Kelly Services Inc (KELYA) Q3 2022 Earnings Call Transcript

Ladies and gentlemen, thank you for standing by. Good morning, and welcome to Kelly Services Third Quarter Earnings Conference Call. All parties will be in a listen-only mode 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. A third 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.

Thank you, Leah. Hello, everyone, and welcome to Kelly Services third quarter conference call. With me today is Olivier Thirot, our Chief Financial Officer, who will walk you through our Safe Harbor language, which can be found in our presentation materials.

Thank you, Peter, and good morning, everyone. 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 metrics in our discussion today exclude the results of RocketPower and Pediatric Therapeutic Services or PTS, both of which we acquired earlier this year. In addition, our organic metrics exclude the results of our Russian operations following the completion of the sale transaction this quarter. Finally, the slide deck that we are using on today's call is available on our website. And now back to you, Peter.

Thank you, Olivier. Before I discuss Kelly's quarterly results, I want to touch on two key developments mentioned in our press release. First, Kelly's Board of Directors has approved a one-year repurchase program for up to $50 million of outstanding Class A common shares. This buyback initiative follows our earlier repurchase of $27.2 million in shares from Persol and demonstrates our ongoing confidence in Kelly as a strong investment and our dedication to a flexible and balanced approach to capital allocation aimed at maximizing returns. Second, as highlighted in the press release, we recorded a goodwill impairment charge in the third quarter related to our acquisition of RocketPower in the RPO space. RocketPower, which focuses on the high-tech industry, has experienced a decline in demand for its services due to customers significantly reducing full-time hiring after a period of rapid growth. In response to these market changes, we are implementing measures to enhance the anticipated value of this acquisition, such as speeding up integration processes, diversifying RocketPower's offerings, and pinpointing additional synergies with Kelly to create growth opportunities. Additionally, we believe that the recent reductions in hiring and layoffs within the high-tech sector could improve the pool of candidates for other industries that are still actively seeking IT talent, including financial services, insurance, and healthcare, where Kelly Technology and Softworld have a solid presence and are well positioned to benefit. The recent slowdown in the high-tech industry illustrates how various sectors are reacting differently to economic challenges. Our Softworld acquisition continues to perform well, and our latest acquisition in pediatric therapeutic services is progressing positively, delivering substantial year-over-year growth in revenue and gross profit. Given the varied impacts of inflation, rising interest rates, supply chain issues, and labor market disruptions, we anticipate continuing to witness this blend of decline in some sectors while maintaining strength in others. What remains unchanged is Kelly's commitment to value creation. Our third quarter results indicate that our specialization strategy is effectively driving structural improvements that enhance our business mix towards higher-value, higher-margin growth. We achieved gross profit rate increases across all five segments, maintaining the positive momentum initiated in the first two quarters, as our specialty teams concentrated their efforts on higher-margin offerings within their divisions. Our SET segment experienced significant revenue growth in telecom, technology, and outcome-based solutions, alongside strong fee growth and effective leverage. The Education segment improved K-12 fill rates, saw robust revenue growth from both existing clients and new contracts, and achieved another quarter of substantial results led by Greenwood/Asher, our executive search specialty in higher education. The OCG segment reported gross profit growth from its highest-margin solutions as new major MSP wins became effective, and demand for RPO products remained firm. The P&I segment generated revenue growth in outcome-based specialties and sustained staffing revenue levels similar to Q2. Lastly, our International segment, when excluding the impact of our Russian operations sale, reported good organic growth in constant currency revenue and fees during the quarter. The ongoing shift toward higher-margin activities in all our business units reflects Kelly's commitment to pursuing our specialty growth strategy. I want to remind you that we have executed five significant transactions this year to divest non-core assets and reallocate capital to support this strategy. In the first quarter, we sold most of our investment in the Persol, Kelly, APAC joint venture. We divested our investment in Persol Holdings common shares and repurchased Class A and Class B common shares to conclude the cross-shareholding arrangement with Persol. In March, we acquired RocketPower to drive further growth in our expanding RPO business, and in May, we added PTS to complement our education services with a new adjacent offering. These strategic moves underline our commitment to specialized growth and value creation in our operations. Now, I will hand it over to Olivier for a more detailed review of Kelly's third-quarter results.

