George Corona - President and CEO Olivier Thirot - CFO.

Kyle Patterson - Northcoast Research.

Good morning and welcome to Kelly Services' Second Quarter Earnings Conference Call. All parties will be on listen-only until the question-and-answer portion of the presentation. Today's call is being recorded at the request of Kelly Services. If anyone has any objections, you may disconnect at this time.

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

Thank you, John and good morning. Welcome to Kelly Services' 2018 second quarter conference call. With me on today's call is Olivier Thirot, our CFO. Let me remind you that any comments made during this call, including the Q&A, may include forward-looking statements about our expectations for future performance.

Actual results could differ materially from those suggested by our comments, and we have no obligation to update the statements made on this call. Please refer to our SEC filings for a description of the risk factors that could influence the company's actual future performance.

As we walk through and results this morning, let me point out that my year-over-year comparisons are represented in nominal currency with the exception of our international staffing segment, which is in constant currency.

Also I'd like to remind you that the recent adoption of the required accounting standard related to equity investments has introduced volatility into the recorded net earnings of many companies including our own. In his remarks, Olivier will explain this in more detail. Turning to Kelly's second quarter results.

Revenue was $1.4 billion, up 4% compared to the second quarter of. Earnings from operations were $20.4 million in the second quarter compared with 2017 earnings of $20.3 million. The diluted earnings per share were a loss of $0.40 per share compared to a $0.47 per share gain in 2017.

Approximately $0.94 of this 2018 EPS number is related to a non-cash pretax loss on our Persol common stock. As a result of decreases in its market price, which we are reporting here in accordance with the new accounting standard I mentioned.

Excluding this unrealized loss, diluted earnings per share were $0.74 per share for the quarter, $0.07 per share higher than a year ago. We are pleased to have delivered a good quarter in the current business environment and in line with our outlook.

With so much of our business in the United States, I'd like to share a few observations about the current U.S. labor market. With unemployment hovering near the lowest level in five decades, qualified candidates are becoming more difficult to attract and retain.

As the economy approaches full employment, candidates now have more job opportunities from which to choose and they are becoming more selective in their job choices. The extended time required to recruit, retain, and replace employees in this constrained the market creates pressure on wages and on the cost of doing business.

While labor market constraints are not affecting our ability to fill job requisitions, they are affecting the level of activity required to do so. Temporary employee turnover and attempt to convergence also contributes to higher activity levels.

Notwithstanding these conditions, demand continues strong and the signs we would have typically look for to indicate a softening of demand are not currently present. Now, with that as a background, here are some of the highlights of the second quarter. Topline revenue continued to grow consistent with Q1.

Gross profit growth was 5.1% and our gross profit rate was up 10 basis points over the prior year. The GP rate increase reflects structural changes in product mix and a focus on permanent placement fees. This puts us back on track after the 60 basis points drop in GP rate we experienced during Q1. Expense growth during the quarter was 5.6%.

We made progress throughout the quarter in bringing expenses in line with the business environment. Now, let's look at how Kelly's three operating segments performed in the second quarter, starting with America Staffing. America Staffing revenue increased 5% in the second quarter compared to the same period last year.

Commercial Staffing revenue was flat to prior year, primarily due to a tight labor supply. Kelly Educational Staffing delivered revenue growth of 27% in the quarter. The growth rate was favorably impacted by the September 2017 acquisition of Teachers On Call. Excluding Teachers On Call, KES revenue was up 7%.

Revenue in our professional and technical specialties increased 10% in the second quarter compared to last year with year-over-year growth in all specialties, continuing the positive trend we saw in the prior two quarters. On a combined basis, permanent placement fees were up 31% year-over-year.

Professional and technical specialties were up 10% year-over-year, with commercial growth increasing 59%, demonstrating the pickup of customer hiring of temporary employees. The second quarter gross profit rate in America Staffing was 18%, the same as last year.

And the gross profit rate for the quarter was positively impacted by strong permanent placement fees, offset by customer mix. Expenses for the quarter were up 9% in America Staffing. We are working to bring these expenses more in line with current and expected business conditions.

The expenses were up primarily due to additional resources and effort required to attract and place candidates and 200 basis points of the increase is attributable to the addition of Teachers On Call. All told, the America Staffing segment achieved an operating profit of $17.8 million for the quarter compared to $20.4 million in the last year.

Let's now to our International Staffing operations outside of the Americas. Revenue for the quarter in International Staffing increased 12% compared to the prior year in nominal U.S. dollars. On a constant currency basis, revenue increased 7% across the region in Europe.

For ease of reference, the remainder of my comments on International Staffing will be on a constant currency basis. Permanent placement fees for the second quarter were up by 16%, representing much of this segment's improvement of GP dollars year-over-year.

