George Corona - President and Chief Executive Officer Olivier Thirot - Executive Vice President and Chief Financial Officer.

John Healy - Northcoast Research Joshua Vogel - Sidoti & Company.

Good morning, and welcome to Kelly Services Third Quarter Earnings Conference Call. [Operator Instructions] 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 like to turn the meeting over to your host, Mr. George Corona, President and CEO. Sir, you may begin..

integrity, quality and service excellence, and I am certain that Terry's spirit will continue to guide us as we build upon the legacy that he and Russ created. Terry Adderley served Kelly Services with tremendous honor and distinction during his 60-year career here, and he will be greatly missed. Thank you and we will now continue with our call.

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 my year-over-year comparisons are represented in nominal currency with the exception of our international segment, which is in constant currency.

Also, I'd like to remind you once again that the 2018 adoption of a required accounting standard related to equity investments has introduced volatility into the reported net earnings of many companies including our own. In his remarks, Olivier will highlight the area in which our investment in PERSOL creates this volatility for Kelly.

Now turning to Kelly's third quarter results. Revenue was $1.3 billion, up 1% compared to the third quarter of last year. Earnings from operations were $21.9 million compared with 2017 earnings of $18.2 million, and diluted earnings per share were $0.84 compared to $0.58 in 2017.

Approximately $0.28 of the 2018 EPS number is related to a noncash gain on our PERSOL common stock net of tax. Excluding this impact on the PERSOL stock fluctuations net of tax, our Q3 EPS was $0.56. We are pleased to have delivered a good quarter in a challenging business environment.

As I did last quarter, I'd like to share with you a few additional insights about the current labor market. Labor demand dynamics continue to be strong in the U.S., making already tight labor markets even tighter.

The tight labor markets affects all business lines and it's particularly challenging in our commercial and Kelly Educational Staffing businesses. Several factors are exasperating the war for U.S. talent including an unemployment rate of 3.7% in October and strong sustained economic growth.

The time required to fill positions has now reached cycle highs as has the effort and activity required to place these employees. Finally, voluntary turnover is increasing creating a significant level of market activity as workers seek to change jobs. Put simply, it's a seller's market for labor, and many workers are actively seeking new positions.

Recruiting and retaining talent will continue to be challenging in the foreseeable future. And with that as a background, here are some of the highlights of the third quarter. Top line revenue continued to grow in all segments. Gross profit growth was 3.6% and our GP rate was 17.8%, up 40 basis points over the prior year.

Permanent placement fees were up 30% year-over-year, and expense growth during the quarter was 2.2% year-over-year. We continue to focus our commitment to carefully manage expenses across all our operations. Now let's look at how Kelly's three operating segments performed in the third quarter, starting with Americas Staffing.

Americas Staffing revenue increased 1.0% in the third quarter compared to the same period last year. Commercial staffing revenue was 1% below prior year primarily due to a tight labor supply and temp-to-perm conversions. Kelly Educational Staffing delivered revenue growth of 15% in the quarter.

This growth rate was favorably impacted by the September 2017 acquisition of Teachers On Call. Excluding Teachers On Call, KES revenue was up 11%. Revenue in our professional and technical specialties increased 6% in the third quarter compared to last year, with year-over-year growth in engineering, IT and science.

On a combined basis, permanent placement fees were up 46% year-over-year. Professional and technical specialties were up 35%, with commercial growth increasing 55%, demonstrating continued customer hiring of temporary employees. The third quarter gross profit rate in Americas Staffing was 18.9%, up 110 basis points from last year.

The gross profit rate for the quarter was positively impacted by lower employee-related costs, and strong permanent placement fees, partially offset by customer mix. Expenses for the quarter were up 7% in Americas Staffing.

Expenses were up primarily due to the additional resources and effort required to attract and place candidates, and a 140 basis points of the increase is attributable to the addition of Teachers On Call. All told, the Americas Staffing segment achieved an operating profit of $14.8 million in the quarter, compared to $13.3 million last year.

Let's now turn to our International Staffing operations outside of the Americas. Revenue in International Staffing increased 1% compared to prior year in nominal U.S. dollars. On a constant-currency basis, revenue increased 3%. Revenue growth slowed versus prior quarters primarily due to volume declines in Western Europe.

For ease of reference, the remainder of my comments on International Staffing will be on a constant-currency basis. Fee-based income for the third quarter was up 11%, coming from strong fee performance in Western Europe.