Thank you, Peter. For the third quarter of 2022, revenue totaled $1.2 billion, down 2.3% from the prior year on a reported basis, which includes 260 basis points of unfavorable currency impact. So without the impact of FX headwinds, revenues for the quarter were up 0.3% in constant currency. Included in that increase is a 130 basis point favorable impact from our acquisitions of RocketPower and PTS, as well as a 250 basis points unfavorable impact resulting from the sale of our Russian operations. So our organic constant currency revenue growth for the third quarter was up 1.5%. As we look at third quarter revenue by segment, in the SET segment, revenue was up 5%. We have continued to see strong demand for our telecom specialty, and growth in our outcome-based solutions remain solid. Science and engineering are slowing, but our technology practice, including software, is still growing, although at a slower pace. In addition, SET permanent placement fee growth also continued, up 8% year-over-year despite the more challenging economic environment. In our Education segment, year-over-year growth continues to be strong, up 57% on a reported basis. The reported results include the May acquisition of PTS, so revenue growth was 45% on an organic basis year-over-year. PTS is on track and performing well with pro forma Q3 year-over-year revenue growth of 23%. Revenue growth trends in our education business reflect robust demand from existing customers and new wins in 2022. Steps taken earlier in the year to broaden the supply of talent have continued to pay off, and we are continuing to see meaningful improvement in our fill rates. Permanent placement fees, primarily higher education executive search with Greenwood/Asher, were up 54% year-over-year. Our OCG segment continued to deliver year-over-year revenue growth, with revenues up 5% on a reported basis. Organic constant currency revenue, excluding the impact of RocketPower, was flat to the prior year in Q3. Declines in PPO as a result of some customer exits in early 2022 offset the continued growth in our high-margin MSP and RPO products. I will provide more context on the situation with RocketPower later in my comments. Revenue in our Professional and Industrial segment declined 10% year-over-year in the quarter. Consistent with the second quarter, revenue from our staffing products declined 14% and lower revenue volume, which has been partially offset by higher bill rates resulting from the upward pressure on wages in the current talent market. About 60% of the staffing revenue decline comes from the shift of a large staffing account, which we discussed as part of our outlook in our August call. The segment's outcome-based business continues to be impacted by a contraction in year-over-year demand from our call center specialty, but growth in other outcome-based specialties has more than offset that headwind, and total outcome-based revenue was up about 3% for the quarter. And finally, Perm fees in P&I were down 10% as our customers' demand for direct hire services has been impacted by the increasing economic uncertainty, especially among our small and midsized customers. Revenue in our International segment declined 16% on a nominal currency basis and was down 5% on a constant currency basis. Excluding the impact of the sale of our Russian operations, organic constant currency revenue growth was 7%. And finally, permanent placement fees in the International segment grew by 10% year-over-year in constant currency. Overall, gross profit was up 5.1% on a reported basis or 7.6% in constant currency. Our gross profit growth was a result of an improving gross profit rate, 20.6% for the quarter compared to 19.2% in the third quarter of last year, a 140 basis point improvement. The primary driver is favorable organic business mix, which contributed more than 90 basis points. Lower employee-related costs and higher burn fees also contributed. And finally, our 2022 acquisitions also positively impacted our total company gross profit rate by 20 basis points, as both PTS and Rocket Power generate higher margins than Kelly's average. And when we look across the business units, gross profit rate improved in each segment, reflecting the continued shift in business mix towards higher-margin products and specialties. SG&A expenses were up 5.1% year-over-year on a reported basis and 7.1% on a constant currency basis. This expense growth rates are impacted by the intangible amortization expense and other operating expenses of Rocket Power and PTS, as well as the favorable impact of the sale of our Russian operations. On an organic constant currency basis, expenses grew by 6% year-over-year. The majority of the increase in SG&A reflects higher compensation-related expenses for our full-time talent. We have continued to add headcount to ship out growth in selected specialties in line with the revenue growth and provided commensurate market-driven adjustments to base pay. This compensation adjustments reflect the impact of inflationary pressure and the continuing need to attract and retain talent. Even with increases in the cost of doing business, we have been taking steps to moderate the level of expense growth in Q3 compared to earlier this year. This reflects both the current level of economic uncertainty and its impact on our top line growth and positions us to react quickly to further market developments if conditions warrant moving forward. Also reflected in our earnings from operations in Q3 is an impairment charge of $30.7 million related to the goodwill of RocketPower. Many customers in the high-tech industry vertical in which Rocket Power specializes have reduced their full-time hiring, reducing the demand for RocketPower services. An ongoing economic uncertainty has more broadly impacted the growth in demand for recruitment process outsourcing in the near term. After experiencing triple-digit pro forma growth in the first and second quarters, Rocket Power's third quarter revenue declined 11% from a year ago. The changes in market conditions triggered an impairment test, which resulted in the Q3 impairment charge. The impairment charge is a noncash item, and more information regarding the impairment charge will be available in our third quarter Form 10-Q. Our reported loss from operations for the third quarter was $21.4 million. Excluding the impairment charge, adjusted earnings from operations were $9.5 million compared to the $8.9 million earned in Q3 of 2021, generally consistent on a nominal currency basis, but up 21% on a constant currency basis. While our adjusted conversion rate for the total company remains flat to 2021, we did see an improved conversion rate in SET and continue to expect other business units to generate improving conversion rates as we move forward. And just a reminder that we monetized our investment in Persol Holdings and most of the Persol Kelly APAC joint venture in the first quarter of 2022. So there will be no further P&L impact from those investments, although the comparable prior year periods will include gains and losses related to those investments until we anniversary the transactions. Income tax benefit for the third quarter was $5 million compared with our 2021 income tax expense of $11.1 million. Our effective tax rate for the quarter was 23.4%. And finally, reported loss per share for the third quarter of 2022 was $0.43 per share compared to earnings of $0.87 per share in 2021. The decrease in earnings per share resulted primarily from the impact of the impairment charge related to RocketPower and the 2021 gain on Persol shares, all net of tax. Adjusting for those transactions, Q3 2022 EPS was $0.25, consistent with an adjusted EPS of $0.25 in Q3 of 2021. Now moving to the balance sheet. As of the end of the third quarter, and as Peter mentioned, our balance sheet reflects the completion of five significant transactions so far this year and demonstrates our commitment to monetize non-core assets. In addition, we completed the sale of our Russian operations in July. At the end of Q3, cash totaled $122 million compared to $44 million a year ago. We had essentially no debt consistent with the end of the third quarter of 2021. With our €300 million in available capacity on our credit facilities, we continue to have ample capital available to deploy. As of the end of Q3, accounts receivable was $1.5 billion and increased 6.7% year-over-year, reflecting our year-over-year increase in revenue as well as an increase in DSO. Global DSO was 64 days, an increase of four days over year-end 2021 and one day higher than the third quarter of 2021. Global DSO increased, primarily as a result of an increase in the mix of MSP and other customers with extended payment terms and, to a lesser extent, to the timing of some customer payments. Accounts payable and accrued liabilities also increased as a result of an increase in MSP supplier payables, partially mitigating the impact of higher DSO and free cash flows. Through the third quarter of 2022, we used €117 million of free cash flow, reflecting increasing investment in working capital. Free cash flows in 2022 also includes the use of approximately €50 million to pay income taxes resulting from the sale of the Persol Holdings common stock, as well as the use of approximately $29 million to repay federal payroll tax balances, which were deferred in 2020 under the CARES Act. And now, back to you, Peter.

