Kelly Services, Inc. (KELYA) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to Kelly Special Investor Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Peter Quigley, President and CEO. Please go ahead.

Thank you, J.J. Hello, everyone, and welcome to the special Kelly investor conference call regarding the acquisition of Motion Recruitment Partners, which I'll refer to as MRP going forward. Before we begin, I'll walk you through our safe harbor language. 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. Finally, the slide deck that we're using on today's call is available on our website. The purpose of today's call is to provide more details about the strategic rationale for Kelly's acquisition of MRP and its expected contribution to Kelly's specialty growth strategy. We will not provide an update on Kelly's financial results for the second quarter. With that, let's get started. On June 3, Kelly announced the completion of our acquisition of MRP to our new colleagues at MRP, who are listening to today's call, I'd like to say how pleased I am to welcome you to Kelly in getting to know the MRP team during the past several months, what immediately stood out is their high-performing culture, their extensive expertise in the markets they serve and our shared commitment to connecting people to work in ways that enrich their lives. I'm confident. I speak for the entire Kelly team when I say I look forward to working together and reaching extraordinary new heights. With the addition of MRP to Kelly, we have taken a transformational step forward on our journey to sharpen our focus on higher growth, higher margin specialty outcome-based and staffing services in North America and global RPO and MSP solutions. This journey began in earnest in 2020 when we launched our streamlined operating model, which organized our business units by specialty. Notwithstanding challenging market dynamics that have persisted during much of the time since then, we have executed a steady cadence of actions to unlock capital, drive specialization and accelerate our transformation. These actions are delivering results, including an adjusted EBITDA margin of 3.2%, a significant improvement from Kelly's recent average of approximately 2% delivered in a very short time. At each step of our journey, we focused on what we can control and kept our sites transquarely on growth. The acquisition of MRP will propel Kelly further on our specialty journey into a new era of growth. It adds both scale and new capabilities that elevate the competitive positioning of our SET and OCG businesses and introduces Kelly to an exciting set of new customers. We took an opportunistic approach to this deal sourcing the target proactively, bypassing the customary auction process. This enabled us to secure optimal terms and reflects our confidence in the strategic fit and outlook reinforced by MRP's management. Their leadership team of recruiting industry veterans has navigated multiple economic cycles building MRP into an efficient, resilient business with a track record of outsized results. At the core of the value case for this deal is the highly complementary nature of MRP's portfolio of businesses and our SET and OCG businesses. Motion Recruitments, technology staffing and consulting business expands Kelly's SET delivery platform and establishes the business as a top provider of tech talent solutions in the U.S. SEVEN STEP its industry-leading brand and attractive client base in both RPO and MSP to build upon Kelly OCG's capabilities and market position. Motion Telco will add a complementary client portfolio and set of delivery capabilities to Kelly's existing telecom specialty to create a market-leading telecom offering. NTG Federal will bring a dedicated new platform in government technology subcontracting with strong partnerships to build upon Kelly SET success in the government space. I'm confident that MRP's portfolio of businesses led by seasoned industry leaders will contribute in a significant way to enhancing Kelly's revenue growth potential and driving continued EBITDA margin expansion. I'll now turn the call over to our Chief Financial Officer, Olivier Thirot, who will provide more details about MRP's financial profile.