The segment's reported GP rate for the quarter was 13.2%, a drop of 110 basis points from the same period a year earlier, driven by adjustments to employee-related benefit costs, customer mix impact, partially offset by the fee growth mentioned earlier.

Expenses were flat compared to the prior year as a result of effective cost management across the region. In summary, International Staffing's reported operating profit was $4.8 million compared to $7.2 million a year ago. Now let's turn to the results of our Global Talent Solutions reporting segment.

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

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

Consistent with last quarter, revenue increased year-over-year in our KellyConnect, Business Process Outsourcing, Contingent Workforce Outsourcing and Recruitment Process Outsourcing products, offset by declines in our centrally delivered staffing 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 and Recruitment Process Outsourcing solutions. Gross profit in the talent fulfillment business was flat year-over-year for the quarter.

This was a result of decreased volume in our centrally delivered staffing and PPO products, offset by continued GP increases in RPO and double-digit growth in CWO. Now turning to our outcome-based services business. This business is comprised of our BPO, KellyConnect, Kelly legal managed services and advisory services products.

Gross profit in our outcome-based services business increased 16% year-over-year, driven primarily by continued momentum and strong results in both our BPO and KellyConnect products. This growth was a result of both program expansions and new BPO wins.

Overall, the GTS segment's gross profit rate was 19.2% for the quarter, up 70 basis points year-over-year. This was due primarily to structural improvement in our product mix, partially offset by an increase in employee benefit costs. Expenses in GTS were up 2% year-over-year in the third quarter.

We continue to align resource and spending levels in line with volume and GP in both our outcome-based and talent fulfillment businesses. All told, GTS third quarter operating profit was $24.1 million, compared to $20.8 million a year ago, an increase of 16% year-over-year. We're pleased with the continued structural improvement in our product mix.

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

Thank you, George. Revenue totaled $1.3 billion, up 1% compared to the third quarter last year. Our total company reported results were unfavorably impacted by 90 basis points due to foreign exchange. So on a constant-currency basis, our revenue growth for the third quarter was 1.9%.

Overall, the Q3 revenue growth rate reflects growth in all three of our operating segments. Permanent placement fees were up 30% year-over-year from continued strong positive momentum in Americas Staffing as well as continued growth in fees in International Staffing. Overall gross profit was up 3.6%.

Our gross profit rate was 17.8%, up 40 basis points when compared to the third quarter last year. The rate improvement reflects the impact of structural margin improvement in our GTS segment, the impact of higher term fees, and the improving Americas Staffing gross profit rate, partially offset by lower gross profit rate in International Staffing.

SG&A expenses were up 2.2% year-over-year. The increase in expense relates primarily to additional resources in Americas Staffing as a result of the current talent environment. The year-over-year expense comparisons are also favorably impacted by prior year litigation-related expenses.

We are committed to generating the returns from our investments in our service delivery infrastructure, and we'll continue to manage expenses across all of our operations in line with GP growth for the full year.

Earnings from operations were $21.9 million in the third quarter compared with 2017 earnings of $18.2 million, an increase of more than 20%. These results reflect a conversion rate or return on gross profit of 9.2% compared to 7.9% for Q3 2017.

As we mentioned on prior calls, Kelly adopted a required accounting standard related to the treatment of unrealized gains and losses on our equity investment in PERSOL Holdings. As a result of that change, we recognized a $15.8 million pretax gain on our PERSOL common stock in the quarter as a result of increases in the market price of PERSOL stock.

This accounting change has introduced significant volatility in our reported net earnings, and does not reflect the trends in our operating performance. Year-to-date, the loss on PERSOL stock is $13 million on a pretax basis. These noncash gains and losses are recognized below earnings from operations as a separate line item.

Income tax expense for the third quarter was $5.9 million compared with our 2017 income tax benefit of $4.1 million. The effective tax rate in 2018 was 16.1% compared to a 22.9% benefit in 2017. Q3 2018 income tax expense includes $4.9 million related to the noncash tax expense on the gain on PERSOL stock.

The 2017 tax rate was favorably impacted by the release of a deferred tax valuation allowance. Adjusted for both items, our 2018 effective tax rate was 5.2% compared with 5.7% in 2017. And finally, diluted earnings per share for the third quarter of 2018 was $0.84 per share compared to $0.58 per share in 2017.

Included in 2018 EPS is approximately $0.28 related to our noncash gain on PERSOL stock net of tax. Excluding the impact of the PERSOL stock fluctuations net of tax, our Q3 EPS was $0.66 on par with Q3 of 2017.

