Kelly Services - Q3 2022

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by. Good morning, and welcome to Kelly Services third quarter earnings conference call. All parties will be on 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 the 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 (President and CEO)

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.

Olivier Thirot (CFO)

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. Now back to you, Peter.

Peter Quigley (President and CEO)

Thanks, Olivier. Before I turn to Kelly's quarterly results, I'd like to address two developments that were highlighted in today's press release. First, yesterday, Kelly's Board of Directors authorized a one-year $50 million repurchase of outstanding Class A common shares. This buyback program, which follows the $27.2 million in shares we repurchased from Persol earlier this year, reflects our continued confidence that investing in Kelly is a good use of capital and our commitment to a flexible and balanced capital allocation strategy that is focused on maximizing the return on capital. Second, as noted in the press release, we incurred a goodwill impairment charge in the third quarter related to RocketPower, our acquisition in the RPO space.

RocketPower specializes in the high-tech industry, and many customers in that vertical have scaled back their full-time hiring, abruptly softening demand for RocketPower services after two quarters of triple-digit growth. In light of these market dynamics, we are taking action to capture more of the expected value from this acquisition, including accelerating integration activities, diversifying RocketPower's portfolio, and identifying additional synergies with Kelly to unlock new opportunities for growth. Furthermore, we are optimistic that hiring reductions and layoffs in the high-tech vertical may strengthen the pipeline of candidates in other industries where demand for IT talent remains strong. Among them, financial services, insurance, and healthcare, where Kelly Technology and Softworld are well established and positioned to capitalize. The recent deceleration in the high-tech industry demonstrates how sectors are responding differently to economic uncertainty.

Our Softworld acquisition continues to deliver solid performance, and Pediatric Therapeutic Services, our latest acquisition in the K12 education specialty, remains firmly on track and is delivering healthy year-over-year revenue and GP growth. Given the uneven impact of inflation, higher interest rates, supply chain constraints, and labor market disruption, it's likely we will continue to see this mixed pattern of deceleration in some industries and resiliency in others. What will not change is Kelly's commitment to creating value, and our third quarter results specialization strategy is indeed driving structural improvements that are shifting our business mix toward higher value, higher margin growth. We once again delivered GP rate improvements in each of our five segments, continuing the positive trend we saw in Q1 and Q2 as our specialty teams focused their energy and resources on higher margin products within their business units.

Our SET segment delivered solid revenue growth in telecom, technology, and outcome-based solutions, along with solid fee growth and good leverage. Our education segment improved K12 fill rates, captured strong revenue growth from existing customers and new wins, and produced another quarter of substantial growth led by Greenwood/Asher, our higher education executive search specialty. Our OCG segment delivered GP growth from its highest margin solutions as recent large MSP wins began going live and overall demand for RPO products remained solid. Our P&I segment delivered revenue growth in outcome-based specialties and kept staffing revenue on par with Q2 revenue trends. Our international segment, excluding the impact of the sale of our Russian operations, delivered good organic constant currency revenue and fee growth during the quarter. The continued shift toward higher margin mix within each of our business units reflects Kelly's active commitment to advancing our specialty growth strategy.

I'll remind you that we have made five significant transactions so far this year to monetize non-core assets and reallocate capital in support of that strategy. In Q1, we completed the sale of most of our investment in the PersolKelly APAC JV. We sold our investment in the common shares of Persol Holdings, and we repurchased Class A and Class B common shares to end the cross-shareholding arrangement with Persol. In March, we acquired RocketPower to drive additional growth in our growing RPO business, and in May, we acquired PTS to add a new adjacent service to our education business. These strategic transactions demonstrate our commitment to specialty growth and value creation within our businesses. I'll turn it over to Olivier now for a closer look at the details of Kelly's Q3 results.

Olivier Thirot (CFO)

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. 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 points 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. 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 a 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, also 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 rate. Permanent placement fees, primary 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 second quarter, revenue from our staffing products declined 14% on lower hours 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. 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 mid-sized 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%. 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 points improvement. The primary driver is favorable organic business mix, which contributed more than 90 basis points. Lower employee-related costs and higher perm fees also contributed.

Finally, our 2022 acquisitions also positively impacted our total company GP rate by 20 basis points as both PTS and RocketPower generate higher margins than Kelly's average. 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. These expense growth rates are impacted by the intangible amortization expense and other operating expenses of RocketPower 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 support growth in selected specialties in line with revenue growth and provided commensurate market-driven adjustments to base pay. These 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 as 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 RocketPower 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, RocketPower's third quarter revenue declined 11% from a year ago. The changes in market conditions triggered an interim impairment test, which resulted in the Q3 impairment charge. The impairment charge is a non-cash 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 currencies, currency basis but up 21% on a constant currency basis. While our adjusted conversion rate for the total company remained flat to 2021, we did see an improvement an improved conversion rate in SET and continue to expect other business units to generate improving conversion rates as we move forward. Just a reminder that we monetize our investment in Persol Holdings and most of the PersolKelly APAC joint venture in the first quarter of 2022. There will be no further P&L impact from those investments, although the comparable period, 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%. 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 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.