Thank you, Peter, and good morning, everybody. MRP provides technology staffing, solutions and consulting services, along with RPO services to customers in attractive end markets. In particular, the opportunity to significantly expand Kelly's presence in the financial services, technology and health care made MRP a very compelling target. At over $500 million of revenue, MRP bolsters Kelly's specialty product offering, especially in our technology practice. Finally, MRP has demonstrated its ability to capture profitable growth during periods of market expansion. MRP's 2023 gross margin of 30% and EBITDA margin of 7% in the same year are commensurate with its position as a highly specialized technology talent solutions provider. In addition of MRP replaces some of the scale divested in the sale of our European staffing operations, but at a higher margin. Taking 2023, Kelly revenue, excluding the results of the divested European staffing operations as a starting point. The addition of MRP adds 100 basis points to Kelly's overall gross margin and will increase SET contribution to revenue from 29% to 38%. Within Kelly SET MRP adds both scale and capabilities in the technology, telecom and government practices. MRP doubles the size of Kelly higher-margin technology practices to approximately 34% offset total revenue in 2023 on the proforma basis, making it the biggest SET practice. It also increases SET 2023 gross margin by almost [ 230 ] basis points. Moving to MRP's indicative financial performance, I'd like to first provide some context. Similar to Kelly and other peers MRP has been impacted by persistent market headwinds, especially in direct hire MRP. In the IT staffing and consulting segment, MRP's revenue declined 8% between '22 and '23, direct hire and RPO businesses, while high margin are more volatile outside of 2023, MRP direct hire revenue has run from approximately $50 million in 2020 to $80 million in 2022. Similarly, 2023 was a challenging year for RPO, especially compared to 2022 at approximately $50 million in revenue. Overall, MRP's total revenue decreased by 14% in 2023 after achieving significant growth of 14% in 2022. While 2023 was a challenging year for the industry as a whole and for MRP, we are confident that with its resiliency and track record of growth, MRP is well positioned for when the market returns to more normalized conditions. Overall gross profit rate was impacted primarily by the flow-through of higher revenue decline as a result of the current challenging market conditions. In 2023, MRP focused on managing its cost base. MRP expense control and cost improvement measures reduced SG&A significantly year-over-year while maintaining capacity to capitalize when market conditions rebound. SG&A initiatives offset approximately half of the year-over-year gross profit decline, resulting in a 2023 adjusted EBITDA margin of 7%. The beginning of 2024 through the continuation of challenging market condition experienced by MRP and the industry as a whole in the second half of 2023, but signs of stabilization began to appear in April of 2024. Kelly acquired MRP for a purchase price of $425 million, additional cash consideration of up to $60 million, maybe due in the second quarter of 2025, if certain conditions are satisfied during an earnout period ending on March 31, 2025. The earn-out payment is based on a multiple of trailing 12 months gross profit and MRP would need to exceed its 2023 gross profit to realize any proceeds from the earn-out. The earn-out provision is designed to mitigate risk to the valuation multiple, resulting from current uncertain market conditions. $425 million cash at close purchase price is equivalent to 11.4x 2023 adjusted EBITDA 7.1x 2022 adjusted EBITDA and about 8.5x 5-year average meaning from 2019 to 2023, adjusted EBITDA, which we believe represents the performance of the business through the entire cycle. If fully achieved, earn-out would decrease the purchase multiple by about 1/3. We expect the transaction to be accretive as soon as 2025, but EBITDA accretive as soon as 2024. We expect to incur approximately $12 million in onetime transaction-related and initial integration planning fees and expenses in 2024. [indiscernible] transaction through debt and available capital, including the rapid redeployment of more than $100 million from the sale of Kelly's European staffing operations in January of 2024. Kelly borrowed $263 million under its current facilities and funded the remainder with cash on hand. At the time of the acquisition, estimated debt-to-EBITDA ratio is 2.3x. At the time of the acquisition, Kelly renewed its credit facilities to fund the acquisition of MRP and to provide additional available capital for future organic and inorganic initiatives by adding an accordion feature to its revolver and securitization facilities. Now I turn the call back to Peter to share more about our approach to realizing the value of this transformational acquisition.

Thanks, Olivier. As we move forward, our initial focus is on facilitating a smooth transition for MRP and supporting its team members and customers. To help achieve this, MRP will continue to deliver services through its existing operating companies and brands while we take a thoughtful and deliberate approach to integration. We will report results for MRP as part of the SET segment. Our integration strategy will leverage learnings from Kelly's acquisition of Softworld as well as MRP's 2022 acquisition of Matrix, a technology staffing and managed solutions company. This approach will enable us to create a clear pathway to achieving revenue and cost synergies. We expect synergies to ramp later in 2025 and throughout 2026, culminating in an expected favorable EBITDA margin impact of approximately 150 basis points. With this acquisition, we are well positioned to compete in the specialty technology staffing and solutions space. The highly complementary nature of MRP and Kelly's businesses. MRP's attractive financial profile and its strong strategic fit, make this transaction a win for all our stakeholders. It's a direct result of our aggressive pursuit of inorganic growth backed by our strong balance sheet and the unwavering support of our Board of Directors. I'm grateful to them to Team Kelly and our new colleagues at MRP for being part of this journey. I look forward to working together to realize the significant growth and value creation opportunities that lie ahead. J.J., you can now open the call to questions.

Our first question comes from the line of Kartik Mehta from Northcoast Research.

To get an asset that's going to provide you higher margins than you have -- obviously, you have to pay a premium. And I'm wondering -- as you look at the current assets, maybe what are the trends have been for 2024? And what do you think is the growth rate of this business? Obviously, 2022 and 2023 could be outliers. I'm just wondering, as you look at the business, what you anticipate from a growth rate standpoint over the next couple of years and what the trends have been so far?