Now as we look ahead to the rest of the year, since our last call our outlook for the full year has been tempered with a continued slower top line growth rate in Q3 and as a result, our outlook has declined slightly since our Q2 call in August.

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 resulting from changes in market price could be material.

For the first quarter, while we expect demand to remain steady in the U.S., we believe talent supply challenges will continue to constrain top line growth and we view the economic conditions in Europe to be a headwind. As a result, we expect revenue to be flat to up 1% including 60 basis points of unfavorable FX impact.

We expect the gross profit rate to be flat to up slightly on a sequential basis. And finally, we expect the SG&A expense to be down 4% to 6% including reductions in performance-based incentive compensation. Now moving to the balance sheet. Cash totaled $21 million compared to $33 million at year-end 2017.

Accounts receivables totaled $1.3 billion, up less than 1% from year-end 2017. Global DSO was 58 days, in line with the same quarter last year and up three days from Q4 2017 due to seasonality. At quarter end, we had debt of $8 million compared to $10 million at year-end 2017.

In our cash flow year-to-date, free cash flow was $15 million compared to generating $18 million of free cash flow last year, reflecting a higher level of capital investments in technology. For more information on our performance, please review the third quarter slide deck available on our website.

I will now turn it back over to George for his concluding thoughts..

Thank you, Olivier. In the face of headwinds created by a difficult labor supply environment, the company performed well in Q3. We are taking the actions necessary to deliver on the bottom line, but we're also continuing to invest in our future.

We are seeking new and creative ways to close the supply gap by looking across our company and using our assets as effectively as possible. Even though we expect the supply of labor to remain challenging in the foreseeable future, we will remain focused on gross profit growth.

We will aggressively pursue higher-margin businesses in our specialty areas as we continue to evaluate, remediate or exit unprofitable business in our customer portfolio.

This shift away from volume towards higher-margin value clients will be an important accelerator for us as we refine our business strategy to meet the changing dynamics of the labor marketplace.

As we navigate through these challenging labor conditions, we will continue to invest in technology that supports greater efficiency in filling customer orders, and this is demonstrated by Kelly's investment in our front-office platform for the U.S. market, for example, in addition to other strategic investments in innovation.

We announced one such investment in July, which was our Kelly Innovation Fund investment in the Kenzie Academy.

As we look to strengthen our position in the independent contractor segment, we recently made a minority equity investment in the Business Talent Group, BTG, a U.S.-based marketplace that connects high-skilled, independent talent to some of the world's largest businesses.

BTG has emerged as a leader in its field and shares Kelly's passion for empowering the future of the independent worker. 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] Our first question is from John Healy with Northcoast Research. Please go ahead..

Thank you. I wanted to ask, George, just about your view on the gross margins in the U.S. business or the Americas business. Quite impressive.

I know you don't kind of talk guidance by segment, but is it realistic to think that the type of improvement that we saw this quarter could be replicated on a more consistent basis maybe in 2019?.

Yes. I think that's as what we're doing, John, is as take a look at our business, especially, when you're looking at a supply-constrained environment, we're looking at lower-margin business, where it's very difficult to place the people and expensive, and we're starting to go after more value-based businesses.

So we're really highly focused on that GP line. And so when you think about moving into the future, we should be able to sustain a higher gross profit rate. Now I wouldn't expect you to see big improvements continuing like that, but sustaining them. Yes, that's reasonable to expect..

Okay, good. And then I wanted to ask just a question about France. I know there's been some kind of legislative changes there regarding tax credits and the CICE.

Is there a way to think about what sort of impact that will have on your fourth quarter and maybe what sort of headwind that might be to 2019 profits?.

I'm going to have Olivier answer it. You should do it in French..

Yes, I should reply on that. So it's still in early stage, but you need to understand that basically, the CICE is going to be transferred to something equivalent in terms of, I would say, impact. It's still, I would say, what I would call, a wage subsidy, and it's going to start in Q1 of next year.

What we know is that there might be some pressure from the market to basically push margin down. We expect that to happen, but we don't expect a very significant impact, maybe a little bit at the beginning of the year, but I think it should ease after that. But that will impact us certainly, yes..

Okay, helpful. And then just one question. With the passing of Mr.

Adderly, I was curious to know if you had any communications with those that are managing the trusts and how shareholders might think about, kind of, the new ownership structure of Kelly in terms of how those shares are being distributed, and how that may impact things going forward?.