Thanks for those details, Olivier. Last quarter marked the two-year anniversary of Kelly's optimized operating model and the formation of our five distinct business units. As those businesses start to mature within the model, they not only deliver strategic contributions to Kelly's overall performance, each segment is also creating higher value within its own specialty. In our SET segment, we said we wanted to see meaningful returns on our investments, both organic and inorganic. The specialties we've invested in, including Softworld and telecom, are delivering those higher margin returns. And in the third quarter, SET also delivered solid fee growth and good operating leverage. In education, we committed to capture K-12 growth, improve our fill rates and further expand our adjacencies. We delivered on the promise of higher fill rates in Q3. We've begun implementing significant new wins as the full year ramps up, and our PTS acquisition is contributing solid revenue and gross profit growth to this segment. In OCG, we said we would invest this year in our fast-growing RPO business. Our organic RPO business continued to deliver solid year-over-year growth in Q3. We've explained the market conditions that triggered the RocketPower impairment charge, and we believe that with diversification and integration, this acquisition will bring strategic long-term value to our business. In our P&I segment, we began to see some softening in staffing demand in the third quarter, not unusual since this segment typically is the first impacted by a slowing economy. Notwithstanding the year-over-year contraction in our call center business, our outcome-based P&I specialties delivered growth in the quarter. Finally, in our International segment, we said we expected continued growth in regional and local specialties, and Q3 delivered that growth with pockets of resilient specialties designed to thrive even in challenging macro conditions. I'll now welcome back Olivier to share more about what we expect in the fourth quarter.