Yes, it's Olivier. And I think I'm going to start, and Peter is going to give some additional color. So you might see that we have shown the trailing 12 months April to give the most recent information. What we see now is a form of stabilization, meaning their revenue is standing firm GP rate as well and net margin. If you think about the future, and we have seen that when you look at beyond '23 and '22 or even the current situation, the growth potential of this business is commensurate with the areas this business is focusing on IT, mainly, and I would say probably if you think about market conditions, when markets are recovering, I don't see? or I would see something around 5% to 10% growth on a more normalized environment. But Peter, you can give more color on to that.

Yes. We think the growth potential for this business is significant, not only as a stand-alone business, but in combination with Kelly. We have highly complementary assets and capabilities. We have very little overlap in terms of our customer sets. So we think the growth potential because they participate in the markets that Olivier mentioned that are high-growth markets in our industry and just generally with the introduction of AI and the increasing focus on cybersecurity and other high-growth areas in the technology space. We think there's a lot of upside both in the Kelly legacy technology space as well as the MRP technology space in addition to their government, Telco and the SEVEN STEP practices.

And then, Olivier, just on the debt, maybe what the focus will be. Are you intending on paying down the debt as quickly as possible? Or you'd like to keep a certain level on the balance sheet.

Yes. I mean, as mentioned at the time of the acquisition, we were and we are still at about 2.3x EBITDA. As explained during this call, we have renewed our current revolver and securitization facilities to give us flexibility in the future. We have added what is called an accordion on both of them to give us flexibility. Not knowing, what are the future inorganic opportunities. If you just look at the current situation, we expect Kelly to deleverage in such a way that by 2026, our debt would be nearly zero. It means that in the course of 2025, financially speaking, we would be at the level of EBITDA multiple in terms of debt that would enable us to potentially go for a next round of acquisition, especially with our accordion that I was mentioning for both our revolver and securitization.

And then just one last question, Peter. Just on synergies between the two businesses. I know you said that you don't have much overlap. But what type of synergies do you think are possible when you combine your SET business with MRP.

Well, I think there are several regarding the opportunities in addition to the lack of overlap. So just the introduction of Kelly to MRP customers and vice versa present some pretty exciting opportunities. But the delivery capabilities that MRP brings both in supporting enterprise customers as well as small and business enterprises complement Kelly's delivery profile. And we think the combination of those two stand to benefit both our large enterprise account business in SET as well as our local delivered small- and medium-sized business and MRP and Kelly have the opportunity to continue to expand into the solution space, our outcome-based businesses in the legacy SET business is doing well in this environment, has a strong track record of growth, and we believe that introducing further solutions capabilities to the MRP customer base provides some additional upside.

Our next question comes from the line of Joshua Zoepfel from NOBLE Capital Markets.

. So I just want to have -- just -- I'm sorry if you guys already talked about this, but can you kind of just expand on the purchase price? Like how much was that $425 million in debt?

Yes, as I indicated, and I'm going to give you the level of debt at the time of the acquisition, we were at basically $233 million. But of course, in then basically the level of debt is filterating. Again, we expect to completely deleverage as early as 2026 putting aside, of course, additional inorganic initiatives we may have as soon as late '24 or beginning of 2025. So this is where we are.

Okay. Perfect. And just going on into the MRP. For the government services, you guys talked about -- you guys having basically great relationships as a subcontractor when you guys move a prime contractor. Kind of how does the margin profile kind of look for that subcontracting portion of MRP.

So the -- yes, that's an important opportunity for both Kelly and MRP, just to explain that, that Kelly tends to be a prime contractor in the government space. That's the majority of our business there, while MRP, the Federal business there tends to be a subcontractor, which are different go-to-market strategies, but potentially very complementary. And so our expectation is that we will be able to introduce the prime contracting expertise to MRP and the subcontracting expertise to Kelly in a mutually beneficial way. In terms of the margin profile, I'm not sure we've...

No. We have not disclosed anything on that. So I think we cannot really comment on that.

Okay. And just kind of on a brand level of thinking, obviously, you guys have mentioned the technology space being historically are even one of the most -- one of the faster-growing ones. I guess kind of want to get the companies just color on just kind of the industry, the space in 2024 and beyond. .