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 and relocating capital to advance our specialty strategy. 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, an increase 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 on 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 we deferred in 2020 under the CARES Act. Now back to you, Peter.

Peter Quigley (President and CEO)

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. 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 school year ramps up, and our PTS acquisition is contributing solid revenue and GP growth to the 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 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.

Olivier Thirot (CFO)

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 a 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. 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 a change of one of our large customers' labor strategy that we mentioned today and on earlier calls. A large staffing customer decided to address their talent challenges and work with Kelly differently by changing its heavy use of continental 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 U.S. 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%-4.3% 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. Finally, our outlook assumes no material changes in macroeconomic conditions.

We expect our Q4 GP 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 GP 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 GP rate outlook, we expect that our GP dollar will grow by as much as 4% in the quarter on a nominal basis, a nice trend given the economic headwinds. We expect SG&A expense to be up 2.5%-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 points 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.

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. Now back to you, Peter.

Peter Quigley (President and CEO)

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 GP. While signals in the macroeconomy 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.

Operator (participant)

Thank you. Ladies and gentlemen, if you would like to ask a question, please press one, then zero on your telephone keypad. You will hear acknowledgment that your line has been placed in queue. You may remove yourself from the queue at any time by repeating the one-zero command. Once again, if you would like to ask a question, please press one, zero on your telephone keypad. Our first question is from Joe Gomes with Noble Capital. Please go ahead.

Joe Gomes (Senior Generalist Equity Analyst)

Good morning. Thanks for taking the questions.

Peter Quigley (President and CEO)

Yeah. Good morning, Joe.

Olivier Thirot (CFO)

Good morning, Joe.

Joe Gomes (Senior Generalist Equity Analyst)

I wanted to kind of start out with talking about talent supply and maybe get a little more detail as to, you know, what you guys are doing to try and attract the 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?

Peter Quigley (President and CEO)

Joe, the labor force participation rate continues to be stubbornly low relative to historic participation. 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 there are unemployed people. 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, using social media to an extent that we've never used it before. 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 aspirations.

Joe Gomes (Senior Generalist Equity Analyst)

Okay. Thank you for that. Now I'm gonna switch on to the education segment. Kinda a little bit of a multipart question here, but you know, I noticed, you know, flipping through the release that that segment did show an operating loss. I'm assuming that's mostly related to just time of the year. Was there anything else that you would note that caused that operating loss in the education segment? Two, you've discussed a little bit in the past about, you know, some additional wins that you were able to get in this space. Just trying to see, you know, where you stand today. You know, is that business still attracting a lot of new wins and the kind of the pace of the wins in that segment?

Peter Quigley (President and CEO)

Yeah, Joe, the operating loss is.

Olivier Thirot (CFO)

Seasonal

Peter Quigley (President and CEO)

seasonal.

Olivier Thirot (CFO)

Yeah.

Peter Quigley (President and CEO)

It's directly related to the fact that in the third quarter, schools are only starting to open. That's just a seasonality. In terms of the wins, we continue to see outstanding demand for our services. We've had significant new wins during the year that we're implementing for the new school year that's ramping up now. We're gonna enjoy a full quarter of that, most of those wins, in the fourth quarter. The pipeline for new wins looks very good. We believe we're taking market share based on our value proposition to our customers of being the best company to deliver instructors into classrooms in an environment where there are severe teacher shortages.

Olivier Thirot (CFO)

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.

Joe Gomes (Senior Generalist Equity Analyst)

Okay. Thanks for that. One last one, if I may. I also saw this morning that you entered into an agreement to, I guess, 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 detail what that is all about.

Olivier Thirot (CFO)

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. Basically, this agreement, which I know is a long disclosure of over 170 pages, is basically on, you know, a new agreement moving from this LIBOR, sorry, to what we call SOFR. The second point is basically a change in some of our bank governance to basically expand some possibility to basically fund the share repurchase that Peter and I were mentioning today. It's basically an amendment to some of the bank governance to basically enable us to fund this $50 million initiative that, again, we have mentioned today.

Joe Gomes (Senior Generalist Equity Analyst)

Okay, great. Thanks for that. Appreciate that. I'll get back in queue. Thank you.

Peter Quigley (President and CEO)

Thanks, Joe.

Olivier Thirot (CFO)

Thank you.