Thank you, Peter. As we reflect on the third quarter results and look ahead, we expect that the growing economic uncertainty will begin to impact our P&I and International businesses, but that there will be steady demand for our SET, OCG and education services. We expect that continued challenges related to talent supply inflation and the upward pressure on wages at all skill levels will continue, although there are signs of a more gradual pace of wage growth as we move forward. And increasing interest rates may put some pressure on certain industries as consumers and businesses react to these higher rates. Specific to Kelly, there are two unusual events that have impacted our Q3 results and will continue to impact the remainder of the year. First is the sale of our Russian operations, which we completed in July. Second is the change of one of our large customer's labor strategy that we mentioned today and on earlier calls. A large staffing customer decided to address their talent challenges and work with scale differently by changing its heavy use of contingent labor to one that instead will rely on hiring talent directly as full-time employees. Given that only one quarter remains in 2022, my comments on our outlook reflect our expectations for the fourth quarter only. We'll return to providing insight into expected full-year results in 2023. I will start with highlighting the impact of the strengthening of the US dollar against several currencies, including the euro. We have experienced and continue to expect a more significant negative impact from FX on our Q4 reported revenue growth rate. With the FX headwinds and other challenges I mentioned, we expect Q4 revenue growth to be flat to up 1% year-over-year in nominal currency. This includes about 230 basis points of unfavorable currency impact. Included in that outlook is 150 basis points of inorganic revenue growth from RocketPower and PTS and an unfavorable 250 basis points impact from the sale of our Russian business. All in, that reflects an expectation of 3.3% to 4.3% of year-over-year organic constant currency revenue growth. While we are not expecting a full traditional seasonal lift in our P&I business, the quarter will include a full quarter of revenue growth from our Education segment as schools will be in session for the entire quarter. And finally, our outlook assumes no material changes in macroeconomic conditions. We expect our Q4 gross profit rate to be around 20.4%, a 70 basis point improvement from the 19.7% we reported in Q4 of 2021. This improvement in our gross profit rate is based on our expectation for continued structural improvement in product and specialty mix, partially offset by a deceleration in permanent placement fees. Given our revenue and gross profit rate outlook, we expect that our gross profit dollar will grow by as much as 4% in the quarter on a nominal basis, a nice run given the economic headwinds. We expect SG&A expense to be up 2.5% to 3% on a reported basis, reflecting growing inflationary pressure in the current environment, partially offset by cost management efforts to ensure alignment with top-line growth. We remain committed to improving productivity across all of our business units and acting with urgency with respect to cost management in response to changes in market conditions. As we execute our organic and inorganic strategies, we are utilizing adjusted EBITDA and adjusted EBITDA margin as additional measures of our progress in delivering profitable growth. Based on our outlook, we expect Q4 adjusted EBITDA margin to improve to 2.5%, a 30 basis point improvement from the 2.2% adjusted EBITDA margin delivered in Q4 of 2021. We also expect an adjusted Q4 effective income tax rate of approximately 50%. This is unusually high, driven by the impact of non-deductible losses on life insurance policies used to fund certain retirement liabilities. For the full year, we expect the effective tax rate to be in the low single digits. And finally, as Peter noted, our Board of Directors has approved a one-year $50 million open market share repurchase program. We expect that such open market repurchases will begin within a few weeks.

Thanks, Olivier. The share buyback program doesn't change Kelly's capital allocation strategy. It complements it and demonstrates our commitment to using our capital to maximize returns. We will continue to pursue organic and inorganic investments that accelerate specialty growth and deliver shareholder value. Though, the current economic climate may result in fewer high-quality properties on the market, we are holding firm to our acquisition criteria, balancing our desire for inorganic growth with our commitment to creating higher value, higher margin mix in our specialty businesses. Our third quarter performance confirms that we are indeed making progress on shifting our business mix and delivering structural improvements that drive higher gross profit. While signals in the macro economy remain mixed, we are capturing strong demand in our SET, education, and OCG segments, and we expect demand to hold steady in these more resilient specialties. We face the future with confidence in our well-defined specialization strategy. We continue to benefit from our optimized operating model, which focuses our attention firmly on growth, and we move forward as a more nimble, proactive company that will adapt quickly to market changes, guided by a seasoned leadership team, wholly committed to specialty growth and value creation. Leah, you can now open the call to questions.

Thank you, and our first question is from Joe Gomes with NOBLE Capital. Please go ahead.

Good morning. Thanks for taking the questions.

Good morning, Joe.

Good morning, Joe.

So I wanted to start out with talking about talent supply and maybe you get a little more detail as to what you guys are doing to try and attract talent in this type of a market. What do you see are the challenges there? Are you seeing any loosening up of the talent supply across the end markets?

So Joe, the labor force participation rate continues to be stubbornly low relative to historic participation. So that's contributing to the ongoing tight labor market. Although the number of job openings has come down somewhat, it's still twice as many job openings as our unemployed people. So that's a structural issue that continues to challenge meeting our customers' demand. We're using all appropriate measures to try to attract more people, including having retirees come back into the workforce, creating new channels for our education practice, and using social media to an extent that we've never used it before. So we're pulling all the levers we can to try to create a value proposition for individuals to work with Kelly to further their career and career aspirations.

Okay. Thank you for that. To switch onto the Education segment, a little bit of a multipart question here, but I noticed flipping through the release that segment did show an operating loss, I'm assuming that's mostly related to just the time of the year. But was there anything else that you would note that caused that operating loss in the Education segment? And then two, you've discussed a little bit in the past about some additional wins that you were able to get in this space. I'm just trying to see where you stand today? Is that business still attracting a lot of new wins in the kind of the pace of the wins in that segment?

Yes, Joe, the operating loss is...

Seasonal...

It's seasonal, related to the fact that in the third quarter, schools are just starting to open, reflecting the seasonality. Regarding our wins, we continue to experience strong demand for our services. We've secured significant new contracts this year that we are implementing for the upcoming school year, which is ramping up now. We expect to benefit from a full quarter of these new contracts, particularly in the fourth quarter. Additionally, our pipeline for new contracts looks very promising. We believe we are gaining market share by providing the best value proposition to our customers, especially in a climate with severe teacher shortages.