The segment's reported GP rate for the quarter is 13.9%, a drop of 40 basis points in the same period a year earlier. Customer mix impact accounted for 60 basis points of the change, but was partially offset by the fee growth mentioned earlier. Expenses were 1% lower versus the prior year due to effective cost management of expenses across the region.

And in summary, International Staffing's reported operating profit was $6.4 million compared to $4.1 million a year ago. Now, let's turn to the results of our global talent solutions' reporting segment.

The GTS reporting segment reflects that the two primary ways that large clients in this segment are buying from us; talent fulfillment and outcome-based services. I'll discuss each businesses' results separately, but first, let's take a look at how GTS performed as a whole in the second quarter.

GTS revenue was down 1% year-over-year, while gross profit increased 5% for the quarter as a result of increased value creation from structural improvement in our product mix.

Consistent with last quarter, revenue increase year-over-year in our KellyConnect business process outsourcing, contingent workforce outsourcing, and the recruitment process outsourcing products, offset by declines in our centrally delivered staffing and payroll process outsourcing products.

Now, let's look at gross profit results in each of the two GTS businesses. Our talent fulfillment business is made up of our contingent workforce outsourcing, payroll process outsourcing, centrally delivered staffing, recruitment process outsourcing products.

Gross profit in the talent fulfillment business was down 1% year-over-year for the quarter due primarily to decreased revenue in our centrally delivered staffing and PPL products, partially offset by continued double-digit GP increases in our CWO and RPO products. Now, turning to our outcome based services business.

This business is comprised of our BPO, KellyConnect, Kelly legal manage services, and advisory services practices. Gross profit in outcome based services business increased 22% year-over-year, driven primarily by continued momentum and strong results in both our BPO and KellyConnect.

This growth is a result of both program explanations and new BPO wins. Overall, the GTS segment gross profit rate was 18.5% for the quarter, up 100 basis points year-over-year due to structural improvement in our product mix, partially offset by an increase in our employee related benefit cost.

Expenses in GTS were up 2% year-over-year in the second quarter. The increases were due to additional headcount and salary costs related to the addition of new programs and our outcome based services business and our CWO product, coupled with increases in incentive-based compensation.

These increases were partially offset by lower cost in centrally delivered staffing and PPO as we aligned our resource levels to the lower volume in these products. All told, GTS second quarter operating profit was $17.7 million compared to $15.3 million a year ago.

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

Thank you George. Revenue totaled $1.4 billion, up 4% compared to the second quarter last year. Our total company reported results were favorably impacted by 100 basis points due to foreign exchange. So, on a constant currency basis, our revenue growth for the second quarter was 3%.

Our Q2 performance also include the results of Teachers On Call, which added 130 basis points to our total revenue growth rate. Overall, the Q2 revenue growth rate reflects continued growth in America Staffing and continued although slowing performance in our international staffing.

Permanent placement fees were up 26% year-over-year from continued positive movement in both Americas and International Staffing. Overall, gross profit was up 5.1%. Our gross profit rate was 17.3%, up 10 basis points when compared to the second quarter last year.

The rate improvement reflect the impact of structural margin improvement in our GTS segment and the impact of higher [Indiscernible] offset by the impact of customer mix in both Staffing segments' gross profit rate. SG&A expenses were up 5.6% year-over-year.

The increase in expense relates primarily to additional resources in America Staffing as a result of current tenant environment. Our expenses also include an increasing technology investments compared to the prior year.

In addition, the year-over-year expense comparisons also reflect the impact of $2.5 million of favorable adjustments relating to executive compensation, which reduced corporate expenses in 2017.

We are continuing to generating returns from our investments in our sales, service, delivering transaction and will continue to manage expenses across all of our operations in line with GP growth for the full year. Earnings from operations were $20.4 million in the second quarter compared with 2017 earnings of $20.3 million.

These results reflect the conversion rate of return of gross profit of 8.5% compared to 8.9% for Q2 2017. As we mentioned on our prior calls, Kelly adopted a required accounting standard relating to the treatment of unrealized gains and losses on our equity investments in Persol Holdings.

As a result of the change, we recognize a $52.8 million pretax loss on our Persol common stock in the quarter as a result of decrease in the market price of Persol stock. This accounting change introduced significant volatility in our reported net earnings. It was a $23.7 million gains in Q1 and does not reflect the trend in our operating performance.

These non-cash gains and losses are recognized below earnings from operations as a separate line item Income tax benefit for the second quarter was $15.6 million compared with our 2017 income tax expense of $1.5 million. The effective tax rate in 2018 was a 49.6% benefit compared to 7.6% expense in 2017.

Q2 2018 income tax benefit increased [$16.2] million related to the non-cash tax benefit on the loss of Persol stock. The 2018 effective tax rate excluding the impact of the Persol stock loss was 2.6% compared to 7.6% for Q2 2017. The lower effective tax rate reflect the impact of lower U.S. tax rates as a result of the Tax Cut and Jobs Act.