Yes, what I can tell you right now, John, is when you think about from a practical perspective, the difference right now, just goes from Terry being the controlling shareholder to the trust that he created. We know the trustees. We've known them for a long time and we have a very good relationship with them.

And I would point you to the 13D that they filed upon Terry's passing, and if you look on the right-hand form of the purpose of the transaction, you'll see that what they have communicated is that they intend to continue to have Kelly run the company as is, no changes in the capital structure as it relates - as of right now and for us to continue to go down the strategic path that we've been operating.

And given that, we know the trustees well and have a good relationship, we feel that, that's where we're going to be heading..

We have a question from Josh Vogel with Sidoti & Company. Please go ahead..

Thank you. Good morning, guys.

So the investment in BTG, can you discuss other opportunities you're targeting, and also maybe talk to how much dry powder you have today to invest?.

Yes, so. First I'll talk about BTG and then I'll have Olivier talk about how we think about investment.

BTG, as we look at, you will have seen over time, Josh, that we continue to talk about the fact that the nature of work is changing in the marketplace and the worker is now starting to have much more flexibility in how they go to work and the ways in which they work.

BTG is a company that goes - primarily serves higher-skilled employees, but in a more flexible way as independent contractors. And we see that, that is going to be an important part of the future of work. So we took a minority equity investment in that business to help us as we try to work through the new ways of work and how do we capitalize on it.

And it was a company that we felt very comfortable with their structure and where they're heading. As far as future investments, I'll have Olivier talk about capability..

Yes, I'm going to start. Of course, our balance sheet today is not leveraged or slightly only. Our debt is now about $8 million. You remember that a year ago in September of last year, we did acquire Teachers On Call for $40 million. Thanks to our good, I would say, free cash flow, we have managed to deliver - deleverage rather quickly.

We have significant available financing capabilities to basically accelerate and continue to invest inorganically as - on top of our organic initiatives that we have in several areas. So we are actively looking out for inorganic initiatives in the near future in our specialty business lines in the U.S., namely in education, science and engineering..

And I think, Josh, the way to think about that is, as we think about preparing the company for the future and looking for future growth opportunities, we see the opportunity to use our balance sheet to be able to do that.

We also see significant opportunity to invest in technology to make the company not only more efficient but also to open up new ways of doing business for us. And we're going to be aggressive in that pursuit..

Helpful. I guess on a little bit of tangent there. You're talking about the investments in technology. Can you just remind us of the timeline? I know it's a several-step process, but the timeline in these technology upgrades. Is it similar to what you've been saying in recent quarters? Or is - you think it can be moved up a little bit or pushed back.

Can you just talk to that, please?.

Yes, so - certainly the biggest investment in technology that we have going on right now is investment in our front and middle office in the United States, which is our biggest business. And what we talked about and have said is that we've done a lot of work on that project during 2018.

That work will accelerate into 2019 and will take us through 2019 to get that technology fully in place. And that is going to be the biggest push for technology investments in 2019. There will be some other smaller things that we'll look at around - along the way.

And then as we move into 2020, once that baseline is in, we'll begin to look at the ecosystem that's available to us with the new front office now and be able to drive more technology that plugs into our front-office system that makes our recruiters far more efficient and helps employees connect with us in a better way..

Okay, great. And then in addition to the tech investments, I know you've made investments in personnel, notably recruiters.

And I guess given this supply-constrained environment, can you just talk to - I don't need necessarily numbers, but the recruiting base - the recruiter base you have on staff today? Do you feel you're in a good position that when the labor market does loosen, you can hit the ground running and fulfill orders? Or do you have recruiters that are kind of just waiting on the side.

I guess kind of trying to get a handle around how much excess capacity - [Technical Difficulty].

To us with the new front office now and be able to drive more technology that plugs into our front-office system that makes our recruiters far more efficient in perspective.

Our recruiters are fully deployed in going after the market trying to fill those orders, and we're using various creative ways to be able to reach the market and to work with employees differently to find them.

So what that says is right now, if the market starts to loosen, we should have good capacity to continue to go forward and grow without significant further investment in resources as you move forward.

Now certainly in certain areas of specialty, we may have to add as we as we see that environment change, but as it loosens, right now, we have people working extra hard trying to get those orders filled, and when it gets easier for them to find things they will have capacity to do more..

At this time, there are no further questions in queue..

Okay, thank you, Paul..

Thank you..

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