Operator (participant)

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

Peter Quigley (President and CEO)

Morning, Kevin.

Olivier Thirot (CFO)

Good morning.

Peter Quigley (President and CEO)

Good morning.

Kevin Steinke (Managing Director)

Morning, Peter and Olivier. Wanted to just start out by asking about RocketPower, and diversify its customer base. Just wondering what that integration would involve. You know, 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 is there something specific about their offering that's tailored to the tech industry? Just wanna get a little more color on both of those things.

Peter Quigley (President and CEO)

Well, as we mentioned, Kevin, you know, RocketPower was enjoying triple-digit growth in Q1 and Q2 and had its hands full, given the abrupt falloff in demand in, specifically in the high-tech vertical where RocketPower had significant exposure. We think pivoting its really well-run operations to other industries will be successful and achievable. The exposure that Kelly has to blue-chip enterprise-sized customers across a variety of industries was part of the original investment thesis anyway. It's just that given the downturn in the tech vertical and specifically, we think this is the opportune time to focus RocketPower's unique operating delivery model to other industries.

That the execution of those plans is already underway, and we actually have a significant win that we'll be seeing implemented even before the end of the year as a result of the combination of RocketPower and Kelly Resources.

Kevin Steinke (Managing Director)

Okay, that's good to hear. When we think about gross margin for the year. Now, I guess if 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?

Olivier Thirot (CFO)

Yeah, I mean, what is specific on the outlook today is that as a practical matter, we have basically discussed about Q4. The 20.4%, Kevin, is related to Q4.

Kevin Steinke (Managing Director)

Understood. Okay.

Olivier Thirot (CFO)

It is still up 70 basis points, not the 220, 230, and 140 we have seen 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 gonna continue to provide some traction in terms of basically improving or continue to improve our GP growth margin rate.

Kevin Steinke (Managing Director)

Okay. I got it. Yeah. Yeah, that's specific to the fourth quarter.

Olivier Thirot (CFO)

Yeah.

Kevin Steinke (Managing Director)

That 20.4%.

Olivier Thirot (CFO)

Mm-hmm.

Kevin Steinke (Managing Director)

Okay. Just thinking about SG&A, you've mentioned that you've kind of slowed down or looking to slow down 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%-9% organically. Has there been a change in that, or is that still kind of what we should expect?

Olivier Thirot (CFO)

So-

Kevin Steinke (Managing Director)

Yep. Go ahead.

Olivier Thirot (CFO)

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 gonna talk about organic constant currency, our SG&A were up 12.6% in Q1, 9.9% in Q2, 6% in Q3. Basically, on a like for like basis, this 6% is gonna 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.

Second thing that we have started in September and that is gonna be more visible in Q4 is cost management, right? Making sure that we deploy our resources according to a very fluid and uncertain environment, as Peter was mentioning. It's very likely that we are gonna continue to see this slowdown in expenses, but also more and more redeployment depending on where, basically we still have, you know, 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 gonna continue to make sure we have sufficient resources to continue to capture growth.

Kevin Steinke (Managing Director)

Okay, great. I guess, yeah, 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 wanna be selling when, you know, the market's softer and their results might be softer. Any more just comment on just the M&A pipeline and, what, you know, what types of things you're, you might be pursuing now?

Peter Quigley (President and CEO)

We're continuing to focus on the higher margin, higher growth specialties, so that would be SET. We are very pleased with our acquisition of the Pediatric Therapeutic Services in the therapeutic adjacency to education. 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. We're, you know, 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.

Kevin Steinke (Managing Director)

Okay, thank you for taking the questions.

Peter Quigley (President and CEO)

Thanks, Kevin.

Olivier Thirot (CFO)

Thanks, Kevin.

Operator (participant)

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

Kartik Mehta (Executive Managing Director and Director of Research)

Hi. Good morning.

Olivier Thirot (CFO)

Good morning.

Peter Quigley (President and CEO)

Good morning.

Kartik Mehta (Executive Managing Director and Director of Research)

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 in the technology sector, because I know, as you said, it's really mixed as to the type of demand you're seeing. Any type of granularity there would be great.

Peter Quigley (President and CEO)

Yeah. 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, you know, all of the companies that are in the press announcing either layoffs or, you know, slowdowns in hiring, including, you know, 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. As I mentioned in the script, we're seeing solid demand in our Softworld. They continue to provide high-quality technology talent to enterprise and small, medium-sized businesses. We don't think there's any pending slowdown in that demand because large institutions continue to need app developers and network architects and cybersecurity experts.

At least for the near term, the high-tech industry, Silicon Valley, you know, Austin, Texas, other areas have been particularly hit by the uncertain macro, as well as potentially over-hiring coming out of the pandemic.