Yeah. And clearly, when you look at our outlook for Q4, we anticipate very similar growth than what we have seen in Q1, Q2 and Q3 of 2022, meaning, above the 40%, 45% mark.

Okay. Thanks for that. And then, one last one if I may, I also saw this morning that you entered into an agreement, I guess, to free up some restricted or the ability to do some with restricted cash levels on the credit agreement. Maybe you could just give us a little more details what that is all about?

Yeah. I mean, two things on that. One is, common to many companies, you know that the LIBOR, reference interest rate is no longer something that is in place. So basically, this agreement, which I know is a long disclosure of over 170 pages, is basically on a new agreement moving from LIBOR to what we call SOFR. And the second point is, basically, a change in some of our bank covenants to basically expand some possibility to basically fund the share repurchase that Peter and I were mentioning today. So it's basically an amendment to some of the bank governance to basically enable us to fund these 50 million initiatives that, again, we have mentioned today.

Okay. Great. Thanks for that. I appreciate that. I'll get back in queue. Thank you.

Thanks Joe.

Thank you.

And our next question is from Kevin Steinke with Barrington Research. Please go ahead.

Good morning, Kevin.

Good morning.

Good morning. Good morning, Peter and Olivier. I wanted to just start out by asking about RocketPower and you mentioned wanting to speed up the integration there and also diversify its customer base. Just wondering, what that integration would involve? And then how, I guess, easy is it to diversify the business? Is it simply a matter of taking their existing offering and bringing it to different industries, or if there's something specific about their offering that's tailored to the tech industry? Just want to get a little more color on both of those things.

Well, as we mentioned, RocketPower was experiencing strong growth in the first and second quarters, but faced challenges due to a sudden decline in demand, particularly in the high-tech sector where it had substantial exposure. We believe that shifting its well-managed operations to other industries will be effective and achievable. Additionally, Kelly's connections to major enterprise customers across various sectors were part of our initial investment rationale. The recent downturn in the tech sector makes this a fitting moment to leverage RocketPower's unique operational model in different industries. Execution of these plans is already in progress, and we anticipate a notable success to be implemented before the year ends, thanks to the partnership between RocketPower and Kelly Resources.

Okay. That's good to hear. And when we think about gross margin for the year, I guess, the guidance for the full year now is 20.4%, correct versus 20.7% previously. Is that just a function of primarily lower permanent placement fees, or the assumption that they'll be lower…?

So, what we're specifically discussing today pertains to our outlook, particularly Q4. The 20.4% that Kevin mentioned is related to Q4.

Understood. Okay.

It is still up 70 basis points, not the 220, 230, and 140 we have seen in Q1, Q2, Q3 of this year. The main difference is basically the fee business that is decelerating. The good news is that we continue to see what we have seen for many years, over five years is a structural improvement on our business mix or specialty mix that is going to continue to provide some traction in terms of basically improving or continuing to improve our gross profit, gross margin rate.

Okay. I got it. Yeah, that's specific to the fourth quarter, that 20.4%. Okay. And just thinking about SG&A, you've mentioned that you slowed down or looking at your slowdown in SG&A expense growth in the third quarter. I'm just trying to calibrate the prior SG&A expense growth outlook that you provided last quarter. I think it was up 8% to 9% organically. Has there been a change in that, or is that still kind of what we should expect…?

So Kevin, if you look at full year, basically versus the outlook we gave three months ago, we have downgraded our SG&A growth by about 200 basis points. If you look at the trend over Q1, Q2, Q3, and here, I'm going to talk about organic constant currency. Our SG&A was up 12.6% in Q1, 9.9% in Q2, 6% in Q3. And basically, on a like-for-like basis, this 6% is going to go down further in Q4 based on the outlook for Q4 we did provide today. Two reasons on that, one is, of course, as the top line is slowing down a little bit, incentives are starting to react, because that's the way it should work when performance is not necessarily at the level of the target. And the second thing that we have started in September, and that is going to be more visible in Q4 is cost management. Making sure that we deploy our resources according to a very fluid and uncertain environment, as Peter was mentioning. So it's very likely that we are going to continue to see this slowdown in expenses, but also more and more redeployment depending on where basically, we still have significant opportunities. Education is a good example. Our BPO business overall is a very good example. Technology, including software, still growing. There are some areas where we are going to continue to make sure we have sufficient resources to continue to capture growth.