And finally, dilutive earnings per share for the second quarter of 2018 was a loss of $0.40 per share compared to $0.47 gain per share in 2017. [Indiscernible] 2018 EPS is approximately 90% related to non-cash loss on Persol stock net of tax.

Excluding the impact of the Persol stock fluctuations net of tax, our Q2 EPS was 50%, an improvement of 50% over Q2 2017. Now, as we look ahead to the rest of the year.

Since our last call, our outlook for the full year has been encumbered with a continued slower topline growth rate in Q2 and as a result, our outlook has declined slightly since our Q1 call in May. Consistent with our prior discussions, the outlook provided does not reflect the gains and losses on Persol stock.

Although we do believe that future unrealized gains and losses resisting from changes in market price could be material. For the full year, we expect revenue growth to be up 3.5% to 4.5%, increasing the impact of favorable FX on revenues of approximately 70 basis points. We expect the growth [Indiscernible] to be flat on a year-over-year basis.

And finally, we expect SG&A expense to be up 3% to 4%, which would leave additional spending on our technology and efficiency initiatives. As a result, we expect to produce operating leverage in 2018.

Our 2018 annual income tax rate without the impact of Persol stock gains and losses is expected to be in the mid-single-digits reflecting the ongoing impact of U.S. tax reform and work opportunity credits. For the third quarter, we expect revenue to be up 2% to 3% including 50 basis points of unfavorable FX impact.

We expect the gross profit rate to be up year-over-year and up sequentially. And finally, we expect SG&A expense to be up for 25%. Now, moving to the balance sheet. Cash totaled $74 million compared to $33 million at year-end 2017. Accounts receivable totaled $1.2 billion and was down 3% from year end 2017.

Global DSO was 55 days in line with the same quarter last year and Q4 2017. At quarter end, we have debt of $2 million compared to $10 million at year-end 2017. In our cash flow year-to-date, free cash flow was $23 million compared to generating $37 million of free cash flow last year.

This reflects a return to free cash flow generation in the second quarter and we continue to actively manage our working capital while making [Indiscernible] investments in technology. For more information on our performance, please review the second quarter slide deck available on our website.

I'm now turning back over to George for his concluding thoughts..

Thank you, Olivier. In a tight labor market, we were pleased with our team's ability to execute during the second quarter. As we look to the remainder of the year, we will continue to concentrate on three things. First, we will continue to focus on delevering more value-added services.

We're going to continue to optimize our structural mix increase profitability, and create deeper relationships of our customers. By deepening these relationships, we increase our professional and technical exposure, drive higher margin products into these professional spaces. Second, we will continue to proactively manage expenses.

We made improvements in this area during Q2 and we intend to scrutinize our expenses going forward, making all areas of our business more efficient will help to redirect capital for investments to support future growth. And finally, we will continue to invest in future areas of growth.

This includes new technology and innovations that enable us to operate our business more efficiently and connect people to work in new ways that enrich their lives.

Demonstrating our commitment to investing in the future of work, our latest investment into the Kelly Innovation Fund which recently participated in the seed fund raising round for Kenzie Academy, a tech apprenticeship program that develops modern tech workers.

Kenzie blends integrated immersive learning and paid apprenticeships to transforming tech education. We made this investment in future talent because we believe in supporting the retraining and upskilling of today's workers as technology continues to drive major changes in the way people work.

Through our Kelly Innovation Fund which we launched in early 2018, we will continue to invest in the next generation of workforce solutions. Just as we pioneered the Modern Staffing industry 72 years ago, we are actively focusing on exciting opportunities that will help us deliver greater efficiency or produce game-changing innovations.

I look forward to reporting back to you on the results of our efforts next quarter. And Olivier and I will now be happy to answer your questions..

[Operator Instructions] And we'll go to line of Kyle Patterson with Northcoast Research. Please go ahead..

Good morning everyone. Thank you for taking my question. On for John Healy this morning. And -- so first I'm curious about just some of the revenue trends that you guys have been seeing within the U.S. market.

I was curious how you guys would create the progress of the PT shift and if you're seeing revenues accelerating or decelerating in the quarter?.

So, when we look at revenue, I look at it from two perspectives, supply and demand. So, the demand has continued pretty strong within the marketplace. But what we're seeing is a few trends going on. Number one, we're seeing a lot more permanent hiring than we achieved in the past and that effects are per the placement fee.

So if you're seeing is two dynamics. Number one, a lot of convergence of temporary staffing into permanent hiring, so temp to perm hiring. But something that is unique has started this quarter was we're also seeing particularly in the commercial space customers going right to permanent hiring, so direct hiring rather than hiring temp.

So, that has a little bit of tempering effect on your temporary staffing growth rate, but it increases your permanent placement fees.

So, when we look at the market still remains strong from a demand perspective, but the constrained labor supply and the way that customers are using, they are starting to have a little bit of downward impact on the growth rate that we have. But we're also seeing particularly strong demand in our outcome based services as well and that continues..

Okay, great.

And then at the end of the call when you're talking about the Kenzie Academy and congratulations on the inaugural investment and I was curious on the purpose -- like of the investment strategy with the Kelly Innovation Fund, is that more to be focused on one specific area or is it meant to be invested in many different types of areas that could complement various parts of the business?.

Yes, it's really designed for us to take a look at the new technologies that are coming out in the workforce solutions area that can help us in a couple of different ways. So, number one, we will look for opportunities to be able to invest in technologies that change the way people work and make them more efficient.

We will look for opportunities for technology breakthroughs. They enhance our business operating model to make us more efficient and more productive as we move forward.

And we will look for ways to invest in the future of work and in the training of the workforce because as we know it's happening as we move forward, more jobs are being automated and as those jobs are automated, the people that were in those jobs need to gather new skills to able to be productive in the workforce and we will invest in places like the Kenzie Academy that helps to retrain workers and make them ready for the new jobs of the future..

Okay, very good. And then you know with Persol and what we saw this quarter given the volatility that this could add to the reported earnings going forward, but also take into consideration the gains that you've already made with the asset.

Is this something that you expect to be holding more for the long-term or have you guys contemplated or will contemplate monetizing it and just reinvesting those proceeds back into the business?.

Yes. So, when we look at the Persol investment, we run into that investment and partnership with Persol for some very specific strategic reasons.

Those strategic reasons were; number one, to be able to support the needs of our global customers in the Japanese market where we currently don't have operations and we formed a joint venture that allowed us to spend more of our time on our -- in Asia on our outsourcing consulting products and more of our capital investment there, while we continue to have a footprint in the fastest growing market which is Asia and a partnership with a company we receive investment in Asia and is looking to grow it.

And we're very happy on all three of those fronts with the investment. Also the investment has been very profitable for us as we take a look even though we had the fluctuation this quarter, it is going introduce volatility, but the strategic reasons that we run into it still hold.

And as long as those still hold, they would be an important part of our go-forward strategy..

Okay. Okay.

And then within the solutions business, I was just curious if you could provide some more color on what you're seeing currently in there and over the next few quarters as well?.

So, it's clear that as we look at the business and the way that customers -- particularly right now, larger customers are looking to lose talent and with the talent shortages, they are moving more and more rapidly towards the companies like Kelly to provide them with an outcome based solutions.

And we don't see any slowdown in the demand for those types of activities and we're having good success in continuing to win those products. So, we continue to see growth in that area, particularly, in BPO. Right now in the current hiring environment, the RPO business, there's a lot of demand out there.

Although it's a smaller business for us, we still have opportunities to continue to see that grow and we see that continuing.

And then finally with the CWO product that we have which is more of a procurement based products, we're starting to see customers shifting some temporary employment purchases of their product more towards by instatement work activities.

So, we continue to see good growth in the solutions business and we're going to have continued improvement structurally in our margins. So, that's what we talk about from the fact that those are higher margin services. And when we look at those, we're much more focused on how fast growth -- traffic grows in those areas rather than topline revenue..

Okay, great. And then lastly just more of a housekeeping question. Looking at the full year guidance, it looks like revenue growth expectations were slightly moderated.

Was that mainly the impact? I noticed you took down about 80 basis points of expectation of favorable currency impact, was that the main reason for the expectation moderations? Or does this also have to do with the international segment showing some slowing growth?.

Interesting, you're right to mention that because we give our guidance, especially, on the revenue side nominal currency. On that outlook, the favorable impact was about 150 basis points and now it's about 70.

We have not impact in our Q3 when we anticipate the negative impact of about 50 basis points due to currency fluctuation; I would say mainly the reason euro versus U.S. If you exclude currency, basically, our previous outlook was expecting a revenue growth in constant currency between 4% to 5% and now we're ranging from 2.8% to 3.8%.

And the main driver as George was explaining is basically our America Staffing and especially U.S. staffing business that's slowing down. Again, it's heavily balanced on the supply side as oppose to lower expectations on the demand side. .

Okay, great. Thank you guys for taking my questions and good luck this quarter..

Thank you..

Thank you..

[Operator Instructions] And while in a few moments, Mr. Corona no further questions coming in..

Okay. John, thank you very much..

Very welcome. Ladies and gentlemen, this conference is available for replay. It starts today at 11:30 A.M. Eastern goes until September 8th at midnight. You can access the replay at any time by dialing 800-475-6701 or 320-365-3844. The access code is 393790. Those numbers again 800-475-6701 or 320-365-3844. Access code 393790.

That does conclude your conference for today. Thank you for your participation. You may now disconnect..