Well, I think the -- as Olivier said, I think we've begun to see signs of stabilization, which is very positive. I think if you look at the most recent SIA and Bullhorn professional services portion of the industry. They're beginning to show signs of some improvement. And we believe in discussions with our customers and just in the industry generally, that large enterprise customers are going to and small customers are going to continue to invest in technology because they need to stay competitive. They need to protect their infrastructure against cybersecurity and other risks. So while the past 12 to 18 months has not been a stellar period for the -- that portion of the industry. We believe that the lag is temporary, and we believe that we will see signs of growth in demand pick up and increase as this been the case according to historical trends. So we're very bullish on the long-term prospects for being a major player in the technology space.

Yes, perfect. Just kind of one last question for me before I get back in the queue. I guess, obviously, with MRP has recently sold [indiscernible] Group as well. Kind of is there any more levers that the company can really pull on a lot more capital in the future?

Well, it has been our track record, we're always looking at opportunities that may come along to create additional value for our shareholders, our employees, et cetera. But the sale of the [ Ares ] was really just to allow a company that's focused on outplacement and coaching to be owned by an organization that is prepared to invest. We were not prepared to invest in that business, and it was not something that had a strategic fit since our new operating structure focusing on specialty businesses. So that was the rationale for the [ Ares ] transaction, not a material transaction in terms of purchase price, but one that we think adds additional focus to Kelly, and we're very excited about bringing MRP into that discussion with us about the future remix of the business towards higher margin, higher growth businesses. .

Just maybe to follow up on the point, it's not material. I mean just to give you an idea, revenue of these years activity as well as the proceed, we have -- we got from the transaction, both of them are less than $10 million, right? So that's just to give you an idea of the fact that it was a good move based on our strategy and our focus. But financially speaking, the impact is limited.

Our next question comes from the line of Marc Riddick from Sidoti.

I wanted to touch a little bit on the -- I think the comment was that this would all sort of be included going forward as far as reporting wise, through SET, if I caught that correctly. I just wanted to sort of maybe you could touch a little bit on because if I recall as far as SEVEN STEP having sort of connection via OCG. So I was wondering if you can maybe sort of clarify that a little bit for us.

Yes. So the decision to have it report into the segment is primarily the result of the fact that majority of the revenue of MRP is related to its technology, telecom and the Federal business. SEVEN STEP is a very important ingredient to the investment thesis. But for the purpose I just mentioned as well as we are in an earn-out period and we'll be operating MRP using its existing delivery means and brands. It just made sense during that period that we're going to report the entirety of MRP within the SET segment. .

Okay. Okay. That makes sense. And then I was wondering if you could talk maybe a little bit about -- and obviously, it's early days, but do you see as far as potential for investment? Or do you see some target areas, whether it's needing to spend on personnel technology, things like that? Could you maybe sort of talk about maybe what you see there? Or maybe it's just sort of too early for that.

Well, we are pleased that MRP has taken the position of being very prudent with their resources during the current market conditions, but they haven't done it where they've sacrificed the opportunity to take advantage of a rebound when it comes. And so our philosophy is very similar to make sure that when particularly the technology markets now that we've seen them stabilize when they rebound be in a position. And when that happens, it can happen very quickly and an investment in recruiters and salespeople is something that we have discussed with the MRP management team. We've also considered the preparation for that inside the Kelly Legacy SET business. And so yes, we'll be prepared to take advantage of an upswing if and when it occurs. I'm sure it will occur, but it's just a matter of timing. But we'll be prepared.

Okay. Great. And then I wanted to sort of get a sense of with a transition of the size is the largest of the company's history. The integration in front of you. I was wondering if you could talk a little bit about maybe what that does for your overall acquisition appetite in either in the near term or how we should be thinking about you sort of pause things a little bit for -- during the integration? Or should we view your general appetite for assets as being similar to what it was prior to this.

Well, I think as a practical matter, given the leverage that we have today, it probably will not lead us to be making an acquisition immediately. But you know the lead times for acquisitions can run 12, 18 months, sometimes longer, particularly if you're trying like we did in the case of MRP to develop a target proactively. So we will continue those efforts in the areas that I've talked about before, primarily in the science engineering technology and telecom, space as well as education and then OCG opportunistically. But the work that we're doing to prepare for another acquisition will begin or will continue, and we'll just have to see how the available capital progresses, as Olivier said, as early as late '24, sometime in '25, we could have an appetite to use some capital for purposes of an inorganic. And certainly, by the time we're back to no debt sometime late '26, we'll be very well prepared.

Thank you. I would now like to turn the conference back over to Peter Quigley for closing remarks.

J.J. if there are no further questions, I think we can end the call, and thank you for everybody's participation.

This concludes today's conference call. Thanks for participating. You may now disconnect.