Labor Market Analysis

Manpower: Aging Adds Complexity

We are admonished to use the new name “ManpowerGroup,” which not only lacks a space but also fails to distract from the gender slant of the company’s name.

Q1 2011 results were chock full of important and distracting details, such as:

• New segment disclosure and limited historical restatement.
• Last Y/Y comparison lacking the COMSYS acquisition in the denominator.
• Significantly positive forex assistance in more than 50% of revenue.
• Continued need to pull a French business tax out of income tax expense and put it in direct labor cost where it belongs.
• Big short-term hit to cash flow from receivables, timing mismatch.
• Need to interpret results-vs.-expectations adjusted for currency and tax variance.
• Addition of post-forex revenue and earnings guidance for the first time.

Gross margin (as presented by management) came in 10 bp below the guidance range. Gross margin is crucial; gross profit is the true revenue for a staffing company. Almost all its cost of revenue is the pay earned by workers on assignment. Almost. More on that later.

Manpower’s profit margins look tiny because more than 80% of its “revenue” is passed through to the mostly-temporary labor force. Focus instead on that line above, operating income as a % of gross income. Also, dwell on gross cash flow (operating cash flow before working capital changes).

MAN’s operating income as a % of gross income was 10%, far above the guidance range despite the gross margin shortfall—related entirely to the counter-cyclical Right Management business, we’re told. Just have to trust them on that, for the obscurantism of MAN’s gross margin disclosure makes it impossible to know what’s going on. Anyway, Q1 apparently benefited from timely cost-cutting at Right, which has been swooning alongside the global recovery. Q2 guidance calls for continued operating leverage, with operating income 14-15% of true revenue (compared with 10% in Q2 2010). 

Management didn’t exactly guide for the new segment disclosures unveiled with the 10-K, but one can back into them. MAN exceeded the top end of revenue growth guidance in the Americas, Southern Europe (inexplicably unites France, Italy and Spain), and Asia Pacific/Middle East.

Northern Europe (the Nordic countries, the Elan IT services business, UK Manpower, Germany, Benelux, and a large “other” probably in the East) only split the guidance range, and Right bottomed the low end. CEO Jeff Joerres expressed calm about Right, expecting that its growing HR process outsourcing business would carry the core outplacement business as employers turn to expansion.

With the addition of COMSYS last April, the United States is 67% of the Americas segment. COMSYS grew 18% Y/Y in Q1 2011, the rest of the US 14%. Manpower has Jefferson Wells, the long-sliding accounting practice, buried inside the US segment and restated back to 2009. But that’s a smidgen of revenue and doesn’t explain what’s going on in Manpower’s traditional US temp business.

Here is a clue: Look at Manpower’s sales at domestic franchisees, which run traditional-style temp help offices.

• Q1 2011 up 12% year over year
• Q4 2010 up 22%
• Q3 2010 up 39%

It’s really not as bad as it looks.

Here I present “adjusted sales,” Manpower’s US revenue + sales of franchisees + pre-acquisition COMSYS — franchise fees recognized as revenue. Given that MAN periodically acquires franchise offices and gains a comparison boost, this presentation is relevant to the company’s current state. And the two-year comp hit a post-recession high, despite the one-year comparison looking like a slowdown.

Why Right?

This chart of quarterly EBITA by segment shows why Manpower owns Right Management. During the vicious staffing downturn, Right provided a handsome earnings bridge. In the upturn, Right has lost money in only one quarter.

Read this chart to see what really matters at MAN. Many analysts spout about how France is soooo important, the United States relatively meaningless. Sorry, but reality is that Manpower makes more of its livelihood around the North and Baltic seas than in any other segment. For all its gross revenue, France isn’t that profitable.

Restoring “value added” is the chief problem at Manpower. Understand that operating cash flow for staffing companies is distorted by cyclical swings in receivables. The receivables are large, relative to profits, because of the mostly pass-through nature of billings. Ever since the late 1990s, clients have fixated on exactly what they’re paying for, when they give a markup to an employment agency.

Gross cash flow is the best measure of profitability. At MAN it’s a clean number—net income + D&A + stock comp pseudoexpense + bad debt accrual + deferred taxes. This is something akin to cash-taxed EBITDA minus interest.

After the 2001 recession, Manpower’s trailing-four-quarters gross cash flow margin (as a % of gross income, true revenue) bottomed at 10%. Profitability soared over the next four years. In fiscal 2007, MAN earned gross cash flow exceeding 18% of gross income. The management team that had replaced “market share before earnings” Mitchell Fromstein lifted MAN to a margin level similar to those of far more exclusive white collar staffing firms.

Then margins went kersplat. The trough—less than 6% in the 12 months ending March 2010. This doesn’t even recognize the mountainous goodwill writedowns and restructuring charges that came post-meltdown. Even after a full year of top-line recovery, MAN’s true profitability is well below its prior-cycle trough.

MAN’s gross cash flow margin in Q1 2011 was 8.6% compared with 5.8% in Q1 2010, 5.7% in Q1 2009, and previous-cycle-high 13.2% in Q1 2007.

Gross margin remains at a depressed level, especially when one strips out the influence of franchise fees (which pass all the way through to operating profit). For six of the past seven quarters, MAN has recorded a true gross margin of less than 17%.

Of paramount importance is the defense and enhancement of value added in staffing services. This urgency makes Manpower’s renewed emphasis on segment branding and service enhancement look very smart.

In this forum, I cannot render investment conclusions. As always, I invite inquiries.

Robert Half Recovery on Track

Robert Half International (NYSE ticker RHI) made progress in Q1 2011 (Mar) results, though Q2 guidance requires interpretation.

The company's longest-running services—temporary and permanent placement of accounting and finance grunts, and temp back-office staffing—remained in footprint-shrinking mode. Continued pairing of locations may stem from the fact that Accountemps, Finance & Accounting, and OfficeTeam added new offices right up to the September 2008 meltdown. In the first three quarters of 2008, Accountemps/perm opened eight new locations, while OfficeTeam expanded to 14 more RHI offices. Robert Half management isn't going to ring your alarm bell on the next economic slump. Anything that opened brand new in 2007-08 faced a murderous path to breakeven.

In my view, the central curiosity is why Robert Half's office count keeps falling, eight quarters after the trough of the business cycle, 10 quarters after the company quit growing. Total offices are now down 6% from the Q3 2008 high point—minus 22 offices, or quite a bit more than were added in nine months of '08.

RHI Management Resources and Technology, the least mature staffing practices, are growing unit revenues and office count on a year/year basis. RHI Tech, though, hasn't grown over the past three quarters, losing a couple doors in the company's office consolidation efforts. Robert Half's staffing businesses share office space with each other. Presumably, this brings efficiency and makes it easier for the company to launch new specialties with less risk than standalone offices would bring.

Robert Half's rebound off the cyclical bottom appears to be far from complete. Revenue per office is well below peak in every staffing practice, even with offices 4% below the previous high. As CEO Max Messmer and CFO Keith Waddell elaborated on the Q1 conference call about hiring in the Tech practice, I calculated that in the 115 offices where it's operating, RHI Technology is running at almost 90% of the revenues of Accountemps.

Back at the previous top, Management Resources reached 92% of Accountemps' run rate. Unfortunately, the temp-executive staffing practice proved to be more volatile in the downturn than any other of RHI's temporary staffing segments.

And Technology declined the least from top to bottom. Strong demand is driving management's decision to invest in the Tech practice, but this risk comparison also is likely a factor in their decision.

Not that RHI is short-sheeting the Management Resources bed. It is up to 154 locations, off the low point of 147 reached in mid-2009.

Robert Half is a temporary staffing company, but the business is less temporary than one might assume. That Accountemps and OfficeTeam kept six-tenths of their previous best revenue run rate going in the depths of a global credit disaster indicates how much permanent corporations depend on "temporary" employees. The resilience of RHI's revenue stream does not necessarily compare well against other temporary staffing companies. Making those comparisons is complicated by the fact that rivals showed no hesitation to make M&A patches on their businesses entering the Great Recession, or even in the middle of it.

Robert Half was the only company on this list that did not spend a dollar on M&A from 2007-09. In some cases, the M&A effect was meaningful. For example, SFN increased its run rate by almost one-quarter after buying Todays Staffing and another firm. After the recession commenced, SFN's bargain looked more like it had paid 0.7x annual revenue, at least 2x overvalued. The balance sheet damage also was ill timed, which was why in the depths of the meltdown SFN's stock price approached $1 per share.

Give kudos to RHI executives for not using acquisitions to lessen the cyclical pain.

More Quarterly Review

The theme of Q1 2011 is "better than two years ago, but still a long way back to the top."

Closest to previous peak was RHI Technology, which is riding strength in corporate spending on all sorts of financial technology. Particularly urgent is the need to transform live customer transactions from relying on batch-processed information (no fresher than overnight) to real-time (updated on demand).

Businesses also need wide-ranging IT upgrades to enable their service people a good enough look at the customer's recent account status—often across multiple accounts—to anticipate a customer's needs. To be useful, an in-store sales person or call center agent needs a fresh picture of the customer's accounts, in 30 seconds or less. Traditional sales and service support platforms were designed to keep the front-line staff close to powerless.

RHI Technology operates out of only one-third of the company's office footprint, but that's the highest % it has ever reached. This financial IT investment cycle could have several years of growth in it, between recessions.

Some observers might have been disappointed by the way Accountemps' sequential revenue growth slowed compared with Q4 10, and the way OfficeTeam flattened out. Over the long term, Accountemps has averaged its greatest sequential growth in Q1; OfficeTeam's Q1, Q3 and Q4 on average have been similar. The past two years, both segments enjoyed unusual surges in Q4 that likely hampered the sequential comparison in Q1. On a year-over-year basis, OfficeTeam grew total revenue 25% in Q1 2010, and Accountemps was up 14%. These were post-recovery bests despite the continuing reduction in office locations.

Guidance

Mr. Waddell said that in April to date, the run rate of "temporary and consulting" was up 20% Y/Y, while permanent placement was up 41%. In Q1 2011, temp + consulting grew 16% Y/Y, perm placement 37%.

Then he gave revenue guidance of 14-21%, which appeared cautious to some observers.

Here is a recent history of RHI performance vs. guidance:

1. Strong upside in Q4 2009, as clients spent to catch up after harshly squeezing budgets throughout the year.
2. RHI overestimated the significance of the Q4 09 run rate, given its budget-flush nature, and Q1 10 looked wobbly.
3. The past four quarters had revenue near or beyond the top end of guidance, EPS hitting the high end, as RHI managed a mix of transitional and growth-stimulating expenses.

On the upper end, RHI is showing a nickel of sequential EPS growth, which the company hasn't accomplished in a Q2 (seasonally flattish for Accountemps) since 2004. Considering the guidance pattern, RHI doesn't look overly cautious about the near future.

The Protiviti Wildcard

The chart depicts Protiviti quarterly gross margin and SG&A margin since the beginning of 2009, when the former Arthur Andersen audit consultancy encountered terribly poor utilization of its well-paid staff. Protiviti in Q1 2011 showed promising signs of living within its means. SG&A was less than 25% of revenue compared with 26-27% in the past two Q1's. Gross margin surpassed 25%, up from last year's 20%-ish and the low teens of two years hence.

That leaves the growth question. Protiviti revenue per day was down 6% from Q4, up 8% Y/Y. The sequential change was same as Q1 2010; the year-over-year was same as Q4 2010.

The upper end of Q2 2011 guidance represents 22% Y/Y growth for the staffing company and 13% for Protiviti. Robert Half's lone significant acquisition in its history continues to provide dilutive results—its growth rate, gross margin and operating leverage are inferior to the rest of the company.

Protiviti cost little to acquire—goodwill is $29 million—but the acquisition cost far more in damage to RHI's earnings stability and growth profile, beginning back when investors began to doubt the longevity of the wave of spending for initial Sarbanes-Oxley compliance.

Employment Services Stocks: Leaders and Laggards

Employment services stocks have split 50/50 between winners and losers after their latest earnings reports, assuming that On Assignment will be up on Friday after its strong results. (Please click on the table; I know you can't read it.)

The winning formula:

1) Good revenue growth + rising gross margin = strong gross cash flow growth.

2) Guidance must not undermine the margin leverage story--cannot afford to push peak earnings further into the future.

Why the losers lost:

Monster: Revenue miss + disturbing falloff in job posting trends.  Despite the official explanation, it looks like recently acquired HotJobs is gushing market share.

TrueBlue: Revenue surprise was in low-margin Boeing business, which investors pretty much discount.  PlaneTechs acquisition continues to obscure comps with drag continuing in 2011.  SG&A was $3 million high, which hurt when the core business failed to show gross profit upside.  If that spending fuels future growth, it might have been worth it.

Robert Half: Staffing businesses were fine, but Q1 guidance took a surprising hit from Protiviti's "normal seasonality" that nobody was expecting.  Some non-core acquisitions are never too old to keep hurting.

Administaff: Good quarter, good outlook, except for a new rebranding program that will be a drag on margins with uncertain ROI.

Kforce: Strong quarter and outlook in staffing.  Non-core government IT consulting business, acquired early in the recession for diversification, is sliding downhill fast.  Non-core...keeps biting.

ADP: Surprising lack of operating leverage, but this likely will be a minor quibble within a quarter or two.

Why the winners won:

SFN Group: Operating leverage showed up nicely, led by expanding bill-pay spread.  Last year's acquisition of Tatum has yet to help, but it didn't hurt anymore.

Dice: Clearly a cut above in the possibly doomed world of job boards.  So far in 2011, Dice leads its peers in growth of new job postings, with outsized share gains that dwarf everything not named LinkedIn.

Kelly Services: Despite facing negative Y/Y comps in office count, Kelly grew revenue in line with the market for the first time in many years.  Just as good, Kelly improved its operating leverage and started to see cash flows help the balance sheet (which needs it).  Growth assumptions for Kelly had to change, and analysts should rethink their views that the oldest staffing company is a long-term share loser.

Manpower: Stock price reaction to good results was muted by Q1 guidance, which shows a big hit from the harsher-than-usual reset of payroll taxes.

What You Should Be Watching in 2011

These numbers decelerated in the last months of 2010 and in early 2011:

• Permanent placement volumes
• Temp-to-perm conversion volumes
• Online job postings
• Temporary employment headcount growth

My ongoing concern is that the increasing power of recruitment management technology, professional/technical peer group social media, and search engines are undermining the value of traditional employment services (which are using the technology themselves to cut the cost of filling jobs).

Social media recruiting tools are proving their ability to prequalify job candidates and reduce the amount of time and labor required to fill open positions.  A new arc of specialized search engines is forming, providing companies' internal online postings with greater search relevance at very low cost--sometimes at no cost to the employer.

It is becoming harder to tell exactly for what HR departments should be paying--and what they can get for next to nothing.

First Staffing Results: Robert Half

From Robert Half's fourth quarter 2010 (December) report:

Among Robert Half's pure temporary staffing businesses, all segments were strong in Q4 2010. Given that the temporary staffing gross margin was flat year-over-year at 34.5%, strength was in temp assignments—suggesting clients, having overslashed the back office, needed seasonal help—rather than in 100% gross margin temp-to-permanent conversion fees—which would rise if clients saw more than a passing need for staff.

The temporary staffing industry is building a thesis: U.S. employers remember the pain that goes with doubling the unemployment rate, and they're convinced they should keep a larger portion of the work force on flexible terms. Permanent, full-time hiring is on a slower up trend.

When the United States lingered for many years at extremely low levels of labor force slack, employers erred on the side of retaining excess full-time staff. At the end of 2010, the country had more people who had been unemployed for more than half a year than the total jobless in 2007. In such conditions, the labor pool includes many experienced workers who would be happy with part-time work. Temporary staffing agencies might be flush with supply for several years. Their chief obstacle to growth is demand.

Even as demand began to recover, Robert Half spent the past eight quarters rationalizing its office network. The company's office total dropped every quarter since Q1 2009 and stands 5% below peak. At its trough, Robert Half had docked three-eighths of its staffing services employee headcount. This doesn't mean Max Messmer overcut his own company—temporary employees in 2009 were down almost 40% from 2007.

While Max pared offices that had lost their mojo, he continued to expand coverage of the Management Resources and Technology specialty staffing practices. In Q4 2010, Technology had its best per-office sales in two years. Both segments are above prior peaks in office count despite the company's closure of 20 locations. And both continue to be substantially better revenue producers than Robert Half's initial service expansion, OfficeTeam, in offices where all services are available.

Management Resources and Technology are better situated to find pockets of need in economic recovery, compared with Robert Half's leading segments. Accountemps, OfficeTeam and the permanent placement business feed off the back-office budgets of corporations that obtained much operating leverage in 2009-10 by emptying the back office.

Nevertheless, the up trends at Accountemps and OfficeTeam look marvelous, even through some consolidation. In Q4 2010, the leaders for year/year growth in revenue per office were 1) Perm, 35%; 2) OfficeTeam, 25%; 3) Accountemps, 15%. Leaders in total revenue growth: 1) Perm, 30%; 2) OfficeTeam, 23%; 3) Technology, 21%.

Max and CFO Keith Waddell made no effort to maximize current profitability, spending as much as they could get away with to stimulate 2011 growth. Revenue slightly exceeded the high end of management's previous guidance, and EPS of $0.17 hit the top end.

Capital expenditures (which at Robert Half are largely driven by office workstation count) jumped to $13 million in Q4 after averaging about $7 million (compared with depreciation of $13-14 million) in the first three quarters of 2010. If the company spends around $35,000 in IT and leasehold improvements to add an employee, the Q4 capex suggests Robert Half added about 370 employees in the quarter. Year over year, employee headcount increased by 800. Almost half of that might have come in Q4. No wonder SG&A grew almost as fast as gross profit did in Q4 vs. Q3.

While staffing office headcount was 80% of what it was two years ago, revenue per office recovered faster—virtually flat with Q4 2008 for OfficeTeam, just 10% down in Accountemps. These numbers remained well off 2007 levels, because sales staff as a % of office staff was still in cautious territory.

Furthermore, the ongoing rollout of Management Resources and Technology across a shrinking office network produced an acceleration of the average number of services offered per office in 2010. Service offerings expanded faster than internal staff did, implying some catchup was required. Stepped-up hiring added as much as $4.5 million to Q4 2010 SG&A expense. Without it, Q4 EBITDA growth would have been more than 50% of incremental gross profit.

Management's guidance for Q1 2011 revenue and EPS, as usual, requires translation.

The unusual year-end budget flush in 2009 fooled Robert Half management into more optimism than was warranted, and Q1 2010 results were modest except for the surprisingly early uplift (off a low number) in permanent placement. Rest of the year, Max and Keith steered earnings to the high end of the guidance range as sales became increasingly predictable. By the end, they were spending down EPS in hopes of a true bull market run in 2011. Last time RHI was growing and reached $900 million revenue, it reported EPS of $0.38 on a share count of 174 million (current = 143 million). The company's asset and personnel utilization remain far below peak levels. Assuming normal recovery in utilization, earnings would more than triple over the next two years.

The Protiviti Footnote

Ever since Robert Half bought the internal audit consulting practice of Arthur Andersen in 2002, it has been a source of deworseification.

Renamed Protiviti (brainchild of a clever brand consultant), the audit consulting practice walked into a fleeting gold mine called Sarbanes-Oxley. Initial compliance projects boosted Protiviti's gross margin near 40% at peak, with an EBITA margin of 18%, almost twice that of temporary staffing. This opportunity, though, was as unsustainable as Y2K compliance projects had been a few years earlier. Ironically, Protiviti has been more intensely cyclical than perm or temp ever were, without any compensating favorable qualities. Fears of the eventual deflation of Sarb-Ox work hammered RHI stock three times (spring of '05, '06 and '07), prematurely kneecapping what should have been a traditional bull run for the staffing bellwether.

Check out Protiviti's gross margin trend over the past eight quarters, below. The business still depends mostly on utilizing a bench of full-time consultants, even though demand for audit consulting is intensely seasonal. This business model was exactly why Robert Half's Accountemps was created. And Max and Keith bought one.

You don't see any 40% or even 30% figures on this chart. You don't even see sustained improvement. Not in gross margin. The improvement is visible in SG&A. As Protiviti pushed temporary staffing above 10% of its consultants on assignment, its SG&A margin fell in the second half of 2010, while gross margin became nearly flat year/year. This flexibility should reduce the magnitude of downswings in gross margin, but is it masking low bench utilization? Likely.

Protiviti was modestly profitable in the second half of 2011. At Q4's $104 million revenue and $30 million gross profit, the segment contributed more earnings than it had at $124 million revenue and $34 million gross profit in Q4 2008. But Protiviti also had reported high teens EBITA margin on $100 million revenue during one quarter of 2004. This business plan was designed around high-30s gross margins, and it's hard to see what force would enable high utilization levels to return. The Sarbanes-Oxley compliance rush briefly turned internal audit into a year-round enterprise. Done, over, gone, and Protiviti has innovated little in search of a new plan.

While the sequential trend implied in management revenue guidance appears favorable, EPS guidance was restrained in part for the annual uncertainty about Protiviti seasonality. Bench idleness flows through at 0% gross margin. Protiviti is not done screwing up the Robert Half story, as the stock's post-earnings behavior demonstrates.

I cannot publish investment recommendations here, but feel free to contact me with questions.