Okay. Great. I guess, yes, you mentioned just how a slowing economy might result in fewer high-quality M&A targets. I guess it's fairly self-explanatory that targets wouldn't want to be selling when the market is softer and their results might be softer. But any more just comment on just the M&A pipeline and what types of things you might be pursuing now?

Well, we're continuing to focus on the higher margin, higher growth specialties, so that would be SET. And also, we are very pleased with our acquisition of Pediatric Therapeutic Services in the therapeutic adjacency to education. So those would be two areas that we'll continue to look for high-quality assets to add to our portfolio. The quantity as well as the quality of companies that are currently in the pipeline is less attractive than it was, say, six months or a year ago. We don't think that's permanent. We think companies will come off the sidelines as the economy improves. But we haven't changed our strategy, but we haven't changed our criteria that we're using to acquire properties. It's a high bar we've set to use our capital to acquire properties, and we'll continue to look at companies that come on the market through that lens.

Okay. Thank you for taking the questions.

Thanks, Kevin.

Thanks, Kevin.

Our next question is from Kartik Mehta with Northcoast Research. Please go ahead.

Hi. Good morning.

Good morning.

Good morning.

Thank you. I was wondering if you could give maybe a little bit more detail on the type of companies that all you're seeing weakness from on the technology sector. Because I know, as you said, it's really mix as to the type of demand you're seeing and any type of granularity there would be great.

Yes. It's a very important question because when we talk about either technology or high tech, sometimes we conflate the technology job types with the technology sector, which is I think all of the companies that are in the press announcing either layoffs or slowdowns in hiring, including Meta, Lyft, Slack, and on and on. That's the sector that's being most impacted. There is still very strong demand for high-quality technology professionals. And as I mentioned in the script, so we're seeing solid demand in our Softworld, they continue to provide high-quality technology talent to enterprise in small and medium-sized businesses. And we don't think there's any pending slowdown in that demand because large institutions continue to need app developers, network architects, and cybersecurity experts. But at least for the near term, the high-tech industry, Silicon Valley, Austin, Texas, and other areas has been particularly hit by the uncertain macro as well as potentially over-hiring coming out of the pandemic.

As you evaluate potential M&A targets and take into account the impairment charge on RocketPower, does this impact your perspective on future M&A targets or how you might assess them going forward?

Well, we're very pleased with the performance of our acquisitions in totality. The RocketPower, the abrupt decline in the high-tech vertical that they had significant exposure to the timing will cause us to reflect on it, but it doesn't change the underlying strategy of looking to add to the Kelly legacy businesses with high quality, high margin, high growth properties that we think will create both primarily topline synergies for the company and create opportunities to attract new customers to Kelly.

Yes. If I may just add, I was looking recently at reflecting a little bit with Peter on the performance of some recent acquisitions. Just to give you an idea, first of all, PTS, as we said, growing 23% in revenue in Q3. We do International interestingly over 80% growth, software is in the technology plus 7% in revenue, and NexGen and GTA, which is now what we call our telecom specialty growing at about 34%. So you see that, of course, we have some challenges with RocketPower, but we have now a plan to capture the value we are expecting at the time of the acquisition, but reflecting on the recent acquisitions, all of them are on track in terms of providing for us additional growth but also additional value creation because all of them got a margin profile or gross margin profile that is, of course, much higher than the average gross margin we have for the rest of Kelly.

And then just one last question. Based on what you just said, Olivier, and what you've mentioned about the demand in business and the supply and demand of labor, as you look at your gross profit margins over the next 12 months, do you foresee any challenges that might lead to a contraction, or is the demand sufficient for you to continue seeing growth in gross profit margins?