Kartik Mehta (Executive Managing Director and Director of Research)

You know, as you look at M&A targets and considering the impairment charge on RocketPower, does that change maybe how you're looking at future M&A targets, or does it change how you might underwrite them in the future?

Peter Quigley (President and CEO)

Well, we're very pleased with the performance of our acquisitions as you know, in totality. The RocketPower, the abrupt decline in the high-tech vertical that they had significant exposure to was a, you know, 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 top-line synergies for the company and create opportunities to attract new customers to Kelly.

Olivier Thirot (CFO)

Yeah, 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, are growing 23% in revenue in Q3. Greenwood & Asher, interestingly, over 80% growth. Softworld, which is in the technology, +7% in revenue. NextGen and GTA, which is now what we call our telecom specialty, growing at about 34%. 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.

Reflecting on 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 growth margin profile that is, of course, much higher than the average growth margin we have for the rest of Kelly.

Kartik Mehta (Executive Managing Director and Director of Research)

Just one last question. You know, based on what you just said, Olivier, and what you've said so far about the demand in business and supply and demand of labor, as you look at your gross profit margins over the next 12 months, you know, are there headwinds that would make you go, you could see them contracting, or is there enough demand that you should continue to see growth in gross profit margins?

Olivier Thirot (CFO)

I think what we are gonna 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, it's already much lower. It's about 10 basis points. What we are gonna continue to see with is what we have seen for the last five years, basically a structural improvement of our GP margin coming from what we call mix, meaning specialty mix, continuing to grow higher growth 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. I see this traction continuing in the future because that's something we have seen for, well, since 2015, in fact, with not one year where basically our GP rate went down. Now, we don't expect 230 basis points that we have seen in Q1 or Q2, but meaningful improvement on a pure organic structural specialty mix, yes. Definitely yes.

Kartik Mehta (Executive Managing Director and Director of Research)

Thank you so much. I appreciate it.

Olivier Thirot (CFO)

Thank you.

Operator (participant)

Next we go to Mitra Ramgopal with Sidoti. Please go ahead.

Mitra Ramgopal (Senior Equity Analyst)

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

Peter Quigley (President and CEO)

Good morning.

Olivier Thirot (CFO)

Good morning.

Mitra Ramgopal (Senior Equity Analyst)

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

Peter Quigley (President and CEO)

Well, we're gonna continue to invest in the areas where we think we can get a meaningful return. 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. 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. 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.

Mitra Ramgopal (Senior Equity Analyst)

Yes, thanks. Just switching gears a little in terms of Europe. Saw some softness in areas France, U.K., Italy. Not surprising given what we're hearing from Europe, but what's your expectation in terms of maybe a stabilization there or should we expect a continued softness well into next year given the macro environment?

Olivier Thirot (CFO)

Yeah. Interestingly, when we, you know, exclude, of course, FX, which is creating a lot of noise, and also Russia, which I think is more like externally driven. You look at in Q1, we are growing at about 9%, so very similar to the entire 2021. Q2 we're around 9%. Q3 we are at about 7%. So. Our fee business was still up 10% in Q3, including the fact that we have lost the benefit of Russia, and Russia historically has been a nice fee business. For the moment, honestly, we don't see specific signs of slowing down. It may come, but we believe that it's gonna slow down a little bit, but what we have seen so far is a very resilient business in Europe.

Of course, we are scrutinizing a little bit, you know, what is going on, looking at hours on a weekly basis, looking at our fee business, getting ready if something is changing. I believe it's gonna slow down a little bit, but for the moment, I would say it seems to be very, very resilient.

Mitra Ramgopal (Senior Equity Analyst)

Okay. No, thanks. I guess finally, it's obviously an unknown for most companies, but as you look into 2023 again and as you look at your portfolio of businesses, despite the environment, should we still continue to expect year-over-year growth? I know you're not providing guidance, but just on a very high level, you still expect the company to grow next year despite the macro headwinds.

Olivier Thirot (CFO)

Yeah. It's probably a difficult question knowing the environment we have now. When you think about resiliency and we can speak about, you know, education, our SET 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 they are gonna be likely more subject to the future economic environment.

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, you know, other areas that are more exposed to, I would say the cyclical, you know, challenges we may see in terms of economic environment in the near future.

Mitra Ramgopal (Senior Equity Analyst)

Okay. Yeah. That's very helpful. Thanks again for taking the questions.

Peter Quigley (President and CEO)

Yeah. Thank you.

Olivier Thirot (CFO)

Thank you.

Operator (participant)

Ladies and gentlemen, for any follow-up questions, please press one then zero at this time. We have no other questions. You may continue.

Peter Quigley (President and CEO)

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

Olivier Thirot (CFO)

Thank you, Leah.

Operator (participant)

You're very welcome. Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation.