Kelly Services Inc (KELYA) 2006 Q3 法說會逐字稿

Good morning and welcome to the Kelly Services third-quarter conference call. All parties will be on listen-only mode until the question-and-answer portion of today's presentation. Today's call is being recorded at the request of Kelly Services. If anyone has any objections, you may disconnect that this time.

I would like to turn the meeting now over to your host, Mr. Carl Camden, President and Chief Executive Officer. Sir, you may begin.

Good morning and welcome to Kelly Services' third-quarter 2006 conference call. With me this morning to review our quarterly results is Bill Gerber, our CFO. I'll begin by giving you some general color on the third quarter and, following that, Bill will provide financial commentary and our guidance for the balance of the year. Then I'll cover the performance highlights for our three business segments and share our outlook. After our comments, we will open the call to your questions.

For those of you did not receive a copy of this morning's release you can visit our website at kellyservices.com, or contact Jim Polehna, our Director of Investor Relations, at 248-244-4586.

Let me remind you that the 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. Please refer to our 2005 10-K for a description of the risk factors that could influence the Company's actual future performance.

Now on to the third quarter. First, revenues increased 5.5% to $1.4 billion. Earnings per share were $0.49, up 40% from the $0.35 delivered in the third quarter of 2005. These third-quarter results exceed the $0.43 to $0.48 guidance we gave on our July conference call.

That's especially satisfying because the long-awaited Work Opportunity Credit legislation still hasn't been approved for 2006. Had that legislation passed during the quarter, as we had expected, our earnings would have been even stronger. Naturally, we're disappointed in the delay, but we still believe that the legislation will be passed before year end.

Equally important, our strong earnings performance occurred in spite of a slowdown in the U.S. economy and moderating temporary job growth. This is noteworthy, given that approximately two-thirds of our business currently comes from the U.S. market.

We were able to mitigate some effects of the slowing with nice improvement in our gross profit, resulting principally from good fee growth and better management of Workers' Compensation in our core U.S. business. Our success in the third quarter was principally driven by demand for Specialty Staffing Services, along with the strong performance of our International segment, affirmation that our strategic investment in PTSA and International is gaining traction.

I'll talk more about that in a few minutes, but first, let's get into the numbers. Here is Bill to take you through our quarterly financials.

Thank you, Carl. I'll start by covering third-quarter results. Revenue for the third quarter totaled $1.419 billion, an increase of 5.5% compared to last year. On a constant currency basis, total Company revenue increased 4.2%. As we expected, this reflects slowing from the 7.6% constant currency growth reported in the second quarter.

Our gross profit rate in the third quarter was 16.8%, and increased 6/10 of a percent compared to last year, primarily due to improved Workers' Compensation costs and growth in fee-based income. Sequentially, the 16.8% rate increased 5/10 of a percent compared to the second quarter.

Selling, general and administrative expenses in the third quarter totaled $213.3 million, and increased 6.2% year-over-year. On a constant currency basis, total expenses increased 4.9%. SG&A expenses were 15% of sales, a 1/10 of a percent increase compared to last year.

Earnings from operations in a third-quarter totaled $25.3 million, a 45.7% increase compared to last year. Other income totaled $348,000 compared to $10,000 last year. The improvement is due primarily to higher U.S. interest rates and higher cash balances.

Well, the effective tax rate for the third quarter was 30.4% which is higher than the 26.9% rate last year. Unfortunately, Congress did not pass the Tax Extenders Bill, which included retroactive extension of the Work Opportunity Credits in the third quarter. We believe that the legislation will still be passed this year, but we can't recognize the benefit until the bill is signed. In contrast, the third quarter of last year did include the Work Opportunity Credits.

Now we originally provided third-quarter tax rate guidance of approximately 26%, which assumed the retroactive extension of the credits. Although we did not get the Work Opportunity Credits, we did benefit from the favorable resolution of a prior year tax audit. The negative impact of not booking the tax credits was partially offset by the favorable audit results. The combined net higher tax rate negatively impacted earnings by about $0.03 per share.

Our third-quarter net income was $17.8 million, a 40.6% increase compared to the $12.7 million earned last year, and diluted earnings per share in the third quarter totaled $0.49 per share, a 40% increase compared to earnings of $0.35 per share last year. Note that the $0.49 includes stock option expense of a bit less than $0.01 a share.

Now I'll cover our segment revenue results for the third quarter. As you know, we divide our operations into three segments -- number one, U.S. Commercial staffing; number two, PTSA, our Professional, Technical, and Staffing Alternatives units; and number three, International.

Revenue in U.S. Commercial totaled $625.2 million, a 1% increase compared to last year. As Carl mentioned in our July conference call, we did see a slowing of growth in the U.S. market. That trend resulted in U.S. Commercial sales growth slowing from plus 6% in the second quarter to plus 1% in the third quarter.

Turning to PTSA, revenue for the third quarter totaled $287.6 million, an increase of 9/10 of a percent compared to last year. Here, revenue growth slowed from 4.3% in the second quarter.

Moving on to the International segment, revenue for the third quarter totaled $506 million, a 14.9% increase versus the prior year. On a constant currency basis, our International revenue increased 10.8%, just a bit slower than the second-quarter growth of 11.8%.

U.S. Commercial earnings totaled $32.5 million, an increase of 5.4% compared to last year. The U.S. Commercial gross profit rate increased 5/10 of a percent from the prior year, primarily due to reduced Workers' Compensation costs, improved payroll tax rates and growth in fee-based income.

U.S. Commercial expenses increased 3.7%. About half of the expense growth was due to the ramp-up of costs for the Nike and Orange County Florida account wins in advance of the full revenue. Expenses were 10.4% of sales, a 3/10 of a percent increase compared to last year.

PTSA earnings totaled $20.8 million, a 25% increase compared to last year. The PTSA gross profit rate increased 160 basis points, primarily due to reduced Workers' Compensation costs at Kelly Staff Leasing and recognizing a full quarter's impact of the higher-margin Ayers outplacement business.

PTSA expenses increased 3.4% year-over-year. Expenses as a percent of sales were 11.6%, an increase of 3/10 of a percent compared to last year. Expenses increased due to a full quarter's impact of the Ayers outplacement business, which was offset by reduced expenses at the Kelly Homecare unit.

International earned a profit of $10.4 million, a 77.9% increase compared to last year. The International gross profit rate of 17.2% was the same as last year. International expenses increased 9.5% in U.S. dollar terms, but increased 5.8% on a constant currency basis. International expenses were 15.1% of sales compared to 15.9% last year.

And finally, moving on to Corporate expenses for the third quarter totaled $38.5 million, an increase of 6.8% versus last year. Corporate included FAS 123(R) stock option expense of approximately $300,000.

Shifting to the Company's third-quarter balance sheet, I'll make a few comments. Cash and short-term investments were $78 million at quarter end, an increase of $19 million compared to last year. Accounts Receivable totaled $878 million at quarter end, and increased $66 million compared to last year. For the third quarter, our global days sales outstanding were 56 days, an increase of one day compared to last year.

Our short-term debt at quarter end totaled $58 million, a $10 million increase to last year. And at quarter end, short-term debt was less than 8% of total capital.

And finally, a few comments on the Company's cash flows. Net cash provided by operating activities was $59 million for the first nine months compared to $15 million last year. The strong improvement was due to higher net earnings and lower growth of Accounts Receivable.

CapEx for the first nine months totaled $26.1 million compared to $17.9 million spent last year.

We now expect our 2006 capital expenditures to total between $36 million to $40 million compared to $29 million last year. The increase is due to investment associated with the design and implementation of the PeopleSoft payroll and billing project.

As highlighted in the press release, our guidance for the fourth quarter is that diluted earnings per share will range from $0.46 to $0.51 compared to $0.37 per share last year. Incorporated into our fourth-quarter guidance are the following assumptions.

Revenue growth in the U.S. market is expected to be comparable to the growth rate in the third quarter, or about flat to up 2%. Stock option expense will be approximately $300,000, or a bit less than $0.01 per share.

The effective tax rate will be approximately 24%, which assumes legislation retroactively extending Work Opportunity Credits to the beginning of 2006 will be signed during the fourth quarter. The 24% rate reflects four quarters of cumulative catch-up. If the Work Opportunity Credits are not renewed during the fourth quarter, the effective tax rate would jump to about 43%.

For the full year, we expect that earnings will range from $1.54 to $1.59 compared to $1.09 per share in 2005. The full year will include approximately $1.5 million, or $0.03 per share, of stock option expense.

We expect that the full-year effective tax rate will be approximately 33%, again assuming retroactive extension of Work Opportunity Credits. If the credits are not renewed for 2006 at all, the full-year tax rate would be about 38% and the negative impact on EPS would be approximately $0.11. We continue to monitor the Tax Extenders legislation carefully and continue to believe the credits will be passed in the fourth quarter.

I'll now turn it back over to Carl, who will highlight our operating results.

Thank you, Bill. Now, let's take a closer look at our segment results, beginning with U.S. Commercial, which makes up 44% of revenue.

After revenue growth of nearly 8% in the first half of 2006, revenue grew only 1% in the third quarter. You may recall that on our second-quarter conference call we said that we were expecting our revenue growth in the U.S. to slow somewhat as U.S. GDP growth moderated.

However, the slowing was a bit more than we had expected. Many of our customers delayed their normal pattern of adding temporary employees during the quarter in response to the slower economic growth in the U.S. But the hiring of permanent employees remains solid and resulted in strong fee growth. This leads us to believe that we're in the midst of an economic pause, or what some are calling a soft landing, rather than the beginnings of a more serious downturn.

Adjusted for the Independence Day holiday, Commercial's revenue was up 3% in July and 1% in August and 1% in September, a more rapid slowing than we had originally expected when the quarter began. However, during the past few weeks, we are again seeing the normal seasonal, sequential increases in the usage of temporary employees, and we're optimistic that this trend will continue for the balance of the year and into 2007.

All major service lines showed slowing in the year-over-year sales growth during the quarter compared to the second quarter. Office clerical staffing, which represents over 50% of Commercial's revenue, was down slightly for the quarter, while lift increased less than 1%.

The growth of both our temp-to-permit and direct placement fees remains solid. Fee income was up over 30% year-over-year, consistent with the growth that we've seen in the second quarter. This is Commercial's ninth consecutive quarter of double-digit fee increases.

The gross profit rate during the quarter increased to 15.6% from 15.1% during the same period last year, also an improvement from the 15.3% GP rate we had in the second quarter.

Expenses increased 4%, about the same as last quarter, but at a faster rate than the 1% sales growth. And as a result, expenses as a percentage of revenue increased to 10.4% from the 10.1% last year.

As mentioned in our second-quarter comments, we won two new, large contracts, Nike and the Orange County Florida public schools. These accounts have large U.S. Commercial components. And as such, we expect Commercials expenses to be higher than normal as we geared up to service these accounts. These accounts are projected to earn a positive return in the fourth quarter.

Summing it all up, year-over-year, operating earnings increased 5% in the quarter in U.S. Commercial.

Moving on now to PTSA, which makes up 20% of revenue. The third quarter for PTSA was also negatively impacted by the slowing in the U.S. On a year-over-year basis, revenue was up only 1%, but earnings increased 25%. PTSA's revenue, again adjusted for the holiday, was up 2% in July, 3% in August and flat in September. We are seeing nice results from the Ayers acquisition and are also beginning to see fee improvement overall as we've been investing in more recruiters.

So let's take a look at PTSA in a bit more detail. First, the Professional group, which is comprised of five business units, Financial Resources, the Law Registry, Homecare, Healthcare and FedSecure.

Year-over-year, revenue growth for this group was up about 1%, while earnings were up by over 40%. The turnaround for Kelly Homecare is evident and continues as planned. Same-branch revenue continues to grow with a significant improvement in bottom-line earnings.

Another leading performer in the Professional group is Kelly Healthcare. This business unit exhibited strong single-digit revenue growth with solid double-digit growth in earnings. And as we expand into new Healthcare segments, we expect this growth to continue.

Second is the Technical Staffing Group, comprised of our business units -- Automotive Services, Engineering, IT and Scientific. Revenues were down slightly and earnings for this group were about flat to last year. Once again, Engineering exhibited the strongest performance, with double-digit revenue and earnings growth. Our Automotive business, however, remained soft, but with solid expense control helping improve their earnings slightly.

Both Kelly Scientific and IT Resources were down year-over-year on both revenue and earnings. But we are seeing early signs of improvement in these two businesses as we enter the fourth quarter.

Finally is the Staffing Alternatives Group, made up of five business units -- Management Services, HR First, Vendor Management, Staff Leasing and Ayers, our outplacement group. Once again, Staffing Alternatives had double-digit growth in both revenue and earnings for the quarter. HR First and Kelly Management Services were the leading performers in the group, with very strong sales and earnings growth.

While year-over-year revenue growth in Staff Leasing declined during the quarter, earnings were up significantly due to both better Workers' Comp experience and a more profitable customer mix.

For nearly a year now, we've been reporting that growth in PTSA fees was decelerating, and in fact went slightly negative in the second quarter of this year. We are pleased that we've seen a reversal of this trend in the third quarter, with fees growing organically at an 8% rate. Combined with the fee income from our newly acquired Ayers group, year-over-year fee growth improved nearly 30% in PTSA.

The PTSA gross profit rate improved 18.8% in the third quarter compared to 17.2% for the same period last year. Also, this was a sequential improvement from the 17.3% in the second quarter.

Expenses increased 3% in PTSA compared to the same period last year, and expenses as a percentage of revenue increased to 11.6% compared to a year ago. We expect moderate expense growth in this segment as we continue to take advantage of growth opportunities and specialty staffing.

Our third segment is International, which makes up about 36% of our total revenue. This was a great quarter for International. Reported revenue increased 15% for the quarter and, on a constant currency basis, International revenue was up 11%. Earnings were $10 million for the quarter, up nearly 80% compared to our Q3 earnings last year. We are very satisfied with the solid sales and earnings growth in International and are pleased with our International development strategy.

Sales in Europe increased over 13% in constant currency. We are encouraged by the positive trends seen throughout continental Europe. Sales in the UK/Ireland decreased about 1%, so excluding the UK, sales growth in Europe would have been closer to 23%.

The 16% growth in our Asia-Pacific region was once again fueled by our operations in India and Malaysia. Sales growth in India increased more than fivefold compared to last year. Growth there is benefiting from both branch openings and significant new accounts. Growth was exceptionally strong throughout the rest of South Asia.

In the Americas, sales for the quarter were slightly positive. Once again, sales growth was positive in Mexico and Canada, but as expected, Puerto Rico sales growth declined significantly.

Consistent with the last few quarters, we saw double-digit growth in fees in International, with fees growing more than 21%. Particularly strong fee growth was seen in continental Europe and Asia-Pacific, at 49% and 26%, respectively.

International's gross profit rate was 17.2%, consistent with the third quarter last year. However, this does represent a sequential improvement compared to the 16.9% in the second quarter, driven primarily by growth in perm fees.

International expenses for the quarter grew 6% on a constant currency basis. Expenses as a percentage of revenue were 15.1% compared to 15.9% last year.

During the quarter, we opened five new International branches, two of which were PTSA offices. In addition, on October 2, we increased our ownership interest in Tempstaff Kelly to 49%. You may recall that in September of 2005, Kelly established a joint venture staffing company in Japan, along with Tempstaff and Sony Corporation. This entity was formed primarily to service the staffing needs of Sony.

The purchase of Sony's interest strengthens Kelly's global presence in this important staffing market, and the pursuit of additional growth opportunities in key Asia-Pacific markets remains a central component of our strategic growth plan.

At present, we believe that we're experiencing a pause in economic growth here in the U.S., one caused by many factors, including geopolitical events, the price of oil, a soft housing market and persistent inflation worries. But as we've said before, it's not uncommon to see similar ebbs and flows as part of a normal economic cycle.

What's important, though, is that we're continuing to see underlying strength in the U.S. economy. Though cautious, our customers' employment outlook remains positive, and the more recent trends in our business suggest that the typical seasonal sequential growth should continue.

Temporary job creation has been somewhat sluggish in recent months, although we believe this is a short-term occurrence. Overall, job creation remains positive and economic expectations point to respectable GDP growth in the range of 3% to 3.5% for this year and a slightly slower 2.5% to 3% rate for 2007.

When we began this year, we did not expect the U.S. to undergo a slowdown. The strength of economic growth and trends in our core Commercial staffing segment during the first quarter certainly supported that view. Moreover, we set our guidance for the year anticipating a much stronger U.S. sales growth, but as you know, things can change quickly and they did.

As it turns out, in the last two quarters, our revenue growth has principally come from International operations. A resumption of growth in the U.S., where nearly two-thirds of our business still resides, would obviously further boost sales and earnings. But even with the U.S. pause, we're confident Kelly will conclude 2006 with record sales and strong earnings.

What's more, growth in the global economy remained strong and is expected to be in the 3% to 4% range next year. If this outlook holds true, we will continue to build a stronger international presence through geographic expansion and globalization of our PTSA businesses.

We are making good progress and the future looks encouraging. Our strategy is working; we are seeing nice earnings growth from both PTSA and International. We are continuing to produce solid sales increases, improve our operating margins and deliver significant earnings growth.

This will end our formal comments. Bill and I will now be happy to answer your questions. To allow as many callers as possible to participate, we ask that you please limit yourself to one question and a single follow-up as needed. If you have additional questions, we will certainly try to return to you later in the call.

Moderator, the call can now be opened for questions.

(OPERATOR INSTRUCTIONS) Jeremy Davis with Credit Suisse.

Good morning, guys. Just want to follow up on your comments on gross profit. Obviously, very strong gross profit margins in the quarter. Wondering if you can provide some comment around the pricing environment. And you talked about the other components helping out -- fee-based income from perm placement and a couple of other things -- Workers' Comp. Just wondering if there is anything unusual contributing to the improvement this quarter.

No, I think -- you have been following us for quite a long time, Jeremy. We've talked about that at this part of the cycle, fee growth should be improving which it is. We said that Workers' Comp rates should be coming down and our expansion be improving, which it is. And that over a longer period of time, unemployment taxes should also be coming down; although that took a little longer in this cycle to get to. Those trends, there is no reason not to expect them to continue. They've been in place now for a couple of years and we expect them to continue to be.

The pricing environment is governed today more by recruiting scarcity in a lot of the skilled areas than it is by intense competitive pressure. So there is always pricing pressure; it never eases up completely. But it is less intense than it has been.

Okay. Just with those comments, I was wondering if you could give us a little bit more detail around your 4Q guidance and what you are assuming. It seems a little bit cautious in terms of earnings guidance, particularly with the 24% tax rate.

I think if I take the midpoint of your guidance, it implies about 20 basis points maybe of consolidated margin improvement over last year. And for the last three quarters, you have been delivering about 50 basis points of margin improvement. So, just wondering if you can give us a little bit more color around that.

(Indiscernible) doing the same math you have on the back of the envelope there. When you have two-thirds of your business in the United States and it has been -- we just came off a quarter with a 1% growth there, and we've talked about the range going from 0% to 2%, we're obviously right where we're at -- very much right on the edge of what type of performance are we going to get out of Commercial and PTSA. So I think the range reflects that lower year-over-year growth rate in the United States and good expectations for what we will do with fees and in International.

Okay. I will let somebody else jump in now. Thanks.

Mike Fox with JPMorgan.

Good morning, guys. I was wondering if you could talk about -- it seems like the perm side of the business is still pretty strong. I was wondering if you could give us an idea of the availability of workers and if you are starting to see any big wage inflation or tightness in any particular market.

To separate your question into two parts -- first the wage inflation part, which we get asked a lot by. We've been for about a year and half talking about wage inflation increasing. We've said in public statements that wage inflation has been floating overall at about the 4% mark. The Fed Reserve has been also reporting increasing wage inflation. And that wage inflation is obviously greatest for more skilled jobs, the more professional and technical type of jobs. And just using the Fed Reserve's numbers, you can see wage inflation rates as much as 7% now in some of those highly skilled categories.

In terms of the availability of labor, it's obviously getting tighter and tighter again for the college educated and other types of credentialed workforce. The unemployment rate for college degree graduates is sitting now in the low into three point somethings, and has been dropping. And that, correspondingly, you would expect us to have more difficulty in finding that talent. But we have been doing so. And again, you've seen nice growth in our year-over-year numbers in both our temp-to-perm conversions and in our direct placement fees.

Just one quick question. Can you talk about the confidence that you have in the legislation that is expected to be passed and whether the upcoming mid-term election could have an impact on that?

You know, I never believe in the United States in the political environment we have now, there is no one 100% confidence. We've used the words probable, we've used the word likely. Without assigning a percentage to it, we think it's pretty probable; but anything is uncertain in the political sphere.

In terms of the mid-term election, I have no way of either predicting the outcome or how the mix of the House and the Senate might particularly affect it.

Mike, I will just add my two cents. What is important to remember about the Work Opportunity Credits is it's not stand-alone legislation. It is part of the Tax Extenders Bill, which has a number of provisions in it, including corporate R&D tax credits, including individual deductibility of state sales tax in lieu of state income tax. It is essentially a goodie bag of tax provisions that has broad bipartisan support.

I agree with Carl. It's an election year; anything can happen. But we -- again, best research continues to favor passage. Not a sure thing, but we believe it is a good bet.

Okay, great. Thanks a lot.

Tobey Sommer with SunTrust.

Thank you. I wanted to ask you a question about the relative sequential improvement that you commented on from September to October, and it typically takes place from a seasonal perspective. Hoping you could give us some more color as to what that has looked like historically. And then to the extent you are comfortable, could you quantify what those changes look like early in the fourth quarter? Thank you.

Tobey, good talking with you again. As always, you ask for much and we can provide less. We can't release the quantitative information on the normal seasonal lift. But if you look both at BLS statistics, you will see a nice seasonal pattern that forms in the use of temporary labor at this point in time.

And during the fall, the transition from summer into fall, you normally see nice weekly sequential, monthly sequential increases. And we went through a period of time there in August and into early September where we weren't seeing those sequential increases. Thus, you get the very flat year-over-year performance.

Beginning in late September and containing on, we've now begun to see the type of sequential increases that you see in anybody's data who has patterned out the temporary employment, including the BLS.

Okay, thank you. I wanted to ask a follow-up question on the rate of expansion of branches, I guess, particularly abroad, but not exclusively. In kind of a slower growth U.S. Commercial staffing environment, to what extent does that impact your thought process and your investment process in opening new branches? Thanks.

At the beginning of the year, we don't set out with a goal that says we're going to open X amount of offices. The offices that you open are in a combination of response to customer need, opportunity that you see in terms of where local markets are expanding, as well as working to hit our strategic expansion plan.

The number flexes from quarter to quarter, and you tend to put more branch openings where there is more secular growth supporting it. And right now with the slowdown in the U.S., you would expect to see less branch openings in the U.S. because there will be less opportunities and demand for it and more elsewhere. But we're highly flexible. We will shift that pattern around in response to the economy shifting around and our customer needs shifting.

Thank you very much.

[Pete Carrillo] with Citigroup.

Question for you is on the PTSA area. Obviously, it's nice margin that came in there. Is this sustainable for fourth quarter or so? Does it look like you can keep up that kind of -- the same (indiscernible) you produced in the third quarter?

No, I don't think that you can see the exact same GP rate go from one quarter to the next. It depends on fee growth, the secular growth of which units are growing faster, which units are growing slower. We've had quarters where some of the lower-margin units have grown dramatically faster than the higher-margin units and the rates go up and down.

So not making any particular forward view as to what the GP rate would be for -- and as you know, we never give GP forecast anyway -- as to what the GP will be for PTSA next quarter.

Did Ayers contribute to the margin and should that happen in the fourth quarter?

Ayers contributed to the margin and you would expect it to continue to contribute to the margin in the fourth quarter.

Okay. Just one more quick one. On your International, was there any currency effect. What was the currency effect on EPS, I guess?

Again, we didn't specifically address that. I can tell you the currency affect on EPS was less than $0.01 a share.

Okay, thanks.

David Feinberg with Goldman Sachs.

Question about your long-term operating structure that you've talked about in the past, without perhaps getting to 1.9%, 2.1% operating margin in '07. My understanding that was contingent on 8% to 9% top line growth. Current quarter, you are bumping up against that operating margin. However, the top-line growth is slowing significantly.

Trying to think as we look out into '07 a little bit longer term how we should think about that long-term operating model. Does it change? Does the operating margin stall if you can't reaccelerate the top-line growth?

We're in the process of formulating our own view as to what next year is going to look like and how our models will reflect that. So a little early -- premature to answer that question. But we will in future conferences be updating the models and updating our forward view in January when we give our Q4 results.

Is it fair to assume that there is a, say, minimum 8% top-line growth that requires you to get operating margin expansion? Or I guess if you could walk us through how it is you're able to continue to get operating margin in a slowing top-line growth environment.

If you look at this particular quarter, the operating margin improvement came out of the International unit, which nicely leveraged their growth with the sales rate, and both PTSA and International expenses as a percentage of sales -- but Commercial and PTSA expenses as a percent of sales increased with the very low growth rates.

When you have wage inflation sitting at the 3%, 4% mark, nearly impossible to get operating leverage with a 0% to 1% growth rate.

Quick follow-up, and then I'll get back in the queue. Perm as a percent of total revenue and where that might go?

We typically don't disclose that. But in prior filings, it is less than 3% of global revenue. Higher in international, generally lower in the U.S. side.

Thank you very much.

Michel Morin with Merrill Lynch.

Good morning, guys. I was hoping you could walk as through a bit more of the mechanics of what is driving the reduction in Workers' Compensation? Is it fewer claims, is it smaller claims, are there reversals to prior period accruals? What is happening there?

Yes, yes, yes, and more. I mean, we've talked about Workers' Coop for years, so I'll summarize what you should be seeing generally at this point in the cycle, as well as we've talked about what Kelly is specifically doing.

Generally at this point in the economic cycle, people find it easier to go back to work, they stay on Workers' Compensation for shorter periods of time. And so in general, you see Workers' Compensation duration declining, so the general average amount per claim tends to fall and the general length of time people are on Workers' Compensation declines. So that just kind of happens for the industry.

For Kelly specifically, we've talked about for years our focus on not working with customers who don't share the same concern for worker safety that we have. We've talked about the very dedicated team and processes that we have to put workers back to work, to help make certain that we've minimized the amount of fraud that is taking place inside the Workers' Comp area. Kelly has always done a very good job in this area.

And we've also talked about, in some of our specialty units in particular, Kelly Staff Leasing, how we went through and very dramatically repositioned customers to move ourselves away from those unsafe work environments.

So as you would expect, you would begin to see reversals in claims, you would begin to see lower frequency of claims. And both from Kelly's efforts as well as the general economy, you'd expect to see a shorter duration in the amount of time people are on that compensation.

And is it possible to quantify in terms of the gross margin impact how much Workers' Comp was?

No, we didn't do so, and --

We didn't quantify it, but we would only list a couple of factors. And really, the two or three factors we listed were Workers' Compensation and growth in fee income. Those are by far and away the two largest drivers.

And within Workers' Comp, if there were some reversals, then presumably there is a bit that could be deemed maybe a bit non-recurring. Is that a fair comment?

Yes, but I would state it a different way -- that every year, every quarter, you're constantly doing actuarial analysis of both current and prior year claims. And at this part in the cycle, I would generally be expecting analysis of prior year claims to be providing favorable income to a quarter. So did it happen in the quarter? Absolutely, yes. Is it possible that it will continue to happen in future quarters? Absolutely, yes.

Okay. And just quickly, you mentioned the UK trends. When are you facing some easier comps or are we already there? I was wondering if you could give us maybe a few quarters of revenue growth trends in the UK market in particular if possible.

No, we've been bumping along. We've come through a decline period; we are now bumping along for the last two quarters with slight gain and now a slight loss for the last two quarters. Again, I think that Kelly, along with a lot of other companies, are repositioning its business inside the UK.

The comps begin to get better -- begin to get better next year. And so the comparisons get a lot less tough then.

Okay. Thanks very much.

Kelly Flynn with UBS.

This is Matt for Kelly. I just had a question on your continental European growth. It seems like it was pretty strong through the quarter. What is your expectation for growth going forward? Do you expect to see sort of this steady growth at around this level or would you see in moderation of this growth?

I would never commit to 23% growth for quarter after quarter anywhere. Right now, Europe has the hot economy. The EU markets have a higher GDP growth rate than the North American markets, and it shows in their use of temporary employees. You see a lot of countries, in particular Germany, who has long been an anchor on the EU growth rates, all of a sudden being a real strong contributor.

We will do well in Europe as long as the GDP growth rate is doing well in Europe. And when the GDP rate declines, our growth rates will correspondingly decline.

Okay, thanks.

(OPERATOR INSTRUCTIONS) Pete Carrillo.

Just a quick -- I think I might have missed when you answered this one earlier. Did you talk about PTSA in the fourth quarter? And I assume you expected to bounce back growth rate wise from the third quarter. Why or what were the things that kept it so slow in the third quarter that may get better in the fourth quarter?

We didn't say that.

Actually, specifically what was said in the guidance section was we expected our U.S. market, which would be defined to include both Commercial and PTSA, to be flat to up 2% in the fourth quarter.

Oh, it includes both. I was trying to figure that out. Okay. Including both --

Right, they were both -- Pete, they were both sitting at about 1% for the third (multiple speakers).

Yes, right. The other one was, can you give a rough breakout of your currency exposure, sort of like Euro, yen, other something like that, so we can get a feeling for how to model the currency movements in the future?

Again, I would tell you the euro is the largest exposure, followed by probably the Pound Sterling followed by the Canadian dollar.

Okay, so maybe 50% euro and the rest -- 50%, something like that?

Again, I really don't want to go there. I think that would be a guess. So let's just say those are the three heaviest currencies.

Okay, thanks.

(indiscernible)

I think you touched on this a little bit, but if you could kind of expand on it. In the third quarter, I'm looking at I guess about 5.5%, 5.6% revenue growth year-over-year, down a little bit from quarters one and two, but still mid single digits. And now you are kind of guiding to 2% revenue -- flat to 2% revenue growth for the fourth quarter. And last year, it was also 2% after a year of -- after a few quarters of 7% to 8%.

Is there something going on in which sort of revs or the fourth quarter is starting to show slower growth becoming less important -- is this something particular to this year? Can you just sort of expand on why there might be such a big drop-off in this fourth quarter or in -- sort of in the growth rates or in fourth quarter maybe more generally?

Well, we talked specifically about -- the 0% to 2% number that you are referencing was just for the United States.

Okay.

And in particular there, because we are building -- because we had this four- to six-week flat period that I discussed earlier in the call, while we are building nicely sequentially, we are building off of a lower base because we had that flat period. So you'd have to dramatically close the gap. You'd have to have extremely fast growth in the use of temporary labor to move much beyond that 0% to 2% range for the U.S.

Nothing is taking place in the fourth quarter on a generic basis to say that the pattern has shifted, that we expect lower growth rates. And we expect very strong growth out of International in the fourth quarter.

Okay. So did you give any guidance for over -- then did I miss it -- did you give any sort of directional guidance for overall sales growth for the fourth quarter?

No, we never provide revenue targets.

Okay, thank you.

Tobey Sommer.

Thank you. I wanted to ask if you could comment about your dual class of stock and see if that is still something you are comfortable with at this point.

There has been no change in our thinking on the dual class structure. And when there is, we will come out and talk about it.

Okay. And one other question. If you step back and look at the Company's strategy, Carl, of serving some of the largest customers that are out there for you to attain, is there any thought that you may be able to also attack kind of the small or medium business market? And if so, I was wondering how easy that may be or challenging that may be for you to do. Thank you.

I always have a thought that every good company should be a Kelly customer, whether they are small, medium or large. And we place a lot of emphasis in various units on pursuing smaller accounts with great passion and vigor.

We've had a -- for very important reasons that we've talked about on many conference calls, we've had a focus on the larger global accounts. We will continue to have a focus on the larger global accounts. But having said that, it has never been meant to be an exclusive focus, it's never been an exclusive focus. And we've got many good sales teams who are focused very intensely on attracting more of that smaller local business, smaller regional business, and we have great service teams decked against it.

It will be a focus and at the points of the economic cycle where that part of the business segment is growing faster, you should expect to see our share in it doing nicely.

Thank you very much.

Pete Carrillo.

Quick question. I was just reviewing some of your seasonality patterns. It seems like the first quarter all the way back to '98 or so has had a falloff in the fourth quarter in the U.S. Commercial operating margins. Can you remind us is that something that should keep happening each first quarter and why?

It should happen in every first quarter, and in fact, I'd be surprised if the pattern only goes back to '98. I would have thought it would have run back a lot further than that.

That is all I had.

I mean, the first quarter has been for as long as I've looked at things -- I'm certain there has been some quarter somewhere, some year, where it was an exception.

The first quarter is the lightest revenue quarter in the year. You've got holiday effects in there, you've got companies gearing back up after coming off of a year. And for as long as I have been able to track back things and, talking to [Terry], as long as we've looked at staffing, quarter one is always the slowest quarter.

Would I be thrilled to come off of the pre-holiday period back at the exact same level? I would be excited, and if you figure out how we can do that, it would be great.

Well, part of why I ask is because you correlated the U.S. and the PTSA in terms of sort of growth, etc., for the next quarter at least. But PTSA doesn't necessarily follow that same pattern as U.S. Commercial does, at least not recently.

If you are asking does PTSA have less of that seasonal effect, the answer for the industry has been yes; the answer for us has generally been yes.

But is it a dramatic difference? Unless you are sitting there with 70%, 80% PTSA business, you still get a good seasonal effect in the first quarter down.

Okay, thanks a lot.

Michel Morin.

Yes, thanks. I was wondering would you happen to have the bill rate increases by segment.

We will publish that in our 10-Q, which will be filed early November. Unfortunately, we don't give that out on the call.

Okay, thank you.

And you wanted to comment in general or --

In general, there is pay rate inflation, in general there is -- the pay rate then gets translated into bill rate increases. That is again by market. Again, with our fastest growth coming in International, you get interesting averages when you have high growth rates in countries like Mexico and Malaysia and so on.

(indiscernible)

Over the course of this last quarter, I think that your chairman, Mr. Adderley, was engaged in the sale of stock -- sort of repeatedly over the tape there was selling stock. Is there a 10(b) -- can you talk a little bit about if you have any update on his plans there, what his 10(b) plan looks like and/or whether that is done -- just give any color there that you have?

We have said before that the estate has ongoing needs related to dealing with estate taxes. I'm not particularly informed as to what the estate's plan will be for the next quarter. Also, as we've said before, the estate considers a full range -- Terry considers a full range of options, ranging from dribble-outs to secondary offerings. And again, as we get past this period, they will announce whatever the next step of that will be.

And when you say past this period, meaning --?

Our blackout period here. And then their own assessment as to what needs do they have.

Okay, fair enough. Thank you.

Mr. Camden, no further questions in queue.

Thank you, John, and thank you all for listening.

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