Business Context and Reporting Period
Kelly Services, Inc. is a global workforce solutions company providing commercial and professional/technical staffing, outsourcing, consulting, recruitment process outsourcing, contingent workforce outsourcing, payroll outsourcing, executive placement, and career transition services. This unaudited Form 10-Q covers the 13-week quarter and 26-week year-to-date periods ended June 29, 2014, compared with periods ended June 30, 2013.
Financial Performance and Position
| Metric | 13 Weeks 2014 | 13 Weeks 2013 | 26 Weeks 2014 | 26 Weeks 2013 |
|---|---|---|---|---|
| Revenue from services | $1,410.5 million | $1,366.9 million | $2,741.3 million | $2,681.7 million |
| Gross profit | $228.1 million | $220.7 million | $450.4 million | $437.6 million |
| Gross profit rate | 16.2% | 16.1% | 16.4% | 16.3% |
| Earnings from operations | $5.9 million | $16.4 million | $12.2 million | $23.5 million |
| Return on sales | 0.4% | 1.2% | 0.4% | 0.9% |
| Net earnings | $2.8 million | $10.0 million | $5.3 million | $22.9 million |
| Diluted EPS | $0.07 | $0.26 | $0.14 | $0.60 |
Second-quarter revenue increased 3.2% year over year, while first-half revenue increased 2.2%. Gross profit increased 3.4% in the quarter and 2.9% year to date. SG&A expense increased 9.7% in the quarter and 6.3% year to date, reflecting planned investments in professional/technical staffing and OCG. The company reported no asset impairment in 2014 versus a $1.7 million impairment in 2013.
- Segment trends: Second-quarter revenue increased 0.6% in the Americas, 9.0% in EMEA, and 16.5% in OCG, while APAC declined 1.2%. OCG operating earnings improved to $1.8 million from a $1.7 million loss.
- Cash flow: First-half operating cash flow was negative $107.5 million versus negative $14.2 million in 2013, primarily because of increased trade receivables and timing of supplier payments. Investing cash flow was negative $13.9 million, including $8.9 million of capital expenditures and a $5.4 million investment in an equity affiliate.
- Liquidity: Cash and equivalents were $62.8 million at quarter-end versus $125.7 million at year-end 2013. Trade receivables were $1.1 billion, and global days sales outstanding increased to 57 days from 54 days in the comparable 2013 quarter.
- Debt and capital: Short-term borrowings were $89.5 million versus $28.3 million at year-end 2013. Debt-to-total capital increased to 9.6% from 3.3%. The company paid $3.8 million of dividends during the first six months.
- Credit availability: The company reported $200.0 million of available capacity under its revolving credit facility and $7.0 million under its securitization facility. The securitization facility had $88.0 million of borrowings and $55.0 million of standby letters of credit. Debt covenants were satisfied at quarter-end.
Material Changes Versus the Prior Comparable Period
- Operating earnings fell 64.8% in the second quarter and 48.9% year to date, despite revenue growth, as SG&A investments outpaced gross-profit growth.
- Net earnings declined 72.0% in the quarter and 76.9% year to date. The first-half comparison was also affected by a $3.0 million 2013 Delaware unclaimed-property settlement included in SG&A and a 2013 income-tax benefit from retroactively recognized work opportunity credits.
- Americas operating earnings declined to $22.9 million from $30.7 million in the quarter, primarily because of higher SG&A. Americas professional/technical revenue declined 3%.
- EMEA revenue improved, but operating earnings declined in the quarter because of lower gross margins and $0.8 million of restructuring costs related to exiting the Sweden staffing business.
- APAC recorded a $0.8 million operating loss versus $0.9 million of operating earnings, reflecting lower margins, reduced staffing fee-based income, and $1.0 million of restructuring costs related to Australian branch closures.
- OCG revenue grew 16.5% in the quarter and 20.6% year to date, driven by RPO, CWO, PPO, KellyConnect, and related outsourced solutions. The prior-year period included restructuring costs and a $1.7 million impairment associated with exiting executive search operations in Germany.
- The company realigned its project-based legal services business from Americas PT to OCG beginning in 2014 and revised prior-period segment information accordingly.
Guidance, Outlook, Risks, and Unusual Items
Management described the economic outlook as encouraging but historically weak and uneven. It expects continued improvement in the U.S. and global economies and is targeting double-digit 2015 sales growth in OCG and Americas PT, assuming continued demand in relevant sectors. Management also stated that revenue growth was expected to lag current investments, resulting in lower overall earnings year over year. The company’s long-term return-on-sales goal is 4.0%, compared with 0.4% in the second quarter.
- Kelly plans to offer healthcare coverage in 2015 to eligible temporary employees under the Affordable Care Act. Implementation and ongoing costs may be significant, and the company may not recover those costs through customer pricing.
- The U.S. work opportunity tax credit had expired for 2014. Retroactive reinstatement could produce a significant tax benefit, but the timing and enactment of related legislation were uncertain.
- Restructuring charges in 2014 related primarily to Sweden and Australia. The company also recorded a $0.2 million increase in estimated prior-year workers’ compensation costs in the second quarter, partially offset by a $1.4 million favorable adjustment for the first six months.
- In a Louisiana litigation matter, Kelly paid $0.25 million toward a $1.0 million settlement funded with its primary insurer. The umbrella/excess insurer continued to appeal and remained responsible for any remaining verdict amount, subject to the appellate process and insurance coverage.
- Principal risks include economic and labor-market weakness, pricing pressure, customer concentration, foreign currency exposure, employment-related litigation, workers’ compensation claims, healthcare reform costs, tax-law changes, impairment risk, covenant compliance, and access to financing.
- Management stated that there were no material changes to the risk factors disclosed in the 2013 Form 10-K and that disclosure controls and procedures were effective.
Important Facts for Investors to Verify
- Whether OCG and Americas PT investments generate the targeted growth and improve the company’s 0.4% return on sales toward the 4.0% long-term objective.
- Whether operating cash flow improves as receivables growth and supplier-payment timing normalize, and whether DSO remains elevated.
- The sustainability of increased short-term borrowings and the company’s remaining securitization capacity during periods of working-capital growth.
- The actual cost of Affordable Care Act compliance and the extent to which those costs can be passed through to customers.
- Whether the work opportunity tax credit is retroactively reinstated and its effect on future tax expense.
- The outcome of the Louisiana appeal and any other employment, wage-and-hour, workers’ compensation, tax, or unclaimed-property matters.
- Whether EMEA and APAC margin pressure, restructuring actions, and foreign exchange movements affect the company’s full-year results.