So, I think what we are going to continue to see is probably the traction and the boost that was coming from high growth in the fee business is slowing down and will not provide the boost we have seen this year, right? In Q1, it was about 100 basis points, Q2, 70. Q3 is already much lower, it's about 10 basis points. What we are going to continue to see is what we have seen for the last five years is basically a structural improvement of our GP margin coming from what we call mix, meaning specialty mix, continuing to grow higher gross margin businesses. Out of the 140 basis points of improvement we had this quarter, 90 basis points is coming from the structural improvement, again, that we have seen for the last five years, including in 2020 during the economic downturn. So I see this traction continuing in the future because that's something we have seen for, well, since 2015, I'm sorry, with not one year where basically our GP rate went down. Now we don't expect 200, 230 basis points that we have seen in Q1 or Q2, but meaningful improvement on a pure organic structural specialty mix yes, definitely, yes.

Thank you so much. I appreciate it.

Thank you.

Thank you.

And next, we go to Mitra Ramgopal with Sidoti. Please go ahead.

Yes. Good morning, and thanks for taking the questions.

Good morning, Mitra.

Good morning.

Yes. Thanks. First, as you look at your investments for next year, given macro uncertainty, is it fair to assume both technology and workforce, you're going to be a lot more cautious just because you just don't have the visibility that you would like?

Well, we're going to continue to invest in the areas where we think we can get a meaningful return. So as Olivier mentioned, the demand for education services is significant, and we'll continue to invest there. We continue to see demand in our SET and OCG practices. But we're also very mindful as Olivier described in the Q4 outlook for SG&A that we're adapting to the current uncertainty and deceleration in certain parts of the economy. And we'll continue to use that lever going forward in 2023. We're a more nimble, more adaptable company. Our cost structure is more flexible than it has been, and we expect to see that continue in 2023.

Yes. Thanks. And then just switching gears a little in terms of Europe. We saw some softness in areas like France, the UK, and Italy, not surprising given what we're hearing from Europe. But what's your expectation in terms of maybe stabilization there, or should we expect continued softness well into next year given the macro environment?

Interestingly, when we exclude the impact of foreign exchange and the situation in Russia, we see that in Q1, we are growing at about 9%. This is quite similar to the 9% growth we achieved in Q2 of 2021. In Q3, our growth is around 7%. Our fee business also showed a 10% increase in Q3, despite losing the benefits we previously gained from Russia, which has historically been a strong fee business for us. At this point, we haven't observed any specific signs of a slowdown. While we anticipate some deceleration, our current observations indicate that our business in Europe remains very resilient. We are closely monitoring the situation, reviewing our operations weekly, and preparing for any changes, but for now, the business appears to be holding up well.

Thanks. As you consider 2023 and your portfolio of businesses, should we continue to anticipate year-over-year growth despite the current environment? I understand you’re not providing guidance, but at a high level, do you still expect the company to grow next year despite the macro challenges?

Yes, it's probably a difficult question, knowing the environment we have now. But when you think about resiliency and we can speak about education, our Ed business and OCG business, we feel that with the structure, the business we have now, the portfolio of specialties we have in each of these segments. For each of them, we believe we have a pretty resilient model, right? Of course, when you think about our P&I and to some extent, international business, we believe there are going to be likely more subject to the future economic environment. But we believe that at least for OCG, SET, and education, we have businesses that are now strong enough, resilient enough to probably weather some challenges in the near future, probably better than it was in the past. And certainly better than other areas that are more exposed to, I would say, the cyclical challenges we may see in terms of economic environment in the near future.

Okay. Yes, that's very helpful. Thanks again for taking the questions.

Yes. Thank you.

Thank you.

And we have no other questions. You may continue.

I think we're all set, Leah. Thank you for your help today.

Thank you, Leah.

You're very welcome. Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect.