have identified ways to improve the operational efficiency in each of our businesses and we expect to see the benefits of that starting immediately.

Kartik Mehta: And then one last question, Olivier. Trends in July, maybe what you saw kind of how they differ – more different than June if they were?

Olivier Thirot: Well, I would say, when I look at the Q2 exit rate in term of revenue and what we start to see in the beginning of Q3, I would say, no real big change. No improvement, I would say, which is not a surprise, because I think the market conditions are pretty similar to what they were in Q2. So, I would say, we have started Q3 with pretty similar situation than in Q2. The only thing that I would like to mention is all about education seasonality, you know that basically Q3, specifically Q3 is a low quarter because of the school year. And that of course is something you need to consider when you look at Q3 because of the seasonality with of course high and the peak season again in Q4.

Kartik Mehta: And then just, I apologize, from an FX standpoint, would you expect FX to be neutral in the second half of this year?

Olivier Thirot: Well, when I was talking about nominal revenue H2 flat of 0.5, expectation now based on what we have seen so far is a positive FX impact between let’s say 100, 120 basis points.

Kartik Mehta: Thank you very much. I appreciate it.

Olivier Thirot: Thank you.

Peter Quigley: Thank you.

Operator: Thank you. And the next question is from Joe Gomes from Noble Capital. Please, go ahead.

Peter Quigley: Good morning, Joe.

Olivier Thirot: Good morning.

Joe Gomes: So, I just trying to wrap my head around the whole program. I was looking in your – excuse me, pardon me, in the presentation from this morning and on Page 16 you’ve got the chart there, the operating model aligns to be specialties, redesigned operating model to drive profitable growth in our chosen specialties. And then I went back and I’m looking at some of your older presentations and basically, it’s the same chart or the same graph, each one of the different segments and the revenues and says everything exactly the same. I’m really trying to figure out what is really going to be different here? I mean, kind of relatedly talk about doing more tech investments. You’ve done a lot of tech investment over the past two years or so, what more tech investment needs to get done in order to really drive what you’re looking to accomplish?